August 2020 Newsletter: Entity Structures Explained, Some Common Business Deductions, Hints on Pricing for Goods and Services
August 2020 Newsletter-Summertime!
An old proverb once stated, “May you live in interesting times.” But interesting is not how I would classify the current situation, and problems facing our country. Still, I hope that you are making the best out of these troubling times, that you and your family are happy and healthy and you’re doing your absolute best to enjoy the summer…just think in 3-4 short months, this will all be gone! You may have heard this before, but difficult times are often the best incubators to act. It’s natural to feel overwhelmed, unfocused, and not as motivated as you normally might be. But this is the perfect time to act. Plan, prepare, and most importantly, act. If your competition is lying low, act. Reach out to your customers, past and present, to just say hello-act. Keep your social media up to date…post a photo, an event, celebrate a business win-but, act. Business Owners need to act, but they also need to dream. Take some time to think about expanding your service or product offering, consider how best to position your product or service to best highlight and strengthen your brand. Accounting is a necessary tool and requirement for your business, but Marketing, successful marketing, is about perception and positive perception drives value. If you cannot create value, you won’t need an Accountant! As your business evolves, you’ll go through many, many changes. You’ll think, plan and implement only to find out that your product or service is not well received. There will be “misfires,” “rabbit holes,” and “dead ends,” if you’ve given these plans enough time, then act. Cut your losses, and change course. Know when it’s time to stop thinking and act.
Ok, let’s refocus to all things Accounting. I hope to pick two or three short topics every month to help my Client’s understand (better) the wonderful world of Accounting, Bookkeeping and Taxation and make it as interesting as I can without curing you of your insomnia. If you end up reading these short posts and come away feeling you got something out of it, then I’ve done my job! Share it, pass it along. My focus is to make you, more successful, and I believe in sharing information. Accountants that don’t share give the profession a bad name, IMHO and tick me off.
Explained: S-Corporations and Single Member LLC’s/Sole Proprietors
This is where a lot of Business Owner’s need help and have questions. Let me briefly recap a few things before going further. Single Member LLC’s (SMLLC’s) are entities that are created at the State level. For Federal Tax purposes, SMLLC’s are the same a Sole Proprietors. A Sole Proprietor Business Owner is “inseparable” from his/her business, in other words, the Proprietor and Business are one and the same. Multiple Member LLC’s are taxed as Partnerships. S-Corp’s are different. You can create an SMLLC at the State level but petition the IRS to be taxed as an S-Corp for federal tax purposes. Why would you do that? S-Corp’s enjoy certain tax advantages if they generate enough net income to take advantage of these benefits, but there’s a catch. The IRS imposes certain requirements that must be met. And yes, you can incorporate at the State level but State’s usually impose their own requirements as well. S-Corp’s are in effect a separate entity, distinct from their Shareholder(s)/Owners.
Sole Proprietors show their business expenses on a Schedule C as part of their 1040 tax filing. S-Corp’s are required to file a separate 1120S Tax Return. Owners/Shareholders declare their share of the income/losses of the S-Corp on their 1040 personal return by way of a K-1. The K-1 is the link between the S-Corp return and Shareholder personal return. So, there is no difference between a Sole Proprietor and his/her business, and the IRS considers Sole Proprietorships “disregarded entities.” However, S-Corp’s are considered separate entities, and Shareholders are separate (separate taxpayers) from the S-Corp’s that they own, even though S-Corp’s typically do not pay taxes-they are what are called “pass-through entities.” These are important and fundamental distinctions.
This is an area that gets a lot of attention and for good reason. Depending on the type of business that you run, vehicle expenses and depreciation account for a significant amount of deductions for business. Sole Proprietors (SMLLC’s) or Shareholders (S-Corp’s) can deduct vehicle expenses based on a Standard Mileage Rate (yearly rate published by the IRS) or based on Actual Expenses, for vehicles owned by the SP or Shareholder. Sole Proprietors deduct these expenses on their Schedule C which is part of their 1040 personal return. For an S-Corp, vehicle expenses are documented on the S-Corp’s 1120S return. The Standard Mileage Rate or Actual Expenses require well-documented mileage logs. Commuting mileage, between your home and place of business does not count as business mileage. Mileage between your place of business and a customer site does. To get vehicle expenses on the books of an S-Corp, Shareholders must be reimbursed, by way of a documented expense reimbursement form. The S-Corp reimburses the Shareholder for Mileage or Actual Expenses for a Shareholder owned vehicle based on the percentage of business use. Reimbursements between an LLC and SP or S-Corp and Shareholder require Accountable Plans so that these reimbursements are not classified as income to the SP or Shareholder. Vehicle expenses for vehicle’s registered in the LLC or S-Corp’s name are paid directly by the LLC or S-Corp. Is it beneficial to register a vehicle as an asset of the LLC or S-Corp? Like most answers (when it comes to tax) it depends.
From a tax strategy standpoint, oftentimes, it’s not a great idea. Putting a vehicle on the books of your company allows the company to depreciate it, and that’s great unless you fully depreciate it and then sell it. Then you’re forced to recapture all that depreciation as ordinary income on the sale. Often too, transferring the title to your company will require you to pay sales tax (again) on the transfer. Also, if the vehicle usage drops less than 50% for business, then a portion of the depreciation taken (in prior years) must be reclassified as ordinary income. Putting the only vehicle, you own on the company’s books may not make a lot of sense if a lot of personal use is involved. It’s a complicated topic and every situation is different. So, it must be looked at carefully to determine what’s best for every individual taxpayer. Tax planning occurs before the end of a tax year…there’s very little that one can do if you wait to act after the year closes out.
Mobile Phone Expenses-Short Topic
Another topic that definitely deserves more attention. I’ll spare you the excruciating legal-ease language regarding IRS guidance. My first thought(s)…if it’s both necessary and reasonable to have you or your employees be accessible during the workday with Clients, Customers, Vendors or other business-related needs and the benefit outweighs the expense, consider putting the phone in the Company’s name. This carries more credibility in terms of validating business usage and will save you time. The alternative would be pouring over prior year phone bills trying to determine which calls were personal and which were business, if you used a personal phone and were under examination by your friendly IRS Representative, if they believed your expenses were excessive.
Let’s get to the good stuff…Employees that use Employer-provided cell phones, in general will not be subject to tax for the use of the phone for personal reasons, subject to a de minimis fringe benefit excludable from the employee’s gross income. If an employer requires an employee to use their personal cell to maintain contact with clients/customers outside normal work hours, IRS guidance allows the employer to reimburse the employee for the monthly cost of the basic coverage plan as long as the employee substantiates this on a monthly reimbursement form. This reimbursement will not be considered income to the employee as long as the pattern of reimbursement does not deviate significantly from month to month and the coverage plan is reasonable to meet the needs of the employer’s business.
Importance of Accurately Pricing Your Service or Product
I just wanted to touch on this a little. More of a Managerial Accounting topic. Sometimes it helps to get a different perspective. I’ve talked to many, many business owners and often, they wonder why they are not as profitable as they would like. I could easily write a book on this, but there are two main points I wanted to share. If it isn’t, maximizing your profitability should be one of your goals. Profitability for any service or product you offer is a function of two broad things: 1. the activities in your business that drive costs that allow you to deliver a product or service and 2. The flexibility you have to price your product or service in a competitive market. There are other factors, but I’m keeping this brief. Concentrating on #1 here. Have you ever considered how much activity is required to deliver (1) unit of service or product to your customer? You may think you don’t have a complicated operation, but if you were to consider all the activities from start to finish to complete every service or product, you may be surprised just how much activity is required. You pay your employees to perform these activities, so that generates cost. That’s easy, you say, but have you thought about all the Indirect activities that are involved? Direct activities are those that directly involve the service or product, but indirect activities are those that are NOT linked to any particular product or service.
Think of it this way. What costs do I have that would vary with sales volume? If I increase sales, what costs are likely to increase (variable costs)? This helps to focus attention to include all those activities and costs toward understanding your cost structure and to develop an accurate unit cost. Why is this helpful? Consider a company whose unit costs (for a product or service, it doesn’t matter) are in reality, higher than the company believes. What happens? The company underbids the job and the job is (in reality) unprofitable. Alternatively, what if the company has unit costs that are in reality, lower than the company believes. Just the opposite occurs. The company will likely overbid the job and run the risk of losing the business, all other factors being equal. Some company’s enjoy little competition, so they have a lot of flexibility in how they can price their products or services. But these advantages often don’t last…word gets out and competition creeps in and forces these owners to rethink their pricing.
Also, I have a referral program but it’s not cast in stone, and will be subject to change. My thought process is that if you are a current Bookkeeping Client and you refer a potential (Bookkeeping) Client, I will discount your Bookkeeping fees by 20% for two Months. If that potential Client turns into a real Client, I will discount your fees 15% for six Months. Tax Clients that refer potential Tax Clients and Tax Clients that refer non-Tax Clients (and vice-versa), I will offer discounts based how involved (complex) the engagement with the new Client becomes. Like I said, it’s not firm, but I wanted to get this out. If you know of someone looking to make a change, or starting a business, or just in need of some advice, send them my way.
I hope you found this beneficial. I want to keep these to 3-4 pages or less, because no one has time to read anything longer than a few pages these days. If it helped you in any way, let me know. If you thought it was too wordy or my approach needs work, I’d like to hear that as well. If there are any topics, you’d like me to write about, send me your thoughts, firstname.lastname@example.org.
Ok, folks that’s it. Until next Month, enjoy your Summer. See below, and have pity on my camera skills…
Best Regards, Mike