The right entity choice: Should you convert from a C to an S corporation?
The best choice of entity can affect your business in several ways, including the amount of your tax bill. In some cases, businesses decide to switch from one entity type to another. Although S corporations can provide substantial tax benefits over C corporations in some circumstances, there are potentially costly tax issues that you should assess before making the decision to convert from a C corporation to an S corporation.
Here are four issues to consider:
1. LIFO inventories. C corporations that use last-in, first-out (LIFO) inventories must pay tax on the benefits they derived by using LIFO if they convert to S corporations. The tax can be spread over four years. This cost must be weighed against the potential tax gains from converting to S status.
2. Built-in gains tax. Although S corporations generally aren’t subject to tax, those that were formerly C corporations are taxed on built-in gains (such as appreciated property) that the C corporation has when the S election becomes effective, if those gains are recognized within five years after the conversion. This is generally unfavorable, although there are situations where the S election still can produce a better tax result despite the built-in gains tax.
3. Passive income. S corporations that were formerly C corporations are subject to a special tax. It kicks in if their passive investment income (including dividends, interest, rents, royalties, and stock sale gains) exceeds 25% of their gross receipts, and the S corporation has accumulated earnings and profits carried over from its C corporation years. If that tax is owed for three consecutive years, the corporation’s election to be an S corporation terminates. You can avoid the tax by distributing the accumulated earnings and profits, which would be taxable to shareholders. Or you might want to avoid the tax by limiting the amount of passive income.
4. Unused losses. If your C corporation has unused net operating losses, they can’t be used to offset its income as an S corporation and can’t be passed through to shareholders. If the losses can’t be carried back to an earlier C corporation year, it will be necessary to weigh the cost of giving up the losses against the tax savings expected to be generated by the switch to S status.
Other considerations
When a business switches from C to S status, these are only some of the factors to consider. For example, shareholder-employees of S corporations can’t get all of the tax-free fringe benefits that are available with a C corporation. And there may be issues for shareholders who have outstanding loans from their qualified plans. These factors have to be taken into account in order to understand the implications of converting from C to S status.
If you’re interested in an entity conversion, contact Dukhon Tax. We can explain what your options are, how they’ll affect your tax bill and some possible strategies you can use to minimize taxes.
© 2020
Need another PPP loan for your small business? Here are the new rules.
Need another PPP loan for your small business? Here are the new rules.
Congress recently passed, and President Trump signed, a new law providing additional relief for businesses and individuals during the COVID-19 pandemic. One item of interest for small business owners in the Consolidated Appropriations Act (CAA) is the opportunity to take out a second loan under the Paycheck Protection Program (PPP).
The Basics
The CAA permits certain smaller businesses who received a PPP loan to take out a “PPP Second Draw Loan” of up to $2 million. To qualify, you must:
- Employ no more than 300 employees per physical location,
- Have used or will use the full amount of your first PPP loan, and
- Demonstrate at least a 25% reduction in gross receipts in the first, second or third quarter of 2020 relative to the same 2019 quarter. Applications submitted on or after Jan. 1, 2021, are eligible to use gross receipts from the fourth quarter of 2020.
Eligible entities include for-profit businesses (including those owned by sole proprietors), certain nonprofit organizations, housing cooperatives, veterans’ organizations, tribal businesses, self-employed individuals, independent contractors and small agricultural co-operatives.
Additional points
Here are some additional points to consider:
Loan terms. Borrowers may receive a PPP Second Draw Loan of up to 2.5 times the average monthly payroll costs in the year preceding the loan or the calendar year. However, borrowers in the hospitality or food services industries may receive PPP Second Draw Loans of up to 3.5 times average monthly payroll costs. Only a single PPP Second Draw Loan is permitted to an eligible entity.
Gross receipts and simplified certification of revenue test. PPP Second Draw Loans of no more than $150,000 may submit a certification, on or before the date the loan forgiveness application is submitted, attesting that the eligible entity meets the applicable revenue loss requirement. Nonprofits and veterans’ organizations may use gross receipts to calculate their revenue loss standard.
Loan forgiveness. Like the first PPP loan, a PPP Second Draw Loan may be forgiven for payroll costs of up to 60% (with some exceptions) and nonpayroll costs such as rent, mortgage interest and utilities of 40%. Forgiveness of the loans isn’t included in income as cancellation of indebtedness income.
Application of exemption based on employee availability. The CAA extends current safe harbors on restoring full-time employees and salaries and wages. Specifically, it applies the rule of reducing loan forgiveness for a borrower reducing the number of employees retained and reducing employees’ salaries in excess of 25%.
Deductibility of expenses paid by PPP loans. The CARES Act didn’t address whether expenses paid with the proceeds of PPP loans could be deducted. The IRS eventually took the position that these expenses were nondeductible. The CAA, however, provides that expenses paid both from the proceeds of loans under the original PPP and PPP Second Draw Loans are deductible.
Further questions?
Contact us with any questions you might have about PPP loans, including applying for a Second Draw Loan or availing yourself of forgiveness.
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What’s better than PPP? PPP + ERC! – Expansion of the employer retention credit under new law
What’s better than PPP? PPP + ERC! – Expansion of the employer retention credit under new law
The CARES Act supports certain employers that operate a business during 2020 and retain employees with an employee retention credit. The tax credit is equal to 50% of qualified wages paid to employees after March 12, 2020, and before Jan. 1, 2021.
On December 27, 2020, the Consolidated Appropriations Act, 2021 (CAA, 2021) was signed into law. The CAA includes the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (TCDTR), which extends and expands upon the Employee Retention Credit (ERC) provided by the CARES Act.
Expansion of the Employer Retention Credit under the TCDTR
Beginning on January 1, 2021 and through June 30, 2021, TCDTR extends and expands the following CARES Act provisions:
- Increases the ERC rate from 50% to 70% of qualified wages
- Expands eligibility for the credit by reducing the required year-over-year gross receipts decline from 50% to 20% and provides a safe harbor allowing employers to use prior quarter gross receipts to determine eligibility
- Increases the limit on per-employee creditable wages from $10,000 for the year to $10,000 for each quarter
- Increases the 100-employee delineation for determining the relevant qualified wage base to employers with 500 or fewer employees
- Removes the 30-day wage limitation, allowing employers to, for example, claim the credit for bonus pay to essential workers;
- Allows businesses with 500 or fewer employees to advance the credit at any point during the quarter based on wages paid in the same quarter in a previous year
- Provides rules to allow new employers who were not in existence for all or part of 2019 to be able to claim the credit and
- reaffirms prior IRS guidance that group health plan expenses can be considered qualified wages even when no wages are paid to an employee
- provides that employers who receive a Paycheck Protection Program (PPP) loan may still qualify for the ERC for wages that are not paid for with forgiven PPP proceeds.
All employers are eligible for the employee retention credit, including tax-exempt organizations. There is no size limitation or threshold. However, state and local governments and their instrumentalities and small businesses that take small business loans are not eligible.
Qualifying employers must be either:
- an employer whose business is fully or partially suspended by a government order related to COVID-19 during the calendar quarter; or
- an employer whose gross receipts are below 50% of the comparable quarter in 2019. However, when the employer's gross receipts go above 80% of a comparable quarter in 2019, the employer no longer qualifies after the end of that quarter.
The credit is calculated quarterly. It is 50% of qualifying wages paid, up to $10,000 in total. Wages paid after March 12, 2020, and before Jan. 1, 2021, are eligible for the credit. Wages are not limited to cash payments, but also include a portion of the cost of employer provided health care.
Have questions? Just contact us
Prevent and detect insider cyberattacks
In one recent cybercrime scheme, a mortgage company employee accessed his employer’s records without authorization, then used stolen customer lists to start his own mortgage business. The perpetrator hacked the protected records by sending an email containing malware to a coworker.
This particular dishonest worker was caught. But your company may not be so lucky. One of your employees’ cybercrime schemes could end in financial losses or competitive disadvantages due to corporate espionage.
Best practices
Why would trusted employees steal from the hand that feeds them? They could be working for a competitor or seeking revenge for perceived wrongs. Sometimes coercion by a third party or the need to pay gambling or addiction-related debts comes into play.
Although there are no guarantees that you’ll be able to foil every hacking scheme, your business can minimize the risk of insider theft by implementing several best practices:
Restrict IT use.
Your IT personnel should take proactive measures to restrict or monitor employee use of email accounts, websites, peer-to-peer networking, Instant Messaging protocols and File Transfer Protocol.
Remove access.
When employees leave the company, immediately remove them from all access lists and ask them to return their means of access to secure accounts. Provide them with copies of any signed confidentiality agreements as a reminder of their legal responsibilities for maintaining data confidentiality.
Don’t neglect physical assets.
Some data thefts occur the old-fashioned way — with employees absconding with materials after hours or while no one is looking. Typically, a crooked employee will print or photocopy documents and remove them from the workplace hidden in a briefcase or bag. Some dishonest employees remove files from cabinets, desks or other storage locations. Controls such as locks, surveillance cameras and restrictions to access can help prevent and deter theft.
Treat workers well.
Create a positive work environment and treat employees fairly and with respect. This can encourage loyalty and trust, thereby minimizing potential motives for employee theft.
Wireless risk
In addition to the previously named threats, your office’s wireless communication networks — including Wi-Fi, Bluetooth and cellular — can increase fraud risk. Fraud perpetrators can, for example, use mobile devices to gain access to sensitive information. One way to deter such activities is to restrict Wi-Fi to employees with special passwords or biometric access.
© 2020
The tax implications of employer-provided life insurance
Does your employer provide you with group term life insurance?
If so, and if the coverage is higher than $50,000, this employee benefit may
create undesirable income tax consequences for you.
“Phantom income”
The first $50,000 of group term life insurance coverage that
your employer provides is excluded from taxable income and doesn’t add anything
to your income tax bill. But the employer-paid cost of group term coverage in
excess of $50,000 is taxable income to you. It’s included in the taxable wages
reported on your Form W-2 — even though you never actually receive it. In other
words, it’s “phantom income.”
What’s worse, the cost of group term insurance must be
determined under a table prepared by IRS even if the employer’s actual cost is
less than the cost figured under the table. Under these determinations, the
amount of taxable phantom income attributed to an older employee is often
higher than the premium the employee would pay for comparable coverage under an
individual term policy. This tax trap gets worse as the employee gets older and
as the amount of his or her compensation increases.
Check your W-2
What should you do if you think the tax cost of
employer-provided group term life insurance is undesirably high? First, you
should establish if this is actually the case. If a specific dollar amount
appears in Box 12 of your Form W-2 (with code “C”), that dollar amount
represents your employer’s cost of providing you with group-term life insurance
coverage in excess of $50,000, less any amount you paid for the coverage.
You’re responsible for federal, state and local taxes on the amount that appears
in Box 12 and for the associated Social Security and Medicare taxes as well.
But keep in mind that the amount in Box 12 is already included
as part of your total “Wages, tips and other compensation” in Box 1 of the W-2,
and it’s the Box 1 amount that’s reported on your tax return
Consider some options
If you decide that the tax cost is too high for the benefit
you’re getting in return, you should find out whether your employer has a
“carve-out” plan (a plan that carves out selected employees from group term
coverage) or, if not, whether it would be willing to create one. There are
several different types of carve-out plans that employers can offer to their
employees.
For example, the employer can continue to provide $50,000 of
group term insurance (since there’s no tax cost for the first $50,000 of
coverage). Then, the employer can either provide the employee with an
individual policy for the balance of the coverage, or give the employee the
amount the employer would have spent for the excess coverage as a cash bonus
that the employee can use to pay the premiums on an individual policy.
Contact us if you have questions about group term coverage or
how much it is adding to your tax bill.
© 2020
File cash transaction reports for your business — on paper or electronically
Does your business receive large amounts of cash or cash
equivalents? You may be required to submit forms to the IRS to report these
transactions.
Filing requirements
Each person engaged in a trade or business who, in the course of
operating, receives more than $10,000 in cash in one transaction, or in two or
more related transactions, must file Form 8300. Any transactions conducted in a
24-hour period are considered related transactions. Transactions are also
considered related even if they occur over a period of more than 24 hours if
the recipient knows, or has reason to know, that each transaction is one of a
series of connected transactions.
To complete a Form 8300, you will need personal information
about the person making the cash payment, including a Social Security or
taxpayer identification number.
You should keep a copy of each Form 8300 for five years from the
date you file it, according to the IRS.
Reasons for the reporting
Although many cash transactions are legitimate, the IRS explains
that “information reported on (Form 8300) can help stop those who evade taxes,
profit from the drug trade, engage in terrorist financing and conduct other
criminal activities. The government can often trace money from these illegal
activities through the payments reported on Form 8300 and other cash reporting
forms.”
What’s considered “cash”
For Form 8300 reporting, cash includes U.S. currency and coins,
as well as foreign money. It also includes cash equivalents such as cashier’s
checks (sometimes called bank checks), bank drafts, traveler’s checks and money
orders.
Money orders and cashier’s checks under $10,000, when used in
combination with other forms of cash for a single transaction that exceeds
$10,000, are defined as cash for Form 8300 reporting purposes.
Note: Under a separate reporting requirement, banks and other
financial institutions report cash purchases of cashier’s checks, treasurer’s
checks and/or bank checks, bank drafts, traveler’s checks and money orders with
a face value of more than $10,000 by filing currency transaction reports.
E-filing and batch filing
Businesses required to file reports of large cash transactions
on Form 8300 should know that in addition to filing on paper, e-filing is an
option. The form is due 15 days after a transaction and there’s no charge for
the e-file option. Businesses that file electronically get an automatic
acknowledgment of receipt when they file.
The IRS also reminds businesses that they can “batch file” their
reports, which is especially helpful to those required to file many forms.
Setting up an account
To file Form 8300 electronically, a business must set up an
account with FinCEN’s BSA E-Filing System. For more information, interested
businesses can also call the BSA E-Filing Help Desk at 866-346-9478 (Monday
through Friday from 8 am to 6 pm EST) or email them at [email protected]. Contact us
with any questions or for assistance.
© 2020
Strengthen your supply chain with constant risk awareness
When the COVID-19 crisis exploded in March, among the many
concerns was the state of the nation’s supply chains. Business owners are no
strangers to such worry. It’s long been known that, if too much of a company’s
supply chain is concentrated (that is, dependent) on one thing, that business
is in danger. The pandemic has only complicated matters.
To guard against this risk, you’ve got to maintain a constant
awareness of the state of your supply chain and be prepared to adjust as
necessary and feasible.
Products or services
The term “concentration” can be applied to both customers and
suppliers. Generally, concentration risks become significant when a business
relies on a customer or supplier for 10% or more of its revenue or materials,
or on several customers or suppliers located in the same geographic region.
Concentration related to your specific products or services is
something to keep a close eye on. If your company’s most profitable product or
service line depends on a few key customers, you’re essentially at their mercy.
If just one or two decide to make budget cuts or switch to a competitor, it
could significantly lower your revenues.
Similarly, if a major supplier suddenly increases prices or becomes
lax in quality control, your profit margin could narrow considerably. This is
especially problematic if your number of alternative suppliers is limited.
To cope, do your research. Regularly look into what suppliers
might best serve your business and whether new ones have emerged that might
allow you to offset your dependence on one or two providers. Technology can be
of great help in this effort — for example, monitor trusted news sources
online, follow social media accounts of experts and use artificial intelligence
to target the best deals.
Geography
A second type of concentration risk is geographic. When gauging
it, assess whether many of your customers or suppliers are in one geographic
region. Operating near supply chain partners offers advantages such as lower
transportation costs and faster delivery. Conversely, overseas locales may
enable you to cut labor and raw materials expenses.
But there are also risks associated with geographic centricity.
Local weather conditions, tax rate hikes and regulatory changes can have a
substantial impact. As we’ve unfortunately encountered this year, the severity
of COVID-19 in different regions of the country is affecting the operational
ability and capacity of suppliers in those areas.
These same threats apply when dealing with global partners, with
the added complexity of greater physical distances and longer shipping times.
Geopolitical uncertainty and exchange rate volatility may also negatively
affect overseas suppliers.
Challenges and opportunities
Business owners — particularly those who run smaller companies —
have always faced daunting challenges in maintaining strong supply chains. The
pandemic has added a new and difficult dimension. Our firm can help you assess
your supply chain and identify opportunities for cost-effective improvements.
© 2020
Reopening concepts: What business owners should consider
A widely circulated article about the COVID-19 pandemic, written
by author Tomas Pueyo in March, described efforts to cope with the crisis as
“the hammer and the dance.” The hammer was the abrupt shutdown of most
businesses and institutions; the dance is the slow reopening of them —
figuratively tiptoeing out to see whether day-to-day life can return to some semblance
of normality without a dangerous uptick in infections.
Many business owners are now engaged in the dance. “Reopening” a
company, even if it was never completely closed, involves grappling with a
variety of concepts. This is a new kind of strategic planning that will test
your patience and savvy but may also lead to a safer, leaner and
better-informed business.
When to move forward
The first question, of course, is when. That is, what are the
circumstances and criteria that will determine when you can safely reopen or
further reopen your business. Most experts agree that you should base this
decision on scientific data and official guidance from agencies such as the
U.S. Department of Health and Human Services and Centers for Disease Control
and Prevention (CDC).
But don’t stop there. Although the pandemic is, by definition, a
worldwide issue, the specific situation on the ground in your locality should
drive your decision-making. Keep tabs on state, county and municipal news,
rules and guidance. Plug into your industry’s experts as well. Establish
strategies for expanding operations or, if necessary, contracting them, based
on the latest information.
Testing and working safely
Running a company in today’s environment entails refocusing on
people. If employees are unsafe, your business will likely suffer at some point
soon. Every company that must or chooses to have workers on-site (as opposed to
working remotely) needs to consider the concept of COVID-19 testing.
Employers are generally allowed to test employees, but there are
dangers in violating privacy laws or inadvertently exposing the company to
discrimination claims. The CDC has said that routine testing will likely pass
muster “if these goals are consistent with employer-based occupational medical
surveillance programs” and “have a reasonable likelihood of benefitting
workers.” Consult your attorney, however, before implementing any testing
initiative.
There’s also the matter of working safely. If you haven’t
already, look closely at the layout of your offices or facilities to determine
the feasibility of social distancing. Re-evaluate sanitation procedures and
ventilation infrastructure, too. You may need to invest, or continue investing,
in additional personal protective equipment and items such as plastic screens
to separate workers from customers or each other. It might also be necessary or
advisable to procure or upgrade the technology that enables employees to work
remotely.
Move forward cautiously
No one wanted to do this dance, but business owners must
continue moving forward as cautiously and prudently as possible. While you do
so, don’t overlook the opportunity to identify long-term strategies to run your
company more efficiently and profitably. We can help you make well-informed
decisions based on sound financial analyses and realistic projections.
© 2020
Even if no money changes hands, bartering is a taxable transaction
During the COVID-19 pandemic, many small businesses are strapped
for cash. They may find it beneficial to barter for goods and services instead
of paying cash for them. If your business gets involved in bartering, remember
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.
For example, if a computer consultant agrees to exchange
services with an advertising agency, 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 is 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. Another example: 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.
Joining a club
Many businesses join barter clubs that facilitate barter
exchanges. In general, these clubs use a system of “credit units” that are
awarded to members who provide goods and services. The credits can be redeemed
for goods and services from other members.
Bartering is generally 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 2,000 credit units one year, and that each unit is redeemable for $1 in
goods and services. In that year, you’ll have $2,000 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 will withhold tax from your bartering income at a 24%
rate.
Forms to file
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.
Many 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. Contact us if you need assistance
or would like more information.
© 2020
Does your business have a unique selling proposition?
Many business owners — particularly those who own smaller
companies — spend so much time trying to eliminate weaknesses that they never
fully capitalize on their strengths. One way to do so is to identify and
explicate your unique selling proposition (USP).
Give it some thought
In a nutshell, a USP states why customers should buy your
product or service rather than a similar one offered by a competitor. A USP
might be rather obvious if you offer a type of state-of-the-art technology or
specialize in a certain kind of service that’s not widely available. Many
businesses, however, will need to dedicate some serious thought and discussion
to identifying their USP — and they may need to do so every year or two to
adapt to market changes.
Ask the right questions
Involve employees from every level of your company in
brainstorming sessions to develop your USP. During these meetings, consider the
answers to questions such as:
- What makes our products or services distinctive?
- What aspect of our business is most important to its
growth? - Which elements of what we do are the most difficult for
competitors to copy? - Why should customers buy from us instead of the
competition?
As you might have noticed, knowledge of your competitors is
critical to developing a strong USP. You can’t differentiate your business from
theirs unless you’re familiar with what competitors are selling, how they sell
their products or services, and how they support those sales in terms of
customer service. To this end, you may need to undertake some “competitive
intelligence” efforts to gather needed information.
Integrate it into the sales process
Your USP should be a powerful, concise statement that customers
and prospects will immediately understand and recognize as fulfilling their
wants or needs. Among the most commonly cited examples is package delivery
giant FedEx’s “When it absolutely, positively has to be there overnight.”
Although the company doesn’t use this slogan anymore, it remains a perfect
example of a USP that’s clear and memorable.
Of course, your USP must be more than just words. Once
established, it should serve as a sort of “mantra” for your sales team. That
is, after identifying your customers’ needs during the sales process, they
should use the USP (or an iteration of it) to explain to customers why your
product or service is the right choice. Just be careful not to overuse your USP in sales
and marketing materials, including on your website.
Now may be the time
Given the monumental changes that have occurred in the U.S.
economy and in many industries because of the COVID-19 pandemic, now may be an
imperative time to reconsider and relaunch your USP. We can help you evaluate
your sales numbers, as well as return on investment in marketing efforts, to
carefully craft the right approach.
© 2020