Although your business may seem big to you, you may wonder how the government classifies it. A recent report by the Joint Committee on Taxation, a nonpartisan committee of the U.S. Congress, discusses what a “small business” is for tax purposes. As the report states, there’s no one definition of a small business. Instead, different definitions apply depending on the context, various criteria and certain thresholds.
Criteria include a business’s gross assets, gross receipts and its number of shareholders and employees. Even if a criterion such as gross receipts is the same across definitions, different thresholds may apply. Also, for some purposes, the tax code might define a small business in more than one way.
Does your business have multiple owners? If so, you need a buy-sell agreement. This type of binding contract determines how (and at what price) ownership shares of a privately held business will change hands should an owner depart. There are also potential tax consequences to consider.
Unique Challenges
Unlike public companies, private ones have no ready or established market on which to sell ownership shares. This can create difficult circumstances for businesses when something unexpected happens. Say an owner suddenly dies. The owner’s shares may pass on to heirs, but how much are those shares worth and to whom can the heirs sell them? A buy-sell agreement will remove uncertainty by stipulating that remaining owners will buy the ownership interest at a price determined by the stated valuation method. Plus, the agreement will help to prevent an unfamiliar and perhaps unwanted owner from suddenly joining the business.
Setting Parameters
A buy-sell agreement sets up parameters for the transfer of ownership interests following any of a number of “triggering events,” such as an owner’s:
Death,
Long-term disability,
Loss of professional license,
Retirement,
Bankruptcy, or
Divorce.
The agreement will also specify a valuation method for appraising the departing owner’s interest at the appropriate time. In choosing a method, you and your fellow owners should carefully define buyout terms and specify the financial data to be used in the agreement. For example, a sound buy-sell agreement will spell out a required end-date for the financial statements that must be used to appraise business interests following a triggering event. Some also mandate a particular level of assurance (compilation, review or audit) regarding those financial statements.
Different Approaches
In most cases business owners don’t have the cash readily available to buy out a departing owner. So most buy-sell agreements include insurance policies to fund the agreement. This is where different types of agreements come into play. Under a cross-purchase agreement, each owner buys life or disability insurance (or both) on each of the other owners. Should one owner die or become incapacitated, the other owners collect on their policies and use the proceeds to buy the deceased or incapacitated owner’s shares.
Another type is a redemption agreement. Here, the company (not each owner) buys the insurance policies and acquires the deceased or incapacitated owner’s shares. This approach can help businesses with a lot of owners, because fewer policies are needed. In some cases, a company will create a hybrid buy-sell agreement that combines aspects of the cross-purchase and redemption approaches. These agreements may stipulate that the business gets the first opportunity to redeem ownership shares. And, if the company is unable to buy the shares, the remaining owners are then responsible for buying the departing owner’s interests. Alternatively, the owners may have the first opportunity to redeem the shares.
Tax Consequences
The life insurance used to fund buy-sell agreement can also have undesirable tax consequences without proper planning. Life insurance proceeds generally are excluded from the beneficiary’s taxable income, whether the beneficiary is a corporation, another shareholder or a separate entity. An exception is the transfer-for-value rule, under which proceeds will be taxable if an existing policy was acquired for value by someone other than the insured or a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is an officer or shareholder.
This issue often arises when structuring or changing a buy-sell agreement using existing insurance policies. It’s important to structure the agreement so that the transfer-for-value rule won’t have an impact; otherwise, the amount of after-tax insurance proceeds will be reduced.
If your business is structured as a C corporation and has a redemption agreement funded by life insurance, you’ll need to watch out for another possible adverse tax consequence: When the departing shareholder’s shares are redeemed, the value of the remaining owners’ shares will probably rise without increasing their basis. This, in turn, could drive up their tax liability in the event they sell their interests.
You may be able to manage this problem by revising your buy-sell as a cross-purchase agreement. Under this approach, owners will buy additional shares themselves, increasing their basis. But there are downsides. If owners are required to buy a departing owner’s shares but the company redeems the shares instead, the IRS may characterize the purchase as a taxable dividend. Your business may be able to mitigate this risk by crafting a hybrid agreement that names the corporation as a party to the transaction and allows the remaining owners to buy back the stock without requiring them to do so.
Complex but Important
Buy-sell agreements can help closely held businesses ensure a smooth transition when an owner leaves the business. But they also require careful planning to be effective, including properly addressing potential tax issues.
At some point, most small business owners will visit a bank or other lending institution to borrow money. Understanding what your bank wants and how to approach it properly can mean the difference between getting a loan for expansion or scrambling to find cash from other sources.
Understand the Basic Principles of Banking
It is vital to present yourself as a trustworthy businessperson, dependable enough to repay borrowed money, and to demonstrate that you understand the basic principles of banking. Your chances of receiving a loan will greatly improve if you can see your proposal through a banker’s eyes and appreciate the position that the bank is coming from.
Banks are responsible to government regulators, depositors, and the community in which they reside. While a bank’s cautious perspective may irritate a small business owner, it is necessary to keep the depositors’ money safe, the banking regulators happy, and the community’s economy healthy.
Each Bank Is Different
While banks in general have a cautious attitude toward lending, they differ in the types of financing they make available, interest rates charged, willingness to accept risk, staff expertise, services offered, and attitude toward small business loans.
Selection of a bank is essentially limited to your choices from the local community. Typically, banks outside of your area will be more reluctant to make loans to you because of the higher costs of checking credit and of collecting the loan in the event of default.
Furthermore, a bank will typically not make loans, regardless of business size, unless a checking account or money market account is maintained at that institution. Ultimately your task is to find a business-oriented bank that will provide the financial assistance, expertise, and services your business requires now and is likely to require in the future.
Building Rapport
Establishing a favorable climate for a loan request should begin long before the funds are needed. The worst possible time to approach a new bank about a loan is when your business is in the throes of a financial crisis. Devote time and effort to building a relationship and goodwill with the bank you choose and early on get to know the loan officer you will be dealing with.
Bankers’ overriding concern generally is minimizing risk. Logic dictates that this is best accomplished by limiting loans to businesses they know and trust. One way to build rapport and establish trust is to take out small loans, repay them on schedule, and meet all loan agreement requirements in both letter and spirit. By doing so, you gain the banker’s trust and loyalty, and the banker will consider your business a valued customer and make it easier for you to obtain future financing.
Provide the Information Your Banker Needs
Lending is the essence of the banking business, and making mutually beneficial loans is as important to the bank’s success as it is to the small business. This means that understanding what information a loan officer seeks and providing the evidence required to ease normal banking concerns is the most effective approach to getting the financing you desire.
A sound loan proposal should contain information that expands on the following points:
What is the specific purpose of the loan?
How much money is required?
What is the source of repayment for the loan?
What evidence is available to substantiate the assumptions that the expected source of repayment is reliable?
What alternative source of repayment is available if management’s plans fail?
What business or personal assets, or both, are available to collateralize the loan?
What evidence is available to substantiate the competence and ability of the management team?
You need to do your homework before making a loan request because an experienced loan officer will ask probing questions about each of these items. Failure to anticipate such questions or providing unacceptable answers is damaging evidence that you may not completely understand your business and are incapable of planning for its needs.
What To Do Before You Apply for a Loan
1. Write a business plan. Your loan request should be based on and accompanied by a complete business plan. This document is the single most important planning activity you can perform. A business plan is more than a device for getting financing; it is the vehicle that makes you examine, evaluate, and plan for all aspects of your business. A business plan’s existence proves to your banker that you are doing all the right activities. Once you have put the plan together, write a two-page executive summary. You will need it if asked to send “a quick write-up.”
2. Have an accountant prepare historical financial statements. You cannot discuss the future without accounting for your past. Internally generated statements are OK, but your bank wants the comfort of knowing an independent expert has verified the information. Also, you must understand your statement and be able to explain how your operation works and how your finances stand up to industry norms and standards.
3. Line up references. Your banker may want to talk to your suppliers, customers, potential partners, or team of professionals. When a loan officer asks for permission to contact references, promptly answer with names and contact information; do not leave the officer waiting for a week.
Walking into a bank and talking to a loan officer will always be stressful. Preparation for and thorough understanding of this evaluation process is essential to minimize the stressful variables and optimize your potential to qualify for the funding you seek.
Seek Advice From a Tax Professional
The advice and experience of a tax and accounting professional are invaluable. Do not be shy about calling the office.
San Jose: (408) 252-1800 Watsonville: (831) 726-8500
When choosing a payroll service provider to handle payroll and payroll tax, employers should choose a trusted payroll service to help them avoid missed deposits for employment taxes and other unpaid bills. Typically, these clients remain legally responsible for paying the taxes due, even if the employer sent funds to the payroll service provider for required deposits or payments.
Employers are encouraged to enroll in the Electronic Federal Tax Payment System (EFTPS) and make sure the payroll service provider uses EFTPS to make tax deposits. EFTPS is free and gives employers safe and easy online access to their payment history, provided they make deposits under their Employer Identification Number (EIN). Using the EFTPS enables them to monitor whether their payroll service provider meets its tax deposit responsibilities.
Employers have two options when finding a trusted payroll service provider:
A certified professional employer organization (CPEO). Typically, CPEOs are solely liable for paying the customer’s employment taxes, filing returns, and making deposits and payments for the taxes reported related to wages and other compensation. An employer enters into a service contract with a CPEO, and then Form 8973, Certified Professional Employer Organization/Customer Reporting Agreement, is submitted to IRS. Employers can find a CPEO on the Public Listings page of IRS.gov.
Reporting agent. A reporting agent is a payroll service provider that informs the IRS of its relationship with a client using Form 8655, Reporting Agent Authorization, that the client signs. Reporting agents must deposit a client’s taxes using the Electronic Federal Tax Payment System (EFTPS) and can exchange information with the IRS on behalf of a client if issues arise. They are also required to provide clients a written statement reminding the employer that it, not the reporting agent, is ultimately responsible for the timely filing of returns and payment of taxes.
Employers should contact a tax professional about any bills or notices received, especially payments managed by a third party. They can also call the phone number on the bill, write to the IRS office that sent the bill, or contact the IRS business tax hotline at 800-829-4933.
Most payroll service providers provide quality service, but some don’t. Each year, a few payroll service providers don’t submit their client’s payroll taxes, close down abruptly, and leave employers on the hook.
Don’t get caught short. Choose a payroll service provider you can count on – and don’t hesitate to call the office with any questions about payroll and other business-related taxes.
When a family member employs someone, the tax implications depend on the relationship and the type of business. Taxpayers and employers need to understand their tax situation. Here is what to know:
Married People in Business Together
Generally, a qualified joint venture whose only members are a married couple filing a joint return isn’t treated as a partnership for federal tax purposes.
Someone who works for their spouse is considered an employee if the first spouse makes the business’s management decisions and the second spouse is under the direction of the first spouse.
The wages for someone who works for their spouse are subject to income tax withholding and Social Security and Medicare taxes, but not to FUTA tax.
Children Employed by Their Parents
If the business is a parent’s sole proprietorship or a partnership in which both partners are parents of the child:
Wages paid to a child of any age are subject to income tax withholding.
Wages paid to a child age 18+ are subject to social security and Medicare taxes.
Wages paid to a child age 21+ are subject to Federal Unemployment Tax Act
If the business is a corporation, estate, or a partnership in which one or no partners are parents of the child:
Payments for services of a child are subject to income tax withholding, social security taxes, Medicare taxes, and FUTA taxes, regardless of age.
Parents Employed by Their Child
If the business is a child’s sole proprietorship:
Payments for services of a parent are subject to income tax withholding, social security taxes, and Medicare taxes.
Payments for services of a parent are not subject to FUTA tax regardless of the type of services provided.
If the business is a corporation, a partnership, or an estate:
The payments for the services of a parent are subject to income tax withholding, social security taxes, Medicare taxes, and FUTA taxes.
If the parent is performing services for the child but not for the child’s trade or business:
Payments for services of a parent are not subject to social security and Medicare taxes unless the services are for domestic services and several other criteria apply.
Payments for services of a parent are not subject to FUTA tax regardless of the type of services provided.
Questions?
Many people work for a family member, whether a child is helping at their parent’s shop or spouses running a business together. If you are one of them, your tax situation may be more complicated than you think. Please call the office for assistance if you need help understanding how your work situation affects your taxes.
With 2021 coming to a close, now is the time to make sure you are maximizing every tax advantage available. One tax advantage many small business owners tend to overlook is the miles they put on their vehicles.
The IRS requires that you substantiate your mileage expenses with adequate records. While there is no specific way you must track your miles, your mileage log should include:
Dates of your business trips
Locations you drove for work
Business purpose of your trips
Trip Mileage
If you drive your vehicle for personal use, you will need to prove the portion of use that is for business compared to personal.
The IRS currently does not require you to record your odometer at the beginning and end of your trips. However, we recommend taking a quick picture of your odometer at year end to make sure total miles are tracked. With so many other things small business owners need to worry about, mileage tracking is probably at the bottom of the to-do list and is quickly forgotten. Lucky for us, there are various apps out there that make it easier to record your business mileage accurately. Here are a few apps worth looking into:
Everlance (iOS and Android friendly)
Intuitive, user-friendly app that allows quick and easy tracking of miles
Frequent places & trips are detected and automatically classified
Customize trips with notes, photos, and vehicles
While there is a free version that allows 30 trips per month, most users benefit from the Premium version, which also includes automatic expense tracking with bank and credit card sync.
MileQ (iOS and Android friendly)
Automatic tracking: App runs in the background tracking your miles and creating a comprehensive record
One-swipe classification: Swipe right for business drives; swipe left for personal drives
Accurate and customizable reports generated
As low as $59.99/year for personal mileage tracking or $50/driver/year for team mileage tracking
Stride (iOS friendly)
In-app guidance on what expenses you can deduct and how to best track
Provides an IRS-ready tax summary to make filing a breeze
Offers an automatic system that detects when you’re driving so you can be sure to log every mile.
It’s free!
TripLog Mileage Tracker (iOS and Android friendly)
Provides administrators with the ability to set custom policies, such as commute mileage exemptions, frequent trip rules, and shortest distance calculations.
Streamlines reimbursement approval process
Allows you to see routes and unsafe driving behaviors so you can review each trip to spot any potential issues.
Choose from Lite, Premium, or Enterprise pricing
Good mileage tracking apps will ensure you keep accurate, detailed records for you to take advantage of the business mileage tax deduction. No matter which app works best for you, remember to always track your mileage, and not leave money on the road!
As always, don’t hesitate to call if you have any questions regarding tax deductions that benefit your small business.
The Main Street Small Business Tax Credit II will provide COVID-19 financial relief to qualified small business employers. Qualified small businesses will be able to offset either their income taxes or their sales and use taxes with the credit when filing their returns.
