LLC’s – Pros and Cons of Entity Election and IRS Penalty Assessments

Everyone seems top be a bit confused when it comes to issues with LLC’s and filing. The basic rules are : A 1 person LLC defaults to a sole proprietorship, two or more person LLC defaults to a partnership. An LLC can elect to be a Corporation no matter how many people in the LLC. There is a form that the election can be made on. If the LLC prefers to be an S Corp they need to simultaneously file the S Election with the Corporate election.

Logically there is no reason to choose to be an S Corp if you are a two or more person LLC as both a Partnership and S Corp act exactly the same for tax purposes. Both are pass-through entities that are taxed at the partner or shareholder level. This does not preclude the partners from doing so if they prefer. It may be prudent to make the Corporate election certainly with the 2018 changes. Prior to 2018 most LLC’s preferred pass through status due to the double taxation of a Corporation, meaning the Corporation is taxed and the monies paid out of the corporation to the shareholders is also taxed to those individual shareholder’s.

I have discussed the pros and cons of Corporate election verses pass through and the law changes in a prior blog. The current maximum tax for a Corporation is now 21%, however, this may only be beneficial if the Corporation does not expect to disburse funds to the shareholders due to the double taxation.

This week an issue came up about penalties assessed by the IRS for pass-through entities such as S Corps and partnerships. Several years past the IRS instituted an penalty on these entities for late filing. The penalty system currently at IRS is to assess penalties on tax returns that have a tax liability. Therefore, since partnerships and S Corps were pass through’s it is impossible for them to have their own tax liability therefore impossible for the IRS to assess a penalty.

The current penalties are based on late filing and assessed by the number of partners and/or shareholders and the amount of months delinquent. The penalty is quite substantial. The issue mostly comes up on a retroactive S Election. If an LLC has not filed for two years and wants to be an S corp, there is a way to do this called Retroactive S Election. The IRS allows it based on certain criteria, however, they have the right to access the penalty. The penalty can be avoided if an timely extension is filed in the year filing and therefore the year filing a penalty will not be assessed, however, the prior year penalty will be. The IRS generally will allow a one time removal of penalty. If an extension was not filed then the penalty will be assessed in the second year and one of the years penalties would have to be satisfied.

I hope this has clarified the issues. Please let me know if you have any further question regarding these matters.

Looking Ahead Once Again at the 2018 Business Tax Changes!

As the Tax Extension season for 2017 begins I plan to continue to be mindful of issues as they arise concerning the 2018 tax year. I have provided, in an earlier blob, a calculator to determine if the 20% business deduction will be beneficial to you as a business owner. If you have not tried it yet, now might be a good time as we move into the final half of of 2018.

http://blog.miamibeachcpa.com/wp-admin/post.php?post=131&action=edit

Due to the changes, many of those forming new entities are now considering the option of forming corporations rather than pass through’s. Remember, an LLC does have the option to elect to be a corporation, even if there are two or more members and it has defaulted to a partnership. As well, those who formed corporations have the option to be as pass through with an S Election.

Thank you for the wonderful comments I have received since I started this blog early in 20I8 and hope you continue to enjoy it. Please let me know if you have questions or need help.

For your information, here is an interesting article for those that are curious about changes to the Meals and Entertainment deduction and a chart that compares the changes from 2017 to 2018.

https://www.schencksc.com/education-center/articles/2018-meals-and-entertainment-deductions

Will You loose the Child Tax Credit in 2018? Extended Benefits of This Refundable Credit.

There has been discussion whether the personal exemptions being removed and the increase in the standard deduction will be better or worse for taxpayers in 2018. Middle income taxpayers have been concerned as they may not have substantial itemized deductions to offset the loss of the dependent deductions despite the increased standard deduction.

My last son is 18 and has moved out of the house. Therefore, I will not be benefiting from the positive changes to the Child Tax Credit. However, taxpayers that have children in their household under 17 years of age will.

The child credit has doubled from $1,000. per child to $2,000. per child. This is a credit against your tax liability, after deductions, with a portion of the credit being refundable. Even if a taxpayer has no tax liability whatsoever, he or she can get back $1,400 for each qualifying child. The refundable portion of the credit is calculated by reducing adjusted gross income by $2,500. and then multiplying that figure by 15%.

Married Taxpayers can now take the credit with adjusted gross income of up to $400,000. This is a substantial change from the prior years threshold. The Child, however, must have a social security number or the credit will be disallowed. If you do not have time to take care of that right away after the baby is born, then be sure to file an extension. Once you receive the social security number for the new baby you can then file the tax return on extension in 2019 and relish in the fact that he or she is already an income earner!

Individual Filers in 2018 and Completion of the 2017 Tax Filing Season

Hi Tax Filers,

Individuals should keep in mind that most middle class Americans will take advantage of the higher standard deduction in 2018, except for those with large mortgages and high interest, excessive medical bills, and/or high contribution amounts.

Dependent deductions are eliminated and terms of the Child Credit have improved, seemingly due to the higher standard deduction and lower rates. I am excited to see how this will effect the tax liabilities of different categories of filers and hope it is as positive overall as the President expects.

We are here to take a look at what you have going in your small businesses and perhaps we can give you some encouragement and help.

We look forward to continuing completion of the 2017 taxes that will be on extension for Corporations, S Corps, partnerships, trust, and individual tax filers through the fall of 2018. Year end, starting in November, is a good time to look at the year and do whatever is possible to maximize your situation based on the new laws.

We are entering the final stretch tomorrow, Monday and Tuesday, April 16th and 17th. It seems that Washington D.C. exclusively celebrates Emancipation Day on the 16th, which is good from an internal administration perspective as the post offices are still open. This enables us to get most of the non e-filed tax returns out, and leaves us with an extra day on Tuesday in case we have some final cases to deal with.

I appreciate the good response we had this year to several of our blogs, specifically the one, with the business tax calculator. Thank you for your support and business and I wish you continued success in the rest of the year.

Comparing Tax Rates of C Corps with S Corps with the Tax Law Changes / Including a Published Article by Frank Cureton with Additional Details of the 20% Deduction

While reading through an article in The Bradford Tax Institute Online Tax Service addressing the question whether a small business owner should switch back to a C Corp now that the maximum tax rate on C Corps is 21%, I decided to blog on this good question, as well as, present additional information on the 20% deduction for pass-through’s as presented by another author. The Bradford article puts all the numbers on the table but basically it proves the true fact that S Corps are still more beneficial for small business owners. If you compare how much tax you would pay on your net business income as a small business owner with an S Corp as compared to a C Corp it still is better than the C Corp even before you apply the highly publicized 20% deduction.

If your income is taxed in a C Corp at 21 % that is great for the Corporation, however, the small business owner needs to get that profit out of the Company. Therefore the business owner would have to distribute the money and be double taxed. An additional tax would have to be paid on that distribution as a dividend at an additional 15%, and possibly, depending on what tax bracket the taxpayer is in, also pay an investment income tax of 3.8%. Now we are up to 39.8%. That is already higher than the maximum individual tax rate of 37%.

So as you can see it is best to stay with your S Corp.

I have been extremely positive about the 20% deduction in many of my posts and it is a fantastic tax savings for most small business owners. In addition, as you can see above, the S Corp remains a better tax entity to operate your business, rather than a standard “Corporation”, as is, even before you consider the 20% deduction.

The remainder of this post is an excerpt from a publication written by Frank Cureton of Haynsworth, Sinkler, Boyd, PA. It gives details on the limitations and exclusions associated with the 20% pass through deduction.

One additional comment before we move into the article below.

An LLC can elect to be a Corporation and simultaneously make an S Election. In plain English, you can be an S Corp for tax filing and legally be an LLC.

Please let me know if you have any questions with that statement, as many people do, or other issues that may arise throughout the year.

The remainder of this post is written by Frank Cureton of Haynsworth, Sinkler and Boyd, P.A.

The key provisions of the new deduction may be summarized as follows:
Types of Entities That May Generate Qualified Business Income.
The 20% deduction applies to business income generated by any business entity other than a C corporation. Accordingly, the deduction will apply for pass-through income from partnerships, limited liability companies that are taxed as partnerships or as disregarded entities, S corporations and even sole proprietorships.

The new deduction may prompt C corporations to consider whether they should convert to S corporation status. There are numerous factors that must be analyzed in connection with such a conversion, but there are two countervailing points in the new tax law that may make C corporation status more attractive. First, the new tax law reduced the maximum rate for C corporations to 21% (down from 35%). The markedly lower rate reduces the impact of double taxation for C corporations that distribute income to their shareholders. Moreover, certain businesses that retain their income might consider converting to C corporation status. Even with the lower rates on pass-through income (potentially 29.6% maximum), a C corporation’s taxable income is taxed only at 21%, unless and until that income is distributed to its shareholders.

Second, the 20% deduction (like most of the individual income tax provisions of the new act) will expire (or “sunset”) after 2025. In other words, beginning in 2026, tax rates on pass-through are scheduled to revert to their pre-2018 levels. Taxpayers considering a change in status must weigh the potentially temporary benefit of the conversion against the costs of the conversion and the costs of a possible second change of status in 2026.

Types of Pass-Through Income That Are Eligible for Deduction.
The 20% deduction applies to any income from a business, so long as that income is effectively connected with the conduct of a United States business. So generally speaking, Section 199A applies to business income generated from operations in the United States.

The deduction does apply to rental income (assuming that the rental operations amount to a business). But the deduction does not apply to certain types of investment income generated by a pass-through entity.

“Qualified business income” generally does not include compensatory payments received by pass-through owners. Consequently, the deduction does not apply to (i) reasonable compensation paid to the taxpayer by any qualified business of the taxpayer for services rendered with respect to the business, (ii) any guaranteed payment paid to a partner (or member) for services rendered with respect to the business, or (iii) to the extent provided in regulations (there are no regulations yet), certain other payments to partners for services rendered with respect to the business.

The exclusion of guaranteed payments may cause partnerships and LLCs to reconsider compensation arrangements with their owners. A guaranteed payment received by a partner will not be eligible for the deduction (and incidentally will decrease the amount of income subject to the deduction). It may be possible for partnerships and LLCs to structure the payment as a priority profits allocation, which may qualify for the deduction.

Limitations Based Upon Type of Business.
Specified Service Businesses. The owners of certain service businesses will only be able to use the deduction if their income does not exceed specified levels. A specified service business is any business involving the performance of services in the fields of health, law, actuarial sciences, accounting, performing arts, consulting, athletics, financial services, brokerage services or any trade or business where the principal asset of such business is the reputation or skill of one or more of its employees or owners.
A taxpayer who receives pass-through income from a specified service business can fully use the 20% deduction if the taxpayer’s taxable income is less than $315,000 (if married) or $157,500 (if single). The deduction phases out as taxable income increases, so that there is no deduction for a taxpayer whose taxable income exceeds $415,000 (if married) or $205,500 (if single). For these purposes, “taxable income” is determined without the 20% deduction.

Other Businesses. Other types of pass-through businesses including non-service businesses (for example, a manufacturing business or even a rental real estate business) can benefit from the 20% deduction. Owners of such pass-through entities can utilize the 20% deduction without regard to their asset or employment levels so long as their taxable income is less than $315,000 (if married) or $157,500 (if single) (with phase-out occurring over the next $100,000 or $50,000 of taxable income).
But such businesses may also use the deduction even when their taxable income exceeds such limits. The owners of such other pass-through businesses may use the deduction up to the greater of (a) 50% of the W-2 wages paid by the business (including to the owners) or (b) the sum of (i) 25% of W-2 wages paid by the business and (ii) 2.5% of the business’s capital (i.e., the unadjusted basis of the depreciable assets of the business). It is the last test (2.5% of unadjusted basis) that allows real estate businesses to benefit from the deduction, even in cases where they have few employees.

In sum, the new 20% pass-through income deduction can add up to big tax savings for business owners and should also prompt businesses to reconsider their business structures to ensure that they are obtaining the most benefit from the new tax law.

Fraud Changing the IRS and New Requirements for Tax Professionals and Tax Software Companies

In the last two years professional tax software has gone through changes. The changes primarily are to protect the IRS from fraudulent tax returns and the taxpayers from identity fraud. Tax software is now required to have encrypted social security numbers and requires secure log in every time we use the software.

Technology is rapidly advancing and the IRS must also keep up with the pace. They can no longer be behind the 8 ball of technology. It seems strange that they just required software companies to initiate log in requirements for professionals, as well as, the controls they now have in place to protect taxpayers and themselves from loosing billions of dollars.

The IRS recently started asking for practitioner’s social security numbers when we call the practitioner hotline on behalf of our clients. This seemed to be an extreme measure, as we are assigned PTIN numbers to avoid revealing our social security numbers, as well as, EFIN, CAF, and CPA numbers, but, I have happily complied.

It is amazing to me how quickly the publishing companies came out with tax publications on the new tax law just weeks into January of this year. I also have been thinking lately about how the software companies are going to update the programs for the changes to the tax law. It is amazing to me how well they do that and how they will stream line the programs so it is easy for us practitioner’s.

I wish everyone a great remainder of the current tax season and look forward to learning more and more about the many changes in technology and tax law throughout 2018.

TRY THE 20% DEDUCTION IN QBI TAX CALCULATOR – TAX CUTS AND JOBS ACT

HERE IT IS: Click here to link to the Online Calculator

Consider deductions on your 2017 tax returns as it may be the last chance you may have to itemize. The standard deduction has increased substantially and many of the deductions you are used to taking are discontinued in 2018. If you filed an extension for your pass through entities ( LLC, Partnership, or S Corp ) last Thursday, March 15, 2018 you have time to consider all the deductions you can take on your 2017 tax returns, as it may not be as beneficial in 2018 due to the increased standard deduction, decreased personal income tax rates and the 20% deduction in qualified business income. Individuals, Sole Proprietors, and Corporations may want to be creative as well. C Corp’s, along with individuals, have till April 15, 2018 to file their 2017 federal tax returns. C Corps also benefit from lower corporate tax rates in 2018.

Realtors may be effected by the changes in the tax law as professionals, however, issues with withholding for international clients on real estate closings and obtaining short term rental licenses and withholding certificates, still remain in effect and can be handled smoothly despite the changes.

Short Term Rentals By Miami Beach Residents / Entities and Legal Tax Implications

I have been working with Condominium associations ever since I started practicing as a CPA in Miami Beach. I represented several associations throughout the years. It therefore is no surprise that I fared well within this nitch of business. The city of Miami Beach has been aware of short terms rentals by condo owners and feels it is time to enforce their rights to collect resort tax. This forces owners that rent on a short term basis to get proper licences with the City which includes licencing with the state, charging sales tax and local Dade County tourist tax to short term renters. Several owners have come to me over the past year and one half looking to obtain the license as it is a long and difficult process. The majority of owners own in there own name, meaning the property is deeded in their name and therefore will operate as a short term renter as such. However, often times those that have a corporation or other entity owning the property, come to me and usually there are issues before we can even start. Yesterday a case came before me and I composed an email response to the person. The name of the Entity is removed to respect the privacy of the client.

EMAIL SENT TO CLIENT…
Your accountant stated there was an EIN assigned to the entity, however, it has been presenting its business activity of renting on a Schedule E on your joint Federal, US resident tax return, form 1040.

The entity was disregarded, as the accountant has stated, however, it seems strange that a two member LLC would be considered as such, as it automatically defaults to a Partnership.

I do not know how _____ presented itself originally when it obtained an EIN number, but at some point, it was changed and not reflected on the Articles of Incorporation in Florida. .

The problem now is the discrepancy between the articles of incorporation and how the entity is being treated for tax purposes. These two must be consistent.

Was there a legal document produced that made this change? If this is the case then the correction needs to be made with with the Florida Department of State.

The one page of the schedule E you sent me has no indication of _________ or to the fact that the properties have a relationship to your wife. The single form you sent me has your tax ID number on the schedule and your joint names.

The City is looking for consistency and will not accept less. Please understand that I am not criticizing how this has been handled in the past nor considering how it may effect your overall tax situation moving forward. This is for you and your tax adviser to decide.

From my viewpoint of the tax papers you have presented to me, there needs to be a Quit Claim of the property from _________ to you and your wife to match the tax return. Otherwise, the necessary changes need to be made in the tax returns to present to the City of Miami Beach. There must be a tax return with the name _________ and an independent EIN number as the property is deeded clearly in the name of __________.

Tax prep changes could include filing on Schedule C for the rental activities of ____________, .on your form 1040 and include the EIN number, or file form 1065. Please speak to your tax adviser about those possible changes.

The New 20% Business Deduction Calculator. TRY IT NOW!

Section 199A of the New Tax reform sets the parameters and defines how the 20 percent business deduction works. As a subscriber to The Bradford Tax Law Library I am offered a free calculator to see if and how much you qualify based on your income and subsequent business income as defined in section 199A. The calculator will determine your tax savings. As I discussed in my prior blog there are limitations on income and also the use of payroll in the calculation. Give it a try and let’s see if it works for you! Please let me know. Chayim

Click here to link to the Online Calculator

TAX CUTS AND JOBS ACT: New 20 Percent Deduction for Business Income!

If you operate your business as a sole proprietorship, partnership, or S corporation, because your 2018 income from these businesses can qualify for some or all of the new 20 percent deduction. You also can qualify for the new 20 percent 2018 tax deduction on the income you receive from your real estate investments, publicly traded partnerships, real estate investment trusts (REITs), and qualified cooperatives.

This is the big picture of how this new 20 percent deduction works and when can you as a business owner qualify for this new 20 percent tax deduction with almost no complications?

To qualify for the 20 percent with almost no complications, you need two things: First, you need qualified business income from one of the sources above to which you can apply the 20 percent. Second, to avoid complications, you need “defined taxable income” .

$315,000 or less if married filing a joint return, or
·
$157,500 or less if filing as a single taxpayer.

Example. You are single and operate your business as a proprietorship. It produces $150,000 of qualified business income. Your other income and deductions result in defined taxable income of $153,000. You qualify for a deduction of $30,000 ($150,000 x 20 percent).

If you operate your business as a partnership or S corporation and you have the qualified business income and defined taxable income numbers above, you qualify for the same $30,000 deduction. The same is true if your income comes from a rental property, real estate investment trust, or limited partnership.

Some unfriendly rules apply to what Section 199A calls a specified service trade or business, such as operating as a law or accounting firm. But if the doctor, lawyer, actor, or accountant has defined taxable income less than the thresholds above, he or she qualifies for the full 20 percent deduction on his or her qualified business income.

In other words, if you were a lawyer with the same facts as in the example above, you would qualify for the $30,000 deduction. For more on how the service trade or business rules work, see Tax Reform Sticks It to Doctors, Lawyers, Athletes, Traders, and Others.

Qualified Business Income

The term “qualified business income” means the net of qualified items of income, gain, deduction, and loss with respect to any of your qualified trades or businesses.

Although qualified business income does not include any qualified REIT dividends, qualified cooperative dividends, or qualified publicly traded partnership income, such dividends and income qualify for the 20 percent deduction under separate special rules.

If the qualified business income produces a loss, then the loss creates a zero benefit for the year, and that loss carries over to the next year to ensure that your loss of money is penalized.

Your qualified business income is from conduct of trades or businesses within the United States only.

You do not include in qualified business income: any item of short-term capital gain, short-term capital loss, long-term capital gain, or long-term capital loss; any dividend, income equivalent to a dividend, or payment in lieu of dividends; any interest income other than interest income that is properly allicable to a trade or business;reasonable compensation paid to you by any qualified trade or business of yours (such as an S corporation) for services rendered with respect to that trade or business;11 or any guaranteed payment described in IRC Section 707(c) paid to you as a partner for services rendered with respect to the trade or business or, to the extent provided in regulations, any payment described in Section 707(a) to you as a partner for services rendered with respect to the trade or business.

Example. You own five rental properties, all of which produce defined taxable income, and they are your sole source of qualified business income. During 2018, the five properties produce $70,000 of income on your Schedule E. You also sold one property at a $50,000 long-term capital gain, which you properly reported on forms other than Schedule E. Because of your itemized deductions, your defined taxable income for the year is $105,000.

Your 20 percent deduction is $14,000 ($70,000 x 20 percent). You consider the operating income of the rentals, and you don’t include the capital gain as qualified business income.

Defined Taxable Income Limit

In the two previous examples, you did not suffer from the defined taxable income limit or face any of the complications in calculating your deduction.

Once you hit the income limit, you can trigger complications to your benefit, depending on the type of business you operate and whether you have wages and/or depreciable property. But for now, let’s stay with the two basic limits and see how the defined taxable income limit comes into play.

Example. You are the sole operator of a proprietorship that is not a service trade or business. It creates $400,000 of qualified business income. Because of other deductions, you and your spouse have $300,000 of defined taxable income. Your 20 percent tax deduction is $60,000 ($300,000 x 20 percent) because you must apply the 20 percent to the lesser of your defined taxable or qualified business income.

Beating the Income Limit with Wages

Once you exceed the income limits as a non-specified service trade or business (including the phaseout limits discussed later), you face a “lesser than” calculation, one of which goes like this: Your deductible amount is the lesser of:

20 percent of your qualified business income, or
·
50 percent of the W-2 wages with respect to the qualified business.

W-2 wages are the total wages subject to wage withholding, elective deferrals, and deferred compensation paid by the qualified trade or business with respect to employment of its employees during the calendar year.

W-2 wages do not include any amount that is not properly allocable to the qualified business income as a qualified item of deduction.

In addition, W-2 wages do not include any amount that was not properly included in a return filed with the Social Security Administration on or before the 60th day after the due date (including extensions) for such return.

Example. You and your spouse have $1.2 million of defined taxable income for the year. Of this, you have qualified business income of $200,000, and that business paid $120,000 of qualified wages. Your deductible amount is the lesser of

$40,000 ($200,000 x 20 percent) or
·
$60,000 ($120,000 x 50 percent).

Your 20 percent Section 199A qualified business income deduction is $40,000 (the lower amount).

Planning note. Because you and your spouse were over the defined taxable income limit of $315,000 plus the $100,000 phaseout ($415,000), you needed the wages to qualify for the deduction. In this example, with no wages, your Section 199A deduction would have been zero.

Beating the Income Limit with Property

If your defined taxable income is greater than the thresholds ($157,500 single or $315,000 married) plus
·
phaseouts ($50,000 single or $100,000 married),

you get a zero qualified business income deduction unless you have wages or property. Above, we used the 50 percent of wages calculation, which is the first of two possible wage exceptions and which would solely apply in the absence of property. Here, we are going to use the second favorable exception, which consists of wages and/or property.

Under this rule and ignoring the “50 percent wage only” rule, your Section 199A deduction is the lesser of17

20 percent of defined taxable income,
·
20 percent of your qualified business income, or
·
the sum of 25 percent of the W-2 wages with respect to the qualified trade or business, plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property.

The term “qualified property” means depreciable tangible property

that is held by, and available for use in, the qualified trade or business at the close of the taxable year;
·
that is used at any point during the taxable year in the production of qualified business income; and
·
for which the depreciable period has not ended before the close of the taxable year.

For Section 199A, the term “depreciable period” means, with respect to qualified property of a taxpayer, the period beginning on the date the property was first placed in service by the taxpayer and ending on the later of
the date that is 10 years after such date, or the last day of the last full year in the applicable recovery period, ignoring any alternative depreciation system period under Section 168(g).

Example. You are single with defined taxable income of $500,000. You have qualified business income of $420,000. Your qualified business owns a building and machinery that qualify as qualified property and that have an original cost (no improvements) of $1.2 million. The business pays no wages. Most of the work is done by robots. Your Section 199A deduction is the lesser of

$84,000 ($420,000 x 20 percent), or
·
$30,000 ($1.2 million x 2.5 percent).

Takeaways

You now have the big picture of how the new 20 percent tax deduction works to reduce your defined taxable income on your Form 1040.

One key point is that your deduction is not limited or complicated when your income is less than $157,500 if you are single, or less than $315,000 if you file jointly with your spouse. Even the out-of-favor specified service trade or business qualifies for the full 20 percent of qualified business income deduction when defined taxable income is less than the limits.

Once you are above the income limits, you suffer the $50,000 phaseout if you are single or the $100,000 phaseout if you are married filing jointly. For how the phaseouts work for both the out-of-favor specified service trade or business and the in-favor group, see Tax Reform: Will Section 199A Phase In or Phase Out Your 20 Percent Deduction?

Once you are above the thresholds and phaseouts, you can qualify for the Section 199A deduction only when
you are not in the out-of-favor group (accountant, doctor, lawyer, etc.), and your qualified business pays W-2 wages and/or has property.