If your business doesn’t already have a retirement plan, now might be a good time to take the plunge. Current retirement plan rules allow for significant tax-deductible contributions.

For example, if you’re self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $61,000 for 2022. If you’re employed by your own corporation, up to 25% of your salary can be contributed to your account, with a maximum contribution of $61,000. If you’re in the 32% federal income tax bracket, making a maximum contribution could cut what you owe Uncle Sam for 2022 by a whopping $19,520 (32% times $61,000).

More options

Other small business retirement plan options include:

• 401(k) plans, which can even be set up for just one person (also called solo 401(k)s),
• Defined benefit pension plans, and
• SIMPLE-IRAs.

Depending on your circumstances, these other types of plans may allow bigger deductible contributions.

Deadlines to establish and contribute

Thanks to a change made by the 2019 SECURE Act, tax-favored qualified employee retirement plans, except for SIMPLE-IRA plans, can now be adopted by the due date (including any extension) of the employer’s federal income tax return for the adoption year. The plan can then receive deductible employer contributions that are made by the due date (including any extension), and the employer can deduct those contributions on the return for the adoption year.

Important: The SECURE Act provision didn’t change the deadline to establish a SIMPLE-IRA plan. It remains October 1 of the year for which the plan is to take effect. Also, the SECURE Act change doesn’t override rules that require certain plan provisions to be in effect during the plan year, such as the provisions that cover employee elective deferral contributions (salary-reduction contributions) under a 401(k) plan. The plan must be in existence before such employee elective deferral contributions can be made.

For example, the deadline for the 2021 tax year for setting up a SEP-IRA for a sole proprietorship business that uses the calendar year for tax purposes is October 17, 2022, if you extend your 2021 tax return. The deadline for making the contribution for the 2021 tax year is also October 17, 2022. However, to make a SIMPLE-IRA contribution for the 2021 tax year, you must have set up the plan by October 1, 2021. So, it’s too late to set up a plan for last year.

While you can delay until next year establishing a tax-favored retirement plan for this year (except for a SIMPLE-IRA plan), why wait? Get it done this year as part of your tax planning and start saving for retirement. We can provide more information on small business retirement plan alternatives. Be aware that, if your business has employees, you may have to make contributions for them, too.

© 2022

In today’s economy, many small businesses are strapped for cash. They may find it beneficial to barter or trade for goods and services instead of paying cash for them. Bartering is the oldest form of trade and the internet has made it easier to engage with other businesses. But if your business gets involved in bartering, be aware that the fair market value of goods that you receive in bartering is taxable income. And if you exchange services with another business, the transaction results in taxable income for both parties.

How it works

Here are some examples:

• A computer consultant agrees to exchange services with an advertising agency.
• A plumber does repair work for a dentist in exchange for dental services.

In these cases, both parties are taxed on the fair market value of the services received. This is the amount they would normally charge for the same services. If the parties agree to the value of the services in advance, that will be considered the fair market value unless there’s contrary evidence.

In addition, if services are exchanged for property, income is realized. For example,

• If a construction firm does work for a retail business in exchange for unsold inventory, it will have income equal to the fair market value of the inventory.
• If an architectural firm does work for a corporation in exchange for shares of the corporation’s stock, it will have income equal to the fair market value of the stock.

Barter clubs 

Many businesses join barter clubs that facilitate barter exchanges. These clubs generally use a system of “credit units,” which are awarded to members who provide goods and services. The credits can be redeemed for goods and services from other members.

In general, bartering is taxable in the year it occurs. But if you participate in a barter club, you may be taxed on the value of credit units at the time they’re added to your account, even if you don’t redeem them for actual goods and services until a later year. For example, let’s say that you earn 2,500 credit units one year, and that each unit is redeemable for $2 in goods and services. In that year, you’ll have $5,000 of income. You won’t pay additional tax if you redeem the units the next year, since you’ve already been taxed once on that income.

If you join a barter club, you’ll be asked to provide your Social Security number or Employer Identification Number. You’ll also be asked to certify that you aren’t subject to backup withholding. Unless you make this certification, the club is required to withhold tax from your bartering income at a 24% rate.

Reporting to the IRS

By January 31 of each year, a barter club will send participants a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” which shows the value of cash, property, services and credits that you received from exchanges during the previous year. This information will also be reported to the IRS.

Conserve cash, reap benefits

By bartering, you can trade away excess inventory or provide services during slow times, all while hanging onto your cash. You may also find yourself bartering when a customer doesn’t have the money on hand to complete a transaction. As long as you’re aware of the federal and state tax consequences, these transactions can benefit all parties. If you need assistance or would like more information, contact us.

© 2022

If you own your own company and travel for business, you may wonder whether you can deduct the costs of having your spouse accompany you on trips.

The rules for deducting a spouse’s travel costs are very restrictive. First of all, to qualify, your spouse must be your employee. This means you can’t deduct the travel costs of a spouse, even if his or her presence has a bona fide business purpose, unless the spouse is a bona fide employee of your business. This requirement prevents tax deductibility in most cases.

A spouse-employee

If your spouse is your employee, then you can deduct his or her travel costs if his or her presence on the trip serves a bona fide business purpose. Merely having your spouse perform some incidental business service, such as typing up notes from a meeting, isn’t enough to establish a business purpose. In general, it isn’t sufficient for his or her presence to be “helpful” to your business pursuits — it must be necessary.

In most cases, a spouse’s participation in social functions, for example as a host or hostess, isn’t enough to establish a business purpose. That is, if his or her purpose is to establish general goodwill for customers or associates, this is usually insufficient. Further, if there’s a vacation element to the trip (for example, if your spouse spends time sightseeing), it will be more difficult to establish a business purpose for his or her presence on the trip. On the other hand, a bona fide business purpose exists if your spouse’s presence is necessary to care for a serious medical condition that you have.

If your spouse’s travel satisfies these tests, the normal deductions for business travel away from home can be claimed. These include the costs of transportation, meals, lodging, and incidental costs such as dry cleaning, phone calls, etc.

A non-employee spouse

Even if your spouse’s travel doesn’t satisfy the requirements, however, you may still be able to deduct a substantial portion of the trip’s costs. This is because the rules don’t require you to allocate 50% of your travel costs to your spouse. You need only allocate any additional costs you incur for him or her. For example, in many hotels the cost of a single room isn’t that much lower than the cost of a double. If a single would cost you $150 a night and a double would cost you and your spouse $200, the disallowed portion of the cost allocable to your spouse would only be $50. In other words, you can write off the cost of what you would have paid traveling alone. To prove your deduction, ask the hotel for a room rate schedule showing single rates for the days you’re staying.

And if you drive your own car or rent one, the whole cost will be fully deductible even if your spouse is along. Of course, if public transportation is used, and for meals, any separate costs incurred by your spouse wouldn’t be deductible.

Contact us if you have questions about this or other tax-related topics.

© 2022

Do you want to withdraw cash from your closely held corporation at a minimum tax cost? The simplest way is to distribute cash as a dividend. However, a dividend distribution isn’t tax-efficient since it’s taxable to you to the extent of your corporation’s “earnings and profits.” It’s also not deductible by the corporation.

Five alternatives

Fortunately, there are several alternative methods that may allow you to withdraw cash from a corporation while avoiding dividend treatment. Here are five areas where you may want to take action:

1. Capital repayments. To the extent that you’ve capitalized the corporation with debt, including amounts you’ve advanced to the business, the corporation can repay the debt without the repayment being treated as a dividend. Additionally, interest paid on the debt can be deducted by the corporation. This assumes that the debt has been properly documented with terms that characterize debt and that the corporation doesn’t have an excessively high debt-to-equity ratio. If not, the debt repayment may be taxed as a dividend. If you make future cash contributions to the corporation, consider structuring them as debt to facilitate later withdrawals on a tax-advantaged basis.

2. Salary. Reasonable compensation that you (or family members) receive for services rendered to the corporation is deductible by the business. However, it’s also taxable to the recipient. The same rule applies to any compensation in the form of rent that you receive from the corporation for the use of property. In both cases, the amount of compensation must be reasonable in relation to the services rendered or the value of the property provided. If it’s excessive, the excess will be nondeductible and treated as a corporate distribution.

3. Loans. You may withdraw cash from the corporation tax-free by borrowing from it. However, to avoid having the loan characterized as a corporate distribution, it should be properly documented in a loan agreement or a note and be made on terms that are comparable to those on which an unrelated third party would lend money to you. This should include a provision for interest and principal. All interest and principal payments should be made when required under the loan terms. Also, consider the effect of the corporation’s receipt of interest income.

4. Fringe benefits.  Consider obtaining the equivalent of a cash withdrawal in fringe benefits that are deductible by the corporation and not taxable to you. Examples are life insurance, certain medical benefits, disability insurance and dependent care. Most of these benefits are tax-free only if provided on a nondiscriminatory basis to other employees of the corporation. You can also establish a salary reduction plan that allows you (and other employees) to take a portion of your compensation as nontaxable benefits, rather than as taxable compensation.

5. Property sales.  Another way to withdraw cash from the corporation is to sell property to it. However, certain sales should be avoided. For example, you shouldn’t sell property to a more than 50% owned corporation at a loss, since the loss will be disallowed. And you shouldn’t sell depreciable property to a more than 50% owned corporation at a gain, since the gain will be treated as ordinary income, rather than capital gain. A sale should be on terms that are comparable to those on which an unrelated third party would purchase the property. You may need to obtain an independent appraisal to establish the property’s value.

Keep taxes low

If you’re interested in discussing any of these approaches, contact us. We’ll help you get the most out of your corporation at the minimum tax cost.

© 2022

If you’re in business for yourself as a sole proprietor, or you’re planning to start a business, you need to know about the tax aspects of your venture. Here are eight important issues to consider:

1. You report income and expenses on Schedule C of Form 1040. The net income is taxable to you regardless of whether you withdraw cash from the business. Your business expenses are deductible against gross income and not as itemized deductions. If you have any losses, they’re generally deductible against your other income, subject to special rules relating to hobby losses, passive activity losses and losses in activities in which you weren’t “at risk.”

2. You may be eligible for the pass-through deduction. To the extent your business generates qualified business income, you’re eligible to take the 20% pass-through deduction, subject to various limitations. The deduction is taken “below the line,” so it reduces taxable income, rather than being taken “above the line” against gross income. You can take the deduction even if you don’t itemize and instead take the standard deduction.

3. You might be able to deduct home office expenses. If you work from home, perform management or administrative tasks from a home office or store product samples or inventory at home, you may be entitled to deduct an allocable portion of certain costs. And if you have a home office, you may be able to deduct expenses of traveling from there to another work location.

4. You must pay self-employment taxes. For 2022, you pay self-employment tax (Social Security and Medicare) at a 15.3% rate on your self-employment net earnings of up to $147,000 and Medicare tax only at a 2.9% rate on the excess. An additional 0.9% Medicare tax is imposed on self-employment income in excess of $250,000 for joint returns, $125,000 for married taxpayers filing separately, and $200,000 in all other cases. Self-employment tax is imposed in addition to income tax, but you can deduct half of your self-employment tax as an adjustment to income.

5. You can deduct 100% of your health insurance costs as a business expense. This means your deduction for medical care insurance won’t be subject to the rule that limits your medical expense deduction to amounts in excess of 7.5% of your adjusted gross income.

6. You must make quarterly estimated tax payments. For 2022, these are due April 18, June 15, September 15 and January 17, 2023.

7. You should keep complete records of your income and expenses. Carefully record expenses in order to claim all of the deductions to which you are entitled. Certain expenses, such as automobile, travel, meals and home office expenses, require special attention because they’re subject to special recordkeeping requirements or limits on deductibility.

8. If you hire employees, you need a taxpayer identification number and you must withhold and pay over employment taxes.

We can help

Contact us if you’d like more information or assistance with the tax or recordkeeping aspects of your business.

© 2022

If you operate a business, or you’re starting a new one, you know you need to keep records of your income and expenses. Specifically, you should carefully record your expenses in order to claim all of the tax deductions to which you’re entitled. And you want to make sure you can defend the amounts reported on your tax returns in case you’re ever audited by the IRS.

Be aware that there’s no one way to keep business records. But there are strict rules when it comes to keeping records and proving expenses are legitimate for tax purposes. Certain types of expenses, such as automobile, travel, meals and home office costs, require special attention because they’re subject to special recordkeeping requirements or limitations.

Here are two recent court cases to illustrate some of the issues.

Case 1: To claim deductions, an activity must be engaged in for profit 

A business expense can be deducted if a taxpayer can establish that the primary objective of the activity is making a profit. The expense must also be substantiated and be an ordinary and necessary business expense. In one case, a taxpayer claimed deductions that created a loss, which she used to shelter other income from tax.

She engaged in various activities including acting in the entertainment industry and selling jewelry. The IRS found her activities weren’t engaged in for profit and it disallowed her deductions.

The taxpayer took her case to the U.S. Tax Court, where she found some success. The court found that she was engaged in the business of acting during the years in issue. However, she didn’t prove that all claimed expenses were ordinary and necessary business expenses. The court did allow deductions for expenses including headshots, casting agency fees, lessons to enhance the taxpayer’s acting skills and part of the compensation for a personal assistant. But the court disallowed other deductions because it found insufficient evidence “to firmly establish a connection” between the expenses and the business.

In addition, the court found that the taxpayer didn’t prove that she engaged in her jewelry sales activity for profit. She didn’t operate it in a businesslike manner, spend sufficient time on it or seek out expertise in the jewelry industry. Therefore, all deductions related to that activity were disallowed. (TC Memo 2021-107)

Case 2: A business must substantiate claimed deductions with records

A taxpayer worked as a contract emergency room doctor at a medical center. He also started a business to provide emergency room physicians overseas. On Schedule C of his tax return, he deducted expenses related to his home office, travel, driving, continuing education, cost of goods sold and interest. The IRS disallowed most of the deductions.

As evidence in Tax Court, the doctor showed charts listing his expenses but didn’t provide receipts or other substantiation showing the expenses were actually paid. He also failed to account for the portion of expenses attributable to personal activity.

The court disallowed the deductions stating that his charts weren’t enough and didn’t substantiate that the expenses were ordinary and necessary in his business. It noted that “even an otherwise deductible expense may be denied without sufficient substantiation.” The doctor also didn’t qualify to take home office deductions because he didn’t prove it was his principal place of business. (TC Memo 2022-1)

We can help

Contact us if you need assistance retaining adequate business records. Taking a meticulous, proactive approach can protect your deductions and help make an audit much less difficult.

© 2022