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Thursday, November 28, 2024
Monday, March 27, 2023
Employee Retention Credit ERC
The Internal Revenue Service warned employers to be wary of third parties who are advising them to claim the Employee Retention Credit (ERC) when they may not qualify. Some third parties are taking improper positions related to taxpayer eligibility for and computation of the credit.
These third parties often charge large upfront fees or a fee that is contingent on the amount of the refund and may not inform taxpayers that wage deductions claimed on the business' federal income tax return must be reduced by the amount of the credit.
If the business filed an income tax return deducting qualified wages before it filed an employment tax return claiming the credit, the business should file an amended income tax return to correct any overstated wage deduction.
Source: irs.gov
Monday, November 21, 2022
RESTRICTED STOCK IN STARTUPS
ELECTION TO INCLUDE VALUE OF RESTRICTED STOCK OR PROPERTY IN GROSS INCOME IN YEAR OF TRANSFER UNDER CODE Section 83(B)
- A Section 83(b) Election is made to include the value of restricted property at the time of transfer (minus any amount you paid for the property) in your income for the year it is transferred.
- If you make this choice, the substantial vesting rules do not apply and, generally, any later appreciation in value is not included in your compensation when the property becomes substantially vested.
- Your basis for figuring gain or loss when you sell the property is the amount you paid for it plus the amount you included in income as compensation.
- To make the Section 83(b) Election, file a written statement with the IRS office where you file your return no later than 30 days after the date the property was transferred.
- You must sign the statement and indicate on it that you are making the choice under section 83(b) of the Internal Revenue Code
No exceptions to this rule are made.
Source: irs.gov
Sunday, November 20, 2022
S corporation Reasonable Compensation
S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly.
The instructions to the Form 1120-S, U.S. Income Tax Return for an S Corporation, state "Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation."
The IRS has the authority to reclassify payments made to shareholders from non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes). Several court cases support the authority of the IRS to reclassify other forms of payments to a shareholder-employee as a wage expense which are subject to employment taxes.
The key to establishing reasonable compensation is determining what the shareholder-employee did for the S corporation by looking to the source of the S corporation's gross receipts.
The three major sources are:
- Services of shareholder
- Services of non-shareholder employees or
- Capital and equipment
To the extent gross receipts are generated by services of non-shareholder employees and capital and equipment, payments to the shareholder would properly be treated as non-wage distributions that are not subject to employment taxes.
But to the extent gross receipts are generated by the shareholder's personal services, then payments to the shareholder-employee should be classified as wages that are subject to employment taxes.
In addition to gross receipts generated directly by the shareholder-employee, the shareholder-employee should also be subject to wage treatment for administrative work performed by him for the other income-producing employees or assets. For example, a manager may not directly produce gross receipts, but he assists the other employees or assets which are producing the day-to-day gross receipts.
Some factors in determining reasonable compensation:
- Training and experience
- Duties and responsibilities
- Time and effort devoted to the business
- Dividend history
- Payments to non-shareholder employees
- Timing and manner of paying bonuses to key people
- What comparable businesses pay for similar services
- Compensation agreements
- The use of a formula to determine compensation
S Corporation Employees, Shareholders and Corporate Officers
Who is an Employee?
The definition of an employee for FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax Act) and federal income tax withholding under the Internal Revenue Code include corporate officers. When corporate officers perform a service for the corporation and receive or are entitled to payments, those payments are considered wages.
The fact that an officer is also a shareholder does not change this requirement. Such payments to the corporate officer are treated as wages. Courts have consistently held S corporation officers/shareholders who provide more than minor services to their corporation and receive, or are entitled to receive, compensation are subject to federal employment taxes.
If an officer does not perform any services or only performs minor services and is not entitled to compensation, the officer would not be considered an employee.
Distributions, Dividends and Other Compensation as Wages
Courts have found shareholder-employees are subject to employment taxes even when shareholders take distributions, dividends or other forms of compensation instead of wages.
In 2001, in a Tax Court case against a Veterinary Clinic, the Tax Court ruled that an employer cannot avoid federal taxes by characterizing compensation paid to its sole director and shareholder as distributions of the corporation’s net income rather than wages. Veterinary Surgical Consultants, P.C. vs. Commissioner, 117 T.C. 141 (2001).
The Sixth Circuit held that a shareholder-employee of a company used the company bank account for personal use. As such, the Court ruled the shareholder was an employee and owed employment tax. Joly v. Commissioner, T.C. Memo. 1998-361, aff’d by unpub. op., 211 F.3d 1269 (6th Cir. 2000).
In yet another similar case, the Tax Court held that an accountant was taking dividends and performing duties for the company. The Tax Court ruled the dividends were actually wages, subject to employment taxes. Joseph M. Grey Public Accountant, P.C. vs. Commissioner, 119 T.C. 121 (2002).
In the above listed cases the shareholders failed to report any wages from their S corporations. In a 2012 case the shareholder received wages of $24,000 per year and large distributions. Though there was no dispute that the shareholder was an employee, the issue dealt with the reasonableness of the wage amount. When challenged on the reasonableness of the wages, the taxpayer contended that the corporation only intended to pay wages of $24,000 and that its intent was controlling. The 8th Circuit disagreed and sustained the District Court which held that the test is whether the payments received by the shareholder were truly remuneration for services performed, thus the intent to limit wages is not a controlling factor. David E. Watson, PC vs. U.S., 668 F.3d 1008 (8th Cir. 2012). The Supreme Court held that it would not hear an appeal of the 8th Circuit decision.
Other decisions:
Payments made by an S corporation to its president and sole shareholder were wages subject to employment taxes, not distributions or loan repayments. Prior transfers by the shareholder to the corporation were capital contributions and not loans. The court rejected the argument that the distributions would represent unreasonable compensation to its president. Glass Blocks Unlimited v. Comm’r, T.C. Memo. 2013-180.
The corporation’s payment of the shareholder’s personal expenses for insurance and utilities were made with the intent to compensate the shareholder for services rendered. As such, the corporation was entitled to a deduction as additional compensation. The amounts when combined with small amounts of “management expenses” paid by the corporation were not unreasonable. Ghosn v. Comm’r, T.C. Memo. 1995-192.
Purported “loans” from S corporation to its sole shareholder, officer, and director, were wages for purposes of FICA and FUTA taxes. The loans were unsecured demand notes bearing no interest, loans were made entirely at the discretion of shareholder, and the shareholder regularly performed substantial, valuable services for taxpayer. Repayment of loan was “simply a paper transaction” in which outstanding loan balance was credited against undistributed income and rental payments owed by the corporation to the shareholder. Gale W. Greenlee, Inc. v. U.S., 661 F. Supp. 642 (D. Colo. 1985).
If the shareholder received or had the right to receive cash or property, then the S corporation must determine and report an appropriate and reasonable salary for that shareholder.
Next Blog : S Corporation Compensation and Medical Insurance Issues for more details on what is considered to be reasonable compensation.
Source: irs.gov
Friday, November 18, 2022
Caution before forming Trust or LLC or Inc
One of the main reasons for small business owners to consider before creating LLC, Inc or a Trust is to understand that, in case of litigation, LLC / Inc / Trust cannot be ProSe.
Only a licensed attorney may represent an artificial entity such as a corporation, partnership, association, or trust in federal court.
Hays v. Hamblen Family Irrevocable Trust (In re Hamblen)
Friday, October 28, 2022
Tuesday, September 27, 2022
Thursday, February 10, 2022
Standard vs Itemized Deductions
Taxpayers have two options when completing a tax return, take the standard deduction or itemize their deductions. Most taxpayers use the option that gives them the lowest overall tax.
Due to all the tax law changes in the recent years, including increases to the standard deduction, people who itemized in the past might want to switch to the standard deduction.
Here are some details about the two options.
Standard deduction
The standard deduction amount increases slightly every year and varies by filing status. The standard deduction amount depends on the taxpayer's filing status, whether they are 65 or older or blind, and whether another taxpayer can claim them as a dependent. Taxpayers who are age 65 or older on the last day of the year and don't itemize deductions are entitled to a higher standard deduction.
- A married individual filing as married filing separately whose spouse itemizes deductions—if one spouse itemizes on a separate return, both must itemize.
- An individual who files a tax return for a period of less than 12 months. This is uncommon and could be due to a change in their annual accounting period.
- An individual who was a nonresident alien or a dual-status alien during the year. However, nonresident aliens who are married to a U.S. citizen or resident alien can take the standard deduction in certain situations.
- State and local income or sales taxes
- Real estate and personal property taxes
- Home mortgage interest
- Mortgage insurance premiums on a home mortgage
- Personal casualty and theft losses from a federally declared disaster
- Gifts to a qualified charity
- Unreimbursed medical and dental expenses that exceed 7.5% of adjusted gross income
Topic No. 551, Standard Deduction
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Most filers who use Form 1040 can find their standard deduction on the first page of the form. The standard deduction for most filers of Form 1040-SR, U.S. Tax Return for Seniors, is on page 4 of that form.
Not all taxpayers can take a standard deduction, which is discussed in the Instructions for Forms 1040 and 1040-SR. Those taxpayers include:
Itemized deductions
Some itemized deductions, such as the deduction for taxes, may be limited. Taxpayers should review the instructions for Schedule A Form 1040 for more information on limitations.
Thursday, January 27, 2022
How a taxpayer’s filing status affects their tax return
A taxpayer’s filing status tells the IRS about them and their tax situation. This is just one reason taxpayers should familiarize themselves with each option and know their correct filing status. The IRS Interactive Tax Assistant can help them determine their filing status.
A taxpayer's filing status typically depends on whether they are considered
unmarried or married on Dec. 31, which determines their filing status for that
entire year.
More than one filing status may apply in certain situations. If this is the
case, taxpayers can usually choose the filing status that allows them to owe
the least amount of tax.
When preparing and filing
a tax return, filing status determines:
- If
the taxpayer is required to file a federal tax return
- If
they should file a return to receive a refund
- Their
standard deduction amount
- If
they can claim certain tax credits
- The
amount of tax they owe
Here are the five filing statuses:
- Single. Normally,
this status is for taxpayers who are unmarried, divorced or legally
separated under a divorce or separate maintenance decree governed by state
law.
- Married filing jointly. If a taxpayer is married, they can file a joint
tax return with their spouse. If one spouse died in 2021, the
surviving spouse can use married filing jointly as their filing status for
2021 if they otherwise qualify to use that status.
- Married filing separately. Married couples can choose to file separate tax
returns. This may benefit taxpayers who want to be responsible
only for their own tax or if it results in less tax than filing a joint
return.
- Head of household. Unmarried taxpayers may be able to file using
this status, but special rules apply. For example, the taxpayer must have
paid more than half the cost of keeping up a home for themselves and a
qualifying person living in the home for half the year.
- Qualifying widow or widower with dependent child. This status may apply to a taxpayer filing a 2021
tax return if their spouse died in 2019 or 2020, and they didn't remarry
before the end of 2021 and have a dependent child. Other conditions also
apply.
More Information:
Publication
501, Dependents, Standard Deduction, and Filling Information
Publication
17, Your Federal Income Tax
Tuesday, January 11, 2022
Qualified Small Business Stock
QSBS is stock in a company where the price appreciates greatly, and when you sell it, you pay NO TAX on your profit!!!!
Also known as Section 1202 stock, QSBS can be a significant planning tool for a startup.
Because of the potential for reaping big profits at no tax cost, companies that can qualify as a “small business” for this purpose should consider using their stock strategically for attracting investors and rewarding employees.
While the tax break for QSBS is very generous, the definition of it is very restrictive. There are many conditions; the key ones are:
The issuer must be a C corporation in the U.S. (not S corporation).
The corporation’s assets must be $50 million or less at all times before and after the issuance of the stock.
The corporation must be an active business.
The corporation must be in a business other than one involving personal services; banking, insurance, financing, leasing, or investing; farming; mining; or operating a hotel, motel, or restaurant.
Both the corporation and the shareholder must consent to provide certain documentation for the stock.
The stock must be acquired in exchange for money or property or as pay for services provided to the corporation.
The statute limits the per-issuer amount that can be excluded to “eligible gain,” which is the greater of:
1) $10 million reduced by any amount the taxpayer excluded from sales or exchanges of QSBS from the same issuer in prior years, or
2) 10 times the aggregate adjusted basis of the QSBS issued by the corporation disposed of by the taxpayer during the taxable year, as measured on the original issue date.
Because the limitation references the higher amount of the two measurements, the potential total gain excluded from gross income may exceed $10 million. Because a corporation qualifying for the provision could have up to $50 million in assets upon inception,10 the maximum amount of gain eligible for exclusion could reach $500 million under the ten-times-basis limitation.
Section 1202(c)(2) contains an active business requirement, as defined in section 1202(e), for qualified small business stock.
Section 1202(e)(1)(A) requires that during the relevant period “at least 80 percent (by value) of the assets of such corporation are used by such corporation in the active conduct of 1 or more qualified trades or businesses”.
Section 1202(e)(3)(A) defines a “qualified trade or business” as any trade or business other than
(A) any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees,
Important Case Laws:
Case Law: TC Memo 2012-21: Owen v. Commissioner of Internal Revenue "failed the active business requirement."
PLR 201436001 – September 5, 2014 "A biotech company met the definition of a qualified trade or business."
PLR 201717010 – April 28, 2017 "A company that provides laboratory reports to health care professionals met the definition of qualified trade or business."
PLR 201636003 – September 2, 2016 "Paper shares need not be issued for shareholders to qualify for QSBS treatment."
source irs.gov