Dear Margi,
Having formed an S-Corp for your business is an excellent idea,
especially if you have losses. I really recommend, that while
Google Researchers are excellent, brilliant, wonderful, and
really quite expert, you need someone to work directly with
you, who can sit down with you and view your entire business
plan, strategy and market, and work with you to set up your
tax planning. We can answer questions in broad sense. But
without being privy to the specifics of your business, we
can't give you all the help you need. So, aside from this
answer, please see if you can hire a good, local tax pro
who understands your industry and S-Corporation, too.
Regardless, we will always be here to help.
1)[Can business expenses incurred prior to the incorporation date (or
S Corp election) be applied towards that tax year?]
In general, expenses taking place before you were open for business are
considered start-up costs. The Internal Revenue Code tells you to
amortize those costs over 5 years or more, depending on what they were.
However, there are ways to pick up some of those costs and get the
benefit of them. Here are two options:
a) If you spent money on equipment and assets, you may contribute
them to corporation, at your cost (since they were new). Then, you
may take advantage of the Section 179 expensing option that lets you
write off up to $24,000 in 2002 (up to $25,000 in 2003, with President
Bush's Economic Stimulus Package wanting to raise that to $75,000)
http://www.irs.gov/formspubs/page/0,,id%3D104269,00.html#T34
b) Some expenses may qualify as legitimate operating expenses.
(Consult with your tax pro to determine which.) For those, you may
prepare an expense report and submit them to your corporation for
reimbursement. That way, you get money out of your S-Corp and you
also get the write-off.
In response to your last question (4) Since an S Corp's taxes pass
through to the individual, can losses for a given tax year be
applied to gross income earned earlier in the year so as to lessen
the tax burden, or are these items somehow dealt with individually?
On the other hand, if you had the same business before you opened the
S-Corporation, you may want to keep many of those expenses in your
(Schedule C) old business. These expenses will reduce your profits
and the 15.3% self-employment taxes you must pay on those profits.
Have your tax advisor review those expenses and see if it makes sense
to leave them in the previous business.
2)[I've heard of a principal making a capital investment (cash and/or
tangible assets) into an S-corp, and having the S-Corp owe an
unsecured note back to the principal (as an individual) at a low rate
of interest.]
Yes. That's a good idea. If the company doesn't have the money to pay
you when you submit the expense report, show the amount due to you as
loan to officer. Use the Federal Applicable Rate table to find the lowest
interest rate allowed by IRS.
http://tax.cchgroup.com/taxbuddy/afr.asp
You asked about the risks? And is it legitimate.
Certainly, it is legitimate and legal. The risk is that if you don't
actually charge interest (and pay it), IRS will frown on the transaction.
Just prepare an written note for the loan, with the interest rate and
repayment terms on it, and actually pay the loan back - and you need
have no more concerns.
3) [I've been deferring my salary since I started the company. Is
deferred comp taxable?]
In an S-Corporation, if you put wages on the books and don't pay them,
yes, the company would get the deduction, and you would report income
on your personal tax return. Deferred compensation is rarely a good
idea in an S-Corporation. Don't set up salaries until you have the
money to pay them. Then, if necessary, pay yourself a higher salary
to catch up. This is definitely an area where you want to consult
with your own tax advisor. There are some excellent strategies, that
I cannot publish in a public forum, that your tax advisor can teach you.
4) [Since an S Corp's taxes pass through to the individual, can losses
for a given tax year be applied to gross income earned earlier in the
year so as to lessen the tax burden, or are these items somehow dealt
with individually?]
And this, Margi, is the beauty of the S-Corp. It takes your losses
and puts them right back on your tax return. So, yes, it will reduce
your total taxable income in the current year.
What will it not do? It won't reduce your self-employment income. So,
if your previous business had a profit, you will still pay that 15.3%
tax on all that profit. However, your overall income taxes will be
reduced.
What's if your losses are higher than all your sources of income?
It's possible that you may have a Net Operating Loss. If you do,
you may be able to carry that back for several years and get some
immediate refunds. Or you may chose to hang on to it and use it in
the future. A good tax advisor can review your financial situation
and help you decide which is the better strategy.
I hope this helps.
Sincerely,
Your TaxMama-ga |
Request for Answer Clarification by
margi-ga
on
02 Mar 2003 12:38 PST
Hi TaxMama... (are you one and the same from taxmama.com???)
I'm sorry it took me so long to get back. We had some major family
issues going on, but now... back to business Anyway... I have one
primary clarification request, and an add-on question. It may be a
stupid question, so please bear with me. I find this year, in
particular, confusing to account for.
I made estimated tax payments in the beginning of the year based on
some contract work. My husband and I file jointly, and he is
employed. I made income and had expenses as a sole proprieter in
2002. I incorporated in Oct of 2002. I rec'd approval from the IRS to
file as a s-chapter corp. Reminder, I have no state income tax.
I'm going to correct my books so that the expenses prior to the date
of incorporation are applied to the sole proprietership. Then, I'm
going to start clean with the corporate books -- which will be for the
last quarter only.
So... does that mean that:
1) I need one set of books for the sole proprietership, and inclusive
of the contracting work I did in the beginning of the year.
2) Then, we have our household bookkeeping as a separate set of books
(we usually only qualify for the standard deduction.)
3) Then the s-corporation as a separate set of books that begin 10/02.
And, if this is the case... I need to prepare the Corporate return,
based on the corporate books only for 2002 and due Mar 15? Then an
individual return for me and my husband based on the contracting, the
sole proprietership plus his income due April 15? And how do I
correlate the two together? Am I still making an estimated tax payment
on Mar 15 too??? UGH!
And, lastly, one more question. In the corporate books, the
corporation assumed a line of credit debt from the sole
proprietorship. This LOC was used to secure capital equipment that is
now part of the corporation (only about $5K worth) and the corporation
now pays for the monthly LOC payments (including interest). Can you
please tell me how to enter that in quickbooks since the corporation
started out with a debt? I can't figure out where the second half of
the transaction goes (you know... that good ol double entry system...)
I'll go ahead and post my tip of $40, plus another $10 for the above
LOC question. I want to do this since it's been so long since you
heard from me, and I don't want you to wait any longer. If posting the
tip closes out this item, would you please post your reply as a
comment?
THANK YOU SO MUCH!
|
Clarification of Answer by
taxmama-ga
on
02 Mar 2003 17:07 PST
Hi Margi,
Welcome back from your travels. I do hope everything worked out.
Let's get to your questions. I'll number them, using Roman
numerals, so we can follow them.
I. So... does that mean that:
1) I need one set of books for the sole proprietership, and inclusive
of the contracting work I did in the beginning of the year.
Yes, Margi, exactly. Each one was a separate business.
II. 2) Then, we have our household bookkeeping as a separate set of books
(we usually only qualify for the standard deduction.)
True. If there are any expenses in your household books or checkbooks
that were really paid on behalf of the business, submit an expense
report and get reimbursed.
III. 3) Then the s-corporation as a separate set of books that begin 10/02.
Exactly.
IV. And, if this is the case... I need to prepare the Corporate return,
based on the corporate books only for 2002 and due Mar 15?
Yes
V. Then an individual return for me and my husband based on the contracting,
the sole proprietership plus his income due April 15?
Yes
VI. And how do I correlate the two together?
Look at the total tax. It's possible that, with your husband's withholding,
you may already be fine for last year. If not, sigh, you'll have a balance
due for last year.
VII. Am I still making an estimated tax payment on Mar 15 too??? UGH!
Maybe. But, since you'll be an S-Corp, you won't have to pay self-employment
taxes on all your profits. This will significantly reduce the amount of
taxes you will owe for 2003. As a result, any estimates you pay will be
lower than they might have been last year.
Remember, the estimates will be based on the total income, less itemized
deductions and exemptions, that you and your husband will have in 2003.
In fact, if he's agreeable, you can always increase his withholding and
make no estimated payments at all during the year.
VIII. And, lastly, one more question. In the corporate books, the
corporation assumed a line of credit debt from the sole
proprietorship. This LOC was used to secure capital equipment that is
now part of the corporation (only about $5K worth) and the corporation
now pays for the monthly LOC payments (including interest). Can you
please tell me how to enter that in quickbooks since the corporation
started out with a debt? I can't figure out where the second half of
the transaction goes (you know... that good ol double entry system...)
OK Margi, here's the outline of the journal entry
(I'll make up numbers):
Loan from Officer ($2,000)
(or equity - this could be the vaue of your stock purchase
LOC debt ($5,000)
Equipment $10,000
Accumulated Deprec (3,000) (from before incorporation)
Total -0-
IX. I'll go ahead and post my tip of $40, plus another $10 for the above
LOC question. I want to do this since it's been so long since you
heard from me, and I don't want you to wait any longer. If posting the
tip closes out this item, would you please post your reply as a
comment?
Many thanks, Margi. I really appreciate your enthusiasm.
And do feel free to let me know if you need any further clarification.
This question isn't closed out until you're satisfied.
Best wishes,
Your TaxMama-ga
|
Request for Answer Clarification by
margi-ga
on
02 Mar 2003 18:32 PST
Thank you! I got the email about your answer while I was doing
research on your site!
===============================================================
You said:
Loan from Officer ($2,000)
(or equity - this could be the vaue of your stock purchase
LOC debt ($5,000)
Equipment $10,000
Accumulated Deprec (3,000) (from before incorporation)
Total -0-
===============================================================
OK... so the concept here is that the debits equal the credits... and
since it was capital equip over $500, I need to use accumulated
depreciation...
So, if I just take my capital equipment cost and plug it in where
you've got the $10K, take the LOC bal that the corp assumed in Oct and
plug it in where you put the $5K, take 30% as the accum deprec
(30/30/40 over 3 years, right?), then ... (deep breath) the bal of the
Equipment number, less the LOC, less the accum deprec goes to owner's
equity?
Then, on a monthly basis... the interest on the LOC gets added to that
account, the payment made then comes off the balance with the monthly
fee being accounted for as payment of the principal liability... and
the interest as interest paid, right? Can you believe I'm trying to
learn QuickBooks at the same time?
Jeez, now I remember why I switch majors from accounting to marketing!
Ugh!)...
Lastly, did you see my other post? I'm trying to pay you your tip of
$50.
THANK YOU, Mama... :-)
Marg
|
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