Features Overview

Frequently Asked Questions

In this section, we’ll try to answer some of the questions we hear most often. Please keep in mind that this is NOT a comprehensive list and is NOT intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. This is a general overview to help you ask the important questions when we meet.

 
 

Should my company make an S Corporation election?

This is an excellent question and we hear it quite a bit. First, please understand the two different kinds of tax that are (mainly) involved in this decision:

  • Income tax - this is paid on ALL earnings

  • FICA tax - this is paid on W2 wages of employees OR all earnings of a sole proprietor or partnership arrangement. FICA is also referred to as self-employment tax and is 15.3% of self-employed income.

You may hear that an S Corp will help you lower your taxes. This happens because S Corp dividends (those funds paid to owners directly, not through payroll) are distributed FICA-tax-free (NOT tax-free; income tax must always be paid). Sounds great, huh? Not so fast.

In order to become an S Corp, any shareholder who contributes significant services to the company must be paid reasonable compensation on payroll - that means that FICA tax is paid on these wages and a W2 is issued, just like any other employee. Now for the kicker: the IRS does not give us a definition of what “reasonable compensation” is. To that end, here are a couple of tests I like to use:

  • If you had to be out for a year, what would you pay someone to do your job? If you’re a brain surgeon and you’re thinking of paying yourself an annual salary of $25,000, think again. That’s definitely not reasonable. Could you hire another brain surgeon for that amount of money?

  • Are there any other revenue-generators in your business?

    • Do you manage a staff of 10 people? Their work must generate some kind of benefit and, therefore, extra revenue. You already pay FICA tax on their wages (employer portion of 7.65%), so paying another 15.3% of the net income that they help generate doesn’t make much sense. If you own a gym, do you personally see to every client, all the laundry, the cleaning, etc.? No, you have a staff. These kinds of services contribute to the overall success of your business and those services are attributable to someone besides you. An S Corp might be a good idea.

    • Are you the sole employee but you have revenue generators that make you more productive? Do you own a business in which you can “set the machines to run” and get 5-6 projects going at once (think of an embroidery business or a printing business)? This type of situation means that you are far more productive than if you had to do all of the work yourself. Without an S Corp election, you would pay self-employment tax on what the machines are doing.

    • Some businesses truly don’t lend themselves to making an S Corp election. If we have a truck driver who only owns one vehicle and is the sole driver, to whom can he attribute revenue? No one. Is there more than one machine at his disposal? Not at one time. (If he can be in two places at once, driving two trucks at once, he has broken physics and needs to cash in on that!) So if the IRS were to question what part of his revenue was not attributable to his own efforts, we wouldn’t have a good answer.

As you can see, this isn’t an easy question. If you’re thinking about an S Corp election, make an appointment with us. Let’s see if it makes sense for you.

 

What business expenses can I deduct?

This is a great question. I often direct my clients to look at a Schedule C to see the kinds of things that are deductible, but that’s not inclusive as some expenses do fall under the category “Other” - and what is that? Businesses can deduct any expenses reasonable and necessary to run their business. Office expenses, production supplies, a computer, etc. Easy enough, right? Not quite. What is reasonable?

  • You use your cell phone for business (don’t we all?). Your cell phone is on a family plan that you pay $250/month to keep up but your phone line is only $90 of that. $90 is deductible if you reimburse yourself from your company. The $250 is not.

  • Insurance? Liability, E & O, anything necessary for your profession is deductible. Health insurance - maybe, it depends on your business structure. Life insurance - definitely not UNLESS it has been purchased solely for the benefit of the business (i.e. necessary for a bank loan).

  • Mileage is reimbursable from your business and deductible. However, the regulations to require that you have records: date/time/place/odometer readings/total miles/who/what was purpose? Honestly, there are so many mileage logs out there in phone-app-form that it’s easy to keep up with these things - but DO keep up with them. You must produce these records if the IRS ever asks for proof.

  • There are some definite “no’s”. For instance, professional attire is not deductible even though it may be required. You have to get dressed anyway, right? Per the regs, if you can wear it anywhere else anyway, it’s not deductible as a business expense. Keep this in mind when looking at attire. A polo with your logo embroidered is attire that can be worn anywhere else and is not deductible as a “uniform”. On the other hand, when my 6’7” son worked at Disney and had to wear a lederhosen, that was most definitely not appropriate street attire. But it was funny.

  • Also “no” is any major expenditure (fixed asset) unless it qualifies for special treatment. (How’s that for vague?) Normally, large expenditures (i.e. a $50,000 vehicle or $10,000 machine) must be depreciated over the life of the asset. In some cases it can be expensed immediately but that is a decision that needs to be made when we look at your whole tax situation. Thanks to the new tax law, we do have a lot more room to expense items that would normally be capitalized but there are actually some situations in which it doesn’t make sense to expense immediately. Of course, if we decide that a big deduction is the right thing to do, we will expense it on the tax return and let you know.

There is no blanket, clear-cut answer for these questions. There is no “these always”/”those never” delineation. If you’re not sure, ask. That’s why we’re here.

 

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