Tax Issues for Women Business Owners
As a business owner, there are several decisions that you make for your business that determine tax percentages and liability exposure, as well as some future choices. Each decision needs to be considered carefully, and you should not hesitate to consult with a tax professional to help you analyze and evaluate alternatives. Some of the business transactions that have tax implications include:
Business Entity Choice
Employees vs. Contract Labor
Employee Benefits
Retirement and Health Insurance plans
Selling Business Assets
Specific Business Deductions
Tax Law Changes
Business Entity
Sole proprietors, partners, LLC members, and corporation shareholders all have different forms to file, and potentially different taxes to pay. The main issues are income tax, and employee taxes. You cannot be paid with wages with any of the first three entity choices, but can with the fourth (and must be if you choose the Subchapter S election, and the business has earnings and profit); you must pay your own Social Security and income tax through estimated payments instead, unless you will owe less than $500 by 4/15/98.
Partners and Members can designate income to be distributed to specific individuals using Guaranteed Draws for hours worked; Sole Proprietors pay tax on all of the taxable earnings. And while corporations appear to be advantageous because of the larger 15% tax bracket (on the first $50,000 of the net earnings of the corporation), taking earnings and profits out through dividends (the only other option besides wages for regular corporations) results in double taxation on those dividends.
The decision on whether to incorporate or not should be based on liability issues, investor needs, succession planning, and the need to retain earnings for reinvestment in equipment and inventory. Don't do it just because someone else did, or told you to do it, unless you have consulted with a professional. Attorneys and Tax professionals will often have differing opinions, depending on how much information you have given them; give permission for them to talk with each other or take your accountant with you to talk with your attorney to help you reach the best decision.
Employees vs. Contract Labor
This has developed into a hot issue over the past few years since the IRS has chosen to pursue those employers using contract labor to avoid paying additional employee taxes. There are still many legitimate contexts for contract labor, as long as the work they are being hired for is temporary, occasional, and you are not determining the schedule and the laborer is providing their own tools. If any of the above conditions are not met, IRS can challenge you on the question of control, and decide if the person is really an employee or not.
You can contract with someone for a specific service to be provided, i.e., repair and maintenance functions that occur at unpredictable times, or for a job that they are in the business providing (e.g., tax preparation, revising or writing software, installing computer hardware), or any other specific job that you do not tell them how to do. Having a time line for completion is definitely your right, as long as they provide the tools and expertise to complete it.
Construction is usually done by contract, with the General Contractor often using sub-contractors for specific jobs (concrete, plumbing, electrical). If you are not sure if you could pass the test, ask yourself: Am I controlling this person's schedule? Am I providing the tools? Are they working in my office space? Is this temporary or occasional? Saying yes probably indicates that you have an employee.
The additional costs associated with employees include State and Federal unemployment, 50% of FICA/Medicare contributions, and Worker's Compensation; the total percentage varies between a low of 11-12% to a high of 28%+ of gross wages, depending on the Worker's Compensation rate (which varies by state and job classification). Employers that have regular claims for unemployment benefits, and high risk work (e.g., sawmills) will pay higher percentages. Make sure you have the appropriate information for your business so you can plan accordingly. Penalties on these taxes can add exponentially if there are continued late filings.
Employee Benefits
Many options exist now for the small business owner, and can include the owner as long as plans are defined according to the rules. Basically, all employees must be eligible, once certain criteria has been met (e.g., employed 6 months, works at least 30 hours), and the plan must not discriminate in favor of highly paid employees. There are restrictions for Sole Proprietors, Partners, and Members; but there are also options that exist for these owners that do not exist for the Corporate shareholder working for the business. Subchapter S Corporations have the most restrictions on benefits for the shareholder/employee because the earnings and profits can already be distributed without double taxation, as long as the shareholder/employee is being paid reasonable compensation.
There are books on this subject, and I think that we can simply say that you need to do your homework before setting up any benefit plans, and talk to appropriate professionals: insurance, legal, or accounting, before putting one in motion.
There are some new provisions for employees, within defined benefit plans, for adoption expenses, similar to child care expenses and medical expenditures. Medical Savings Accounts are a new option, and is an experimental program. Check with your insurance/benefit plan advisor for more information.
Retirement and Health Insurance
Also restricted according to the type of entity, there are options here for everyone, including the small business owner. Retirement funding has finally become noticed as a major issue for women since women tend to live longer, and set aside less than their male counterparts.
As a business owner, you should make it a priority to start setting aside funds for yourself as soon as possible, even in small increments. Even though you might think that this is something you will deal with later, you need to get it into your long range plan now. Don't wait until you're 55 or 60 to notice that you have not yet set aside what you need; your business may not sell for what you want it to. However, any time is better than not doing anything at all.
Consult an investment counselor for options and earnings potential. For 1998, the phase-out range for IRA contributions has been raised, making this an option for more taxpayers. Simplified Employee Pension-Individual Retirement Accounts (SEP-IRA) and a Savings Incentive Match Plan for Employees IRA (SIMPLE IRA) are two plans that can be used for small businesses.
Selling Business Assets
This is probably the area that business owners know the least about, besides knowing that this is when the capital gains tax comes into effect. Any time you sell something that you have been taking deductions for as business use property, there will most likely be a taxable event, gains, and tax liability generated.
If you sell the item for less than you paid for it, why is there a gain and tax, you say? Let's take a look at the copy machine you bought in 1995, that you want to sell because you need a higher capacity model:
You paid $3000 for the copy machine, and set up accelerated depreciation on your tax return, which you took as deductions in 1995 and 1996. This method of depreciation allowed you to take 20% the first year, and 32% of the cost the second year, for a total of $1560 in depreciation, reducing the basis of the copy machine (what's left to depreciate) to $1440. You have an offer of $1750, for the machine, which will generate a gain of $310 ($1750 less $1440) because you have already take deductions of $1560 to reduce your taxable income. And if you had selected the Section 179 deduction in 1995, you would have written off the entire cost of the copy machine in one year, and would now have a gain of the entire $1750.
The capital gains tax rate has just been reduced for assets that have been held for more than 18 months, from 28% to 20% maximum.
The rules for depreciation are complex, although you do have some choice about the amount of deduction to take each year, over the life of the asset. You do not have a choice about the tax treatment when you sell it, however, and if it is property that you used prior to putting it in the business, your options become even less. Any property that has been depreciated (this includes vehicles that you have taken the mileage deduction for) can generate taxable gain, called ordinary gain and capital gain, depending on the selling price. And the faster you have depreciated the item, the more likely it is that you will have gain to pay tax on.
There is nothing wrong with making money on the sale of business assets; you just need to be prepared for the additional tax liability it generates. If you sell your business, you are selling many different types of assets, and each type has a different rule about calculating taxable gain, i.e., inventory and A/R, fixed assets (equipment), and goodwill all have to have share of the selling price allocated to them, and gain calculated separately. And if you are a partner and/or member in a business that has changed partners and/or members along the way, there are other surprises in store.
A word of caution here is to be prepared for this type of action to be more complicated and take more planning than ordinary inventory sales. Talk with your accountant before negotiating the agreement to find out what works best for your situation.
Specific Business Deductions
Many of your business tax deductions will be obvious, and some will be mixed personal and business, especially if you are a sole proprietor. The basic rule to follow is that if you spent the money because you have your business, then it will be deductible in some form.
Some expenses that are incurred in the start-up phase of the business have to be expensed over five years, like some fixed assets. And some other expenses have to be allocated between personal and business, e.g., a trip that is both for attending a conference and taking vacation. There are some ways to take advantage of business trips, staying a day or two over, e.g., to get reasonable airfares, or the weekend is incidental to the week long conference you attended. But you must be careful, and all business expenses must be documented with a receipt.
Records supporting tax deductions must be kept for 10 years; keep all tax forms for the life of the business. Other mixed personal and business use items, such as vehicles, must have a log book that is used concurrently with the use (keep it current). Odometer readings must be recorded, and receipts obtained for all gas, repairs, and other maintenance if the expense method is being used for the vehicle deduction.
To take business meals, a receipt should have name and brief purpose noted on it; or, when traveling, a per diem rate can be used when there is an overnight lodging receipt. When you stay with friends and/or family, get receipts for meals out and grocery shopping trips; the per diem cannot be used in this situation.
Office-in-home expenses can only be taken if at least 50% of your work time is spent in that space (this will become more flexible in 1999, with some restrictions), however, personal space used for storage can qualify for a deduction.
Remember to keep your receipts; monthly bills from charge card companies that list individual transactions can be substituted for actual charge receipts. Phone bills that are mixed personal and business should have business calls marked, and a name written next to it (who was called). If you are audited, you may have to show any and all receipts to substantiate your deductions; don't get caught without them.
Tax Law Changes
There have been a few changes this year and last year that apply to small business owners, creating a more affordable retirement plan option, and reducing the capital gains tax percentage, to name two. Most of the other changes apply to individuals (which can include you of course), but are not business oriented. I mentioned the office in home deduction change in 1999 above, and there are some other breaks for businesses with increased Section 179 deductions limits (for fixed assets), and deduction of health insurance (30% of premiums paid now; will go to 100% by 2007). And there is a special estate tax deduction for qualified family-owned businesses that comes into effect after 12/31/97. The regulations on some of these changes may be slow in coming, but all tax professionals have information on them, and will be able to help you with your questions.
Always ask about your specific situation; the business owner sitting next to you in class, or on the bus may have a very different situation. Our lives are all different, and there our needs with regard to our businesses, and our tax planning.
