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Which entity is most suitable for your new or existing business?
The Tax Cuts and Jobs Act (TCJA) has changed the landscape for business taxpayers. That’s because the law introduced a flat 21% federal income tax rate for C corporations. Under prior law, profitable C corporations paid up to 35%.
The TCJA also cut individual income tax rates, which apply to sole proprietorships and pass-through entities, including partnerships, S corporations, and LLCs (treated as partnerships for tax purposes). However, the top rate dropped from 39.6% to only 37%.
These changes have caused many business owners to ask: What’s the optimal entity choice for me?
Entity tax basics
Before the TCJA, conventional wisdom was that most small businesses should be set up as sole proprietorships or pass-through entities to avoid the double taxation of C corporations. A C corporation pays entity-level income tax and then shareholders pay tax on dividends — and on capital gains when they sell the stock. For pass-through entities, there’s no federal income tax at the entity level.
Although C corporations are still potentially subject to double taxation, their current 21% tax rate helps make up for it. This issue is further complicated, however, by another tax provision that allows noncorporate owners of pass-through entities to take a deduction equal to as much as 20% of qualified business income (QBI), subject to various limits. But, unless Congress extends it, that deduction is available only through 2025.
Many factors to consider
The best entity choice for your business depends on many factors. Keep in mind that one form of doing business might be more appropriate at one time (say, when you’re launching), while another form might be better after you’ve been operating for a few years. Here are a few examples:
Suppose a business consistently generates losses. There’s no tax advantage to operating as a C corporation. C corporation losses can’t be deducted by their owners. A pass-through entity would generally make more sense in this scenario because losses would pass through to the owners’ personal tax returns.
What about a profitable business that pays out all income to the owners? In this case, operating as a pass-through entity would generally be better if significant QBI deductions are available. If not, there’s probably not a clear entity-choice answer in terms of tax liability.
Finally, what about a business that’s profitable but holds on to its profits to fund future projects? In this case, operating as a C corporation generally would be beneficial if the corporation is a qualified small business (QSB). Reason: A 100% gain exclusion may be available for QSB stock sale gains. Even if QSB status isn’t available, C corporation status is still probably preferred — unless significant QBI deductions would be available at the owner level.
As you can see, there are many issues involved and taxes are only one factor.
For example, one often-cited advantage of certain entities is that they allow a business to be treated as an entity separate from the owner. A properly structured corporation can protect you from business debts. But to ensure that the corporation is treated as a separate entity, it’s important to observe various formalities required by the state. These include filing articles of incorporation, adopting by-laws, electing a board of directors, holding organizational meetings and keeping minutes.
The best long-term choice
The TCJA has far-reaching effects on businesses. Contact us to discuss how your business should be set up to lower its tax bill over the long run. But remember that entity choice is easier when starting up a business. Converting from one type of entity to another adds complexity. We can help you examine the ins and outs of making a change.
© 2019
Put a number on your midyear performance with the right KPIs
We’ve reached the middle of the calendar year. So how are things going for your business? Conversationally you might say, “Pretty good.” But, analytically, can you put a number on how well you’re doing — or several numbers for that matter? You can if you choose and calculate the right key performance indicators (KPIs).
4 common indicators
There are a wide variety of KPIs to choose from. Here are four that can give you a solid snapshot of your midyear position:
1. Gross profit. This figure will tell you how much money you made after your manufacturing and selling costs were paid. It’s calculated by subtracting the cost of goods sold from your total revenue.
2. Current ratio. This ratio will help you gauge the strength of your cash flow. It’s calculated by dividing your current assets by your current liabilities.
3. Inventory turnover ratio. This ratio will warn you ahead of time if certain items are moving more slowly than they have in the past. It also will tell you how often these items are turned over. The ratio is calculated by dividing your cost of goods sold by your average inventory for the period.
4. Debt-to-equity ratio. This ratio will measure your company’s leverage, or how much debt is being used to finance your assets. It’s calculated by dividing your total liabilities by shareholder’s equity.
Customized KPIs
KPIs aren’t limited to widely used ratios. You can make up your own and apply them to any area of your business.
For example, let’s say the company’s goal is to improve its response time to customer complaints. Its KPI might be to provide an initial response to complaints within 24 hours, and to eventually resolve at least 80% of complaints to the customer’s satisfaction. You can track response times and document resolutions and eventually calculate this KPI.
As another example, say your business wants to improve its closing rate on sales leads. Its KPI could be to convert 50% of all qualified leads into customers over the next six months with the goal of raising this percentage to 60% next year.
Notice that these KPIs are both specific and measurable. Just saying that your company wants to “provide better customer service” or “close more sales” won’t produce a sound KPI.
Good decisions
Midyear is the perfect time to stop, take a breath and objectively assess your company’s performance. This way, if things are really going well, you can determine precisely why and keep that momentum going. And if they’re not, you can figure out how you’re ailing and adjust your budget and objectives accordingly. Our firm can help you choose the KPIs that will provide the information you need, as well as help you apply that data to good business decisions.
© 2019
Could you unearth hidden profits in your company?
Can your business become more profitable without venturing out of its comfort zone? Of course! However, adding new products or services may not be the best way for your business — or any company — to boost profits. Bottom-line potential may lie undiscovered in your existing operations. How can you find these “hidden” profits? Dig into every facet of your organization.
Develop a profit plan
You’ve probably written and perhaps even recently revised a business plan. And you’ve no doubt developed sales and marketing plans to present to investors and bankers. But have you taken the extra step of developing a profit plan?
A profit plan outlines your company’s profit potential and sets objectives for realizing those bottom-line improvements. Following traditional profit projections based on a previous quarter’s or previous year’s performance can limit you. Why? Because when your company reaches its budgeted sales goals or exceeds them, you may feel inclined to ease up for the rest of the year. Don’t just coast past your sales goals — roar past them and keep going.
Uncover hidden profit potential by developing a profit plan that includes a continuous incentive to improve. Set your sales goals high. Even if you don’t reach them, you’ll have the incentive to continue pushing for more sales right through year end.
Ask the right questions
Among the most effective techniques for creating such a plan is to consider three critical questions. Answer them with, if necessary, brutal honesty to increase your chances of success. And pose the questions to your employees for their input, too. Their answers may reveal options you never considered. Here are the questions:
1. What does our company do best? Involve top management and brainstorm to answer this question. Identifying your core competencies should result in strategies that boost operations and uncover hidden profits.
2. What products or services should we eliminate? Nearly everyone in management has an answer to this question, but usually no one asks for it. When you lay out the tough answers on the table, you can often eliminate unprofitable activities and improve profits by adding or improving profitable ones.
3. Exactly who are our customers? You may be wasting time and money on marketing that doesn’t reach your most profitable customers. Analyzing your customers and prospects to better focus your marketing activities is a powerful way to cut waste and increase profits.
Get that shovel ready
Every business owner wishes his or her company could be more profitable, but how many undertake a concerted effort to uncover hidden profits? By pulling out that figurative shovel and digging into every aspect of your company, you may very well unearth profit opportunities your competitors are missing. We can help you conduct this self-examination, gather the data and crunch the resulting numbers.
© 2019
Hiring this summer? You may qualify for a valuable tax credit
Is your business hiring this summer? If the employees come from certain “targeted groups,” you may be eligible for the Work Opportunity Tax Credit (WOTC). This includes youth whom you bring in this summer for two or three months. The maximum credit employers can claim is $2,400 to $9,600 for each eligible employee.
10 targeted groups
An employer is generally eligible for the credit only for qualified wages paid to members of 10 targeted groups:
Qualified members of families receiving assistance under the Temporary Assistance for Needy Families program,
Qualified veterans,
Designated community residents who live in Empowerment Zones or rural renewal counties,
Qualified ex-felons,
Vocational rehabilitation referrals,
Qualified summer youth employees,
Qualified members of families in the Supplemental Nutrition Assistance Program,
Qualified Supplemental Security Income recipients,
Long-term family assistance recipients, and
Qualified individuals who have been unemployed for 27 weeks or longer.
For each employee, there’s also a minimum requirement that the employee have completed at least 120 hours of service for the employer, and that employment begin before January 1, 2020.
Also, the credit isn’t available for certain employees who are related to the employer or work more than 50% of the time outside of a trade or business of the employer (for example, working as a house cleaner in the employer’s home). And it generally isn’t available for employees who have previously worked for the employer.
Calculate the savings
For employees other than summer youth employees, the credit amount is calculated under the following rules. The employer can take into account up to $6,000 of first-year wages per employee ($10,000 for “long-term family assistance recipients” and/or $12,000, $14,000 or $24,000 for certain veterans). If the employee completed at least 120 hours but less than 400 hours of service for the employer, the wages taken into account are multiplied by 25%. If the employee completed 400 or more hours, all of the wages taken into account are multiplied by 40%.
Therefore, the maximum credit available for the first-year wages is $2,400 ($6,000 × 40%) per employee. It is $4,000 [$10,000 × 40%] for “long-term family assistance recipients”; $4,800, $5,600 or $9,600 [$12,000, $14,000 or $24,000 × 40%] for certain veterans. In order to claim a $9,600 credit, a veteran must be certified as being entitled to compensation for a service-connected disability and be unemployed for at least six months during the one-year period ending on the hiring date.
Additionally, for “long-term family assistance recipients,” there’s a 50% credit for up to $10,000 of second-year wages, resulting in a total maximum credit, over two years, of $9,000 [$10,000 × 40% plus $10,000 × 50%].
The “first year” described above is the year-long period which begins with the employee’s first day of work. The “second year” is the year that immediately follows.
For summer youth employees, the rules described above apply, except that you can only take into account up to $3,000 of wages, and the wages must be paid for services performed during any 90-day period between May 1 and September 15. That means that, for summer youth employees, the maximum credit available is $1,200 ($3,000 × 40%) per employee. Summer youth employees are defined as those who are at least 16 years old, but under 18 on the hiring date or May 1 (whichever is later), and reside in an Empowerment Zone, enterprise community or renewal community.
We can help
The WOTC can offset the cost of hiring qualified new employees. There are some additional rules that, in limited circumstances, prohibit the credit or require an allocation of the credit. And you must fill out and submit paperwork to the government. Contact us for assistance or more information about your situation.
© 2019
Your succession plan may benefit from a separation of business and real estate
Like most businesses, yours probably has a variety of physical assets, such as production equipment, office furnishings, and a plethora of technological devices. But the largest physical asset in your portfolio may be your real estate holdings — that is, the building and the land it sits on.
Under such circumstances, many business owners choose to separate ownership of the real estate from the company itself. A typical purpose of this strategy is to shield these assets from claims by creditors if the business ever files for bankruptcy (assuming the property isn’t pledged as loan collateral). In addition, the property is better protected against claims that may arise if a customer is injured on the property and sues the business.
But there’s another reason to consider separating your business interests from your real estate holdings: to benefit your succession plan.
Ownership transition
A common and generally effective way to separate the ownership of real estate from a company is to form a distinct entity, such as a limited liability company (LLC) or a limited liability partnership (LLP), to hold legal title to the property. Your business will then rent the property from the entity in a tenant-landlord relationship.
Using this strategy can help you transition ownership of your company to one or more chosen successors, or to reward employees for strong performance. By holding real estate in a separate entity, you can sell shares in the company to the successors or employees without transferring ownership of the real estate.
In addition, retaining title to the property will allow you to collect rent from the new owners. Doing so can be a valuable source of cash flow during retirement.
You could also realize estate planning benefits. When real estate is held in a separate legal entity, you can gift business interests to your heirs without giving up interest in the property.
Complex strategy
The details involved in separating the title to your real estate from your business can be complex. Our firm can help you determine whether this strategy would suit your company and succession plan, including a close examination of the potential tax benefits or risks.
© 2019
Employers: Be aware (or beware) of a harsh payroll tax penalty
If federal income tax and employment taxes (including Social Security) are withheld from employees’ paychecks and not handed over to the IRS, a harsh penalty can be imposed. To make matters worse, the penalty can be assessed personally against a “responsible individual.”
If a business makes payroll tax payments late, there are escalating penalties. And if an employer fails to make them, the IRS will crack down hard. With the “Trust Fund Recovery Penalty,” also known as the “100% Penalty,” the IRS can assess the entire unpaid amount against a responsible person who willfully fails to comply with the law.
Some business owners and executives facing a cash flow crunch may be tempted to dip into the payroll taxes withheld from employees. They may think, “I’ll send the money in later when it comes in from another source.” Bad idea!
No corporate protection
The corporate veil won’t shield corporate officers in these cases. Unlike some other liability protections that a corporation or limited liability company may have, business owners and executives can’t escape personal liability for payroll tax debts.
Once the IRS asserts the penalty, it can file a lien or take levy or seizure action against a responsible individual’s personal assets.
Who’s responsible?
The penalty can be assessed against a shareholder, owner, director, officer, or employee. In some cases, it can be assessed against a third party. The IRS can also go after more than one person. To be liable, an individual or party must:
Be responsible for collecting, accounting for, and paying over withheld federal taxes, and
Willfully fail to pay over those taxes. That means intentionally, deliberately, voluntarily and knowingly disregarding the requirements of the law.
The easiest way out of a delinquent payroll tax mess is to avoid getting into one in the first place. If you’re involved in a small or medium-size business, make sure the federal taxes that have been withheld from employees’ paychecks are paid over to the government on time. Don’t ever allow “borrowing” from withheld amounts.
Consider hiring an outside service to handle payroll duties. A good payroll service provider relieves you of the burden of paying employees, making the deductions, taking care of the tax payments and handling recordkeeping. Contact us for more information.
© 2019