S Corporations and Fringe Benefits

A major reason why small businesses choose to make an “S” election is that choosing to be an S corporation eliminates the double taxation that a regular (“C”) corporation is subject to. Limited liability companies (LLC) and partnerships have also been known to make the “S” election, since net income for an S corporation isn’t subject to self-employment tax, as a LLC or partnership would ordinarily be subject to. While there are definitely tax benefits to being an S corporation, some things are either not beneficial, or procedures need to be followed to get a benefit, and this is in the area of fringe benefits. The discussion below will pertain to “greater than 2-percent shareholders” of an S corporation, so if you’re the sole shareholder, or have a ‘partner’ who owns more than a two-percent interest, this applies to you.

Self Employed Health Insurance-if an S corporation pays premiums for health, dental, vision, hospital, accident (AD&D), or long-term care for a 2-percent shareholder, those premiums must be included in that person’s W-2, in order to be deductible. If they’re not included, there’s no deduction allowed at the entity level, and the individual can’t take a deduction for self-employed health insurance on page 1 of the Form 1040. The amount included in the W-2 is subject to federal and state tax withholding (but not Social Security/Medicare).

Cafeteria Plan-no, this has nothing to do with food, but this is food for thought. A 2-percent shareholder cannot participate in a cafeteria plan, and if she/he does, it’s not a cafeteria plan for any participating employee. If that’s the case, not even employees can make pretax contributions for any benefits within the plan.

Other items that must be included in a 2-percent shareholder’s W-2 include qualified transportation fringe benefits, qualified adoption assistance, employer contributions to medical savings accounts, qualified moving expense reimbursements, personal use of employer-provided property or services, and meals furnished for the convenience of the employer. Generally, these amounts aren’t taxable to employees, but when the employee is also a 2-percent shareholder, the game changes.

The key to this discussion is that if you’re a 2-percent shareholder of an S corporation, you need to consider what benefits are being paid by the corporation on your behalf, and have those amounts added to your W-2 before the end of the year. If you wait too long, you’ll lose the deduction, which means more tax money out of your pocket, and you don’t want that, do you?!

Please pass this article along to somebody you know, for whom it might be applicable. Leave a comment if you’ve had any experience with being a 2-percent S corporation shareholder and taking benefits.

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Work From Home, Take a Deduction, Right? Maybe

I don’t know about you, but I seem to be meeting more and more people who work from home. You certainly can’t beat the commute and the low overhead, but being able to save on taxes is the icing on the cake. I can’t speak for everybody, but I think that saving money on taxes is way better than being able to work in your underwear!

For any business, expenses directly attributable to that business are deductible. For example, the supplies you buy at Office Depot, the lunch with the prospective client, the miles you logged to get to and from a client, all of these are deductible. When it comes to claiming a “home office deduction”, there are hoops to jump through (yes, even in your underwear!), to be able to fulfill the requirements, so I’ll lay some of them out.

Trade or business-a home office deduction can only be taken for a trade or business activity. You can’t claim it for something personal, such as trading stocks/managing investments for yourself.

Regular and exclusive use-whatever room or separate area of your home is used for your business must be used only for that business. For example, if you operate your business from your dining room table, but also use that dining room for family meals, it’s not being used ‘regularly and exclusively’ for the business, and a deduction wouldn’t be allowed for the dining room. If you have one bedroom in your home that’s your dedicated office, and you and the family use all the other rooms for personal use, that one bedroom would qualify.

Principal place of business-if you conduct your business at more than one location, you must consider the relative importance of each location you operate from, to determine if the home office is your principal place of business. If the home office is where you regularly carry out your administrative activities (and you have no other fixed location to do it), the home office will qualify.

There are other requirements for determining whether your home office qualifies for the deduction, but I can’t give away everything for free!

Say you’ve jumped through all the hoops and you’ve determined that your home office qualifies for the deduction, so what are you actually able to deduct? Good question you ask!

Deductible items can be direct and indirect. Direct expenses are ones that are paid just for that home office space, such as a light fixture repair in that one room. Indirect expenses are the most common, and are expenses that apply to the entire home, and need to be allocated. Some common ones are mortgage interest, real estate tax, rent, and utilities. Indirect expenses are allocated based on what percentage of your total living space is used regularly and exclusively for business. For example, if you rent an apartment that’s 1000 square feet, and the one bedroom you use for biz is 250 square feet, 25% of your indirect expenses would be deductible as the home office deduction.

As I mentioned at the beginning, there are a bunch of hoops to jump through, and I just barely touched on some of them. If you work from home, and haven’t previously thought of taking a home office deduction, now’s the time to start thinking about that, as well as other tax planning. Speak with your favorite CPA (hopefully that’s me) for more details.

Please leave a comment about your own home office deduction experience, or leave a comment to let me know that you like this article, and please pass it along to somebody you know, for whom it might be helpful. Let me know if you have a topic you’d like me to write about in the future. Nice underwear!

Spring Cleaning…Fall Tax Planning

For those of you who don’t me personally, one of my favorite extra-curricular activities is performing in community theatre. I was just in a show in which I played (of all things) an accountant! In one scene, one of the other characters asks me if it was a slow time for accountants, to which I reply “I’m doing a lot of tax planning for clients these days”. The play takes place in November, so I’m a couple of weeks ahead of that, but now’s the time to start thinking about tax planning, since there’s still plenty of time before year end to consider various things.

Defer income and accelerate deductions-this is a “standard” CPA tax planning mantra. For wage earners, deferring income isn’t something that usually happens (“thanks boss, but you don’t have to pay me this month…wait ‘til January”), but for small business owners with the ability to hold off billing clients, this can effectively push off income (and tax) from this year to next. Prepaying the January mortgage payment in December can increase the amount of mortgage interest deductible this year. If you think that you won’t wind up with an Alternative Minimum Tax (AMT), prepaying your January state tax estimate by Dec 31 could help save some federal tax.

Capital gains and losses-now is a good time to take a look at last year’s tax return, and see if you have a capital loss carryforward to this year. On the outside chance that you have some stocks that are actually up right now, it may be a good time to lock in those gains, if you have loss carryforwards to offset the gains. On the flip side, if you have a bunch of gains from earlier this year, you might want to think of selling some losers off now, to offset the losses against the gains.

Retirement plans-my character in the play talked about “retirement plans, IRAs, 401Ks, pensions” as part of the tax planning for clients, and you should follow my character’s lead! If you can afford to take money out of current cash flow, and put it toward your retirement, do it, and do as much as possible. If you’re in a 28% marginal federal tax bracket, and earn a dollar in taxable interest income, you’ll net seventy two cents in your pocket. If that same dollar is in a retirement plan (any type) you’ll net one hundred cents!

Charitable giving-if you are charitably inclined, and have securities that have appreciated in value, but you don’t want to pay tax on the gain (if you sell), you can give appreciated stock to a recognized charity, and get a deduction for the fair market value of the stock. So not only do you not pay tax on the gain, you get a deduction for the appreciated value!

These are just few things to consider, to help you save a few bucks in taxes by the end of this year. I hope you found this article helpful, and please pass it along to somebody you know who could benefit from the information. As always, if you have any thoughts or personal experiences on this topic, please leave a comment, and let me know if there’s a topic you’d like to see me write about.

Mortgage Debt Forgiveness and Taxes

Ever since the housing market tanked a few years ago, we’ve all heard or read about the explosion of mortgage foreclosures and short sales. For those of you who have not experienced this for yourself, imagine the surprise if you were relieved of a crushing debt that you had no cash flow for, only to find out that you now owed tax on that forgiven debt! The Mortgage Forgiveness Debt Relief Act of 2007 (“The Act”), addressed this issue, but “The Act’s” provisions will end when 2012 does, so I figured I’d give everybody a quick reminder of what “The Act” does.

Generally (one of IRS’s favorite words) forgiven debt is considered taxable income to the person who no longer has to pay the debt. For example, if you rack up $5K of charges on your credit card and then can’t pay it, and the bank forgives that debt, they’ll send you a Form 1099-C (Cancellation of Debt), and you will have to pay tax on that $5K of ‘income’. The same has held true for cancelled mortgage debt, until the “The Act” came into being.

The provisions of “The Act” allows for discharge or reduction of mortgage debt to be tax-free. As with anything coming from Congress or IRS, there are plenty of rules. Here are a few:

1-The provisions of “The Act” only apply to debts forgiven during tax years 2007 through 2012.

2-Up to $2 million of debt can be forgiven ($1 million for a married person filing a separate return).

3-The debt can only be on your principal residence. It cannot be for a second home, a rental property, business property, credit cards, or car loans.

4-The debt must have been used to buy, build, or substantially improve your principal residence, and be secured by that residence.

5-Proceeds of refinanced debt used to substantially improve your principal residence qualify, but proceeds used for other purposes (for example, to pay off credit card debt) do not.

To claim the exclusion, a form needs to be attached to your tax return, and obviously the proper underlying information must be kept, to support the tax-free treatment on a tax return. It can be a tremendous financial weight off one’s shoulders to not owe tax on mortgage debt forgiven in a foreclosure, but the rules need to be followed, and the clock is ticking toward the end of “The Act’s” provisions.

I hope you found this information helpful, and please pass it along to anybody you know who is currently struggling to pay their mortgage. As always, let me know if you have any subjects you’d like to see me write about.