Archive for the ‘insurance’ Tag

Do I Need to Set up an LLC or Incorporate?

Originally published in the Cedar Street Times

October 3, 2014

Two weeks ago I discussed some of the pitfalls of using an online service to help you set up an entity such as an LLC, C-Corporation, or S-Corporation for your business.  In a nutshell, you really need tailored advice from an accountant and an attorney to address your circumstances and you should use an attorney to properly set everything up.  I have found that people that utilize these services generally do not have a good understanding of what they did and why, and they don’t know much about their ongoing responsibilities, the importance of carrying them out, or the consequences of failing to do so.

Now I am going to turn the tables and ask you why you think you need a formal entity at all?  When I say this I am thinking about small businesses getting started.  If your accounting and legal advice is from family or friends, hopefully they actually are accountants and business attorneys and reviewing your WHOLE situation.  Or maybe you read something online – maybe even an article like this!  Be careful what you read!

My personal feeling is that there are a lot of small businesses out there that have set up entities prematurely, and have entangled themselves in a lot of extra cost, record keeping, and administrative hassle for very little benefit.

The vast majority of people setting up entities for small businesses do it because of perceived liability protection for their personal assets.  Some do it for certain circumstances that can lead to tax benefits, and others do it in rare circumstances where a major customer requires it.

It is important to understand there is no bullet proof solution when it comes to shielding yourself from liability.  There is almost always a way to spoil a good plan.  Legions of lawyers make their living at this.  Layers of protection are often implemented to mitigate the risk of chinks in your armor.  For instance have an entity and also having insurance would be a good example.

It is also important to understand that entities do not protect you from all forms of claims.  For instance, professionals cannot be shielded by an entity for acts of malpractice.  Malpractice insurance, however, could cover you.

If you do not respect the entity by following all the rules of corporations, s-corporations, or LLCs promulgated by various government authorities, then if there is a lawsuit, the courts could say, “You didn’t respect the entity, so why should we?”  They could look right through your entity and allow a creditor to go after your personal assets.

Small businesses are at a much higher risk for this since they generally don’t have a legal department trying to keep up with all the details!  I have seen small businesses that have gone through the hassle and expense of setting up corporations, filing tax returns and paying the California Franchise Tax each year and yet they have never held a corporate meeting or elected officers, never recorded any corporate minutes (and even if it is just you wearing all hats, you can’t ignore these things!), and treated the bank accounts of the company like an extension of their personal checking account.  And all the while they were thinking they had solid liability protection because they were a corporation…uhh no.  The devil is in the details as it is said!

Besides the initial cost of setting up an entity properly which could run two or three thousand dollars or more, you then have to file separate business tax returns, file an informational filing with the Secretary of State, possibly have an attorney draft a document or two each year, have better accounting for the tax returns (true double-entry accounting which includes an accurate balance sheet in addition to the profit and loss statement), and then you get the privilege of paying California at least $800 a year whether you make a dime or not.  So you have at least another couple thousand dollars each year of ongoing costs (more if you need to hire a bookkeeper when you find out that QuickBooks actually requires a fairly good amount of accounting knowledge to operate it properly.)

If the inherent risk of the business is relatively small or moderate, and especially if you are starting very small and do not even know if the business is going to be successful, then I think you need to carefully way the benefits and costs.  Could you just carry really good insurance and mitigate your risk to an acceptable level?  Do you need the additional layer of protection?  You can always incorporate or set up an LLC later.  Do you have employees, and what amount of risk do they expose you to?  Are they driving vehicles a lot for your business?  Or do you have rental property with lots of tenants?  Maybe you are a free-lance graphic artist designing business cards remotely from your home – not much risk there!  What are you trying to protect anyway – maybe the bulk of your personal assets you have would be considered exempt assets from creditors already? Although attorneys are generally risk-averse because they see all the things that can go wrong, and therefore would prefer to set up an entity, I think these types of discussions can be had with them and really question if it is right to set up an entity for your business for liability reasons.

Taxwise, there can be benefits to setting up an entity, depending on your circumstances, but it is rarely a driving force in and of itself for most small businesses.  The most common one people ask about deals with reducing self-employment taxes for the owner of an S-corporation.  There are ways this can be successful, but it is an issue that is in jeopardy of being eliminated.  It also has the drawback of possibly reducing your future Social Security benefits – although our government will probably beat you to the punch on that one anyway.

If you read this article and think, gee, I am not sure I really need the entity I have – do not just ignore the entity and pretend it doesn’t exist anymore!  Besides getting the proper tailored advice for you, you generally must properly dissolve it, or you will be plagued with continuing mandates for tax returns as well as Franchise Tax fees to California.  (There are limited circumstances where you can just walk away.)

In summary, get competent advice from an accountant and an attorney in light of YOUR facts and circumstances before jumping into an entity.  And question its necessity if you are small or if your business has low or moderate inherent risk and you have access to insurance that could protect you sufficiently.

Prior articles are republished on my website at www.tlongcpa.com/blog.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Home Office Part III – How Big is My Deduction?

Originally published in the Cedar Street Times

August 23, 2013

Four weeks ago, I discussed a new simplified option for calculating the home office deduction that is effective for 2013.  Two weeks ago I discussed the rules to qualify for a home office deduction.  In this final installment on home office deductions, we will discuss the standard method of determining your deduction, which will still yield the greatest benefit for most people – especially in high cost localities.  (If you missed the prior two articles, you can find them on my website at www.tlongcpa.com/blog.)

The standard method of calculating your home office deduction is done on a Form 8829 or on tax worksheets.  It typically starts with a square footage calculation of the livable space in your home, and a calculation of the portion used exclusively for your business activity, to determine the percentage used by the business.  You can use a calculation based on the number of rooms in the house if they are similarly sized, but in practice hardly anybody uses this method.

The next step is to gather your expenses and multiply them by the business percentage you just determined.  Add up in separate categories your utilities, water, trash/recycling service, janitorial (house cleaner), repairs and maintenance, homeowner’s or renter’s insurance, and any other recurring expenses used to maintain your house.   If you regularly meet with clients at your house, you can generally do the same for your landscape maintenance expenses as well.

If you rent your home, you add up your total rent and multiply it by the business percentage.  If you own, you apply the business percentage to your mortgage interest and real estate taxes (the balance go on Schedule A).  Some people will throw their internet access fees on the 8829, but often a better deduction is obtained by thinking about actual business use versus personal use, as square footage is not a great metric for internet use.  You could then put that directly on your schedule C if you run a business, or Form 2106 if you are an employee with a qualifying home office.  If you buy furniture or equipment exclusively for your office, that is generally put on a depreciation schedule and often linked directly to your Schedule C or Form 2106 instead of running it through your business use of home form.

The first telephone line into the house is not deductible at all.  A second line could be, however.  But in that case it is typically a dedicated business line, and you would put that on your schedule C or Form 2106 in full to get a better deduction.  Your cable or satellite service is probably off limits for most people since there is such a high degree of personal use and it is an area subject to abuse.  Based on facts and circumstances some people may be able to build a case for part of it – such as a day trader that depends on the financial channels, or if you have a waiting area which clients regularly use to watch television.

If you own the home you need to set up the home and and any improvements on a 39-year depreciation schedule (not 27.5 like a rental home – common mistake) and run depreciation deductions through your business use of home calculation (beyond the scope of this article).  Many people fail to do this thinking it is a choice.  It is not.  There is a use or lose it rule, and you are responsible for depreciation recapture taxes upon the sale of the home whether or not you claimed the deduction.  So you might as well take it!

Facts and circumstances and reasonableness will generally rule the day as an overarching principle to the application of all of these rules.  Technically, if you only painted your office, you can take 100% of the cost into consideration for your business use of home deduction.  On the flip-side, if you painted everything but your office, you shouldn’t really take any deduction.  In practice, records are generally not kept that precisely, and the dollar figures are not that large, so  you often end up applying the business percentage to everything in that category for the year for practical purposes.

Even after calculating the deduction, there is another hurdle you must pass – you cannot create an overall loss on your Schedule C from business use of home expenses with the exception of real estate taxes, mortgage interest, or casualty losses which would be deductible on Schedule A regardless.  If you have a loss, the excess business use of home expenses will get suspended and carried over to a future year when your business is profitable.

Employees have a different hurdle since their home office deduction is an employee business expense which is a miscellaneous itemized deduction subject to a two percent of adjusted gross income floor.  So if their total miscellaneous itemized deductions exceed two percent of their adjusted gross income, then the excess is an itemized deduction, and if their itemized deductions exceed the standard deduction, then they can benefit!

Of course there are many other considerations that can come into play depending on your circumstances such as separately metered properties, or separate structures, multiple offices in the same home, or different homes, a daycare home office, etc.  This article should be enough to give you the gist, but it is always best to consult with a professional to ensure you are complying with the laws as well as getting all the deductions you deserve.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.