Unfortunately, the COVID-19 pandemic has forced many businesses to shut down. If this is your situation, we’re here to assist you in any way we can, including taking care of the various tax obligations that must be met.
Of course, a business must file a final income tax return and some other related forms for the year it closes. The type of return to be filed depends on the type of business you have. Here’s a rundown of the basic requirements.
Sole Proprietorships. You’ll need to file the usual Schedule C, “Profit or Loss from Business,” with your individual return for the year you close the business. You may also need to report self-employment tax.
Partnerships. A partnership must file Form 1065, “U.S. Return of Partnership Income,” for the year it closes. You also must report capital gains and losses on Schedule D. Indicate that this is the final return and do the same on Schedules K-1, “Partner’s Share of Income, Deductions, Credits, Etc.”
All Corporations. Form 966, “Corporate Dissolution or Liquidation,” must be filed if you adopt a resolution or plan to dissolve a corporation or liquidate any of its stock.
C Corporations. File Form 1120, “U.S. Corporate Income Tax Return,” for the year you close. Report capital gains and losses on Schedule D. Indicate this is the final return.
S Corporations. File Form 1120-S, “U.S. Income Tax Return for an S Corporation” for the year of closing. Report capital gains and losses on Schedule D. The “final return” box must be checked on Schedule K-1.
All Businesses. Other forms may need to be filed to report sales of business property and asset acquisitions if you sell your business.
Employees and contract workers
If you have employees, you must pay them final wages and compensation owed, make final federal tax deposits and report employment taxes. Failure to withhold or deposit employee income, Social Security and Medicare taxes can result in full personal liability for what’s known as the Trust Fund Recovery Penalty.
If you’ve paid any contractors at least $600 during the calendar year in which you close your business, you must report those payments on Form 1099-NEC, “Nonemployee Compensation.”
Other tax issues
If your business has a retirement plan for employees, you’ll want to terminate the plan and distribute benefits to participants. There are detailed notice, funding, timing and filing requirements that must be met by a terminating plan. There are also complex requirements related to flexible spending accounts, Health Savings Accounts, and other programs for your employees.
We can assist you with many other complicated tax issues related to closing your business, including Paycheck Protection Plan (PPP) loans, the COVID-19 employee retention tax credit, employment tax deferral, debt cancellation, use of net operating losses, freeing up any remaining passive activity losses, depreciation recapture, and possible bankruptcy issues.
We can advise you on the length of time you need to keep business records. You also must cancel your Employer Identification Number (EIN) and close your IRS business account.
If your business is unable to pay all the taxes it owes, we can explain the available payment options to you. Contact us to discuss these issues and get answers to any questions.
© 2020 Covenant CPA
The subject of payroll has been top-of-mind for business owners this year. The COVID-19 pandemic triggered economic changes that caused considerable fluctuations in the size of many companies’ workforces. Employees have been laid off, furloughed and, in some cases, rehired. There has also been crisis relief for eligible businesses in the form of the Paycheck Protection Program and the payroll tax credit.
Payroll recordkeeping was important in the “old normal,” but it’s even more important now as businesses continue to navigate their way through a slowly recovering economy and ongoing public health crisis.
Most employers must withhold federal income, Social Security and Medicare taxes from their employees’ paychecks. As such, you must keep records relating to these taxes for at least four years after the due date of an employee’s personal income tax return (generally, April 15) for the year in which the payment was made. This is often referred to as the “records-in-general rule.”
These records include your Employer Identification Number, as well as your employees’ names, addresses, occupations and Social Security numbers. You should also keep for four years the total amounts and dates of payments of compensation and amounts withheld for taxes or otherwise — including reported tips and the fair market value of noncash payments.
In addition, track and retain the compensation amounts subject to withholding for federal income, Social Security and Medicare taxes, as well as the corresponding amounts withheld for each tax (and the date withheld if withholding occurred on a day different from the payment date). Where applicable, note the reason(s) why total compensation and taxable amount for each tax rate are different.
So much more
A variety of other data and documents fall under the records-in-general rule. Examples include:
- The pay period covered by each payment of compensation,
- Forms W-4, “Employee’s Withholding Allowance Certificate,” and
- Each employee’s beginning and ending dates of employment.
If your business involves customer tipping, you should retain statements provided by employees reporting tips received. Also carefully track fringe benefits provided to employees, including any required substantiation. Retain evidence of adjustments or settlements of taxes and amounts and dates of tax deposits.
Follow the records-in-general rule, too, for records relating to wage continuation payments made to employees by the employer or third party under an accident or health plan. Documentation should include the beginning and ending dates of the period of absence, and the amount and weekly rate of each payment (including payments made by third parties).
Last, keep copies of each employee’s Form W-4S, “Request for Federal Income Tax Withholding From Sick Pay,” and, where applicable, copies of Form 8922, “Third-Party Sick Pay Recap.”
Proper and comprehensive payroll recordkeeping has become even more critical — and potentially more complex — this year. Our firm can help review your processes in this area and identify improvements that will enable you to avoid compliance problems and make better use of this valuable information.
© 2020 Covenant CPA
If you recently launched a business, you may want to set up a tax-favored retirement plan for yourself and your employees. There are several types of qualified plans that are eligible for these tax advantages:
- A current deduction from income to the employer for contributions to the plan,
- Tax-free buildup of the value of plan investments, and
- The deferral of income (augmented by investment earnings) to employees until funds are distributed.
There are two basic types of plans.
Defined benefit pension plans
A defined benefit plan provides for a fixed benefit in retirement, based generally upon years of service and compensation. While defined benefit plans generally pay benefits in the form of an annuity (for example, over the life of the participant, or joint lives of the participant and his or her spouse), some defined benefit plans provide for a lump sum payment of benefits. In certain “cash balance plans,” the benefit is typically paid and expressed as a cash lump sum.
Adoption of a defined benefit plan requires a commitment to fund it. These plans often provide the greatest current deduction from income and the greatest retirement benefit, if the business owners are nearing retirement. However, the administrative expenses associated with defined benefit plans (for example, actuarial costs) can make them less attractive than the second type of plan.
Defined contribution plans
A defined contribution plan provides for an individual account for each participant. Benefits are based solely on the amount contributed to the participant’s account and any investment income, expenses, gains, losses and forfeitures (usually from departing employees) that may be allocated to a participant’s account. Profit-sharing plans and 401(k)s are defined contribution plans.
A 401(k) plan provides for employer contributions made at the direction of an employee under a salary reduction agreement. Specifically, the employee elects to have a certain amount of pay deferred and contributed by the employer on his or her behalf to the plan. Employee contributions can be made either:
- On a pre-tax basis, saving employees current income tax on the amount contributed, or
- On an after-tax basis. This includes Roth 401(k) contributions (if permitted), which will allow distributions (including earnings) to be made to the employee tax-free in retirement, if conditions are satisfied.
Automatic-deferral provisions, if adopted, require employees to opt out of participation.
An employer may, or may not, provide matching contributions on behalf of employees who make elective deferrals to the plan. Matching contributions may be subject to a vesting schedule. While 401(k) plans are subject to testing requirements, so that “highly compensated” employees don’t contribute too much more than non-highly-compensated employees, these tests can be avoided if you adopt a “safe harbor” 401(k) plan. A highly compensated employee in 2020 is defined as one who earned more than $130,000 in the preceding year.
There are other types of tax-favored retirement plans within these general categories, including employee stock ownership plans (ESOPs).
Small businesses can also adopt a Simplified Employee Pension (SEP), and receive similar tax advantages to “qualified” plans by making contributions on behalf of employees. And a business with 100 or fewer employees can establish a Savings Incentive Match Plan for Employees (SIMPLE). Under a SIMPLE, generally an IRA is established for each employee and the employer makes matching contributions based on contributions elected by employees.
There may be other options. Contact us to discuss the types of retirement plans available to you.
© 2020 Covenant CPA
As year-end draws near, many businesses will be not only be generating their fourth quarter financial statements, but also looking back on the entire year’s financials. And what a year it’s been. The COVID-19 pandemic and resulting economic fallout have likely affected your sales and expenses, and you’ve probably noticed the impact on both. However, don’t overlook the importance of inventory management and its impact on your financial statements.
Cut back as necessary
Carrying too much inventory can reflect poorly on a business as the value of surplus items drops throughout the year. In turn, your financial statements won’t look as good as they could if they report a substantial amount of unsold goods.
Taking stock and perhaps cutting back on excess inventory reduces interest and storage costs. Doing so also improves your ability to detect fraud and theft. Yet another benefit is that, if you conduct inventory checks regularly, your processes should evolve over time — increasing your capacity to track what’s in stock, what’s selling and what’s not.
One improvement to perhaps budget for here: upgraded inventory tracking and ordering software. Newer applications can help you better forecast demand, minimize overstocking, and share data with suppliers to improve accuracy and efficiency.
Make tough decisions
If yours is a more service-oriented business, you can apply a similar approach. Check into whether you’re “overstocking” on services that just aren’t adding enough revenue to the bottom line anymore. Keeping infrastructure and, yes, even employees in place that aren’t contributing to profitability is much like leaving items on the shelves that aren’t selling.
Making improvements may require some tough calls. Sadly, this probably wouldn’t be the first time you’ve had to make difficult decisions in recent months. Many business owners have had to lay off or furlough employees and substantively alter how they deliver their products or services during the COVID-19 crisis.
You might have long-time customers to whom you provide certain services that just aren’t profitable anymore. If your company might start losing money on these customers, you may have to discontinue the services and sacrifice their business.
You can ease difficult transitions like this by referring customers to another, reputable service provider. Meanwhile, your business should be looking to either find new service areas to generate revenue or expand existing services to more robust market segments.
Take a hard look
As of this writing, the economy appears to be slowly recovering for most (though not all) industries. An environment like this means every dollar is precious and any type of waste or redundancy is even more dangerous.
Take a hard look at your approach to inventory management, or how you’re managing the services you provide, to ensure you’re in step with the times. We can help your business implement cost-effective inventory tracking processes, as well as assist you in gaining key insights from your financial statements.
© 2020 Covenant CPA
It’s been a year like no other. The sudden impact of the COVID-19 pandemic in March forced every business owner — ready or not — to execute his or her disaster response plan.
So, how did yours do? Although it may still be a little early to do a complete assessment of what went right and wrong during the crisis, you can take a quick look back right now while the experience is still fresh in your mind.
When devising a disaster response plan, brainstorm as many scenarios as possible that could affect your company. What weather-related, environmental and socio-political threats do you face? Obviously, you can now add “pandemic” to the list.
The operative word, however, is “your.” Every company faces distinctive threats related to its industry, size, location(s), and products or services. Identify these as specifically as possible, based on what you’ve learned.
There are some constants for nearly every plan. Seek out alternative suppliers who could fill in for your current ones if necessary. Fortify your IT assets and functionality with enhanced recovery and security capabilities.
Another critical factor during and after a crisis is communication, both internal and external. Review whether and how your business was able to communicate in the initial months of the pandemic.
You and most of your management team probably needed to concentrate on maintaining or restoring operations. Who communicated with employees and other stakeholders to keep them abreast of your response and recovery progress? Typically, these parties include:
- Staff members and their families,
- Banks and other financial stakeholders, and
- Local authorities, first responders and community leaders (as appropriate).
Look into the communication channels that were used — such as voicemail, text messaging, email, website postings and social media. Which were most and least effective? Would some type of new technology enable your business to communicate better?
Revisit and update
If the events of this past spring illustrate anything, it’s that companies can’t create a disaster response plan and toss it on a shelf. Revisit the plan at least annually, looking for adjustments and new risk factors.
You’ll also want to keep the plan clear in the minds of your employees. Be sure that everyone — including new hires — knows exactly what to do by spelling out the communication channels, contacts and procedures you’ll use in the event of a disaster. Everyone should sign a written confirmation that they’ve read the plan’s details, either when hired or when the plan is substantially updated.
In addition, go over disaster response measures during company meetings once or twice a year. You might even want to hold live drills to give staff members a chance to practice their roles and responsibilities.
Heed the lessons
For years, advisors urged business owners to prepare for disasters or else. This year we got the “or else.” Despite the hardships and continuing challenges, however, the lessons being learned are invaluable. Please contact us to discuss ways to manage costs and maintain profitability during these difficult times.
© 2020 Covenant CPA
IRS audit rates are historically low, according to the latest data, but that’s little consolation if your return is among those selected to be examined. But with proper preparation and planning, you should fare well.
In fiscal year 2019, the IRS audited approximately 0.4% of individuals. Businesses, large corporations and high-income individuals are more likely to be audited but, overall, all types of audits are being conducted less frequently than they were a decade ago.
There’s no 100% guarantee that you won’t be picked for an audit, because some tax returns are chosen randomly. However, the best way to survive an IRS audit is to prepare for one in advance. On an ongoing basis you should systematically maintain documentation — invoices, bills, cancelled checks, receipts, or other proof — for all items to be reported on your tax returns. Keep all your records in one place. And it helps to know what might catch the attention of the IRS.
Audit hot spots
Certain types of tax-return entries are known to the IRS to involve inaccuracies so they may lead to an audit. Here are a few examples:
- Significant inconsistencies between tax returns filed in the past and your most current tax return,
- Gross profit margin or expenses markedly different from those of other businesses in your industry, and
- Miscalculated or unusually high deductions.
Certain types of deductions may be questioned by the IRS because there are strict recordkeeping requirements for them — for example, auto and travel expense deductions. In addition, an owner-employee salary that’s inordinately higher or lower than those in similar companies in his or her location can catch the IRS’s eye, especially if the business is structured as a corporation.
Responding to a letter
If you’re selected for an audit, you’ll be notified by letter. Generally, the IRS doesn’t make initial contact by phone. But if there’s no response to the letter, the agency may follow up with a call.
Many audits simply request that you mail in documentation to support certain deductions you’ve taken. Others may ask you to take receipts and other documents to a local IRS office. Only the harshest version, the field audit, requires meeting with one or more IRS auditors. (Note: Ignore unsolicited email messages about an audit. The IRS doesn’t contact people in this manner. These are scams.)
Keep in mind that the tax agency won’t demand an immediate response to a mailed notice. You’ll be informed of the discrepancies in question and given time to prepare. You’ll need to collect and organize all relevant income and expense records. If any records are missing, you’ll have to reconstruct the information as accurately as possible based on other documentation.
If the IRS chooses you for an audit, our firm can help you:
- Understand what the IRS is disputing (it’s not always clear),
- Gather the specific documents and information needed, and
- Respond to the auditor’s inquiries in the most expedient and effective manner.
The IRS normally has three years within which to conduct an audit, and often an audit doesn’t begin until a year or more after you file a return. Don’t panic if you’re contacted by the IRS. Many audits are routine. By taking a meticulous, proactive approach to how you track, document and file your company’s tax-related information, you’ll make an audit much less painful and even decrease the chances that one will happen in the first place.
© 2020 Covenant CPA
Whether it’s a smart phone, tablet or laptop, mobile devices have become the constant companions of today’s employees. And this relationship has only been further cemented by the COVID-19 pandemic, which has thousands working from home or other remote locations.
From a productivity standpoint, this is a good thing. So many tasks that once kept employees tied to their desks are now doable from anywhere on flexible schedules. All this convenience, however, brings considerable risk.
Perhaps the most obvious threat to any company-owned mobile device is theft. That could end a workday early, hamper productivity for days, and lead to considerable replacement hassles and expense. Indeed, given the current economy, thieves may be increasing their efforts to snatch easy-to-grab and easy-to-sell technological items.
Worse yet, a stolen or hacked mobile device means thieves and hackers could gain possession of sensitive, confidential data about your company, as well as its customers and employees.
Amateur criminals might look for credit card numbers to fraudulently buy goods and services. More sophisticated ones, however, may look for Social Security numbers or Employer Identification Numbers to commit identity theft.
5 protective measures
There are a variety of ways that businesses can reinforce protections of their mobile devices. Here are five to consider:
1. Standardize, standardize, standardize. Having a wide variety of makes and models increases risk. Moving toward a standard product and operating system will allow you to address security issues across the board rather than dealing with multiple makes and their varying security challenges.
2. Password protect. Make sure that employees use “power-on” passwords — those that appear whenever a unit is turned on or comes out of sleep mode. In addition, configure devices to require a power-on password after 15 minutes of inactivity and to block access after a specified number of unsuccessful log-in attempts. Require regular password changes, too.
3. Set rules for data. Don’t allow employees to store certain information, such as Social Security numbers, on their devices. If sensitive data must be transported, encrypt it. (That is, make the data unreadable using special coding.)
4. Keep it strictly business. Employees are often tempted to mix personal information with business data on their portable devices. Issue a company policy forbidding or severely limiting this practice. Moreover, establish access limits on networks and social media.
5. Fortify your defenses. Be sure your mobile devices have regularly and automatically updated security software to prevent unauthorized access, block spyware/adware and stop viruses. Consider retaining the right to execute a remote wipe of an asset’s memory if you believe it’s been stolen or hopelessly lost.
More than an object
When assessing the costs associated with a mobile device, remember that it’s not only the value of the physical item that matters, but also the importance and sensitivity of the data stored on it. We can help your business implement a cost-effective process for procuring and protecting all its technology.
© 2020 Covenant CPA
Do you buy or lease computer software to use in your business? Do you develop computer software for use in your business, or for sale or lease to others? Then you should be aware of the complex rules that apply to determine the tax treatment of the expenses of buying, leasing or developing computer software.
Some software costs are deemed to be costs of “purchased” software, meaning software that’s either:
- Non-customized software available to the general public under a non-exclusive license or
- Acquired from a contractor who is at economic risk should the software not perform.
The entire cost of purchased software can be deducted in the year that it’s placed into service. The cases in which the costs are ineligible for this immediate write-off are the few instances in which 100% bonus depreciation or Section 179 small business expensing isn’t allowed or when a taxpayer has elected out of 100% bonus depreciation and hasn’t made the election to apply Sec. 179 expensing. In those cases, the costs are amortized over the three-year period beginning with the month in which the software is placed in service. Note that the bonus depreciation rate will begin to be phased down for property placed in service after calendar year 2022.
If you buy the software as part of a hardware purchase in which the price of the software isn’t separately stated, you must treat the software cost as part of the hardware cost. Therefore, you must depreciate the software under the same method and over the same period of years that you depreciate the hardware. Additionally, if you buy the software as part of your purchase of all or a substantial part of a business, the software must generally be amortized over 15 years.
You must deduct amounts you pay to rent leased software in the tax year they’re paid, if you’re a cash-method taxpayer, or the tax year for which the rentals are accrued, if you’re an accrual-method taxpayer. However, deductions aren’t generally permitted before the years to which the rentals are allocable. Also, if a lease involves total rentals of more than $250,000, special rules may apply.
Software developed by your business
Some software is deemed to be “developed” (designed in-house or by a contractor who isn’t at risk if the software doesn’t perform). For tax years beginning before calendar year 2022, bonus depreciation applies to developed software to the extent described above. If bonus depreciation doesn’t apply, the taxpayer can either deduct the development costs in the year paid or incurred or choose one of several alternative amortization periods over which to deduct the costs. For tax years beginning after calendar year 2021, generally the only allowable treatment will be to amortize the costs over the five-year period beginning with the midpoint of the tax year in which the expenditures are paid or incurred.
If following any of the above rules requires you to change your treatment of software costs, it will usually be necessary for you to obtain IRS consent to the change.
We can assist you in applying the tax rules for treating computer software costs in the way that is most advantageous for you.
© 2020 Covenant CPA
The business use of websites is widespread. But surprisingly, the IRS hasn’t yet issued formal guidance on when Internet website costs can be deducted.
Fortunately, established rules that generally apply to the deductibility of business costs, and IRS guidance that applies to software costs, provide business taxpayers launching a website with some guidance as to the proper treatment of the costs.
Hardware or software?
Let’s start with the hardware you may need to operate a website. The costs involved fall under the standard rules for depreciable equipment. Specifically, once these assets are up and running, you can deduct 100% of the cost in the first year they’re placed in service (before 2023). This favorable treatment is allowed under the 100% first-year bonus depreciation break.
In later years, you can probably deduct 100% of these costs in the year the assets are placed in service under the Section 179 first-year depreciation deduction privilege. However, Sec. 179 deductions are subject to several limitations.
For tax years beginning in 2020, the maximum Sec. 179 deduction is $1.04 million, subject to a phaseout rule. Under the rule, the deduction is phased out if more than a specified amount of qualified property is placed in service during the year. The threshold amount for 2020 is $2.59 million.
There’s also a taxable income limit. Under it, your Sec. 179 deduction can’t exceed your business taxable income. In other words, Sec. 179 deductions can’t create or increase an overall tax loss. However, any Sec. 179 deduction amount that you can’t immediately deduct is carried forward and can be deducted in later years (to the extent permitted by the applicable limits).
Similar rules apply to purchased off-the-shelf software. However, software license fees are treated differently from purchased software costs for tax purposes. Payments for leased or licensed software used for your website are currently deductible as ordinary and necessary business expenses.
Was the software developed internally?
An alternative position is that your software development costs represent currently deductible research and development costs under the tax code. To qualify for this treatment, the costs must be paid or incurred by December 31, 2022.
A more conservative approach would be to capitalize the costs of internally developed software. Then you would depreciate them over 36 months.
If your website is primarily for advertising, you can also currently deduct internal website software development costs as ordinary and necessary business expenses.
Are you paying a third party?
Some companies hire third parties to set up and run their websites. In general, payments to third parties are currently deductible as ordinary and necessary business expenses.
What about before business begins?
Start-up expenses can include website development costs. Up to $5,000 of otherwise deductible expenses that are incurred before your business commences can generally be deducted in the year business commences. However, if your start-up expenses exceed $50,000, the $5,000 current deduction limit starts to be chipped away. Above this amount, you must capitalize some, or all, of your start-up expenses and amortize them over 60 months, starting with the month that business commences.
We can determine the appropriate treatment of website costs for federal income tax purposes. Contact us if you have questions or want more information.
© 2020 Covenant CPA