Having structured countless businesses in our community, I find it beneficial to work closely with my clients' accountants. When it comes to strategic and operational advice on running a business, the accountant serving my clients is in the best position to create the most advantageous results for the business owners. I have enjoyed learning about frequently asked questions that I often receive from William "Bill" D. King’s perspective. Bill is CEO of Accountants and Business Advisors, Inc. (ABA) and serves professionals and small businesses nationwide.
Mital: How does the legal structure of a business affect the taxes?
Bill: A fundamental issue that needs to be decided by small business owners is whether or not they would like to utilize a Pass-Through Entity (“PTE”) versus a stand alone entity (such as a C corporation). PTEs are generally preferred, as the entity itself does not pay any tax. Instead, the income or loss flows through the individual owner – and the owner pays taxes on their personal return for the income from the PTE. Conversely, C corporations pay an income tax of 21% - and dividends are generally “Qualified Dividends” that result in capital gains tax for the owner when distributions are made. This “double taxation” is generally not advantageous to small business owners.
Mital: What legal structure do you recommend and when?
Bill: Business owners need to have entities in place to protect them from liability. Having a business entity can also facilitate significant income tax strategies. The most common structure is a Limited Liability Company (“LLC”). LLCs can be sole proprietorships, partnerships, C corporations, or S corporations. Most small businesses are best served to have an S corporation election filed for their LLC, which allows them to extract funds from the business (once overhead is paid) for business expense reimbursement to themselves, salary, and dividends [which are officially called (“Shareholder Distributions”)].
Mital: What are the three must-dos for business owners to help them avoid tax problems and audits?
Bill: First, report all income. Deductions taken for expenses may be debated or challenged by the IRS, but the outcome of a denied deduction is simply a payment of income tax, plus penalties and interest. Conversely, failure to report all income is considered fraud – and can be elevated to a criminal level by the IRS.
Second, understand all payment requirements and filing deadlines – and comply. This includes income tax requirements, payroll tax requirements, and sales tax requirements.
Third, if your business suffers losses in consecutive years, be sure to take all appropriate steps to conduct all activity as a true “Business”. This means separate accounts, recordkeeping, marketing strategies, and so on.
Mital: When a business owner comes to ABA for an assessment, what are the top three mistakes we see that have led them to a higher tax burden?
Bill: 1) Not understanding which legal structure best helps minimize their tax burden. 2) Failing to understand all eligible “Business-Related” expenses for which they can be reimbursed – including, but not limited to home office, automobile, social activities, travel, and meetings in their home. 3) Failure to include family members with lower tax brackets as employees or potential owners.
Mital: What would your advice be to an owner selling their business to help them mitigate a large tax burden?
Bill: First and foremost, get coaching from people who understand your options – and do this a few months or even years prior to the sale. Make sure your advisors are familiar with deferred sales trusts, private placement life insurance, opportunity zones, and the plethora of other tax mitigation strategies available to help reduce or eliminate capital gains tax when your business is sold.
The bottom line is that business owners need to solicit advice from professionals familiar with all the income tax opportunities available to small business owners. They then need to comply with proper execution of strategies, proper documentation, and all other aspects of tax mitigation, putting them in the best possible place to have the least amount of income tax burden and to be able to properly defend themselves in the unlikely event of an audit.
Mital D. Patel, Attorney
TriAmicus Law, PLLC