I Received a Notice From the IRS - What Do I Do Now?

The first thing to do is to take a deep breath and relax. Then call me immediately at 954.591.8290 for a FREE no cost obligation consultation, or use my contact form.

You only have a short time to respond to the IRS before the situation escalates. Call us immediately so that we can put you at ease.

The financial press is abuzz with all the latest announcements from IRS about calls for increased enforcement of the nation's tax laws.

IRS recently announced they have reviewed or audited nearly a third of all tax returns that reported income of $10 million or more in the past year. One may recall in the September 2010 issue of For the Record, IRS introduced the Global High Wealth Industry Group in 2009 - a specialized team within IRS to pursue a more unified approach to audits of wealthy individuals. With that context in mind, this is a good time to review the most common types of letters and notices that IRS sends taxpayers.

It is important to note that very few audits actually require a face-to-face meeting with an IRS agent. There are many issues that IRS can examine or question on a taxpayer's return via correspondence. Often, having a good understanding of what positions in a return are being examined as well as responding in a timely fashion to IRS inquiries can result in a quick resolution of the audit or examination. Here's a brief overview of the more common types of notices:

• Notice CP 30 Estimated Tax Penalty: This form is used to notify a taxpayer all or part of an overpayment has been applied to an estimated tax payment penalty. It will also advise a taxpayer that all or some of required estimated tax payments were not timely. It is important to double check your records to determine whether the payments were made on time. It is recommended that payments be made through the electronic deposit program, or alternatively, mailed in via certified mail.

• Notice CP 2000 Notice of Proposed Adjustment for Underpayment/Overpayment (aka the Matching Notice): Receipt of this notice is fairly common and is mainly due to the increased Form 1099 e-filing requirements for financial institutions. The notice will typically list out proposed adjustments to a tax return and indicate the total increase in tax based on the changes. Although it may look like a demand for payment, it is not really a final determination of changes to a tax return. IRS uses this notice to request additional documentation from the taxpayer to verify the income, credits and deductions reported on your tax return because they're different from the information received from other sources. This letter often includes a detailed description of the adjustments and the basis for IRS' position, which is presented in an Explanation of Items (Form 886-A). A typical Form 886-A will contain the issue, the facts, the IRS' legal position and the IRS' understanding of the taxpayer's position. Good recordkeeping is of the utmost importance when preparing a response to this type of notice. If the taxpayer can substantiate the rationale for the position taken, as well as provide adequate third-party documentation for the amounts in question, the taxpayer has a greater likelihood of obtaining a speedy and favorable resolution.

• Letter 525 General 30 Day Letter: Per IRS: "This letter accompanies a report giving you a computation of the proposed adjustments to your tax return. It informs you of the courses of action to take if you do not agree with the proposed adjustments." Basically, the letter outlines what to do if a taxpayer wants to appeal the findings within IRS. The taxpayer should submit a request for appeal/protest to the office/individual that sent the letter. The protest should be filed within 30 days from the date of the letter in order to appeal the proposed adjustments with the Office of Appeals.

• Letter 531 Notice of Deficiency: This is the letter advising a taxpayer of their last chance to appeal. Per IRS: "The Internal Revenue Code authorizes the Commissioner to send this notice. The letter explains how to dispute the adjustments in the notice of deficiency if you do not agree. To dispute the adjustments without payment, you file a petition with the Tax Court within 90 days from the notice date." If a taxpayer neglects to address this letter, the collection process can officially begin.

• CP 504 IRS Intent to Levy: This is a final notice of a balance that is due on the taxpayer's account. This is usually the fourth notice that is sent, and will inform the taxpayer that a levy will be issued against their state tax refund. It may also include details stating that IRS plans to search for other assets on which a levy can be placed. Additionally, a Federal Tax Lien may also be filed if payment is not made at once.

This article can only provide a sample of the more common types of IRS notices. It cannot be overemphasized that responding timely to IRS is critically important. IRS has many tools at their disposal that can quickly escalate the severity of the penalties that can be imposed for willful neglect or noncompliance. However, it is important to note that many IRS notices, especially matching and late payment notices, are erroneous or have a simple explanation.

K.R. Hoffman & Co., LLC, counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how we can help you overcome your tax and business challenges. For more information or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

I truly value your business and I appreciate your referrals. Refer your family, friends, acquaintances, and business colleagues to KR Hoffman & Co., LLC. If your referral retains our services, we will send you a $25 gift card and your referral will receive a $25 discount on their first invoice.

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Something to Scream About

It's one of the most recognizable images in all of art. It's Norwegian artist Edvard Munch's iconic vision The Scream: an agonized figure --little more than a garbed skull and hands -- set against a background of blood-colored sky. And last month, it sold for a record-setting price. But could it have been inspired, at least in part, by his tax return?

Munch grew up in Oslo, son of a dour priest. At 16, he enrolled in college to become an engineer. He did well, but he quickly dropped out, disappointing his father, to study painting, which he saw as an attempt "to explain life and its meaning" to himself. At 18, he enrolled at the Royal School of Art and Design of Christiana, where he began painting portraits. His personal style addressed psychological themes and incorporated elements of naturalism, impressionism, and symbolism. He wound up studying in Paris and exhibiting in Berlin before painting the first of four versions of The Scream in 1893.

In 1908, Munch suffered a brief breakdown, followed by a recovery. That recovery brightened Munch's art as well as his life, as his later work becoming more colorful and less pessimistic. He finally gained the public approval he had sought for so long; he was made a Knight of the Royal Order of St. Olav; and he hosted his first American exhibit. Munch spent the last years of his life painting quietly and alone on a farm just outside Oslo. Today, he appears on Norway's 1,000 kroner note, set against a background inspired by his work.

We remember Munch now for his art, not his life. But that life included some frustrating run-ins with the tax man. Apparently, Munch wasn't any happier keeping timely and accurate records than the rest of us. Here's part of a letter that his biographer, Sue Prideaux, quotes him as writing, in her book Edvard Munch: Behind the Scream:

"This tax problem has made a bookkeeper of me too. I'm really not supposed to paint, I guess. Instead, I'm supposed to sit here and scribble figures in a book. If the figures don't balance I'll be put in prison. I don't care about money. All I want to do with the limited time I have left is to use it to paint a few pictures in peace and quiet. By now, I've learned a good deal about painting and ought to be able to contribute my best. The country might benefit from giving me time to paint. But does anyone care?"

Even without that tortured face in The Scream, most of us can still probably relate to his frustration!

Last month, Sotheby's auction house in New York sold a pastel-on-board version of The Scream that Munch painted in 1895 for $119.9 million -- a new record for art sold at auction. The seller was Norwegian billionaire Petter Olsen; the buyer remains unknown. If the seller had been American, there could have been quite a tax to pay. "Capital gains" from the sale of appreciated property held more than 12 months are ordinarily capped at 15%. (Republican presidential candidate Mitt Romney has proposed eliminating tax on capital gains for taxpayers earning under $200,000; while President Obama has proposed raising them to 20% for taxpayers earning over $250,000.) But paintings like The Scream are classed as "collectibles" and subject to a top tax of 28%. (You would be disappointed if we didn't say that's enough to make a collector scream!)

Are you holding precious artwork or antiques that are just taking up space in your house? Call us before you call the auctioneer. We'll make sure you keep as much of your record-setting price as possible. And remember, we're here for your family, friends, and colleagues, too!

K.R. Hoffman & Co., LLC, helps individuals and businesses take control of their taxes. Discover how we can help you with your business and tax challenges; call me at (954) 591-8290 or drop me a note.

Churches - Unrelated Business Income

A church must make quarterly estimated tax payments if it expects an unrelated business income tax liability for the year to be $500 or more.

Use IRS Form 990-W to figure your estimated taxes. Quarterly estimated tax payments of one-fourth of the total tax liability are due by April 15, June 15, September 15, and December 15, 2012, for churches on a calendar year basis.

If you need assistance in completing Form 990-W, have any questions about this topic, tax law changes, have questions about the IRS and your church, or want to become a client, please call us at 954-591-8290 or use our Contact form.

Report Card Time

Memorial Day has come and gone, and the school year is quickly winding down, if it isn't already over. Kids are getting excited for summer vacay, and there's just one hurdle left -- the dreaded report card. (If your kids are getting nervous and antsy around mail time, you might want to pay attention!)

 Kids in school aren't the only ones who have to sweat report-card time. That's right, the IRS gets a report-card time, too. In fact, they get two. By law, National Taxpayer Advocate Nina Olson has to submit two reports to Congress each year: the "Objectives Report," which outlines goals and activities planned for the coming year, and the "Annual Report," which summarizes the 20 most serious problems encountered by taxpayers, recommendations for solving those problems, and other IRS efforts to improve "customer" service and reduce taxpayer burden.

 And how do you think our friends at the IRS are doing? Well, this year's Annual Report listed twenty-two problems, not 20. Their biggest conclusion is that the IRS is simply "not adequately funded to serve taxpayers and collect taxes." It identifies "the combination of the IRS's expanding workload and declining resources as the most serious problem facing taxpayers."

 Granted, the IRS faces an especially tough challenge. "There were approximately 4,430 changes to the tax code from 2001 through 2010, an average of more than one a day, including an estimated 579 changes in 2010 alone. The IRS must explain each new provision to taxpayers, write computer code so it can process returns affected by the provision, and train its auditors to identify improper claims."

 And there were more specific problems, too. The IRS has to rely on computers to do most of their work, and computers don't always get things right. The IRS adjusts about 15 million returns per year -- but treats only 10% of those as "audits," so taxpayers don't always get traditional audit protections. And sometimes the IRS is just too busy to respond: they answer just 70% of taxpayer phone calls, and just 53% of written correspondence gets answered in 45 days. It's hard to ace your report card when you're missing that much of your homework!

 What can the IRS do about their report card? Well, they can't just make up their missing credit in summer school. But the Taxpayer Advocate does have two main recommendations. First, she urges Congress to "develop new budget procedures designed to fund the IRS at a level that will enable it to meet taxpayer needs and maximize tax compliance." And second, she suggests codifying a "Taxpayer Bill of Rights" to clearly outline and explain taxpayer protections and and responsibilities.

 Fortunately, the news isn't all bad -- the IRS has joined the social media revolution! There's a smartphone app to help track your refund, a YouTube channel with helpful videos in English, American Sign Language, and various foreign languages, and podcasts you can download from the iTunes store. You can even follow them on Facebook and Twitter!

 Our "Plan A," of course, is to give you the concepts and strategies to help you pay the least amount of tax legally possible -- then help prepare returns that avoid IRS scrutiny. But just in case that scrutiny finds you, we're always ready with "Plan B" -- to help deal with the IRS on your behalf, and make sure you don't become another Annual Report statistic!

 If you have any questions about this topic, tax law changes, have questions about your business, or want to become a client, please call us at 954-591-8290 or use our Contact form.

It Pays To Hire A Tax Professional

In Bilal Salahuddin et ux. (T.C. Memo. 2012-141) the taxpayers owed outstanding Federal income tax liabilities for tax years 2004, 2005, and 2006.

The IRS issued them a levy notice to collect those unpaid liabilities. The taxpayers requested a collection due process (CDP) hearing before IRS Appeals pursuant to Sec. 6330, during which they sought an installment agreement. They submitted a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, without supporting documentation. The taxpayer did not use a tax professional to assist them.

An Appeals team manager informed the taxpayers that the IRS's Philadelphia Service Center had calculated their acceptable amount for an installment agreement to be $900 to $1,000 monthly and advised them that their prior submission would be "sufficient". Without further communication with the taxpayers, the Appeals settlement officer closed the CDP hearing and sustained the proposed levy on the ground that the taxpayers had not provided sufficient financial information and that their ability to pay exceeded the proposed $900 to $1,000 per month.

The taxpayers filed a timely petition for review of that determination with the Tax Court, and the IRS moved for summary judgment. The Court held there was a genuine issue of material fact as to whether Appeals, having advised the taxpayers that their submission was "sufficient", abused its discretion in terminating the CDP hearing and rejecting their proposal for an installment agreement, rather than soliciting a satisfactory substitute proposal. The Court denied the IRS's motion for summary judgment.

If the taxpayers had consulted with a tax professional, the taxpayers may have saved themselves a lot of money, time and aggravation. A qualified tax professional would have ensured that the 433-A was properly completed and with the required documentation.  When the IRS said they wanted $900-$1000 per month, a tax professional could have invoked the "One Year Rule" as outlined in the Internal Revenue Manual, to force the IRS to accept payments the taxpayers could have afforded.  KR Hoffman & Co., LLC is that tax professional. Call us at 954.591-8290 to see how we can assist you.

K.R. Hoffman & Co., LLC, counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how we can help you overcome your tax and business challenges. For more information or to become a client, call me at (954) 591-8290 TODAY or drop me a note.

Proper Recordkeeping and Tax Deductions Go Hand in Hand

Recordkeeping is critical to securing a deduction. In Gabriel S. Garcia et ux. (T.C. Memo. 2012-139) the taxpayer operated two businesses that provided services to other entities.

The taxpayer paid various workers wages or contract labor expenses. Some of the payments were made by check and some of the payments were in cash. The taxpayer did not maintain complete books and records of the wages or contract labor payments he made during 2007 or 2008. Some, but not all, of the payments were reported to the IRS and to the workers as wages, and some were reported as nonemployee compensation.

Some, but not all, of the workers reported the income received from the taxpayer on their tax returns. Some of the workers provided to the taxpayer incorrect or illegible Social Security numbers. For 2007, the taxpayers reported on their tax return $356,581 as wage and contract labor expenses. The taxpayer was able to substantiate wage and contract labor expenses of only $230,291.

The IRS allowed a deduction $230,291 for 2007. For 2008, the taxpayers reported on their tax return $283,613 as wage and contract labor expenses but could substantiate expenses of only $157,190. The IRS allowed a deduction $157,190 for 2008.

The taxpayers' returns were prepared by his brother, who was not an accountant. The returns claimed erroneous, overstated or unsubstantiated deductions other than the ones for wages or contract labor. While the taxpayer testified he paid the amounts claimed, his testimony was not corroborated by any witnesses and he could not explain how he derived the amounts deducted on his tax returns in the absence of records, and his brother, who prepared the returns, did not testify.

The Court noted the taxpayer did not have any time records or other evidence from which we could estimate the amounts that he paid without substantiating documents. He did not identify any sources for cash payments to workers. The Court noted that it could have made an estimate of the expenses, but noted it could do so only when the taxpayer provides evidence sufficient to establish a rational basis upon which the estimate can be made. Without such evidence, the Court would not make an estimate. It allowed no more than the IRS allowed.

If you have any questions about this topic, tax law changes, have questions about your business, or want to become a client, please call us at 954-591-8290 or use our Contact form.

Charitable Contributions Substantiation and Disclosure Requirements

A recent summary opinion by the United States Tax Court highlights the importance of following the substantiation and record-keeping rules that the federal tax code has put in place for charitable contribution deductions. It is imperative that churches and other religious organizations do their part to comply with these requirements to ensure that their church members are eligible to receive charitable contribution deductions for their gifts and tithes.

In Gomez v. Comm’r, (T.C. Summary Op. 2008-93, 2008) a husband and wife contributed a total of $6,548.27 to their local Texas church. The taxpayers made the donations by writing 20 separate checks. Ten of the checks were each for an amount over $250. The IRS challenged the deductions related to the ten donations over $250 by arguing that the petitioners failed to meet the substantiation requirements imposed by section 170(f)(8) of the Internal Revenue Code (the “Code”).

Specifically, section 170(f)(8)(A) of the Code disallows a charitable contribution deduction of $250 or more unless the church member substantiates the contribution by a “contemporaneous written acknowledgment.” The acknowledgment must come from the church and must include the following information: (i) the amount of cash and a description (but not value) of any property other than cash contributed by the church member to the church; (ii) whether the church provided any goods or services in consideration, in whole or in part, for anything the church member contributed; and (iii) a description and good faith estimate of the value of any goods or services provided by the church, or, if such goods or services consist solely of intangible religious benefits, a statement to that effect. To be “contemporaneous,” a church must provide the written acknowledgment on or before the earlier of: (i) the date on which the church member files a return for the taxable year in which the contribution was made; or (ii) the due date, including extensions, for filing the return.

Because their church did not provide the Gomez family with a contemporaneous acknowledgement, the Tax Court denied them a deduction for any of the contributions that were for $250 or more. The Tax Court determined that a letter from the church written almost three years after the contributions did not meet the federal tax law requirements for a “contemporaneous” acknowledgment. The court was careful to note that even though it was clear that the Gomez family wrote checks for tithes to their church, and the cancelled checks for these tithes were “reliable,” the failure to meet the necessary substantiation requirements required the court to disallow the claimed charitable contribution deductions for checks equal to or greater than $250. (The IRS allowed the Gomez family to deduct eight other checks that were less than $250, and the court acknowledged that this was the appropriate result with respect to those checks.)

The Tax Court again reiterated that a taxpayer cannot deduct a charitable contribution without complying with the § 170(f)(8)(A) substantiation requirements. Durden v. Commissioner, T.C. Memo. 2012-140 (May 17, 2012).

Mr. & Mrs. Durden contributed $22,517 to their church in 2007. Although the church provided them with a timely statement acknoweldging the $22,517 contribution, it did not state whether they had received any goods or services as required by § 170(f)(8)(A) (the “first acknowledgment”). After being notified by the IRS of this deficiency, the Durdens obtained another statement from the church acknowledging the $22,517 contribution and stating that they received no goods or services (the “second acknowedgment”)..

The Tax Court accepted the IRS’s position that both acknowledgments failed § 170(f)(8)(A): (1) the first acknowledgment did not include the required goods or services statement; and (2) the second acknowledgment was not contemporaneous within the meaning of Reg. § 1.170A-13(f)(2) because it was not received by the Durdens before they filed their 2007 return.

The issue considered by the Tax Court in Gomez is inherent in the context of church-plate offerings. Thus, it is important that both donee churches, as well as their tithing members, are aware of the recordkeeping requirements for charitable contribution deductions. In this regard, churches and other religious organizations should consider the following:

• Churches should encourage church members to make donations using checks rather than cash. A cancelled check provides the tithing member with an appropriate “bank record” to substantiate the donation and makes it easier for the church to track and record each donation for purposes of preparing a written contemporaneous acknowledgement.
• For church members making cash contributions, churches should provide an envelope for a donor to fill out his or her name and the date and amount of the contribution. The church can then use this envelope for providing a written communication to the church member that the member can use to meet his or her recordkeeping requirements.
• Churches should keep ongoing records of the amounts received from each church member and update those records each week. See the IRS Publication 1771 Charitable Contributions: Substantiation and Disclosure Requirements.
• As soon as possible after the close of each calendar year, churches should send a letter containing the following information to each tithing church member: (i) the amount of each contribution of cash (whether made in currency or by check); (ii) a statement explaining whether the church provided any goods or services in consideration, in whole or in part, for anything the church member contributed; and (iii) a description and good faith estimate of the value of any goods or services provided by the church, or, if such goods or services consist solely of intangible religious benefits, a statement to that effect. Delay in sending out this letter could result in a tithing member being unable to deduct his or her tithes on his or her federal income tax return.

If your church or religious organization has additional questions concerning these or other substantiation and recordkeeping requirements for charitable contribution deductions, please contact us at 954-591-8290 or use our Contact form.

Crowd Funding Tax Questions

If you've been looking for funding for your business, you've probably heard of it. The concept is simple. Go to a web site that facilitates a matchup between you and potential investors. Investors may contribute small amounts (e.g., $50) or make a more substantial contributions (e.g., $2,000).

A bill defining the legal limits for investors was recently signed by President Obama, The Jobs Act & Investment CrowdFunding Act But the IRS has yet to weigh in on the craze.

Will the contributions be a "gift" and not income to the business? If the business provides a service or product in return will the contribution be "income"? If the contribution is significant, it couldn't be classified as a gift and probably not income, but then is it a loan or equity capital? If it's equity, does that mean the investor is now a partner or shareholder?

If you're doing business as a partnership, LLC, or S corporation and the contribution is equity capital, you may have to send the individual a K-1 each year. You may consider the tax issues a minor problem if you're getting several large (e.g., $10,000) contributions, but not if you receive 100 small contributions and have to treat them as equity interests. Talk to your tax adviser before making a commitment.

Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday between 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

If you found this article helpful, I invite you to leave a commit and  please share it on twitter, facebook or your favorite social media site and  with your friends, family and colleagues. Thank you.

Thou Shalt Not Sin?

It's no secret that Washington uses the tax code to do more than just raise revenue. Lawmakers also use it to influence some of our biggest financial decisions, with tax deductions for mortgage interest to encourage homeownership, tax credits for fuel-efficient cars to encourage conservation, and "bonus depreciation" to stimulate business spending. Washington seems to believe those incentives really work. And cynics argue that the real reason we'll never see a true flat tax is because lawmakers are loath to give up the power to regulate that comes with their power to tax.

Government also uses the tax code to sway some of our smaller decisions, too. This is especially true with so-called "sin taxes" -- essentially, fees we pay to consume unhealthy products or engage in unhealthy behaviors. As Adam Smith wrote in The Wealth of Nations, "sugar, rum and tobacco are commodities which are nowhere necessaries of life, which are become objects of universal consumption, and which are therefore extremely proper subjects of taxation."

230 years later, sugar, rum, and tobacco are still taxed. (In New York City, a pack of smokes comes with a hefty $6.86 in federal, state, and local taxes -- the tobacco is extra!) The 2010 health care reform slapped a 10% tax on tanning beds. Public health advocates have proposed taxes on fatty foods and sugary sodas to fight obesity. And many Americans, discouraged by what they see as a decades-long failure in the War on Drugs, call for legalizing drugs, taxing them to shift profits from private cartels, and using the revenue to fund anti-addiction efforts.

So, how effective are sin taxes at balancing their dual goals of raising revenue and discouraging unhealthy behavior? Well, federal and state tobacco taxes alone raise nearly $30 billion per year. They seem to do that job just fine. But some economists find that sin taxes send the wrong message by legitimizing the behavior they try to discourage. Here's what Harvard Professor Michael J. Sandel says in his new book, What Money Can't Buy: The Moral Limits of Markets:

"A study of some child-care centers in Israel shows how this can happen. The centers faced a familiar problem: parents came late to pick up their children. A teacher had to stay with the children until the tardy parents arrived. To solve this problem, the centers imposed a fine for late pickups. What do you suppose happened? Late pickups actually increased."

Clearly, telling parents "don't be late or we'll fine you" sends a very different message than telling them simply "don't be late." And so it goes with sin taxes, too. Telling smokers and drinkers "don't indulge or we'll tax you" offers them implicit forgiveness -- that it's actually OK to light up and enjoy two-for-one Happy Hour so long as they pay the fee. (If you're reading these words with a cigarette in one hand and a Red Bull in the other, you can breathe a sigh of relief!) It may sound hypocritical for Uncle Sam to wag his finger at you with one hand while he reaches into your pocket with the other. But sin taxes have been around a lot longer than income taxes, and they aren't going away.

 There's really no "planning" we can help you do to avoid sin taxes. (We would just give you the same advice as your mother.) But it may be worth it, next time you pay any tax, to ask yourself "what's the government trying to accomplish with this tax? What's the government trying to get me to do?" Understanding why you pay a tax can make you a better-informed consumer. And that, in turn, helps all your dollars go farther.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

Tax Choices for Startups

Choosing which entity to operate your business involves two fundamental choices: 1) will you remain personally liable for business debts; 2) how will you and your business pay tax? There’s no “pat” answer, and in many cases you’ll want more than one entity. Consider these options as starting points:

• Proprietorship: This is a business you operate yourself, in your own name or trade name, with no partners or formal entity. You remain personally liable for business debts. You report income and expenses on your personal return and pay income and self-employment tax on your profits. These are best for startups and small businesses with no employees in industries with little legal liability.
• Partnership: This is an association of two or more partners. General partners (“GPs”) run the business and remain liable for partnership debts. Limited partners (“LPs”) invest capital, but don’t actively manage the business and aren’t liable for debts. The partnership files an informational return and passes income and expenses to partners. GP distributions are taxed as ordinary income and subject to self-employment tax; LP distributions are taxed as passive income.
• “C” Corporation: This is a separate legal person organized under state law. Your liability for business debts is generally limited to your investment in the corporation. The corporation files its own return, pays tax on profits, and chooses whether or not to pay dividends. Your salary is subject to income and employment tax; dividends are taxed at preferential rates. These are best for owners who need limited liability and want the broadest range of benefits.
• “S” Corporation: This is a corporation that elects not to pay tax itself. Instead, it files an informational return and passes income and losses through to shareholders according to their ownership. Your salary is subject to income and employment tax; pass-through profits are subject to ordinary income but not employment tax. These are best for businesses whose owners are active in the business and don’t need to accumulate capital for day-to-day operations.
• Limited Liability Company (“LLC”): This is an association of one or more “members” organized under state law. Your liability for business debts is limited to your investment in the company, and LLCs may offer the strongest asset protection of any entity. Single-member LLCs are taxed as proprietors, unless you elect to be taxed as a corporation. Multi-member LLCs choose to be taxed as partnerships or corporations. This flexibility and asset-protection strength makes LLCs the entity of choice for many new businesses.

If you expect your business to lose money at first, consider a proprietorship, LLC, or “S” corporation. Losses from these entities (up to your basis in the business) offset outside income from salaries, investments, and other businesses. If losses exceed that income, they generate net operating losses (“NOLs”) that you can carry back two years or forward 20.

Filing Guide

Proprietors and single-member LLCs file Schedule C then carry profits or losses to Form 1040. Partnerships and LLCs taxed as partnerships file Form 1065, then report partners’ income and expenses on Form K1 “C” corporations file Form 1120 or 1120-A. “S” corporations file Form 1120S, then report shareholder income and expenses on Form K1.

IRS Publication 334:
Tax Guide for Small Business
 
IRS Publication 535:
Business Expenses
 
IRS Publication 536:
Net Operating Losses
 
IRS Publication 583:
Starting a Business and Keeping Records

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.