Massachusetts has joined other states which have attempted to reduce the gap between taxes due and taxes collected by requiring most partnerships, Subchapter S corporations, and multi-member limited liability companies which are classified as partnerships under federal income tax laws (“Pass-through Entities”) to withhold tax on the income taxable to their members. The new Pass-through Entity withholding requirements are effective for tax years beginning after 2008 and will require that almost all Pass-through Entities which maintain an office in or do business in Massachusetts take some action. Failure to comply may subject a Pass-through Entity to penalties and, in the case of willful failure, fines of up to $100,000 and imprisonment. (more…)

The IRS has issued final regulations (T.D. 9356) on employment and excise taxes for disregarded entities, including single member LLC’s, and Qualified Subchapter S Subsidiaries (QSUB’s). These final regulations provide that a disregarded entity is treated as a separate entity (a corporation) for purposes of employment taxes and the related reporting requirements. The new regulations were effective August 16, 2007 and are applicable to wages paid on or after January 1, 2009.

Practically speaking these regulations mean that the business entity is responsible for filing and paying for employment taxes, as opposed to the owner at the individual level. With this treatment, owners of single member LLC’s are not responsible for the employment tax obligations of the entity. However, TLB cautions the owner may still have exposure under other rules, such as the responsible party provisions.

The IRS will still allow a single member LLC to calculate, report and pay all employment tax obligations as though the employees of the LLC were employed directly by the owner – and under the owner’s name and taxpayer identification number.

Alternatively, the single member LLC may calculate, report and pay all employment tax obligations under the entities name and taxpayer identification number.

Effective January 1, 2009, those who report employment taxes under the owner method are required to continue to use this method ongoing unless and until otherwise permitted by the IRS Commissioner. However, a taxpayer may take the opportunity now to convert from the owner method to the entity method of reporting without seeking permission – as long as it is done before January 1, 2009. Taxpayers who switch methods may consider wages paid by the owner to employees during the calendar year of the switch as having been paid by the entity for purposes of determining the various wage and benefit bases used in calculating employment taxes.

Please contact TLB if we can help you evaluate which option is the best for your facts and circumstances. Posted by Rich Bienvenue

When choosing the type entity to operate your business there are several legal and financial aspects to consider. These considerations vary, and carry different weight, depending upon each set of facts and circumstances. However, if you operate your business entity as a corporation - TLB recommends you recheck your reasons for not making the so-called “S” election. Some of the reasons why the S-election is advantageous are as follows:

1. Your selling your business - Upon the sale or distribution of corporate assets or business, tax is paid at both the corporate and shareholder level. If you are thinking of retiring or selling your small business in the future, you should seriously consider the advantages of making an S-election.

2. Unreasonably high compensation issues - C-Corporations have to worry about paying unreasonably high compensation. In order to get money out of a C-Corporation most taxpayers take out cash in the form of compensation bonuses. On an IRS examination, agents consider these unreasonable high compensation issues to determine if taxpayers are trying to avoid paying a corporate level tax and tax at the individual level for the receipt of dividends. If raised during examination the service will hit you for the tax and for substantial penalties. This issue doesn’t exist for the S-Corp, as all the corporate income flows through to the shareholder and is taxed only at that level.

3. Accumulated Earnings - O.K. if you avoid the unreasonable compensation issue noted in number 2 above, perhaps you will run into too high a level of accumulated earnings. In this scenario, the IRS may try to assert that the C-Corporation is not paying this cash out because of a desire on the part of the taxpayer to avoid paying taxes on the dividends. Again, this issue just doesn’t apply to the S-Corp, because all income flows through each year.

4. Personal expenses - lets face it many taxpayers try to funnel personal expenses through the business, or perhaps something that every body thought was legitimately a business expense is disallowed upon IRS examination. In a C-Corporation environment this could be disaster. Most likely the IRS will consider the payment of the personal expenses a dividend - so the taxpayer has to pickup the tax on that. In addition, now that the corporation loses the expense, its taxable income is increased and the corporation has to pickup the tax on its level. Add on penalties and something as innocuos as disallowed auto expenses totaling, lets say $10,000, will now cost the taxpayer an additional $7,000 - $9,000 in tax and penalties. Lets hope tax preparers out there are encouraging their clients to play it straight when it comes to personal expenses - especially with their C-Corp clients.

5. Utilization of losses - As a C-corporation any losses generated by the business, stay with the corporation, but may be carried forward. This is nice, but isn’t particularly useful if you are generating income otherwise (other businesses, earned compensation, etc.) The S-Corp allows losses to flow through to the shareholders, which can then utilize these losses to offset other income.

6. Save on payroll taxes - As noted in number 2 above, many taxpayers pay themselves a salary higher than they normally would in order to get the cash out of their C-Corporation and to avoid having to pay the corporate level tax. In this scenario, the taxpayer is paying 12.4% (6.2 employee, 6.2 employer) for social security on approximately the first $95,000 of wages plus 2.9% medicare on the total wages paid. If you were an S-Corp you might pay yourself a more reasonable wage, say comparable what you might pay an outsider and save yourself up to 15.3% in employment taxes by taking the resulting corporate profits as flow through income.

7. Keep the cash basis of accounting - C-Corporations that exceed $5million when applying the average annual gross receipts test (Is your accountant monitoring this every year for you?) are required to convert to the accrual basis of accounting. This could result in a huge change in taxable income, expecially in the first year. In this scenario, an S-election could save you and the use of the cash basis of accounting, particularly in light of IRS Revenue Procedure 2002-28, which provides for safe harbor provisions.

8. Is your C-Corporation a QPSC or a PSC? If so an S-Corp may be for you.

In many small businesses TLB has found that the S-Corporation is the preferred corporate entity and just seems to make the most sense. Of course there may be reasons one would want to operate as a C-Corporation - sounds like a future post. As always, please consult with TLB on any and all of these issues, before taking action, to determine the ramifications of an “S” election (i.e. the built in gains tax) and to plan accordingly.

The case of Hospital Corp. of America v. Commissioner of Revenue established the right of taxpayers to utilize cost segregation studies for computing depreciation and provides guidance in identifying tangible personal property in a building, which is eligible for accelerated methods of depreciation over fewer years as compared to the traditional 27.5 year recovery period for residential rental property and the 39.5 year recovery period for commercial real estate.The result of cost segregation analysis is significant savings to the taxpayer, and an incentive for investment, particularly when the taxpayer has the ability to elect the provisions of code section 179, which allows expensing (to a limit) of certain depreciable items all in one year.

The determination of whether an item is personal property or real property (ie: a structural component), as usual, depends upon the facts and circumstances, however, the IRS position is that the following items, if used in the operation and maintenance of a building are examples of structural components (ie: real property): bathtubs, boilers, ceilings, central air conditioning and heating systems, chimneys, doors, electrical and wiring, fire escapes, floors, hot water heaters, HVAC units, lighting fixtures, paneling, partitions – if not readily removable, plumbing, roofs, sinks, sprinkler systems, stairs, tiling, walls, and windows (Reg. Section 1.48-1(e)(2))

Obviously, if a taxpayer can recover the cost of acquiring an asset sooner rather then later, it is to her benefit.  There are several instances I can think of where the life of an asset is not defined or particularly clear in the tax code.  Well in the case of Trentadue v. Comissioner (128T.C. No. 8 – 4/3/2007), the Tax Court provides us with some guidance as these issues relate to the classification and depreciable life of wine grape trellises, irrigation systems, and a well used in the taxpayers’ wine production activity. (more…)