Archives for October 2020

You likely formed an S-corporation to save on self-employment taxes.

If so, is your S-corporation salary

• nonexistent?
• too low?
• too high?
• just right?

Getting the S-corporation salary right is important. First, if it’s too low and you get caught by the IRS, you will pay not only income taxes and self-employment taxes on the too-low amount, but also both payroll and income tax penalties that can cost plenty.

Second, in most cases, the IRS is going to expand the audit to cover three years and then add the income and penalties for those three years.

Third, after being found out, you likely are now stuck with this higher salary, defeating your original purpose of saving on self-employment taxes.

Getting to the Number

The IRS did you a big favor when it released its “Reasonable Compensation Job Aid for IRS Valuation Professionals.”

The IRS states that the job aid is not an official IRS position and that it does not represent official authority. That said, the document is a huge help because it gives you some clearly defined valuation rules of the road to follow and takes away some of the gray areas.

Market Approach

The market approach to reasonable compensation compares the S-corporation’s business with others and then looks at the compensation being paid by those businesses to employees who look like you, the shareholder-employee who is likely the CEO.

The question to be answered is, how much compensation would be paid for this same position, held by a nonowner in an arm’s-length employment relationship, at a similar company?

In its job aid, the IRS states that the courts favor the market approach, but because of challenges in matching employees at comparable companies, the IRS developed other approaches.

Cost Approach

The cost approach breaks your employee activities into their components, such as management, accounting, finance, marketing, advertising, engineering, purchasing, janitorial, bookkeeping, clerking, etc.

Here’s an example of how the cost approach works to support a $71,019 salary as reasonable compensation for this S-corporation owner whose corporation had $3.5 million in revenue and 19 employees:

Task	Hours	Wage	Amount
Taxi driver and chauffeur	104	$12.75	$1,326
General manager	624	$58.32	$36,392
Wholesale buyer	166	$27.59	$4,575
Collections clerk	146	$15.32	$2,237
Sales representative	624	$30.96	$19,149
Order clerk	416	$18.56	$7,340
Totals	2,080	N/A	$71,019

Health Insurance

The S-corporation’s payment or reimbursement of health insurance for the shareholder-employee and his or her family goes on the shareholder-employee’s W-2 and counts as compensation, but it’s not subject to payroll taxes, so it fits nicely into the payroll tax savings strategy for the S-corporation owner.

Pension

The S-corporation’s employer contributions on behalf of the owner-employee to a defined benefit plan, simplified employee pension (SEP) plan, or 401(k) count as compensation but don’t trigger payroll taxes. Such contributions further enable the savings on payroll taxes while adding to the dollar amount that’s considered reasonable compensation.

Planning note. Your S-corporation compensation determines the amount that your S-corporation can contribute to your SEP or 401(k) retirement plan. The defined benefit plan likely allows the corporation to make a larger contribution on your behalf.

Section 199A Deduction

The S-corporation’s net income that is passed through to you, the shareholder, can qualify for the 20 percent Section 199A tax deduction on your Form 1040.

If you would like our help with your S-corporation salary, please contact Manay CPA for a virtual appointment.

Good thoughts for you and your loved ones.

Burcu Bree Manay, CPA, MPAc, CTC
President & Managing Partner

 

 

Can your business use an infusion of cash to deal with losses caused by the COVID-19 epidemic?

The hugely popular federal Payroll Protection Program (PPP) loan program that paid forgivable loans to millions of businesses ended on August 8 (although it could come back in revised form). But you can still obtain a low-interest Emergency Income Disaster Loan (EIDL) of up to $150,000 from the Small Business Administration (SBA).

Do You Qualify for an EIDL?

You can qualify for an EIDL if your business has fewer than 500 employees and has suffered “substantial economic injury” due to the COVID-19 pandemic. You have suffered economic injury if you’re unable to pay your normal business operating expenses and other bills, or to sell or produce your goods or services because of the pandemic.

You can obtain an EIDL even if you already received a PPP loan. However, you may not use the EIDL to pay the same payroll costs or other expenses you pay with a PPP loan.

How Much Can You Borrow?

The SBA is currently capping EIDLs at $150,000. The amount you receive is intended to cover six months of your business operational expenses. For most small businesses, the loan amount is based on gross revenues minus cost of goods sold during the period from February 1, 2019, through January 31, 2020, divided by two.

What Are the Loan Terms?

These are 30-year loans at a 3.75 percent interest rate. You don’t have to make any payments until one year after you receive the loan (interest continues to accrue during the one-year delay). There is no prepayment penalty.

How Do You Apply?

You apply for an EIDL with the SBA, and the loan is funded directly from the U.S. Treasury. Unlike with PPP loans, banks are not involved. You can apply online, and the SBA has created a streamlined application.

Do You Need to Have Collateral or Make Guarantees?

The SBA does not require a personal guarantee for an EIDL of less than $200,000.

Collateral is required only if the loan is over $25,000.

For loans over $25,000, the SBA obtains a security interest in all tangible and intangible property your business owns or acquires, including inventory, equipment, and receivables. The SBA files a UCC-1 lien against your business.

How You Can Use the Money

The money is supposed to be used to help you carry on your business until life gets back to normal. You can use the money to pay normal operating expenses, such as employee salaries and benefits, rent, utilities, and fixed debt payments.

But EIDLs are not supposed to be used to replace lost sales, fund business expansion, start a new business, or refinance long-term debt. Nor can you use them to pay yourself dividends or bonuses.

As you can see, EIDLs can be a useful source of low-interest financing during these troubled times. If you need our assistance or would simply like to discuss EIDLs, please contact Manay CPA for a virtual appointment.

Good thoughts for you and your loved ones.

Burcu Bree Manay, CPA, MPAc, CTC
President & Managing Partner

Suppose you just received that lovely letter from the IRS telling you that you are the subject of an IRS audit.

What one record receives special attention? What one record can create a nightmare for you? What one record makes the IRS suspect that you are the keeper of lousy records?

Think of the record people most hate keeping. That’s the one we are talking about. You have probably guessed what that record might be.

Red-Flag Record for the IRS Examiner

Once your audit examination begins, the examiner likes to see this record. If the record is missing or lacking, the IRS examiner knows that your other records probably are lacking, too.

This record—the one you probably hate keeping—is the mileage log on your vehicle or vehicles.

The IRS notes that a taxpayer’s failure to keep a mileage log on vehicles indicates that the activity under examination is not being conducted in a businesslike manner.

Do as the Tax Form Says

As a one-owner or husband-and-wife-owned business, regardless of whether it’s a corporation, a partnership, or a proprietorship, you file a tax form that asks you for the following information about your vehicles:

1. Do you have evidence to support the business/investment use claimed? (If “yes,” is the evidence written?)
2. List your total business/investment miles on each vehicle.
3. List your total commuting miles on each vehicle.
4. List your total personal miles on each vehicle.

IRS Form 4562 has columns for answers to the above questions for up to six vehicles used by either a sole proprietor or an owner of more than 5 percent of a corporation, a partnership, or another entity.

The mileage log is the record of proof that you need to use for your answers to the tax form questions.

Do What the Audit Would Require

Above, we said to do as the IRS form says. For additional clarification, it is good to know what information the IRS, in a correspondence audit, requires you to provide related to that tax form:

1. Send copies of repair receipts, inspection slips, and other records showing total mileage for the year.
2. Send copies of logbooks and other records to support the business mileage claimed.
3. Provide a copy of your appointment book or calendar of business activities for the year.
4. If you are claiming actual expenses, provide copies of paid bills, invoices, and canceled checks for automobile expenses. These would include gas, oil, tires, repairs, insurance, interest, tags, taxes, parking fees, and tolls.
5. Send a copy of the bill of sale or other verification to establish your basis in the vehicle, including the trade-in of another vehicle.

Note that the IRS is looking for

• a match of the repair bill odometer reading with the mileage in your logbook;
• a match of the inspection slip odometer reading with the mileage in your logbook;
• the mileage between repair stops, to see whether that ties in with your claimed mileage; and
• a business purpose that ties in with your appointment book or other calendar of business activities.

Takeaways

If you want to avoid big trouble during an IRS audit, keep a good mileage log. This takes just minutes a day.

The mileage log is often one of the first records that an IRS examiner will look at. A good mileage log shows that you know the rules and you respect them. We have seen dozens and dozens of IRS audits end favorably and quickly upon presentation of a good mileage log.

If you need our assistance with your bookkeeping or a mileage log, please contact Manay CPA for a virtual appointment.

Good thoughts for you and your loved ones.

Burcu Bree Manay, CPA, MPAc, CTC
President & Managing Partner