S-Corporation Compensation Revisted

In May I wrote about a friend of mine who owns an S-corporation and who received bad advice from his CPA regarding the salary rules for S-corps.

My friend’s corporation took in about $25,000 of gross income and netted about $10,000 after expenses. He drew out nearly all of that $10,000 profit for himself.

Despite what his CPA said, the IRS’s position and case law are quite clear that since he drew money out of the corporation and he provided services to the corporation he needs to pay himself a salary.

But what should the salary be? And what if the year has ended and the W-2 deadlines have passed, but the corporate tax return still needs filed?

Here are some options:

ONE: Find legitimate expenses the owner incurred, and call the draws expense reimbursements.

My friend could legitimately document his cell phone usage for business (paid out of personal funds) as well as mileage.  As long as there’s a written reimbursement policy in place, (which — shockingly — my friend DID have), he could legitimately argue that some or all of his draws were reimbursements rather than salary.

Another thing he had going for him: in his articles of incorporation, a resolution was created that specifically said that he would pay the startup costs out of his own funds and the corporation would reimburse him.

In his case, between the startup costs and other reimbursements, he was probably close to the $10,000 mark and could reasonably say his salary that first year was $0.

TWO: File the payroll forms late.

What if there were no reimbursements (or no documentation in place to justify reimbursements)? You could classify some or all of the draws as salary and file the payroll forms late and pay whatever penalties might be assessed. While this is the least desirable, it’s probably the most “right and proper” fix.

THREE: The 1099 route.

One thing I’ve done before – and it’s admittedly not “right and proper” – is to have the owner issue himself a 1099 for some or all of his draws for the year in question, and then get real payroll set up for the current year and going forward. Doing this results in the FICA taxes being paid on the owner’s personal return (in the form of self-employment tax) rather than on the corporate side. Again, not right and proper, but it’s a quick and dirty fix in a pinch.

Proper Documentation of Business Expenses

file9411346624378Keep your receipts.

When I talk to business owners or anyone who needs to document expenses or deductions, that’s the number-one piece of advice I give. So I’ll repeat it in bolder type:

Keep your receipts.

The IRS doesn’t really say what a business should keep in order to prove expenses. See, for example, IRS Publication 583, starting on page 11 (“Recordkeeping”).

Basically, you can use a variety of methods in order to prove your income and expenses.

But my professional opinion is that receipts in conjunction with bank statements, canceled checks, etc. are the ideal way to go.

Receipts will show the date of the purchase, the amount of the purchase, and what was purchased. This, combined with proof of payment (bank statements, canceled checks, credit card statement, etc.) provides the ideal documentation. Not just for the IRS but also for basic recordkeeping and business management purposes.

Sometimes you need to keep receipts for certain expenses, such as for meals and entertainment expenses.

It’s sometimes necessary to keep receipts in non-business settings too. One example is the the tax credit for daycare expenses. Keep the receipt from the daycare.

One time Iowa audited a client’s daycare credit that was claimed on the Iowa return. The client handed the auditor a stack of carbon-copies of checks written to the daycare, but the client couldn’t find the receipts. For whatever reason, the daycare couldn’t or wouldn’t provide receipts.

The state rejected the daycare credits for several years worth of tax returns because there were no receipts.

In most circumstances, you can prove your expenses even if you don’t have a receipt. But again, I feel that receipts AND other documents are the safest way to go.

PS: If you don’t like the idea of massive stacks of paper, you can scan your receipts, so long as the scanned copy contains a complete copy of the receipt, is legible and is easily accessible.

Don’t Be “That” Business Owner

Don’t be “that” business owner. ID-100259612

That’s what I tell business owners who complain about having to follow the laws, regulations, rules, etc.

Case in point: one time I was talking to a business owner who was venting about his insurance company and the fact that he had to carry workers’ comp insurance. And he was unhappy about payroll headaches.

He went on to say that he was driving around and saw a roofer with “a bunch of illegal immigrants up on the roof and you know he doesn’t have payroll set up or carry workers’ comp.”

His question for me was: “why should I do things the right way and spend all this money on insurance and payroll when this guy doesn’t do those things and he doesn’t get caught?”

My answer was: you don’t want to be “that” business owner.

Actually my answer was more detailed than that.

ONE: Is that Business Really Being Underhanded?

Unless you know the business owner personally or have inside information, you have no idea how that business is really operating.

TWO: Is that Business Owner Really “Getting By with It?”

I hear this one all the time, even from people who don’t own a business. “My brother-in-law deducts ‘this or that’ and he’s always gotten by with it.”

You have no way of knowing if they’re getting by with it. Just because someone isn’t in prison doesn’t mean they haven’t been audited.

THREE: Is that Business Really Successful or Stable?

From a distance, it can seem like certain businesses are operating outside the bounds of the law, getting by with it, and doing just fine.

And in the short term, that is true.

Compliance is a long-term strategy.

If you plan to have a business that lives for a long time, it’s more cost-effective to be compliant up front, even though it might not seem like it.

But when you get caught, it all comes crashing down and you could lose everything you’ve worked to build.

Why Am I Preaching About This?

Yes, I am being preachy in this blog post.

I deal with a lot of businesses that are in the startup phase. I see too many with preconceived notions of what they can “get by with.” I’ve seen and read about too many people whose life got turned upside-down when they ended up NOT “getting by with it” after all.

So don’t be “that” business owner.

Image courtesy of Stuart Miles / freedigitalphotos.net

Have an HRA? Deadline for Patient-Centered Outcomes Trust Fund Fee Looms

Below I am re-publishing a blog post I wrote last July (with edits and updates) regarding the “Patient Centered Outcomes Trust Fund” fee that is assessed against employers who have health reimbursement arrangements (HRAs).

The only change for this year is that the fee is now $2 per person (it was $1 per person last year).

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Originally published July 15, 2013. Edits and updates are in italics

If you have a health reimbursement arrangement plan (HRA, sometimes called a “Section 105 plan”), you probably owe a “Patient-Centered Outcomes Trust Fund Fee.”

Most people reading this blog post are probably saying, “What the heck is that?”.

The Patient-Centered Outcomes Trust Fund Fee is part of the Affordable Care Act. The fee is imposed on businesses or insurance companies at a rate of $1 $2 per participant in a health plan. A “health plan” of course includes traditional health insurance plans, but it also includes HRAs.

(Side note: on an employer-provided health insurance policy [not an HRA], whether the employer or the insurance company owes the fee depends on the nature of the plan; I am not an expert on health insurance plans so I won’t get into that here.) Updated to add: in most cases, the employer will NOT owe a fee on the insurance policy itself.

Back to HRAs: for purposes of this fee, an HRA is considered a health plan, thus making HRAs subject to the fee.

Here’s what’s annoying for businesses with an HRA: there’s no exemption for small businesses — and almost all HRAs (at least that I deal with) are with small businesses, oftentimes sole proprietors who have hired their spouse.

Updated to add: HRAs may be dying out for many small businesses because of other changes to HRA rules

So you have a sole proprietorship. You hired your spouse and you set up an HRA because of the tax advantages (self-employment tax savings) of running medical expenses through the HRA as deductible business expenses via your spouse. Before July 31, you’ll need to fill out a Form 720 and send a $1 $2 check to the U.S. Treasury ($1 $2 x the number of participants in the HRA).

This is insane, of course. An abject waste of a small business’s time. But it’s what the Affordable Care Act calls for.

Certainly a $1 or $2 fee is no reason to eliminate your HRA. But it’s yet another piece of paperwork to keep track of and another form to fill out.

ROBS Transactions – Be Very Careful of Using Retirement Funds to Start a Business

True scenario that happened a couple of years ago:

A client asked the following: I have $20,000 in a retirement account with a former employer. My husband wants to start a new business. We were thinking that he could hire me as an employee, and then form a retirement plan under the business.

I would transfer the money from my old retirement account into my husband’s company’s retirement plan and purchase stock in my husband’s company through the plan. This would give him startup funds without having to pay taxes on the $20,000. Will this work?

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This type of transactions is called a “ROBS” transactions (ROBS = Rollovers as Business Startups). Theoretically, it can work.  

The key word is “theoretically.”  There is a risk that the IRS could place ROBS on the list of “abusive tax transactions.”  ROBS are not on that list yet, but the IRS has issued guidance that states that ROBS are on a watch list.
There are many issues:
  1. Valuation. You’d have to figure out some way of valuing the stock so you knew how much your account was worth.
  2. Getting cash out when you want it or need it. What if your account balance is higher than the cash the company has in the bank when you’re ready to take your money out?
  3. What if the company is a flop? You’ve just lost your retirement account.
  4. What if the business needs to hire employees someday? Non-discrimination rules apply to retirement plans, meaning you can’t have special benefit programs just for the owner and his or her spouse. You’d have to let the other employees into the plan and probably give them access to purchasing company stock.
  5. Issues with UBIT (“Unrelated Business Income Tax”), which could be assessed against the retirement plan.
ROBS are workable in theory, but the transaction and maintenance of the plan need to be done just right. Attorney fees would be steep. 

What I Told the Client

I told them all of these things. I then went on to say that it made more sense, if they really wanted to use the retirement funds to start the business, to just withdraw the money and pay the taxes and penalties on the $20,000. Doing this wouldn’t have been a great option, either. But the taxes and penalties were likely to be in the same neighborhood as the compliance costs over time.

In the end, after learning of the complications, the client dropped the idea entirely and went on to find other means of getting the business off the ground.