Monday, March 24, 2014

S CORPS Vs LLC: Not A Court Case But A Real Decision To Be Made

Someone said, "The 3 C's of life were: CHOICES, CHANCES & CHANGES. One must make a choice to take a chance or one's life will never change". We are faced with choice in every thing we do, and making the right choices requires sound knowledge of the various options available to us. 

When choosing an operating entity for a company, it is very important that we thoroughly research the options available. Your business can be a sole proprietorship, a partnership with someone else, a single member LLC, a pass through entity like an S Corporation or it can be a C corporation. What I will layout in this blog today are the characteristics of an Limited Liability Company & an S Corporation; the pros & cons of choosing each entity type; & converting from one entity to another. 

What Is an LLC?: 

  • An LLC is a business structure similar to a sole-proprietorship or a general partnership. According to the IRS, 'It is designed to provide the limited liability features of a corporation and the tax efficiency and operational flexibility of a partnership. 
  • As a pass-through entity, all profits and losses pass through the business to the LLC owners (AKA 'members'). 
  • The members themselves report the profits/losses on their federal tax returns but not the LLC. Some states charge the LLC an income tax.
  • What differentiates the LLC is the limit of the liability for which a member is responsible. Typically, the member's investment in the company is that limit. 

Pros and Cons of the LLC:

  • One of the features that distinguishes the LLC from an S-Corp is its operational ease. There are far fewer forms required for registering and there are fewer start-up costs. Filing taxes is a once-a-year affair on April 15: a single-member LLC files a 1040 and Schedule C like a sole proprietor; partners in an LLC file a 1065 partnership tax return like owners in a traditional partnership. 
  • There are also fewer restrictions on profit-sharing within an LLC as members distribute profits as they see fit. Members might contribute different proportions of capital. Consequently, it's up to them to decide who has earned what percentage of the profits or losses. Moreover, LLCs are not required to have formal meetings and keep minutes.
  • LLCs are not the perfect entity for all businesses. First, an LLC has a limited life: when a member dies or undergoes bankruptcy, the LLC is dissolved. Typically, you would determine in advance the length of the LLC's duration when you file it with your state. If your future plans include taking your company public or issuing shares to your employees (essentially prolonging its life), then you would need to convert to a corporate business structure.
  • The owner of an LLC is considered to be self-employed and must pay the 15.3% self-employment tax contributions towards Medicare and social security. As such, the entire net income of the LLC is subject to this tax. 
  • The IRS also limits the 'characteristics' of your company. An LLC may only have two of the four characteristics that define corporations: 'Limited liability to the extent of assets, continuity of life, centralization of management, and free transferability of ownership interests.' Therefore, if you wish to have more than two of these characteristics, you'll need to convert to a corporate business structure.

What is an S-Corp?:
  • An S-Corp is a corporation that has received the Subchapter S designation from the IRS. A business must first be chartered as a corporation in the state where it's headquartered then file to be considered an S-Corp. 
  • According to the IRS, S-Corporations are "considered by law to be a unique entity, separate and apart from those who own it". This allows for a limit on the financial liability for which an owner (AKA 'shareholder') is responsible. 
  • The S-Corp has the ability to have profits and losses pass through to the shareholder's personal tax return. Therefore the business is not taxed itself, only the shareholders. 
  • There is an important caveat: any shareholder who works for the company must pay him or herself "reasonable compensation". Basically, the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as 'wages.' 
Pros and Cons of the S-Corp:
  • One of the best features of the S-Corp is the tax savings for you and your business. If you remember, the members of an LLC are subject to employment tax on the entire net income of the business. Conversely, only the wages of the S-Corp shareholder who is an employee are subject to employment tax. The remaining income is paid to the owner as a 'distribution' which is taxed at the same rate as the rest of the shareholder's income.
  • The benefits that shareholder/employees receive can be written off as business expenses. 
  • An S-Corp also allows the business to have an independent life separate from the shareholders. If a shareholder dies, leaves the company, or sells his or her shares the S-Corp can continue doing business relatively undisturbed. Thus by maintaining the business as a distinct corporate entity, clearer lines are defined between the shareholders and the business that improve the protection of the shareholders.
  • These could however come with a price, as a separate structure, S-Corps require scheduled director and shareholder meetings, minutes from those meetings, adoption and updates to by-laws, stock transfers and records maintenance.
  • There will be a greater number of forms required by the IRS for an S Corp. 
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Combining the Benefits of an LLC with an S-Corp:
  • There is always the possibility of requesting S-Corp status for your LLC. Your tax professional can advise you on the pros and cons. 
  • A special election has to be made with the IRS to have the LLC taxed as an S-Corp using Form 2553. 
  • This must be filed before the first two months and fifteen days of the beginning of the tax year in which the election is to take effect. Some late elections are allowed by the IRS under special circumstances. 
It is important that you consult a qualified tax professional to walk you through this arduous process and to weigh in on the best choice that needs to be made. 

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. 
More of my contact information is on my website,

Sunday, March 16, 2014

The Homeowner's Guide To Deductions

We had a quintessential jovial uncle in the family who said, "Fools build houses for wise men to live in". He may have been partly right in his own case since he ended up moving every time he bought a home. 

But for those new home owners, things may not seem so foolish when they come to the realization that they may be able to itemize deductions they couldn't before. The standard deduction is $6100 for those filing single & $12200 for those filing married joint. Having enough in itemized deductions to take you above the standard will help bring down your tax liability. 

So what are these additional deductions that lower your taxes & increase your refunds? Let's take a look! 

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  • Mortgage Interest: This one is a biggie & the most common one & every knows (or should know) about it! The cap on deductibility is $1.1 million in mortgage debt!  This can include first and second mortgages. It can also include first and second homes. Interest on home equity loans are deductible as well- beware though if the home equity loan was not used to improve your home, you cannot deduct it. Points paid to bring down the rate of the loan can also be amortized over the life of the loan on your federal tax return. 
  •  Private Mortgage Insurance (PMI): It is the insurance you pay your mortgage company if you didn't put down 20%. Mind you, 2013 may be the last year you can claim PMI and it has to be on your form 1098. Please don't confuse this with hazard insurance you pay for protection against fire or loss. 
  • Residential Energy Credits: 2013 can also be the last year to claim up to $500 in green energy credits. You can claim Insulation, energy efficient windows, doors, high efficiency air conditioners, heaters, installed in your main residence. There is an additional credit for solar energy installations in your primary residence. 
  • Property Taxes: Property taxes paid on your primary residence can also be itemized on your federal tax return. Many states also provide a credit for property taxes against your state tax in addition to the federal. Make sure you know if the state you live in allows these credits and what the amounts are.
  •  Casualty Losses: Given the harsh winter we have had in most of North America, many of us have dealt with flooded basements & other casualty losses. You can get a tax break from a loss from disaster. This loss has to be out-of-pocket, and must exceed 10% of your income & not covered and compensated by your insurance. Make sure you can prove the value of your loss. 
So folks, don't be like my uncle, use your home deductions wisely and continue to stay in & enjoy your home. 

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. 
More of my contact information is on my website,

Sunday, March 9, 2014

Saving For Retirement? Wrangle a Credit Out Of It!!

Warren Buffet, the modern day Guru of all-things-financial, the Investing Pundit of the 21st century, has said "No matter how great the talent or efforts, some things just take time. You can't produce a baby in one month by getting nine women pregnant.” There is truth in this statement for all but especially for those who are in the lower income brackets, or those starting on their career paths, saving a little over time adds up! 

 So you just got a job or you are one of those who are thinking of starting up your retirement basket, the Internal Revenue Service (IRS) has an incentive for you. It's called the "Saver's Credit". It is available to you if you contribute to a 401K or an IRA. 

The credit is worth $2000 to taxpayers filing with the "Married Filing Joint" status and worth $1000 to those filing "Single". So you can see that the amount of credit depends on your filing status. 

The eligibility for the credit also depends on your annual income (the following are for 2013 Tax Year): 
  • Married filing separately or a single taxpayer with income up to $29,500
  • Head of household with income up to $44,250
  • Married filing jointly with income up to $59,000

This credit is further restricted by the following rules: 

  • You must be at least 18 years of age.
  • You can’t have been a full-time student in 2013.
  • You can’t be claimed as a dependent on another person’s tax return.

The retirement contribution has to be made by the end of the year, however an IRA contribution can be made before April 15th to qualify for the credit. It is claimed on Form 8880. 
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You can see the income thresholds to be eligible for this credit are phased out at lower amounts.  Maybe it is an incentive for taxpayers with lower incomes to save for their retirement, but something to be considered nonetheless. There is an Indian saying that roughly translates as "Little drops of water make pearls"! I tell my younger clients that it's never too early to start saving for retirement, one can be eligible for this credit in addition to tax savings that IRAs/ 401Ks provide. 

Bibliography: Form 8880

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. 
More of my contact information is on my website,