Come tax time, owner-employees face a variety of distinctive tax planning challenges, depending on whether their business is structured as a partnership, limited liability company (LLC) or corporation. Whether you’re thinking about your 2016 filing or planning for 2017, it’s important to be aware of the challenges that apply to your particular situation.
Partnerships and LLCs
If you’re a partner in a partnership or a member of an LLC that has elected to be disregarded or treated as a partnership, the entity’s income flows through to you (as does its deductions). And this income likely will be subject to self-employment taxes — even if the income isn’t actually distributed to you. This means your employment tax liability typically doubles, because you must pay both the employee and employer portions of these taxes.
The employer portion of self-employment taxes paid (6.2% for Social Security tax and 1.45% for Medicare tax) is deductible above the line. Above-the-line deductions are particularly valuable because they reduce your adjusted gross income and modified adjusted gross income, which are the triggers for certain additional taxes and phaseouts of many tax breaks.
But flow-through income may not be subject to self-employment taxes if you’re a limited partner or the LLC member equivalent. And be aware that flow-through income might be subject to the additional 0.9% Medicare tax on earned income or the 3.8% net investment income tax (NIIT), depending on the situation.
S and C corporations
For S corporations, even though the entity’s income flows through to you for income tax purposes, only income you receive as salary is subject to employment taxes and, if applicable, the 0.9% Medicare tax. Keeping your salary relatively — but not unreasonably — low and increasing your distributions of company income (which generally isn’t taxed at the corporate level or subject to employment taxes) can reduce these taxes. The 3.8% NIIT may also apply.
In the case of C corporations, the entity’s income is taxed at the corporate level and only income you receive as salary is subject to employment taxes, and, if applicable, the 0.9% Medicare tax. Nevertheless, if the overall tax paid by both the corporation and you would be less, you may prefer to take more income as salary (which is deductible at the corporate level) as opposed to dividends (which aren’t deductible at the corporate level, are taxed at the shareholder level and could be subject to the 3.8% NIIT).
Whether your entity is an S or a C corporation, tread carefully, however. The IRS remains on the lookout for misclassification of corporate payments to shareholder-employees. The penalties and additional tax liability can be costly.
As you can see, tax planning is extra important for owner-employees. Plus, tax law changes proposed by the President-elect and the Republican majority in Congress could affect tax treatment of your income in 2017. Please contact us for help identifying the ideal strategies for your situation.
In a Federal Tax Update from Checkpoint Newsstand by Thomson Reuters, they break down the details of the 21st Century Cures Act. Part of this law is replealing the penalty assessed against small employers (less than 50 employees) who offer health insurance reimbursements.
The Senate on December 7 passed, by a 94-5 vote, H.R. 34, the "21st Century Cures Act" (the Act) which was passed by the House of Representatives on November 30 by a 392-26 margin. The Act covers a wide-ranging group of nontax health subjects and also includes a provision exempting small employer health reimbursement arrangements (HRAs) from the Affordable Care Act (ACA)'s group plan rules. The Act is expected to be signed into law by President Obama.
Prior law. HRAs typically consist of a promise by an employer to reimburse medical expenses (as defined in Code Sec. 213(d)) for a year up to a certain amount, with unused amounts available to reimburse medical expenses in future years. The reimbursement is excludable from the employee's income. HRAs generally are considered to be group health plans for purposes of the Code, Employee Retirement Income Security Act of 1974 (ERISA), and the Public Health Service Act (PHS Act), provisions of which were incorporated into the Code by the ACA.
The ACA contains certain market reforms that generally apply to group health plans, including the following provisions:
- PHS Act § 2711 which provides in part that a group health plan (or a health insurance issuer offering group health insurance coverage) may not establish any annual limit on the dollar amount of benefits for any individual.
- PHS Act § 2713 which requires non-grandfathered group health plans (or health insurance issuers offering group health insurance plans) to provide certain preventive services without imposing any cost-sharing requirements for these services (the preventive services requirements).
IRS distinguishes between employer-funded HRAs that are "integrated" with other coverage as part of a group health plan (which can meet the PHS Act § 2711 annual limit rules) and HRAs that are not so integrated, i.e., "stand-alone" HRAs (which cannot meet the PHS Act § 2711 lifetime and annual limit rules). Similarly, IRS says a stand-alone HRA would not meet the PHS Act § 2713 preventive services requirement.
Code Sec. 4980D imposes an excise tax on any failure of a group health plan to meet the requirements of Chapter 100 ("Group Health Plan Requirements") of the Code.
The ACA's complex employer-shared responsibility provisions apply only to applicable large employers (ALEs), defined for 2016 as employers that employed an average of at least 50 full-time employees (including full-time equivalent employees) on business days during the preceding year.
Employers, whether or not they are ALEs, are subject to the Code Sec. 4980D excise tax if they maintain group health plans that don't meet the ACA market reform requirements. Notice 2015-17, 2015-10 IRB 845, provided that the Code Sec. 4980D excise tax will not be asserted for any failure to satisfy the market reforms by employer payment plans that pay, or reimburse employees for individual health policy premiums or Medicare part B or Part D premiums
- For 2014, for employers that are not ALEs for 2014, and
- For January 1 through June 30, 2015, for employers that are not ALEs for 2015.
Thus, under prior law, after June 30, 2015, small employers that maintain a stand-alone HRA may be liable for the Code Sec. 4980D excise tax.
New law.Code Sec. 4980D relief for small employers. Effective generally for tax years beginning after Dec. 31, 2016, a qualified small employer HRA is not treated as a group health plan for income tax purposes (except for Code Sec. 4980I(f)(4), as amended by the Act, and notwithstanding any other provision of the Code) (Code Sec. 9831(d)(1), as amended by Act Sec. 18001(a)) There are similar exceptions for ERISA and PHS Act purposes. (Act Sec. 18001(b) and (c), effective for plan years beginning after Dec. 31, 2016)
RIA observation: Thus, under the Act, a qualified small employer HRA will not face the Code Sec. 4980D excise tax levied on group health plans that don't meet the ACA market reform requirements.
Transition rule: Under Act Sec. 18001(a)(7)(b), the relief under Notice 2015-17, is treated as applying to any plan year beginning on or before Dec. 31, 2016.
RIA observation: Thus, for plan years beginning on or before Dec. 31, 2016, HRAs maintained by employers that are not ALEs – that is, small employers with fewer than 50 employees – won't face the Code Sec. 4980D excise tax even if the plans are not qualified small employer HRAs.
Qualified small employer HRA defined. A qualified small employer HRA is one that meets all of the following requirements:
- It is maintained by an eligible employer. (Code Sec. 9831(d)(2)(A)(ii)) An eligible employer is an employer that is not an ALE as defined in Code Sec. 4980H(c)(2) – i.e., it employs fewer than 50 employees — and does not offer a group health plan to any of its employees. (Code Sec. 9831(d)(3)(B))
- It is provided on the same terms to all eligible employees. (Code Sec. 9831(d)(2)(A)(ii)) An eligible employee is any employee of an eligible employer, except that the arrangement may exclude from consideration employees who haven't completed 90 days of service, employees who haven't attained age 25, part-time or seasonal workers, employees covered in a collective bargaining unit, and certain nonresident aliens. (Code Sec. 9831(d)(3)(A))
- It is funded solely by an eligible employer, and no salary reduction contributions may be made under the HRA. (Code Sec. 9831(d)(2)(B)(i))
- It provides, after the employee provides proof of coverage, for the payment of, or reimbursement of, an eligible employee for expenses for medical care (as defined in Code Sec. 213(d)) incurred by the eligible employee or the eligible employee's family members (as determined under the HRA's terms) (Code Sec. 9831(d)(2)(B)(ii)) and
- The amount of payments and reimbursements do not exceed $4,950 ($10,000 in the case of an arrangement that also provides for payments or reimbursements for family members of the employee). (Code Sec. 9831(d)(2)(B)(iii)) For any year beginning after 2016, the above dollar amounts are subject to cost of living increases. (Code Sec. 9831(d)(2)(D)(ii)) For employees who are covered by a qualified arrangement for less than an entire year, the above dollar amounts are prorated.Code Sec. 9831(d)(2)(D)(i))
An arrangement will not fail to be treated as provided on the same terms to each eligible employee merely because the employee's permitted benefit under such arrangement varies in accordance with the variation in the price of an insurance policy in the relevant individual health insurance market based on—
- The age of the eligible employee (and, in the case of an arrangement which covers medical expenses of the eligible employee's family members, the age of such family members), or
- The number of family members of the eligible employee the medical expenses of which are covered under such arrangement. (Code Sec. 9831(d)(2)(C))
Employer reporting requirements. For years beginning after Dec. 31, 2016, an employer funding a qualified arrangement for any year must, not later than 90 days before the beginning of such year (or, in the case of an employee who is not eligible to participate in the arrangement as of the beginning of such year, the date on which such employee is first so eligible), provide a written notice to each eligible employee which includes
- A statement of the amount of the employee's permitted benefit under the arrangement for the year;
- A statement that the eligible employee should provide the information described in clause (i) to any health insurance exchange to which the employee applies for advance payment of the premium assistance tax credit;
- A statement that if the employee is not covered under minimum essential coverage for any month, the employee may be subject to tax under Code Sec. 5000A for such month, and reimbursements under the arrangement may be includible in gross income. (Code Sec. 9831(d)(4))
The term "permitted benefit" means, with respect to any eligible employee, the maximum dollar amount of payments and reimbursements which may be made under the terms of the qualified arrangement for the year with respect to such employee. (Code Sec. 9831(d)(3)(C))
For calendar years that begin after Dec. 31, 2016, employers also have to report contributions to a qualified arrangement on their employees' W-2s. (Code Sec. 6051(a)(15))
Coordination with other rules. For purposes of Code Sec. 105 (Amounts received under accident and health plans) and Code Sec. 106 (Contributions by employer to accident and health plans), payments or reimbursements from a qualified plan aren't treated as paid or reimbursed under employer-provided coverage for medical expenses under an accident or health plan if, for the month in which such medical care is provided, the individual does not have "minimum essential coverage" within the meaning of Code Sec. 5000A(f). (Code Sec. 106(g))
For any month that an employee is provided affordable individual health insurance coverage under a qualified arrangement, he is not eligible for a premium assistance tax credit under Code Sec. 36B. (Code Sec. 36B(c)(4)(A)) The Act sets out a definition for "affordable" for this purpose. (Code Sec. 36B(c)(4)(C))
With the filing season in the rear view mirror, now is the time to think about giving your business a little post-tax season tweaking. The benefit is this, it will make next year's taxes easier and more likely that you will improve your financial standing.
Day-to-day accounting. It can be tough to keep your financial records current. If you are behind the past several months, now is the time to get caught up. If this is the weak link in your business we can help you get current before the lag in accounting starts to hamper your business.
By reconciling your business accounts you will find out if you are current on your expenses and deposits. This investment of time will give you the information you need to evaluate what changes are needed to make your business more profitable.
Retirement plans. If you do not have a retirement plan, consider starting a retirement plan to lower your income taxes and provide future income. This is the best tax deduction out there. You get a tax deduction by funding for your retirement. There are several different types of plans and they all have different start up dates. There are the IRA, Roth-IRA, Simple IRA, SEP-IRA, Profit Sharing, 401(k), to name just a few.
Adjust estimated tax payments or withholdings. If you had a owed a lot of taxes or had a large refund, you may want to adjust your estimated tax payments or withholdings. The benefit is that you will minimize or eliminate any penalties that may be assessed for underpayment of taxes. As the year moves on, monitor your bottom line and adjust your tax estimates accordingly.
Employee benefits. If you have employees consider providing them with tax-free fringe benefits while your business reaps tax savings as well. Adding benefits such as health insurance, group term life insurance, or a cafeteria plan saves your business money. The benefit comes in he form of happier employees which will be more productive and you save money because you are not required to pay the employer’s share of payroll taxes (Social Security and Medicare) on those benefits.
It is always beneficial to tweak your business finances and tax situation now, rather than waiting at the end of the year. By being engaged now, you benefit from valuable tax savings and other opportunities to improve your financial picture.
These are some very common things the IRS pays extra attention to. If you have any of these issues please contact our office so we can prepare your return to maximize your deductions and not lose the deductions and expenses you are entitled to.
- Claiming 100% business use of a vehicle. From the IRS’ point of view, it is rare for an individual to use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use.
- Deducting business meals, travel, and entertainment on Schedule C. Expensing big dollar amounts for meals, travel, and entertainment can cause extra scruntity on your tax return. If the amounts are to high for the type of business listed, expect a letter from the IRS.
- Hobby loss write-offs. If you have wage income and file a Schedule C with large losses, you can expect a letter from the IRS. Typlical hobby issues include and are not limited to dog breeding, dance instruction, furniture refinishing, etc.
- Claiming rental loss deductions. Real estate losses on rental properties is another area of interest for the IRS, especially those written off by taxpayers who claim to be real estate professionals. If you have a W-2 or other non-real-estate businesses that show high income this can be a red flag.
- Operating a small business. Owners of cash-intensive small firms such as taxi companies, hair salons, pet groomers, etc. can often be the target of an audit, so be prepared to substantiate all of your income and your expenses.
- Owning a foreign bank account. The IRS has been able to obtain the ownership information for offshore bank accounts, especially those in tax havens, and is committed to ensuring that income stored in these accounts is reported by U.S. citizens. Failure to report these accounts and the income can lead to stiff penalties and fines.
- Taking higher-than-average deductions. The IRS may pull a return for review if the deductions shown are disproportionately large compared with reported income. But folks who have proper documentation shouldn’t be afraid to claim the write-offs.
While you should definitely take advantage of every tax deduction you are entitled to, sometimes it can be difficult to ascertain which deductions are applicable to your specific situation. Contact our office to help determine you determine you are entitled to deduct.