IRS Advice On How to Pay Yourself When You Have a Business

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People go into business to make money. Figuring out how to account for the money they make can be a challenge. Thankfully, the IRS has provided guidance on how to handle accounting for the money business owners make.

Here is the guidance:

The procedures for compensating yourself for your efforts in carrying on a trade or business will depend on the type of business structure you elect. Below are topics that frequently arise when new business owners ask the Internal Revenue Service questions about paying themselves.


Corporate officers

An officer of a corporation is generally an employee, but an officer who performs no services or only minor services, and who neither receives nor is entitled to receive any pay, is not considered an employee. Refer to “Who Are Employees?” in Publication 15-A, Employer’s Supplemental Tax Guide (PDF).

Partners

Partners are not employees and should not be issued a Form W-2 in lieu of Form 1065, Schedule K-1, for distributions or guaranteed payments from the partnership. Refer to partnerships for more information.

Dividend distributions

Any distribution to shareholders from earnings and profits is generally a dividend. However, a distribution is not a taxable dividend if it is a return of capital to the shareholder. Most distributions are in money, but they may also be in stock or other property. For information on shareholder reporting of dividends and other distributions, refer to Publication 550, Investment Income and Expenses.

Form 1099-MISC or Form W-2

You cannot designate a worker, including yourself, as an employee or independent contractor solely by the issuance of Form W-2 or Form 1099-MISC. It does not matter whether the person works full time or part time. You use Form 1099-MISC, Miscellaneous Income (PDF) to report payments to others who are not your employees. You use Form W-2 to report wages, car allowance, and other compensation for employees.

Treating employees as nonemployees

You will be liable for social security and Medicare taxes and withheld income tax if you do not deduct and withhold them because you treat an employee as a nonemployee, including yourself if you are a corporate officer, and you may be liable for a  trust fund recovery penalty. Refer toPublication 15, Circular E, Employer’s Tax Guide for details about the trust fund recovery penalty orIndependent Contractor for more information on employee classification.

Shareholder loan or officer’s compensation?

A loan by a corporation to a corporate officer should include the characteristics of a loan made at arm’s length. That is, there should be a contract with a stated interest rate, a specified length of time for repayment, and a consequence for failure to repay the loan. Collateral would also be an indication of a loan. A below-market loan is a loan which provides for no interest or interest at a rate below the federal rate that applies. If a corporation issues you, as a shareholder or an employee, a below-market loan, the lender’s payment to the borrower is treated as a gift, dividend, contribution to capital, payment of wages, or other payment, depending on the substance of the transaction.

See “Below-market interest rate loans” under Employees’ Pay / Kinds of Pay / Loans or Advances in Publication 535, Business Expenses for more information.

Reasonable compensation

Because an officer of a corporation is generally an employee with wages subject to withholding, corporate officers may question what is considered reasonable compensation for the efforts they contribute to conducting their trade or business. Wages paid to you as an officer of a corporation should generally be commensurate with your duties. Refer to “Employee’s Pay, Tests for Deducting Pay” in Publication 535, Business Expenses for more information. Public libraries may have reference sources that provide averages of compensation paid for various types of services. The Internal Revenue Service may determine that adjustments must be made to the income and expenses of tax returns for both the corporation and an individual shareholder if the officer is substantially underpaid for services provided.

Draw account

If you are a sole proprietor  or partner in a partnership, the money or other forms of payment you take from your business should be accounted for in a draw account. This helps you know what amount of benefits you have taken from the business during the year. You cannot deduct the sole proprietor s own salary or any personal withdrawals made from the business.

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Average Tax Prep Fee Inches Up to $273 (REPOST FROM ACCOUNTING TODAY)

REPOST FROM ACCOUNTING TODAY:
WASHINGTON, D.C. (JANUARY 14, 2015)

The average fee for preparing a tax return, including an itemized Form 1040 with Schedule A and a state tax return, will increase a few dollars to $273 this year, a 4.6 percent increase over the average fee of $261 last year, according to a survey by the National Society of Accountants.

The figure also represents an 11 percent increase from two years ago when the survey was conducted.

The average cost to prepare a Form 1040 and state return this season without itemized deductions is expected to be $159, also a 4.6 percent increase over the average fee last year, which was $152. It is an 11.2 percent increase from two years ago.

“When you consider that it takes the average taxpayer five hours to complete a tax return, this is a very strong value,” said NSA executive vice president John Ams in a statement. “The tax code continues to become more complex each year, including some new Affordable Care Act reporting requirements. Professional tax preparers may also be able to find tax deductions and credits that may taxpayers might not notice.”

The NSA collected the fee information during a survey of preparers. The tax and accounting firms surveyed are owners, principals, and partners of local “Main Street” tax and accounting practices who have an average of more than 27 years of experience.

NSA member tax preparers typically hold multiple credentials that demonstrate their expertise, including Enrolled Agent, CPA, Accredited Tax Preparer, Accredited Tax Advisor, and others.

The survey also reported the average fees for preparing additional Internal Revenue Service (IRS) tax forms, including $174 for a Form 1040 Schedule C (business), $634 for a Form 1065 (partnership), $817 for a Form 1120 (corporation), $778 for a Form 1120S (S corporation), $457 for a Form 1041 (fiduciary), $688 for a Form 990 (tax exempt), $68 for a Form 940 (Federal unemployment), $115 for Schedule D (gains and losses), $126 for Schedule E (rental) and $158 for Schedule F (farm).

The NSA noted that the fees vary by region, firm size, population, and economic strength of an area.

The average tax preparation fee for an itemized Form 1040 with Schedule A and a state tax return in each U.S. census district are:

•    New England (CT, ME, MA, NH, RI, VT) – $246
•    Middle Atlantic (NJ, NY, PA) – $314
•    South Atlantic (DE, DC, FL, GA, MD, NC, SC, VA, WV) – $268
•    East South Central (AL, KY, MS, TN) – $262
•    West South Central (AR, LA, OK, TX) – $205
•    East North Central (IL, IN, MI, OH, WI) – $240
•    West North Central (IA, KS, MN, MO, NE, ND, SD) – $198
•    Mountain (AZ, CO, ID, MT, NV, NM, UT, WY) – $256
•    Pacific (AK, CA, HI, OR, WA) – $348

Most accounting firms offer prospective clients a free consultation, the NSA pointed out, which can be worth well over $100 based on the hourly fees of most tax preparers.

All the fees cited assume a taxpayer has gathered and organized all the necessary information.

Taxpayers should also make sure they provide information on time to avoid additional fees, the NSA noted. Many tax preparers will charge an average fee of $114 for dealing with disorganized or incomplete files.

Some will charge an average fee of $42 to file an extension, an average fee of $88 to expedite a return, and an average fee of $93 if information is not provided in advance of an agreed-upon deadline. For taxpayers who are audited by the IRS, the average hourly fee to handle the audit is $144.

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Life After Death for Partnerships: What Happens When a Partner Dies?

business-woman3Have you thought about what will happen to your business when your partner dies? If no other arrangements have been made, the partnership will no longer exist as a legal business organization except for the purpose of winding up its affairs.

When a partner dies, the survivors have only two alternatives: they must either liquidate or reorganize.

Liquidation usually is not a good solution. The business generally will have to be sold quickly and for only a fraction of the value it had as a “going concern.” In most cases, good will is lost entirely. Physical assets may bring little more than one-fourth of their true value.

Reorganization Scenarios

Reorganization generally is a better answer. The reorganization of a partnership usually follows ne of four scenarios:

1. Your partner’s heir(s) become new partners. This plan may or may not work. One or more of the heirs might be a minor, and few of the heirs, if any, will have been regular employees of our business. They may not have the knowledge and experience needed to be a partner.

2. Your partner’s heir(s) sell their interest to someone else. This means you may not have a say in who your new partner will be.

3. Your partner’s heir(s) buy your interest in the business. In most cases, the heirs simply can’t afford to buy the business. Even if they can afford to buy, they may not be willing to pay a price adequately reflecting the value of the business.

4. Your partner’s heir(s) sell their interest to you. This would be an ideal solution if the surviving partners can raise a sufficient amount of cash and if they can agree on the terms of the purchase with the heirs.

The best solution is to plan ahead for the sale of your business upon the death of a partner. This can be accomplished with a “buy-sell” agreement.

A properly structured buy-sell agreement can establish the business value and ensure the continuation of the business by the surviving owners. In addition, the agreement generally establishes a pre-determined price for the business, as well as provides the money to actually buy the business from the heirs.

Value Your Business

Many business owners have a difficult time determining a realistic fair market value for their business. Partners can use a number of valuation methods to estimate the value of their interest n the business. No one method will work in every case but one, or a combination of several, should serve the needs of most business owners.

No matter which method you use to value the partnership, there is one important factor you should keep in mind: The buy-sell agreement should make provisions for future valuations of the business – either through periodic updating or use of a formula. That is because a fair market value that is “just right” today may be too low next year and entirely inadequate in five years.

When partners devote the bulk of their time, effort and ability to the operation of a business, its fair market value usually continues to increase. This constant appreciation should be taken into consideration when valuing the business.

Plan For The Future

Planning today for the future of your business helps protects you, your partner and your families.

You know exactly what will happen if a partner dies…the purchase price, the funding arrangements, etc. It allows you to continue in business and provides the partner’s heir(s) with immediate cash. There may be life after death for partnerships – when partners plan ahead.

 

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