Are you considering forming a C Corp?

business-desk_LI-532x266-1 Are you considering forming a C Corp?

Many owners of private companies have been leery of operating as a regular C corporation. If you make that choice, you will be exposed to double-taxation of business income.

First, a corporate income tax applies to the company’s profits. Second, any dividends that pass to you and other shareholders will be subject to personal income taxes. Making matters even more expensive, your C corporation won’t get an income tax deduction for the dividends it pays out.

Tax Pain Relief

The Tax Cuts and Jobs Act (TCJA) of 2017 has made this tax parlay easier to bear. Personal income tax rates generally have come down: the top federal rate, from now through 2025, has been lowered from 39.6% to 37%, for example.

During these years, corporate income will be taxed at a flat 21%, regardless of the amount. (Formerly, there was a graduated tax schedule, going up to 35%.) These tax rate reductions, combined with the retention of the 15% or 20% tax rates on qualified dividends received (which are based on the capital gains rates), may make it cost effective to operate your business as a C corporation.

Example: Mike Morton owns 100% of a C corporation, which has a $100,000 profit this year. The company pays $21,000 in corporate income tax, at 21%, and pays the $79,000 balance as a dividend to Mike.

Assume Mike and his wife Nora owe the maximum 20% tax rate on the dividend, as well as the 3.8% net investment income tax on that dividend: 23.8% of $79,000, or about $18,800. Altogether, the total tax on that $100,000 of company profits is $39,800, which is much less than it would have been, under the 2017 tax rates.

Pros and Cons

Other factors should be weighed when deciding on a business entity. For example, C corporations have some tax advantages, such as the ability to deduct the cost of certain fringe benefits and not pass on imputed income to significant shareholders.

At the same time, C corporations pose other tax perils. Owners may have to contend with possible unreasonable compensation (paying too much in salary and bonus) and excess accumulated earnings (saving too much, rather than paying dividends) issues.

We Can Help

Our staff can help you put numbers on all of these looming tax traps, so you can make an informed decision. Give us a call before you solidify the formation of your business.

How To: Trim the Inventory Fat

Inventory-costs_LI-532x266 How To: Trim the Inventory Fat
Photo: Samuel Zeller

Inventory is expensive. Here are some ways to trim the fat from your inventory without compromising revenue and customer service.

Objective Inventory Counts

Effective inventory management starts with a physical inventory count. Accuracy is essential to know your cost of goods sold — and to identifying and remedying discrepancies between your physical count and perpetual inventory records. A CPA can introduce an element of objectivity to the counting process and help minimize errors.

The next step is to compare your inventory costs to those of other companies in your industry. Trade associations often publish benchmarks for:

  • Gross margin ([revenue – cost of sales] / revenue),
  • Net profit margin (net income/revenue), and
  • Days in inventory (annual revenue / average inventory × 365 days).

Your company should strive to meet — or beat — industry standards. For a retailer or wholesaler, inventory is simply purchased from the manufacturer. But the inventory account is more complicated for manufacturers and construction firms. It’s a function of raw materials, labor, and overhead costs.

The composition of your company’s cost of goods will guide you on where to cut. In a tight labor market, it’s hard to reduce labor costs. But it may be possible to renegotiate prices with suppliers.

And don’t forget the carrying costs of inventory, such as storage, insurance, obsolescence, and pilferage. You can also improve margins by negotiating a net lease for your warehouse, installing anti-theft devices or opting for less expensive insurance coverage.

Product Mix

To cut your days-in-inventory ratio, compute product-by-product margins. Stock more products with high margins and high demand — and less of everything else. Whenever possible, return excessive supplies of slow-moving materials or products to your suppliers.

Product mix should be sufficiently broad and in tune with consumer needs. Before cutting back on inventory, you might need to negotiate speedier delivery from suppliers or give suppliers access to your perpetual inventory system. These precautionary measures can help prevent lost sales due to lean inventory.

Reality Check

Often management is so focused on sales, HR issues and product innovation that they lose control over inventory.

Contact us for a reality check.

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Sales Tax and the Out-of-State Buyer

qtq80-vJG8zn-1024x680 Sales Tax and the Out-of-State Buyer

If your company makes sales to out-of-state buyers, do you need to collect state sales tax? Until recently, Supreme Court decisions from the 20th-century declared that would not necessarily be the case.

Example 1: ABC Corp., based in Alabama, sends a catalog to customers and prospects. A consumer who lives in Wyoming places a $100 order.

Assume that ABC has neither employees nor property in Wyoming. ABC would not be required to collect Wyoming sales tax on the $100 purchase price and remit to Wyoming under those Supreme Court decisions because ABC had no “physical presence” in that state. (Wyoming, like most states, requires consumers to pay a use tax instead of a sales tax, but states have found it difficult to enforce compliance with their use taxes.)

Because they must collect sales tax, in-state retailers have been at a significant disadvantage versus out-of-state sellers who don’t collect sales tax.

South Dakota v. Wayfair

The 20th-century reasoning of the physical presence requirement did not recognize the realities of the 21st century, a divided (5-4) Supreme Court found earlier this year. In South Dakota v. Wayfair, Inc., 6/21/18, the Court held that the physical presence requirement no longer applied, paving the way for enforcement of a South Dakota law that requires many “remote” sellers to collect applicable sales tax on purchases by South Dakota residents.

The majority in the Wayfair decision pointed to some favorable aspects of the South Dakota law. For one, it applies only to remote sellers with at least 200 transactions or $100,000 in revenue from South Dakota buyers in a calendar year. Therefore, a company that occasionally ships a few moderately priced items across state lines needn’t master all the sales tax rules pertaining to South Dakota buyers and collect the tax and remit it to the state.

In addition, South Dakota is a party to the Streamlined Sales and Use Tax Agreement, which reportedly has 24 member states. This agreement, designed to standardize taxes in order to reduce administrative and compliance costs, provides sellers access to sales tax administration software.

Going Forward

After this Supreme Court decision, many (perhaps most) states will consider new legislation that requires out-of-state vendors to collect and forward sales tax, even without a physical presence in the buyer’s state. However, Congress might pass a federal law addressing the issue of interstate sales tax collection.

If no federal law is passed, the focus will remain on states’ actions. Assuming that states follow the format of the South Dakota law, companies that do a minimum amount of online retailing may not be greatly affected.

Contact Us

Conversely, small businesses that do a great deal of online selling, or plan to do so, might have to make extensive efforts to collect and forward sales tax to multiple states. We can help such companies comply with any requirements that arise. Contact us for help and guidance.

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Take Steps to Avoid the Warm-Weather Slow Down

pool_LI Take Steps to Avoid the Warm-Weather Slow Down
Photo: Raphaël Biscaldi

During the summer, it may be true that “the living is easy,” as the old song goes. The midyear season, though, is often not so easy at small businesses because many employees are taking vacations. Total work hours often shrink and so may company productivity.

Spreading vacation time over the rest of the year might not be practical, especially if many of your workers have school-age children and desire family vacations during summer break. You may prefer to squeeze most vacations into the summer so the disruption is minimal the remainder of the year. Nevertheless, you probably won’t welcome a warm weather slowdown, so it’s best to take steps to keep things running at an acceptable pace.

Scheduling Strategies

It’s vital to create and maintain a visual schedule of who is taking time off and when. This might be created with a simple wall board or online. In a relatively small company, you could have your assistant keep up this schedule and show it to you every week or so. A larger firm could leave the schedule supervision to department or division heads, each of whom would track their workers.

However you decide to do it, you should have an easy way to see who will be away next week, the week after, and so on. If several people are scheduled for vacations during, say, the third week of July, you (or the manager who will be affected) might push forward some projects or delay them until you have a full crew in the office. Also, you probably should be cautious about approving additional vacation requests for weeks when multiple employees are already planning time off.

Reaching Out

Summer vacations can be extra troubling because your business won’t be the only one shorthanded from now until Labor Day. Chances are that your customers, suppliers, and other companies with which you work also will have employees who won’t be available. Their absence can put a crimp in your own operations. If you have strong relationships with such business associates, you might ask about their vacation schedules and who to contact if your company runs into a snag.

In some situations, you might decide to revise some of your company’s efforts to make the timing mesh with that of key outsiders.

Filling the Gaps

There is not much you can do about vacationing employees elsewhere, but there are things you can do this summer to help your company manage with a reduced workforce. If there are deadlines, require employees to finish all projects before they leave. For ongoing efforts, have your workers write up a summary of work-to-date with helpful materials attached. Get mobile numbers and email addresses where they can be reached, in case a need for contact should arise.

Make sure employees place vacation responses on their work phones and email, with dates of departures and returns. You might consider assigning someone to create templates for these employees to use for their vacation responses; this can assure that vacation responses will contain the required information and without any comments that could offend or reveal confidential matters.

In addition, arrange for some employees to cover for those on vacation, if necessary. You’re probably better off if you can avoid one-on-one coverage because the worker staying at the office will be doing two jobs. Work sharing among multiple co-workers might be a better solution. If you have summer interns, ask if they might be able to handle some of the tasks usually assigned to the vacationers.

Clarity Begins at Home

With all this planning, don’t forget to schedule your own vacation. Obviously, you also work hard throughout the year, so some downtime will be beneficial, whether you travel or wind down at home.

In addition, you should keep track of what unexpected flaws arise this vacation season and how you might remedy them in 2019. Should you require all summer vacation requests two weeks, or even a month, ahead of time? Demand that all requests be turned in by Memorial Day before you grant any approvals? Treat conflicts in favor of seniority? Offer those who lose out by conflict a chance to jump the line next year? The more clarity in a vacation plan you disseminate to all employees, the greater the chance your company will keep operating at its peak this summer and next.

Additional Business Resources

This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.

Many Business Expenses Are No Longer Deductible

business-expense_LI Many Business Expenses Are No Longer Deductible
Photo: Antenna

The good news is that the TCJA of 2017 lowered corporate tax rates from a graduated schedule that reached 35% to a 21% flat rate. The bad news? Many business expenses are no longer tax deductible. That list includes all outlays that might be considered entertainment or recreation.

As of 2018, tickets to sports events can’t be deducted, even if you walk away from the game with a new client or a lucrative contract. The same is true if you treat a prospect to seats at a Broadway play or take a valued vendor out for a round of golf. Those outlays will be true costs for business owners without any tax relief.

Drilling Down 

Does that mean that you should drop all your season tickets supporting local teams? Cancel club memberships? Pack away your putter and your tennis racquet? Before taking any actions in this area, take a breath and crunch some numbers.

Example: In recent years, Luke Watson spent about $20,000 a year on various forms of entertainment, which his company claimed as a business expense. Indeed, these were valid expenses and helped his LW Corp. grow rapidly.

Assume that LW Corp. paid income tax at a 34% rate. In 2017 and prior years, business entertaining was only 50% deductible. Thus, LW Corp. deducted $10,000 (half of Luke’s expenses) and saved $3,400 (34% of $10,000). With $3,400 of tax savings and $20,000 of out-of-pocket costs, Luke’s net cost for entertaining was $16,600 under the law in effect during 2017.

Now suppose that Luke has the same $20,000 of entertainment costs in 2018 and that those costs would have still been 50% tax deductible at the new 21% tax rate. His tax savings would have been only $2,100, so the net entertainment cost would have been $17,900. As it is, under the new law his actual entertainment cost would be the full $20,000 with no tax benefit.

This example assumes that LW Corp. pays the corporate income tax on its profits. If Luke operates his business as an LLC or an S corporation, with business income passed through to his personal tax return, the calculation would be different, but the principle would be the same.

Business entertainment has been done mainly with after-tax dollars. Under the new TCJA, you’ll entertain clients and prospects solely with after-tax dollars. You should be careful about how this money is spent and judge the expected benefit. Nevertheless, if business entertaining has paid off for your company in the past, it may still prove to be valuable even without tax breaks.

Fine Points 

Meal expenses associated with operating a trade or business, including employee travel meals, generally continue to be 50% tax deductible. However, keep in mind that the rules have changed for meals provided for the employer’s convenience. Previously, these were 100% deductible if they were excludible from employees’ gross income as de minimis fringe benefits. That might have been the cost of providing free drinks and snacks to employees at the workplace. Now outlays for such meals are only 50% deductible and they’re scheduled to become nondeductible after 2025.

On the bright side, the new law doesn’t affect expenses for recreation, social, or similar activities primarily for the benefit of a company’s employees, other than highly compensated employees. So, your business likely can still pay for holiday office parties with pre-tax dollars.

Give us a call if you have questions about business expenses for yourself or your staff. We are glad to help you to understand the tax changes businesses are going through.

 

This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.