You see, choosing an entity takes care and consideration and no entity qualifies as one-size-fits-all. So while an S corporation may be awesome for your neighbor (and his mom), the same may not be true for you.

When is organizing your company as an S corporation ideal? And just what makes them so awesome?

For starters, S corporations, unlike regular corporations, aren’t subject to double taxation. Regular corporations pay tax on income, and then you, as a shareholder, pay tax on the profits distributed to you (known as dividends). S corporations don’t pay income tax (though they may be subject to other taxes). The income is simply “passed through” to each individual shareholder, who then reports his share of income on his personal income tax return. The corporation can then distribute profits to each shareholder tax free (so long as there’s sufficient basis). Therefore, any amount distributed by the corporation to each shareholder is only subject to tax once.

This pass through nature of the S corporation is one of the reasons the entity can be ideal in some tax planning situations.

Here’s one situation where an S corporation may be ideal:

For some companies, particularly in the early years, the company may be operating at a loss. Each individual shareholder gets their share of this loss (assuming there is enough basis), which can then be deducted on their personal income tax return. This can be used to offset income that otherwise would’ve been taxable. And since S corporation owner-shareholders are supposed to pay themselves a reasonable salary, this loss can even be used to offset the wages paid to you by your company. Awesome, indeed.

There’s more… S corporations are eligible for Section 1244 treatment. So, let’s say this startup of yours is unsuccessful and the stock is later disposed of at a loss. This loss is allowed to be categorized as an ordinary loss, instead of what normally happens: treating the loss as a capital. Categorizing it as a capital loss means you can only net it against other capital gain or be limited to a $3,000 annual deduction. Being allowed to categorize the loss as ordinary means that the entire amount can be deducted at once.

Here’s another:

Quite the opposite of the above scenario, your company is very successful and actually has quite a bit of cash on hand. Your company’s future is looking pretty good. With a regular corporation, if you were going to distribute some of this wealth to shareholders, it would be ideal to be able to classify this as salary and not as dividends. Why? Because salaries, unlike dividends, are deductible to the corporation and they are taxable as ordinary income to the shareholder. The IRS, being the IRS and all, is obviously aware of this and is notorious for reclassifying unreasonably high compensation as dividends.

However, with S corporations, this isn’t necessarily an issue. And organizing as such minimizes any issues you’d have with unreasonable compensation. You either pay this as a salary (deductible by the corporation) or as distributions (not deductible by the corporation, but not taxable to the individual shareholder either).

The above situation is especially ideal when the corporation is a personal service corporation (PSC). PSCs are those companies that:

1. At least 95% of the the time spent by the company’s employees is devoted to services in either the health (including veterinary), law, engineering, architecture, accounting, actuarial science, performing arts, or consulting, and
2. At least 95% of the stock is held directly (or indirectly) by either the employees performing these services or retired employees who did perform these services or their estates, or any other person that in the two-year period starting with the date that such an employee died, acquired that individual’s stock because of his death.

That was a mouthful.

So, if my company was organized as a regular corporation, I’d be considered a PSC. So would my family physician, my dog’s vet, the architect that designed the building I live in, that ballet company… you get the idea.

This is important because PSCs are subject to a flat tax of 35%. That’s right, no graduated rates for PSCs. It would therefore be beneficial for the company to be organized as an S Corporation. Not only does the S Corporation get rid of that dreadful flat tax of 35%, it is free to distribute enough of the accumulated cash to each shareholder to pay the tax they’d be subject to (remember: income of the S corp. is passed through to each shareholder).

Let’s look at a few situations where you’d probably want to stay away from an S corporation.

As mentioned before, S corporations are pass-through entities, so the income is reported on each individual shareholder’s personal income tax return. Depending on the marginal tax rate, sometimes the tax can be cheaper when using the corporate tax rates than the individual. So it would make more sense to be organized as a regular corporation and have the corporation pay the tax.

Another situation is with fringe benefits. Fringe benefits of closely-held companies are normally taxable to an S corporation’s shareholder-employees. Again, another situation where you’d probably want to be a regular corporation.

Another reason you may want to stay away from S corporations is if you are looking for investors. Investors prefer regular corporations because S corporations aren’t allowed to have more than 100 shareholders, and they are limited to one class of stock, which means… no preferred stock.

Now, this obviously isn’t all inclusive. The point is, don’t just go out and form an S Corporation (or any entity for that matter) because someone told you to. The important thing to do before you create your entity is have some kind of understanding of the direction your company will likely head in and what’s important to you (investors, flexibility, lower income tax, etc.) and chose an entity based on that. And for goodness sake go talk to a decent tax accountant. Who probably isn’t your neighbor.

Apparently people are confused.  And I think most of the confusion has to do with the fact that individual tax returns aren’t actually due until April 15 (this year they are due April 18). Because of this, quite a few people, especially those that haven’t filed a corporate tax return before,  assume that the corporate tax return due date is also April 15. 

Corporate tax returns are in fact due March 15. (that’s today!)
So if you haven’t filed your corporate tax return as yet, either finalize the filing or do yourself a favor and file an extension using Form 7004, please.

While we’re on the subject of extensions, plthis would be a good time to point out that an extension is only an extension of time to file, not an extension of time to pay. So, if your return is on extension, and you end up with a balance due when you file the actual return, you may not be assessed a failure-to-file penalty, but you will get hit with the failure-to-pay penalty, which is currently .5%. Oh, and let’s not forget about interest.

So, what are you waiting for? Go file that return—or extension!

Hello and thank you for your helpful website! I have been unable to find an answer to this question and I hope you can help.

I live in California and work part-time for a small business that is a corporation. I will be moving to Texas and my current employer and I have agreed that I would begin working for myself as an accountant. I will get a business license and be working for the same company as a bookkeeper. I will set my own schedule and help with payroll taxes and basic accounting for the company.

My question is this: Will there be any difficulty in my being a W-2 employee and 1099 Independent Contractor in the same year? For my employer or myself?
Also what forms should I fill out to make sure everything is legal and kosher?

I have researched this subject on irs.gov and I will qualify as a Independent Contractor as far as I can tell. Being the one who dictates how, when and why I do things for the company and no longer an hourly employee answering the phones and setting appointments. Also I may expand in the future to other small business (in Texas most likely) that will allow me the same freedom to work online from home as an accountant or bookkeeper.

First, congratulations are in order. Making the move from employee to self-employed is quite an accomplishment.

It seems like you’ve obviously done your homework on the independent contractor classification. Nowadays, the IRS will tend to look at the level of control you have regarding the work being performed. There are 20 factors that the IRS will consider when determining who qualifies as an independent contractor—from things such as whether you set your own hours, perform the work on your clients’ premises, work for more than one person, etc. The full list with a bit of guidance can be found here.

It sounds like you should be fine, and there is absolutely nothing wrong with you going from an employee to an independent contractor in the same year. I know of a few instances where employees have gone from being employees, to freelancing on the side, to being full-time self employed—all in the same year. In a couple of those situations, their employer ends up being one of their clients.

As for the what you should do, definitely apply for an EIN, if you haven’t already done so—it’s fast, and you’ll have the number in minutes. It also wouldn’t hurt to have some kind of contract or written agreement, such as an engagement letter. Also, give them a signed copy of a W9.

Good luck and enjoy being an entrepreneur!

Disclaimer: like any decent tax professional will tell you, since you’re not currently a client of mine—though you can be—it’s almost impossible to provide complete and accurate tax advice over the internet without being aware of the taxpayer’s entire situation; therefore, I suggest you consult your tax professional before relying solely on any information provided on this site.

The returns that are impacted are those that claim deductions on Schedule A (mortgage interest, property taxes, medical expenses, etc.), the higher education tuition and fees deduction on Form 8917, and the educator expense deduction.

Also as previously mentioned, just because the returns won’t be accepted by the IRS until February 14 doesn’t mean that you can’t prepare them before that; you or your tax preparer will just have to hang on to them until then.

Taxpayer asks:

I was sued in 2010 for a divorce that never went through. I spent $3,000 in atty fees. I am self-employed as a Physical Therapist independent contractor. Is there anywhere I can legitimately deduct the $3,000 in fees paid to protect my business accounts and assets?

Legal fees can be split into two categories: personal and business. Legal fees incurred in connection with a business are always deductible—so long as the expenses are ordinary and necessary. However, with the exception of fees paid in connection with collecting alimony or for tax advice, those fees that are personal in nature are generally not deductible.

In the case of a divorce, legal fees are almost always considered personal expenses, and, as such, are not deductible. This is true even if it affects your business.

At this point you’re probably saying to yourself, “but I paid the fees to defend my business assets; shouldn’t I be able to deduct this as a business expense?” I hear you. But unfortunately the Tax Court doesn’t agree. They previously ruled that whether or not legal fees are deductible depend on how the claim originated, not the consequences should you fail to defeat the calm.

From what I can tell, the fees you incurred were solely because of the divorce, which is personal in nature, and, therefore, isn’t deductible as a business expense.

Also, keep in mind that if you were allowed to deduct the fees as a personal expense, you only get to deduct the amount that exceeds 2% of your adjusted gross income (AGI). This means that unless your AGI exceeded $150,000, you wouldn’t be able to deduct any portion of the $3,000 expense (150,000 x 2%=$3,000).

I’m sure this wasn’t the answer you were hoping for, but such is the case sometimes when it involves the tax code. Good luck with you business!

Disclaimer: like any decent tax professional will tell you, since you’re not currently a client of mine—though you can be—it’s almost impossible to provide complete and accurate tax advice over the internet without being aware of the taxpayer’s entire situation; therefore, I suggest you consult a tax professional before relying solely on any information provided on this site.

I was audited last year, but with all the moving, I never received my audit paperwork, can I still file this year or do I need to take care of the audit first

While getting audited isn’t fun, having to also pay penalty and interest for late filing a return would be even worse. So go ahead and file your 2010 return.

While you’re at it, reach out to the IRS examiner that was handling your audit to find out the status. An audit is just not something you want hanging over your head.

If the audit is still pending, depending on your circumstances, you may even want to hire a tax professional to assist with the audit.

Good luck!

Disclaimer: like any decent tax professional will tell you, since you’re not currently a client of mine — though you can be — it’s almost impossible to provide complete and accurate tax advice over the internet without being aware of the taxpayer’s entire situation; therefore, I suggest you consult a tax professional before relying on any information provided on this site.

First, the good news: you now have 3 more days to prepare your return. Returns will now be due on April 18 instead of the usual due date of April 15.

The due date extension is apparently so there aren’t any confusions with Emancipation Day, which is observed on Friday, April 15. Those taxpayers who itemize deductions on Schedule A, claim the tuition and fees deduction, or claim the educator expense deduction will need to wait until mid-February before they can e-file their return. The IRS estimates that this should affect less than 7% of taxpayers.

Keep in mind that the return can still be prepared now, the IRS just won’t be prepared to except them for another month. Most paid preparers and some commercial software providers have said they will prepare the return now and wait until they receive notification from the IRS to e-file.

We have always filled out 1099-Misc forms for all of our artists who earn more than $600. I have an artist who is insisting that she doesn’t need to provide her tax ID # to us because her artwork is a good and not a service and therefore does not fall under the 1099 form. Can you help me resolve this?

Ken, the quick answer is she’s right, but not for long.

You’re normally required to issue a Form 1099-Misc to all non-employees that you pay more than $600 for services — corporations are generally exempt. Since her artwork is a tangible product and not a service, it doesn’t fit the requirement for non-emloyee compensation.

However, starting in 2012, a 1099-Misc will have to be issued for practically everything. The exemption for corporations and payments for products will no longer apply. So any business that buys products from, say their local office supply store, will have to issue a 1099-Misc to them so long as they make payments of over $600 in any given year. I know, it’s absolutely ludicrous, which is why so may people and organizations are completely against it. It places an unnecessary burden on small business especially.

You don’t need to issue her a 1099-MISC for 2011, but starting in 2012, she — and all the other artists you work with — will have to provide you with her Taxpayer ID so you can issue her a 1099-Misc if you pay her more than $600. And you will also be required to issue a 1099-Misc to any business that your gallery pays more than $600, corporation or not.

Hope that helps.

Disclaimer: like any decent tax professional will tell you, unless you’re an actual client of mine — and currently you’re not — it’s almost impossible to provide complete and accurate tax advice over the internet without being aware of the taxpayer’s entire situation; therefore, I suggest you consult a tax professional before relying on any information provided on this site.

Bear with me as I try to make sense of it all.

But first, a quick explanation of what these tax cuts are: In 2001, and again in 2003, there were a series of tax breaks that were enacted to help stimulate the economy.  If nothing is done, these tax breaks would basically be nonexistent after 2010. Hence the debacle we’re now in.

Now, let’s take a closer look at the provisions in this deal.

1. Tax Rates  Tax rates were initially lowered during President Bush’s term.  A new 10% tax bracket was created.  And most rates dropped by 3%.  Should this deal be enacted, the lower rates that we had in 2010 would be the same for 2011 and 2012.

2. Estate Tax  This is probably what has upset Democrats the most.  The deal makes the top rate 35% with an exemption of 5 million.  Yeah, 5 million dollars.  At this point, for most Americans, there would be no estate tax for 2010 and 2011.  I mean, seriously, that’s a 10 million dollar exemption for a married couple.

3. Capital Gain.  These rates would remain at its all-time-low of 15% for long-term gains for two years.

4. Dividends  Same as with the capital gain rates, the top rate of 15% would remain the same for two years.

5. Unemployment Benefits.  Apparently this is the reason Obama agreed to this deal in the first place.  Federal unemployment benefits would be extended through 2011.  I’m sure some of those that are out of work are breathing a sigh of relief right now.

6. Payroll tax The social security tax rate would drop from 6.2% to 4.2% on the first $106,800 earned.  Note that this rate decrease is for the employees’ portion of social security taxes only.  And unlike the other provisions in this deal, this one will only last for 1 year.

7. Child Tax Credit.  This was raised to $1,000 per child during the Bush-era.  Guess what would be extending for another 2 years?  You guessed it. The $3,000 earned income that was needed to make the credit refundable still stands as well.

8. American Opportunity Tax Credit Specifically the modified version of the Hope credit with an increased available deduction of $2,500 – instead of $1,800 – would also remain the same.

9. Earned Income Tax Credit  What is probably the most abused and controversial of all tax credits also gets extended.  The base amounts were changed to allow more low and middle class family to be eligible for the credit.

10. State and Local Sales Tax Deduction  This went away in 2009, and from what I’ve read, there is a posibility that it could be brought back – maybe even without the need to itemize.

11.  Deductibility of Real Estate Tax Without Itemizing.  You’ve always been able to deduct real estate taxes, but just like last year, you would be able to deudct them even if you didn’t itemize your return. It would simply increase your standard deduction.

12. Transfer of IRA to Charities  Taxpayers that are over age 70 1/2 can transfer their IRA balance directly over to a charity.

13.  And before I forget, ATM  We got a patch.  Again.  How many times are we going to dance this dance?  Seriously?  Just get rid of the damn thing already.

And that, my friend, is what this deal would mean for you.  Some of it will affect you directly, then again some won’t.  But make no mistake about this, it will affect us all.  How much do you think all of this is going to cost? If you answered anywhere close to $900 billion, then you’d be right.

President Obama gets unemployment benefits and lower social security tax, and apparently the Republicans got everything else.  No wonder the Democrats are upset.  So much so that Nancy Pelosi and other House Democrats passed  a resolution stating that the package should not come to the floor of the House of Representatives.  At least not in its current form.  They want changes.  Then again, don’t we all.

This year, like all the others before it, the IRS is trying to return undeliverable refund checks to a few taxpayers. This time around they’re on a mission to return $164.6 million, with an average of $1,471 per check. Do the math; that’s 83 million cups of coffee or clean drinking water for 8.2 million people in Africa, in case you’re the charitable kind.

While that number represents only a small percentage of the total amount refunded by the IRS, it never ceases to amaze me.

Think some of that money belongs to you? Visit Where’s My Refund to find out. From there you can update your address, and from what I understand, the IRS should then automatically mail the check to you. You can also check the status of your refund by calling 800-829-1954.

Direct deposit is almost always faster and more reliable than getting a check mailed. Next time you’re getting a refund from the IRS, think about getting it direct deposited.