Author Archive: CCG

An S-Corporation could cut your Self-employment tax

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If your business is organized as a sole proprietorship or as a wholly owned limited liability company (LLC), you’re subject to both income tax and self-employment tax. There may be a way to cut your tax bill by conducting business as an S corporation.

Fundamentals of self-employment tax

The self-employment tax is imposed on 92.35% of self-employment income at a 12.4% rate for Social Security up to a certain maximum ($142,800 for 2021) and at a 2.9% rate for Medicare. No maximum tax limit applies to the Medicare tax. An additional 0.9% Medicare tax is imposed on income exceeding $250,000 for married couples ($125,000 for married persons filing separately) and $200,000 in all other cases.

What if you conduct your business as a partnership in which you’re a general partner? In that case, in addition to income tax, you’re subject to the self-employment tax on your distributive share of the partnership’s income. On the other hand, if you conduct your business as an S corporation, you’ll be subject to income tax, but not self-employment tax, on your share of the S corporation’s income.

An S corporation isn’t subject to tax at the corporate level. Instead, the corporation’s items of income, gain, loss and deduction are passed through to the shareholders. However, the income passed through to the shareholder isn’t treated as self-employment income. Thus, by using an S corporation, you may be able to avoid self-employment income tax.  

Keep your salary “reasonable”

Be aware that the IRS requires that the S corporation pay you reasonable compensation for your services to the business. The compensation is treated as wages subject to employment tax (split evenly between the corporation and the employee), which is equivalent to the self-employment tax. If the S corporation doesn’t pay you reasonable compensation for your services, the IRS may treat a portion of the S corporation’s distributions to you as wages and impose Social Security taxes on the amount it considers wages.

There’s no simple formula regarding what’s considered reasonable compensation. Presumably, reasonable compensation is the amount that unrelated employers would pay for comparable services under similar circumstances. There are many factors that should be taken into account in making this determination.

Converting from a C corporation 

There may be complications if you convert a C corporation to an S corporation. A “built-in gains tax” may apply when you dispose of appreciated assets held by the C corporation at the time of the conversion. However, there may be ways to minimize its impact.

Many factors to consider

Contact us if you’d like to discuss the factors involved in conducting your business as an S corporation, and how much the business should pay you as compensation.

© 2021 Covenant CPA

Defending your Auto Dealership from Fraud

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Although auto sales plunged at the start of the COVID-19 pandemic, they’ve since rebounded. In fact, some dealerships are reporting record sales in 2021. Problems remain — including supply bottlenecks. Also, your dealership may be more vulnerable to fraud. Factors such as employees working from home, new vendors and even booming sales, can put your business at risk. Here’s how to prevent fraud from cutting into profits.

Focus on accounting

Fraud prevention starts with strong internal controls. For example, good controls generally require a dealership’s accounting department to post transactions daily, including new and used vehicle sales, repair orders, invoice payments, payroll and cash receipts.

By 1 p.m. on any given day, you should have access to real-time checkbook balances and other accounting information effective as of 5 p.m. the day before. Timeliness makes it easier for you to spot the first signs of fraud and use the data to catch a perpetrator before he or she gets away with theft.

Protections that work

Complex computer passwords that must be changed frequently, background checks on employees and vendors, and security cameras are also essential to preventing fraud. But these protections may have fallen by the wayside during the pandemic. Review your safeguards now and ensure they’re being used.

Your business should always “segregate” duties. Generally, this means that certain tasks, such as managing payroll, are broken into pieces and performed by more than one employee. This limits opportunities to perpetrate fraud and cover up the crime. If you don’t have enough workers to properly segregate duties, consider outsourcing one or more accounting functions to a third-party service.

Loose controls lead to losses

To understand how loose controls can facilitate theft, consider the real-life example of a parts manager who stole $70,000 by selling his employer’s parts and pocketing the cash. If the dealership’s owner had performed random inventory counts throughout the year, rather than waiting for his CPA to physically verify inventories at year end, he could have prevented or limited losses.

In another case, a dealership caught its cashier stealing by voiding service orders and falsifying deposit slips. The cashier’s responsibilities included collecting cash, issuing receipts to customers, preparing the daily deposit slip and reconciling the daily cash report. A loss of $16,000 might have been prevented if the dealership had segregated these duties.

Back to normal

The pandemic is waning. But that doesn’t mean you can afford to relax fraud protections. If you didn’t get a chance to properly vet new workers or vendors in the past year or haven’t kept up with inventory checks, get back to your usual controls as soon as possible. Contact us if you need help or if you suspect fraud in your dealership.

© 2021 Covenant CPA

Look at your Employee Handbook with Fresh Eyes

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For businesses, so much has changed over the past year or so. The COVID-19 pandemic hit suddenly and companies were forced to react quickly — sending many employees home to work remotely and making myriad other tweaks and revisions to their processes.

Understandably, you may not have fully documented all the changes you’ve made. But you should; and among the ideal places to do so is in your employee handbook. Now that optimism is rising for a return to relative normalcy, why not look at your handbook with fresh eyes and ensure it accurately represents your company’s policies and procedures.

Legal considerations

Among the primary reasons companies create employee handbooks is protection from legal challenges. Clearly written HR policies and procedures will strengthen your defense if an employee sues. Don’t wait to test this theory in court: Ask your attorney to review the legal soundness of your handbook and make all recommended changes.

Why is this so important? A supervisor without a legally sound and updated employee handbook is like a coach with an old rulebook. You can’t expect supervisors or team members to play by the rules if they don’t know whether and how those rules have changed.

Make sure employees sign a statement acknowledging that they’ve read and understood the latest version of your handbook. Obviously, this applies to new hires, but also ask current employees to sign a new statement when you make major revisions.

Motivational language

Employee handbooks can also communicate the total value of working for your company. Workers don’t always appreciate the benefits their employers provide. This is often because they, and maybe even some managers, aren’t fully aware of those offerings.

Your handbook should express that you care about employees’ welfare — a key point to reinforce given the events of the past year. It also should show precisely how you provide support.

To do so, identify and explain all employee benefits. Don’t stop with the obvious descriptions of health care and retirement plans. Describe your current paid sick time and paid leave policies, which have no doubt been transformed by federal COVID relief measures, as well as any work schedule flexibility and fringe benefits that you offer.

Originality and specificity

One word of caution: When updating their handbooks, some businesses acquire a “best in class” example from another employer and try to adopt it as their own. Doing so generally isn’t a good idea. That other handbook’s tone may be inappropriate or at least inconsistent with your industry or organizational culture.

Similarly, be careful about downloading handbook templates from the Internet. Chances are you’ll have no idea who wrote the original, let alone if it complies with current laws and regulations.

Document and guide

Your employee handbook should serve as a clearly written document for legal purposes and a helpful guide for your company’s workforce. Our firm can help you track your employment costs and develop solutions to any challenges you face.

© 2021

Beware of the “reciprocal trust” doctrine

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If you and your spouse have similar irrevocable trusts that benefit each other, it’s important to know that the trusts might be subject to the “reciprocal trust” doctrine. In a nutshell, the doctrine prohibits tax avoidance through trusts that are interrelated and place both spouses in the same economic position as if they’d each created trusts naming themselves as life beneficiaries.

Avoid this scenario

Let’s suppose that your and your spouse’s estates will trigger a substantial tax bill when you die. You transfer your assets to an irrevocable trust that provides your spouse with an income interest for life, access to principal at the trustee’s discretion and a testamentary, special power of appointment to distribute the trust assets among your children.

Ordinarily, assets transferred to an irrevocable trust are removed from your taxable estate (though there may be gift tax implications). But let’s say that two weeks later, your spouse establishes a trust with a comparable amount of assets and identical provisions, naming you as life beneficiary. This arrangement would violate the reciprocal trust doctrine, so for tax purposes the transfers would be undone by the IRS and the value of the assets you transferred would be included in your respective estates.

In this example, the intent to avoid estate tax is clear: Each spouse removes assets from his or her taxable estate but remains in essentially the same economic position by virtue of being named life beneficiary of the other spouse’s estate.

Create two substantially different trusts

There are many ways to design trusts to avoid the reciprocal trust doctrine, but essentially the goal is to vary factors related to each trust, such as the trust assets, terms, trustees, beneficiaries or creation dates, so that the two trusts aren’t deemed “substantially similar” by the IRS. Contact us to learn more.

© 2021 Covenant CPA

Working in the gig economy results in tax obligations

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Before the COVID-19 pandemic hit, the number of people engaged in the “gig” or sharing economy had been growing, according to several reports. And reductions in working hours during the pandemic have caused even more people to turn to gig work to make up lost income. There are tax consequences for the people who perform these jobs, which include providing car rides, delivering food, walking dogs and providing other services.

Bottom line: If you receive income from freelancing or from one of the online platforms offering goods and services, it’s generally taxable. That’s true even if the income comes from a side job and even if you don’t receive an income statement reporting the amount of money you made.

Basics for gig workers

The IRS considers gig workers as those who are independent contractors and conduct their jobs through online platforms. Examples include Uber, Lyft, Airbnb and DoorDash.

Unlike traditional employees, independent contractors don’t receive benefits associated with employment or employer-sponsored health insurance. They also aren’t covered by the minimum wage or other protections of federal laws and they aren’t part of states’ unemployment insurance systems. In addition, they’re on their own when it comes to retirement savings and taxes.

Pay taxes throughout the year

If you’re part of the gig or sharing economy, here are some tax considerations.

  • You may need to make quarterly estimated tax payments because your income isn’t subject to withholding. These payments are generally due on April 15, June 15, September 15 and January 15 of the following year. (If a due date falls on a Saturday or Sunday, the due date becomes the next business day.)
  • You should receive a Form 1099-NEC, Nonemployee Compensation, a Form 1099-K or other income statement from the online platform.
  • Some or all of your business expenses may be deductible on your tax return, subject to the normal tax limitations and rules. For example, if you provide rides with your own car, you may be able to deduct depreciation for wear and tear and deterioration of the vehicle. Be aware that if you rent a room in your main home or vacation home, the rules for deducting expenses can be complex.

Keeping records

It’s important to keep good records tracking income and expenses in case you are audited by the IRS or state tax authorities. Contact us if you have questions about your tax obligations as a gig worker or the deductions you can claim. You don’t want to get an unwanted surprise when you file your tax return.

© 2021 Covenant CPA

Fending off “friendly” fraud

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Fraudulent behavior isn’t necessarily perpetuated by people hiding their identities. For example, legitimate customers sometimes use the credit card chargeback process to their advantage — and to the disadvantage of merchants. Others routinely abuse chargebacks to steal merchandise. Here’s how to protect your business from these types of “friendly” and sometimes dishonest fraud.

Chargeback mechanics

Friendly fraud pivots on a customer’s failure to communicate with a merchant. Instead of contacting a seller to discuss a problem with a good or service, some customers immediately dispute a charge with their bank or credit card company. They generally provide plausible reasons for the dispute and don’t mask their identify at any phase of the process.

A chargeback takes time and effort to resolve. And if the bank or credit card company honors a customer’s dispute (which they often do), the merchant must assume the loss.

4 steps

To prevent such chargebacks from harming your bottom line:

1. Track shipments. Keep an “eye” on orders from the moment they leave your facility to their arrival at a customer’s location. For shipments worth more than a certain amount, consider requiring the customer’s signature to release it from the shipper’s possession. With a robust document trail, you’ll be able to support your denial of a chargeback — even if a customer claims he or she didn’t receive the goods.

2. Communicate your refund policy. Create a detailed refund policy and communicate it to customers throughout the shopping process and when the sale is made. For example, post signs in your store or notices on item pages of your website. Just keep in mind that an overly restrictive refund policy may create an incentive for customers to go directly to their credit card companies to dispute a transaction.

3. Invest in customer service. Some customers resort to chargeback requests because they’ve had trouble contacting or reaching a resolution with the merchant. Make sure you provide customers with multiple support channels, such as phone, email, and instant message. Additionally, give customer service personnel the authority to resolve disputes quickly — including to issue refunds or credits without supervisory approval.  

4. Watch customer activity. Collecting and analyzing customer data can deepen your company’s understanding of purchasers’ behavior and help detect anomalies. For example, if a customer frequently checks the status of his order and then denies placing the order, you may be able to use this fact when disputing a chargeback. 

Play defense

It’s important to understand that not all chargeback requests are hostile or intentionally fraudulent. But you also need to protect your business from bad actors. Contact us for more information on “friendly” fraud.

© 2021 Covenant CPA

Help Ensure the IRS doesn’t Reclassify Independent Contractors as Employees

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Many businesses use independent contractors to help keep their costs down. If you’re among them, make sure that these workers are properly classified for federal tax purposes. If the IRS reclassifies them as employees, it can be a costly error.

It can be complex to determine whether a worker is an independent contractor or an employee for federal income and employment tax purposes. If a worker is an employee, your company must withhold federal income and payroll taxes, pay the employer’s share of FICA taxes on the wages, plus FUTA tax. A business may also provide the worker with fringe benefits if it makes them available to other employees. In addition, there may be state tax obligations.

On the other hand, if a worker is an independent contractor, these obligations don’t apply. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if it’s $600 or more).

What are the factors the IRS considers?

Who is an “employee?” Unfortunately, there’s no uniform definition of the term.

The IRS and courts have generally ruled that individuals are employees if the organization they work for has the right to control and direct them in the jobs they’re performing. Otherwise, the individuals are generally independent contractors. But other factors are also taken into account including who provides tools and who pays expenses.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Section 530. This protection generally applies only if an employer meets certain requirements. For example, the employer must file all federal returns consistent with its treatment of a worker as a contractor and it must treat all similarly situated workers as contractors.

Note: Section 530 doesn’t apply to certain types of workers.

Should you ask the IRS to decide?

Be aware that you can ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, be aware that the IRS has a history of classifying workers as employees rather than independent contractors.

Businesses should consult with us before filing Form SS-8 because it may alert the IRS that your business has worker classification issues — and it may unintentionally trigger an employment tax audit.

It may be better to properly treat a worker as an independent contractor so that the relationship complies with the tax rules.

Workers who want an official determination of their status can also file Form SS-8. Disgruntled independent contractors may do so because they feel entitled to employee benefits and want to eliminate self-employment tax liabilities.

If a worker files Form SS-8, the IRS will notify the business with a letter. It identifies the worker and includes a blank Form SS-8. The business is asked to complete and return the form to the IRS, which will render a classification decision.

These are the basic tax rules. In addition, the U.S. Labor Department has recently withdrawn a non-tax rule introduced under the Trump administration that would make it easier for businesses to classify workers as independent contractors. Contact us if you’d like to discuss how to classify workers at your business. We can help make sure that your workers are properly classified.

© 2021 Covenant CPA

A Difficult Decision: Choosing a Guardian for your Children

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If you have minor children, choosing a guardian to care for them should you die unexpectedly is one of the most important estate planning decisions you must make. It’s also one of the most difficult. So difficult, in fact, that avoiding it is one of the most common reasons people put off drafting an estate plan.

If you’re hesitant to name a guardian for your children, consider the alternative: A court will name one, without any prior guidance from you. So it’s important to choose a guardian now, while you still have a say in the matter.

Here are four tips to guide you in making your selection:

1. Take inventory. Make a list of potential guardians — people you trust to love and care for your children. Don’t limit yourself to immediate family members. Extended family members and friends may also be good choices if they have a close relationship with your children and share your values.

2. Make value judgments. Consider the values that are important to you, such as religious and moral beliefs, parenting philosophy, educational values, and social values. Determine which people on your list share these values most closely.

Bear in mind that you’re not likely to find a perfect match, so you’ll need to prioritize your values. For example, is it more important to you that your guardian share your religious beliefs or that he or she share your parenting philosophy? Can educational values take a back seat to social values?

3. Consider age. The age of the guardian as well as the ages of your children are factors to consider. If your children are very young, a grandparent or other older person may not have the energy to keep up with them. And remember, if a guardian becomes necessary it means that something has happened to you. Choosing a younger guardian reduces the risk that your kids will go through the trauma of losing another loved one.

4. Don’t dismiss the possibility of separate guardians. If you have more than one child, it’s generally best for all concerned to keep the siblings together. But sometimes it’s preferable to split them up. This may be the case if you have children from different marriages, if your children are far apart in age or if they have special needs that are better served by separate guardians.

After you narrow your list of potential guardians to a primary choice and one or two alternates, discuss your plans with them. You can’t force someone to act as your children’s guardian, so it’s critical to talk with all the candidates to make sure they understand what’s expected of them and that they’re willing to take on the responsibility. If your children are old enough, get their input as well. Contact us with any questions regarding choosing a guardian.

© 2021 Covenant CPA

The Restaurant Revitalization Fund is now Live

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The COVID-19 pandemic has affected various industries in very different ways. Widespread lockdowns and discouraged movement have led to increased profitability for some manufacturers and many big-box retailers. The restaurant industry, however, has had a much harder go of it — especially smaller, privately owned businesses in economically challenged areas.

In response, the Small Business Administration (SBA) has launched the Restaurant Revitalization Fund (RRF). It was established under the American Rescue Plan Act (ARPA) signed into law in March. The RRF went live for applications on May 3, and the SBA is strongly urging interested, eligible businesses to apply as soon as possible.

Who’s eligible?

Funds are available for restaurants, of course, but also many other similar types of businesses. Food stands, trucks and carts can apply, as well as bars, saloons, lounges and taverns. Catering companies may also file an RRF application.

In addition, the program is available to snack and nonalcoholic beverage bars, as well as “licensed facilities or premises of a beverage alcohol producer where the public may taste, sample, or purchase products,” according to the SBA.

For some restaurant-like businesses, on-site sales to the public must comprise at least 33% of gross receipts. These include bakeries; inns; wineries and distilleries; breweries and/or microbreweries; and brewpubs, tasting rooms and taprooms.

How much funding is available?

Under the ARPA, the RRF received a total of $28.6 billion in direct relief funds for restaurants and other similar establishments that have suffered economic hardship and substantial operational losses because of the COVID-19 pandemic.

The dollar amount an eligible business can receive under the RRF will equal its decrease in gross revenues during 2020 compared to gross revenues in 2019 — less the amount of any Paycheck Protection Program (PPP) loans received. Other amounts must be excluded from 2020 gross receipts as well, including:

  • SBA Section 1112 debt relief,
  • SBA Economic Injury Disaster Loans,
  • SBA advances (targeted and otherwise), and
  • Local small business grants.

Overall, the RFF may provide a qualifying establishment with funding equal to its pandemic-related revenue loss up to $10 million per business and not more than $5 million per physical location. Recipients must use funds for allowable expenses by March 11, 2023.

What will we need to apply?

A timely, properly completed application is critical to acquiring this funding. An applicant business must submit documentation of its 2020 and 2019 gross receipts, as well as at least one of the following:

  • A federal tax return,
  • A point of sale report, or
  • Externally or internally prepared financial statements.

Warning: Internally prepared financials could significantly delay SBA review of your application.

You’ll also need to disclose the amount of any PPP loans you’ve received. However, the SBA’s online application system should provide this information automatically.

Get started now

To get started, register for an account at restaurants.sba.gov. The SBA advises applicants to first download a sample version of the application here. Our firm can help you identify necessary documentation and navigate the process.

© 2021 Covenant CPA

Tax filing deadline is coming up: What to do if you need more time

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“Tax day” is just around the corner. This year, the deadline for filing 2020 individual tax returns is Monday, May 17, 2021. The IRS postponed the usual April 15 due date due to the COVID-19 pandemic. If you still aren’t ready to file your return, you should request a tax-filing extension. Anyone can request one and in some special situations, people can receive more time without even asking.

Taxpayers can receive more time to file by submitting a request for an automatic extension on IRS Form 4868. This will extend the filing deadline until October 15, 2021. But be aware that an extension of time to file your return doesn’t grant you an extension of time to pay your taxes. You need to estimate and pay any taxes owed by your regular deadline to help avoid possible penalties. In other words, your 2020 tax payments are still due by May 17.

Victims of certain disasters

If you were a victim of the February winter storms in Texas, Oklahoma and Louisiana, you have until June 15, 2021, to file your 2020 return and pay any tax due without submitting Form 4868. Victims of severe storms, flooding, landslides and mudslides in parts of Alabama and Kentucky have also recently been granted extensions. For eligible Kentucky victims, the new deadline is June 30, 2021, and eligible Alabama victims have until August 2, 2021.

That’s because the IRS automatically provides filing and penalty relief to taxpayers with addresses in federally declared disaster areas. Disaster relief also includes more time for making 2020 contributions to IRAs and certain other retirement plans and making 2021 estimated tax payments. Relief is also generally available if you live outside a federally declared disaster area, but you have a business or tax records located in the disaster area. Similarly, relief may be available if you’re a relief worker assisting in a covered disaster area.

Located in a combat zone

Military service members and eligible support personnel who are serving in a combat zone have at least 180 days after they leave the combat zone to file their tax returns and pay any tax due. This includes taxpayers serving in Iraq, Afghanistan and other combat zones.

These extensions also give affected taxpayers in a combat zone more time for a variety of other tax-related actions, including contributing to an IRA. Various circumstances affect the exact length of time available to taxpayers.

Outside the United States

If you’re a U.S. citizen or resident alien who lives or works outside the U.S. (or Puerto Rico), you have until June 15, 2021, to file your 2020 tax return and pay any tax due.

The special June 15 deadline also applies to members of the military on duty outside the U.S. and Puerto Rico who don’t qualify for the longer combat zone extension described above.

While taxpayers who are abroad get more time to pay, interest applies to any payment received after this year’s May 17 deadline. It’s currently charged at the rate of 3% per year, compounded daily.

We can help

If you need an appointment to get your tax return prepared, contact us. We can also answer any questions you may have about filing an extension.

© 2021 Covenant CPA