“It Depends” Disclaimer – As tax professionals, we try (and love) to give tax advice and guidance the best we can. But the truth is, more often than not, the answer is “it depends”. An experienced and savvy tax professional knows that not all tax situations are the same. Each situation must be assessed on its own. There are almost always exceptions and typically not a “one size fits all”.

Many tax questions end up taking us through a dizzying and lengthy decision tree with many different branches that are dependent on the answers to the questions given. The FAQs provide general guidance and some of the more common answers.

1. What entity should I choose for my business?

There are many questions to ask yourself before choosing the right business entity. There are several options out there and what’s right for one person, may not be right for another. Determining your priorities is important. Some questions (this is by no means an exhaustive list) to ask yourself are:

• Are you needing flexibility in allocating income (losses) and distributing capital to owners?
• How many owners and what type of owners will there be?
• Do you intend on funding the business via owner’s capital or debt?
• What type of business are you going into? Is there real estate involved?

Learn more information on choosing the right entity.

2. What’s the difference between tax preparation and tax planning?

The biggest difference between the two is that tax preparation looks to the past while tax planning looks towards the future. Tax preparation consists of compiling historical information into a tax return to report income, deductions and tax withholdings (or estimated tax payments) to the IRS. Tax planning looks towards the future to proactively strategize in an effort to minimize tax liability and plan ahead. While a complete and accurate prepared tax return is important, a CPA can really add value by meeting with their clients throughout the year to provide timely advice and strategy.

The annual timeline below shows an ideal breakdown on time spent during the year.

                                       

3. I use my personal vehicle in my business. Can I take a deduction?

Yes. There are two options in calculating your business use of car deduction. You have the option to itemize vehicle expenses (gas, insurance, repairs, etc.) or just apply a flat standard mileage rate set by the IRS You’ll want your tax professional to calculate both methods and choose the deduction that yields the largest tax benefit. Either way, you’ll need to track the business vs. personal miles to properly allocate and calculate expenses. IRS Topic 510 provides more details on business use of car.

4. I use my home office in my business. Can I take a deduction?

Yes. Much like the business use of car, you have two options when calculating the home office deduction. You have the option to itemize home operating expenses (insurance, property taxes, etc.) or apply a flat rate of $5 per square foot (max of 300 square feet). The home office must be used exclusively for business purposes. You’ll want your tax professional to calculate both methods and choose the deduction that yields the largest tax benefit. IRS Topic 509 provides additional details on business use of home office.

 5. I am a business owner or earn income that’s not subject to federal tax withholdings. Should I pay in quarterly estimated tax payments?

One of the most significant variables in this question is cash flow. If you forego making estimated quarterly tax payments, the IRS sees this as providing you with a loan. For individual taxpayers, the IRS has set the interest rate at the federal short-term rate plus 3 percentage points. Find detailed information on current IRS interest rates here. Note: this is a two-way street, and the IRS will pay you interest if you make overpayments!

If your business is either in need of cash or using the cash that would have otherwise been paid to the IRS on more profitable work with returns greater than the interest rates charged by the IRS, it may be best to forego making quarterly estimated tax payments. However, it’s important that a business does not forget that taxes due on income earned are due on 4/15 of the following year. Note: a filed extension is only good for the filing of the tax return itself. Any tax due is to be paid by 4/15 in order to avoid triggering additional failure to pay penalties.

Should a business not necessarily need the cash in their business as described above or the taxpayer simply prefers to make estimated tax payments, it may be recommended to make the estimated quarterly tax payments. There are times when it makes sense to skip quarterly estimated tax payments and vice versa. Having regularly scheduled tax meetings with your CPA are beneficial in making this determination.

6. What should I look for in a CPA firm?

When we talk to prospects, the most common complaint we hear is that we wish our CPA would pick up the phone or email us back. Communication should be one of the most important things you look for in a CPA. You want a CPA who thoroughly explains complex concepts in an easy-to-understand manner. Your CPA should take a comprehensive and forward-looking approach. They should constantly make considerations to best serve you now but also for the future.

Taxes and money are emotional to most people. Emotions can sometimes cloud judgment. A good CPA will be objective for their clients in order to best advise their clients. 

7. If I am not ready to file by the deadline, can I get an extension?

Yes, if you are not ready to file by the original due dates during the Spring, you or your tax professional can file an extension to extend. It’s important to remember that the extension is only good for the tax return filing itself. If there is any tax due, an estimated payment must be made by the original due date in order to avoid triggering additional failure to pay penalties.

The table below summaries the due date and timeline of the most commonly filed tax returns.

                                     

8. Why didn’t I get a tax refund this year?

Too often taxpayers misconstrue the result of their tax returns by the dollar amount of their refund (or lack thereof) upon filing. This is a mistake. The amount due or refunded upon filing is merely just a result of math and inputs. You can better analyze the results of your tax return by looking at tax credits taken, tax as a percentage of taxable income, maximized deductions, deferrals, etc.

To get ahead of a sizeable tax liability, it’s best to meet with your CPA during the year. Tell them what’s going on with your situation and what you’re expecting for the remainder of the year. Your CPA can help you minimize a tax liability if it’s brought to their attention during the year it occurs. It can be tougher to work magic after it’s all said and done.  

9. I am a business owner. Should I file on the accrual or cash basis method?

There are certain requirements for a business to be eligible to file on the cash basis method of accounting for tax purposes. Generally, businesses that report less than $25 million gross revenue (3-year average), can elect to report income on the cash method. If able to file on the cash method, it’s typically recommended to do so as it more closely matches up taxes to be paid with when it was realized resulting in better cash flow to the business.

10. How do I minimize my taxes owed?

The IRS provides us parameters to work in. Each unique tax situation creates its own scenario which a taxpayer can work within to maximize deductions, claim credits, defer income, defer taxes, accelerate deductions, etc. These are all great options when it comes to minimizing your tax liability and vary by situation.

From time to time, we find taxpayers “chasing deductions”. Meaning, they’re looking for anything to deduct whether it’s a necessary purchase or not. This can be dangerous as before you know it, you’ve spent 30 cents just to save 70 cents. A good CPA will advise you when it’s advisable to spend the money for a deduction but will also let you know when you’re otherwise just wasting money to fulfill the satisfaction of claiming a deduction.  

11. What’s the difference between federal taxes and payroll taxes?

FICA (Federal Insurance Contributions ACT) taxes, also known as payroll taxes (or self-employment taxes if self-employed), are an additional tax assessed on taxpayers. This tax is separate from regular federal taxes. Payroll taxes were enacted by law in 1935 to fund the Social Security and Medicare programs. The total amount of payroll taxes is calculated by multiplying 15.3% by compensation or income earned. Among employee/employer relationship, this is split evenly. Self-employed individuals are responsible for the entire 15.3%. A savvy CPA can help a self-employed individual strategize to reduce self-employment taxes or avoid them altogether. Below is a table that summarizes payroll tax responsibilities.

                                         

12. How much “reasonable compensation” should S corporation owners take?

Income earned in an S Corporation is not subject to 15.3% self-employment tax. The IRS recognizes this and therefore requires businesses taxed as an S Corp to pay a “reasonable compensation” via W-2 wages to its shareholders. These W-2 wages are subject to the self-employment taxes. There is no exact formula in determining what’s considered reasonable. Important information such as industry norms and profitability are among some of the considerations made when determining what’s considered reasonable. Note: An S Corp shareholder isn’t limited to taking only W-2 wages as a form of income from their business. It’ll likely be a combination of both W-2 wages (subject to self-employment tax) and distributions (not subject to self-employment tax). 

13. I am a business owner. Can I pay my kids tax-free wages and take the deduction in my business?

Yes. You can pay each of your children wages up to the standard deduction ($12,550 in 2022). The compensation paid to your child Is considered tax free to them and your business can take the deduction lowering your taxable income. A few things to consider here:

• Compensation must be paid via W2 wages.
• The child must actually perform services for the business. It can be tasks as simple as filing documents, easy administrative duties, etc.
• If you pay them more than the standard deduction, they’ll begin to incur federal and payroll taxes owed and will be required to file their own tax return.
• Wages paid to children under the age of 18 are not subject to payroll (FICA) taxes and FUTA taxes if the parent’s business is a sole proprietorship, disregarded entity (single member LLC) or a partnership where each partner is the parent of the child.

Find more details on paying your children from the IRS here.

Tip: Consider setting up a Roth IRA for your child. There is no age requirement to contribute to a Roth IRA. The account provides tax-free growth and tax-free withdrawals. Compound interest is powerful, and time is on their side. They’ll thank you later in life! This is not formal financial investing advice. Please consult with your financial advisor before making any decisions.