Chapter 6 BASICS OF BUSINESS TAXATION

EBD 301Accounting and Finance

for Entrepreneurs

Introduction

IRS Publications – New Employers• IRS Publication 15 (Circular E),

Employer’s Tax Guide (2014)o EINs, Defining Employees, Paying Payroll

Taxeso Rules for Submitting Form 941 or 944 (when

advised by IRS to do so)• IRS Publication 334 Tax Guide for Small

Businesso Obligations as an employer

BUSINESS OR HOBBY?

Hobbies are considered an activity not engaged in for profit.

IRS Code section 183 limits the legal deductions that can be taken for a hobby.

• Guidelines to determine if business or hobbyo Do you depend on income?o Have you made efficiency changes?o Have you earned profits in 3 of last 5 years?o If activities not made for profit, IRS will disallow

deductions

See IRS Publication 535, Business Expenses

Election for Husband and Wife Unincorporated Businesses

Unincorporated business jointly owned by a married couple is generally classified as a partnership for Federal tax purposes.

• Extensive tax filing requirements Qualified Joint Venture (Public Law

110-28)• Only members are a husband and a wife

filing a joint return – can elect to not be treated as a partnership.

• Each spouse must report share of income

Qualified Joint Venture

(1) the only members of the joint venture are a husband and wife who file a joint return,

(2) both spouses materially participate in the trade or business, and

(3) both spouses elect not to be treated as a partnership.

Spouses make the election on a jointly filed Form 1040

Qualified Joint Venture

Both spouses must divide all items of income, gain, loss, deduction, and credit between them in accordance with each spouse’s respective interest in the joint venture, and

Each spouse filing with the Form 1040 a separate Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship)

• May also be required to file Schedule SE (Self-Employment Tax)

Qualified Joint Venture

Husband and Wife organized as LLC• A business owned and operated by the

spouses through a limited liability company does not qualify for the election as a Q.J.V.

An EIN is not required unless the QJV is required to file excise, employment, alcohol, Tobacco, or Firearms returns.

• If an EIN is required, the filing spouse should complete a Form SS-4 and request an EIN as a sole proprietor.

S Corporations

S corporations are corporations that elect to pass corporate income, losses, deductions and credits through to their shareholders for federal tax purposes

Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. (avoids double taxation of income)

S Corporations

To qualify for S corporation status, the corporation must meet the following requirements:

• Be a domestic corporation• Have only allowable shareholders

o including individuals, certain trust, and estates ando may not include partnerships, corporations or non-resident

alien shareholders• Have no more than 100 shareholders• Have one class of stock• Not be an ineligible corporation

o i.e. certain financial institutions, insurance companies, and domestic international sales corporations

S Corporations

S corporations file their Federal income taxes using form 1020S.

• must also prepare Schedule K-1 as required.• K-1 identifies each shareholders share of current

year’s income• Shareholders must also file a Schedule E, Part II,

Income or Loss If they have employees• S corporations must also file a Form 941,

Employer’s Quarterly Federal Tax Return and Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return

S Corporations

In order to become an S corporation, the corporation must submit Form 2553 Election by a Small Business Corporation (PDF) signed by all the shareholders.

• The instructions for Form 2553 specify all the required information as well as where to file the form.

C Corporations

Corporations must file Form 1120 whether or not they have taxable income or are in bankruptcy proceedings.

The returns must be signed and dated by any of the following corporate officers; President, vice president, treasurer, assistant treasurer, chief accounting officer, or any other corporate officer authorized to sign.

C Corporations

Corporations must pay any tax due by the 15th day of the third month after the end of the tax year. In addition, corporations must use electronic funds transfers (EFT) to make all federal tax deposits.

These deposits are made using the Electronic Federal Tax Payment System (EFTPS). Deposits must be initiated by 8 PM eastern time on the day before the deposit is due

Partnerships

IRS publication 541 Partnerships, provides supplemental federal income tax information for partnerships and partners.

• File Form 1065, U. S. Return of Partnership Income

• Must also file Schedule K-1 (Form 1065)• Taxes are paid on flow through of profits to

the partners who in turn attach the K-1 to their individual Form 1040 US Individual Income Tax Return

IRS Publications of Interest to Partnerships

1. 334: Tax Guide for Small Business2. 505: Tax Withholding and Estimated tax3. 535: Business Expenses4. 537: Installment Sales5. 538: Accounting Periods and Methods6. 544: sales and Other Dispositions of

Assets7. 551: Basis of Assets8. 925: Passivity and At-Risk Rules9. 946: How to depreciate Property

Family Partnership

Members of a family can be partners. IRS Publication 541 (December 2013) states that family members (or any other person) will be recognized as partners if at least one of the following requirements is met

1. “If capital is an income producing factor, they acquired their capital interest in a bona fide transaction (even if by gift or purchase from another family member), actually owned the partnership interest, and actually control the interest.”

• “…Capital is a material income-producing factor if a substantial part of the gross income of the business comes from the use of capital. For example: If the business requires significant inventories or investments in plant, machinery, or equipment.”

Family Partnership

2. “If capital is not the material income-producing factor, they joined together in good faith to conduct a business. They agreed that the contributions of each entitles them to a share in the profits, and some capital for service has been or is provided by each partner.”

• “…Capital is not material income-producing factor if the income of the business consists principally of fees, commissions, or other compensation for personal services performed by members or employees of the partnership.” (Pages 2, 3, Pub. 541)

Limited Liability Companies (LLC)

• The IRS defines a limited liability company “…as a business entity organized in the United States under state law. (Page 2, Pub. 3402, dated March 26, 2010).

• “…an LLC may be classified for federal income tax purposes as a partnership, corporation, or any entity disregarded as separate from its owner by applying the rules and regulations section 301.7701–3.”

Limited Liability Companies (LLC)

The default treatment is as a partnership

• “…An LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes).

• An LLC with at least 2 members and classified as a partnership must file form 1065. Only a member or manager of an LLC can sign the partnership tax return.

Limited Liability Companies (LLC)

If an LLC elects to be classified as a corporation, even if it has just one member, it must file a Form 8832, Entity Classification Election. The LLC may decide to be taxed as an S corporation.

Subsequent elections possible• Partnership to Corporation:

o treated as if the partnership contributed all of its assets and liabilities of the corporation in exchange for stock in the partnership and then immediately liquidated by distributing the stock to its partners.

Limited Liability Companies (LLC)

• Corporation to Partnershipo treated as if the corporation distributed all of its

assets and liabilities to its shareholders in liquidation and the shareholders then immediately contributed all the distributed assets and liabilities the new partnership

• Corporation to disregarded entityo treated as if the corporation distributed all of its

assets and liabilities to its single owner in liquidation• Disregarded entity to corporation

o treated as if the disregarded entity contributed all its assets and liabilities of the corporation in exchange for stock.

IRS HELP AND RESOURCES

IRS: http://www.irs.gov/Help-&-Resources

SBA: http://www.sba.gov/category/navigation-structure/starting-managing-business/starting-business/establishing-business/taxes