What You Want to Know: Cash & Pass Through Income

What do you mean I owe tax? I didn’t get any cash!

Welcome to the world of cash distributions versus pass-through income of an entity. Confused yet? Stick with us on this. It’s important.

This is a common question for owners of pass-through entities. A pass-through entity is a fancy tax term which boils down to that a business doesn’t pay income tax. Rather, the profits “pass through” the company to the owners. We’re talking here about organizations structured as S-corporations, partnerships or LLCs.

It’s a pretty common misconception that income tax is paid on cash distributions from the business. And yes, this is partly true. There are certain instances where cash distributions from partnerships or S-corporations are taxable. But the majority of the time, this is simply not the case.

As an owner of an S-corporation or partnership, you are taxed on the activity of the business, which is reflected as income or losses on the Schedule K-1 issued with the business tax return. It is possible for a business to generate taxable income and have no cash distributions to owners. So you would still have to pay income tax, regardless of if you received cash distributions or not.

Common reasons for this include:

  • Cash is used to pay down debt
  • There is income attributable to uncollected accounts receivable
  • Business expansion

And to complicate things even further, it’s also possible for a business to have losses, yet still issue owner distributions. This is most commonly due to depreciation and other non-cash expenses. Another reason is collection of accounts receivable included as income in prior years.

The moral of the story is that taxes are rarely straightforward. So even if you didn’t receive a cash distribution, there’s still the potential tax is owed. The best way to know for sure is to consult with your tax professional. They’ll help you see what’s coming round the bend and then, even if you owe, you hopefully won’t be surprised by it.

I’m Profitable … Now What?

You’ve got something great and now you’re profitable. Congratulations! But it’s not all sunshine and rainbows. What do you need to consider now that you’re profitable?

TAX PLANNING 

We all are familiar with Uncle Sam (everyone’s favorite uncle after all) and now that you’re profitable, he’s entitled to a piece of your pie. With combined federal and state tax rates of over 40%, Uncle Sam’s portion can be a pretty big piece. So how do you make sure he is only getting his piece, no more, no less?

Tax professionals can advise you on factors affecting your tax liability. These factors include, but are not limited to, entity selection (LLC, S-Corp, C-Corp, etc.), organization (ownership) structure, and nexus.

Reminder: Nexus, at its simplest, is the responsibility to file and pay taxes in a state that you may be selling goods or providing services.

In addition, tax professionals can strategize with you to minimize your tax liability. Those strategies include deferring income or accelerating deductions (within the tax regulations, they’re not in the business of tax avoidance) for tax reporting purposes.

To sum it all up, tax professionals strive to assist you in ensuring you are filing taxes in all the states you are required (and only those states) and paying the amount of taxes you need to pay (and only the amount you need to pay).

STRATEGIC PLANNING 

You got to this point, but where will you go next? We think it’s a safe bet that most of you want to do more and be more, but how do you get there?

Strategic planning is all about helping you assess who you want to be today, who you want to be tomorrow and how you will get there.

Business advisors can facilitate your strategic planning. The role of the business advisor is to help you develop a clear, concise and compelling strategic vision for your business and to hold you accountable in attaining that vision.

How? Business advisors will ask you the hard questions, draw on your knowledge (and the knowledge of others you involve in the process) and use available resources and connections to help you find (or reinvent) your strategic vision.

And it doesn’t stop there. The business advisor will be by your side during the implementation stage and help you track your progress in attaining your strategic vision. You can think of the business advisor as your personal guide through the strategic planning process.

TRANSACTION PLANNING 

You might be one of those serial entrepreneurs and, now that you are profitable, you want to move on to your next idea. But do you know what key drivers affect a business’s value (guess what, it’s not just profitability)? Have you done your due diligence (and no, that’s not just for buyers)?

Business advisors in this arena have expertise in financial analysis, valuation, sale preparation and other areas. They are available to help you through every step of the transaction process. They can help you determine the value of your business by providing market data research, valuation models, and one-one discussions about value drivers and pro forma financials (that’s accountant speak for projections). In addition as your advisor, they can help with document preparation and negotiation.

You don’t have to feel alone when selling your business (or looking at bringing in an investor for that matter). There are people out there to help you navigate the path and help you position yourself to achieve the maximum results.

When you become profitable, there are many considerations (the above are only a few of those considerations). However if there is one hidden message… it is important to find your advisory team (because it really takes a team). A team that helps you think holistically (there are a lot of moving parts in a business). A team that is proactive and engaged. A team that will have your back.

Something to Brighten Your Tax Day

NOTICE: Taxes are due today!

Hey, wait…isn’t tax day April 15th? Come on numbers nerds, get with the program.

Well, in most cases, you would be correct. Normally the most awesome day of the year is April 15. But this year is special. Why? Because this year Emancipation Day was observed on April 15th by the District of Columbia and therefore tax day was moved to April 18th.

That means you were given a few extra days to file your tax return or extension (you still have to pay though). But who needs the extra days right? You’re already on top of it, we’re sure.

In honor of tax day, we thought we could take a break from the normal content and spread some laughter with some of our favorite tax humor. Enjoy!

The hardest thing in the world to understand is the income tax. – Albert Einstein

How do you tell an introverted accountant from an extroverted one?

An introverted accountant stares at their shoes, an extroverted one stares at yours

What’s the difference between an accountant and a lawyer? The accountant knows he’s boring.

Woman goes to the doctor and finds out she has 6 months to live. Her doctor advises that she marry an accountant.

Woman: Why marry an accountant? Will that make me live longer?

Doctor: Well… no, but it sure will seem longer!

Why was the accountant so excited on the weekend? Because he gets to wear casual clothes to work.

The Need for Good Books

It’s time to talk records … and no, we’re not talking about filing cabinets full of paper. We’re talking about records in terms of financial records, also known as your books. Before you hit the snooze button, let’s first talk about a few reasons why keeping accurate financial records (also known as good books) is so important.

Accurate bookkeeping allows you to make sound business decisions.

Your books keep you in touch with your business’ operations and obligations. They will also help you see problems before they occur.

Here’s just a few things good books will help you answer:

  • How is my cash flow? Are vendors being paid on time? Are customers paying me on time?
  • Do I have too much money tied up in inventory? Or do I have adequate inventory to fulfill sales orders?
  • Do I need to purchase new equipment? Do I have the ability to purchase new equipment given the current state of my finances?
  • Do I need to hire additional help? Will I be able to pay said help?
  • Which areas of my business are successful? Which areas need improvement?
  • Can I cut my costs in any areas?
  • Am I following my budget?
  • How does my profitability compare to others in my industry? (Don’t forget, profitability isn’t the same thing as cash flow)

Accurate books are critical when it comes to tax time.

Tax time isn’t so fun when you haven’t had accurate bookkeeping. After all, good books allow you to report accurate revenue, keep track of deductible expenses, calculate gain or loss on sold property and support items reported on your tax return (read, in case you get audited). All of these things are good to know and have at tax time.

Accurate financial records help others, like your bank.

Without good books, your bank won’t be able to make lending decisions for your organization. Don’t believe us? Read up on what this bank has to say.

So now that you know why it’s important, here’s a few things to consider on your record journey:

Implementing a bookkeeping system.

  • Keep it simple!
  • Maintain books that have the right level of detail depending on the complexity of your business.
  • Make sure you have the essential information you need on a timely basis. If you don’t have access to timely information, even the most accurate records won’t help you a whole lot.
  • Compare current data with historical data to check your progress. (cough benchmarking cough)

Need some more help with setting up your books?? We’ve written two blogs on this for you: Part 1 and Part 2.

Find the right tool/partner.

As a reminder, before you make a decision regarding accounting software, make sure you understand your needs.

There several different types of software that can help you track your records. Many are cloud based accounting programs (QuickBooks, Zero, Wave, FreshBooks, Bill.com … to name a few) that allow you to access your information from almost anywhere for a small monthly fee.

If you’re not sure of how to set up your books, or you need just a little more help understanding and updating, talk to a reputable CPA firm. They can be a trusted ally on your business journey, especially if you visit them more than once a year.

Estimated Taxes

Doing taxes is fun. Especially when you have to pay tax estimates, which is our topic for today. Yes, you heard us right. Estimated taxes are a thing.

Estimated taxes refers to the method used to pay tax that is in excess of your withholding (read, the thing your employer takes out of your paycheck for things like income tax). Typically, this happens for income from self-employment, investments, prizes, awards, etc.

So who has these?

Typically, if you are a sole proprietor, partner, or S-corporation shareholder, you win. You get to pay estimated tax. But, there are a few things to consider.

You have to pay estimated tax if both of the following apply:

  1.  You expect to owe $1,000 or more in the following year after subtracting your withholding and refundable credits, and
  2. You expect your withholding and refundable credits to be less than the smaller of:
    1. 90% of next year’s tax (that would be your 2016 taxes); or …
      1. Fun fact … if at least 2/3 of your income is from farming or fishing, you can substitute 66% for 90.
    2. 100% of the tax on your current year return (we’re looking at you 2015 tax return, which is due on April 18, 2016).
      1. Another fun fact … if your adjusted gross income for the current year is more than $150,000, you must substitute 100% for 110%.  This is known as safe-harbor.

Anything else?

If you are a household employer (otherwise known as a person who has employees paid for a service within their residence … think babysitters or nannies), you must include household employment taxes when estimating next year’s taxes. Of course, there’s an if (did you expect anything less?). This is true if you have federal taxes withheld from wages, pensions, etc. or if you would be required to make estimates even if you did not include household employment taxes in figuring your estimates.

When are estimated payments due?

Estimates are due in four equal installments on April 18, 2016; June 15, 2016; September 15, 2016; and Jan 17, 2017.  Of course the IRS will not object if you make the payments early. They’re nice like that.

I don’t want to pay quarterly estimates.  What are my options?

You can increase the amount of withholding from your paycheck, pension, or other income sources to cover the amount that would otherwise have been paid via estimates.

How about no?

You may be subject to a penalty for failure to make estimated tax payments.  The penalty is essentially simple interest on the underpayment amount for the time period of underpayment.  The rate is adjusted quarterly by the IRS, but for 2015, the rate was 3% each quarter. There are different methods to compute the required installment in calculating the underpayment penalty.

You will also be subject to the penalty if you make a payment late.  For example, if you forget to pay the second quarter estimate until July 15, you will be assessed the penalty for the month the payment was late.

I don’t get it.

Taxes are fun … and complicated. So save yourself some time and headache and meet with a qualified CPA who can help you navigate tax estimates.

 

 

What You Want to Know: Sales & Use Tax

We want to give you a better experience, where you feel connected to your financial journey and confident that you’re making the best decisions for your business. As part of this, we’ll feature blog posts on frequently asked questions. No question is a dumb question, so if you want to learn more about something, just ASK.

You started your business with a dream. Now you’ve created a product people love and they want to buy it. As you get ready to sell, the first thing on your mind is sales tax right?

Don’t worry, we’re here to help. While it might not be as sexy as creating or selling your product, sales tax is important … and it can cost you dearly if you don’t pay attention to it.

First a few definitions …

NEXUS = a responsibility to collect tax

Typically, nexus in a state occurs if you:

  • Own or rent property in the state
  • Have employees including salespeople or independent contractors in the state
  • Employees make deliveries
  • File an income tax return in the state

Sales tax

A tax imposed by your friends at the government on the sale of goods and services. Sales tax is typically levied (collected) at the point of sale (when you purchase the product or service). The sales tax is collected by the business and then passed on to the government. A business must charge sales tax if it has nexus in that particular area (hence why we explained nexus first).

Use tax

To correct the price advantage out of state retailers have over retailers who have to collect sales tax, there’s a little thing called use tax. This is also a tax imposed by your friends at the government and is assessed at the same rate as sales tax. So how are they different? Well use tax is applied not when a product or service is sold, but after the sale. In other words, tax was not paid on the initial purchase, so instead it is paid to “use” the product.

Exemption Certificates

Some customers may claim to be treated as exempt (off the hook) from paying taxes. However, you should never take them at their word. Rather, always treat them as taxable until you are provided an exemption certificate.

As a rule of thumb, update your exemption certificates every three years.

We now further convolute this by saying that there are different types of exempt organizations (see this list) and not every item is subject to tax as there are different tax rules in every state. So (you guessed it) it’s best to work with your accountant when it comes to exempt organizations and items, as well as sales tax in general.

So how do you know when sales and use taxes are applied and when they’re not?

The answer is a little less than simple. But here’s the basic gist:

You should consider all sales subject to tax unless:

  • You do not have a responsibility to collect tax (cough nexus cough) in the state of delivery
  • Purchaser presents a valid exemption certificate.
  • Item is exempt from tax at point of delivery.

Use tax applies to all taxable purchases including:

  • Office equipment and supplies
  • Paper
  • Staples
  • Computers
  • Pens
  • Office furniture

Do you really need to be concerned?

Sales and use tax rules are constantly evolving and growing more complicated. This lovely complexity makes it vital for companies of all sizes to understand their environments so they’re in compliance with tax obligations.

Here’s just one example. Certain activities, such as selling a product over the Internet, or advertising through an online marketing company, can inadvertently establish nexus in a state, making you subject to that state’s tax laws. What does that mean for you? Well, if you have unknowingly established nexus, you can face responsibility for back sales tax, as well as super fun things like penalties and interest.

So yeah, you should probably pay attention to sales and use tax. The best way is to work with a trusted accountant who can help you see where you’ve established nexus, where you might potentially have issues, and help you track your tax obligations.

Will You Be Our Valentine?

your accountant!It’s Valentine’s Day. A day filled with telling people you love them, buying chocolates and flowers and (hypothetically) stealing your kids’ Valentine’s Day treats from their boxes.

It’s also a time to think about relationships. Now before this becomes too much like a mushy romcom, we’ll get to the point: you should be putting some serious thought into your accountant relationship.

Yes, you read that right. Your relationship with your accountant. We believe that to truly be a useful resource, you have to have more than a once-a-year meeting that normally involves something that rhymes with maxes and happens on or around the 15th of April.

Here’s a few tips to move your relationship with your accountant out of the “friends” zone and into a committed, mutually beneficial relationship:

  • Know what you need, and what to look for. What do you know about the financial state of your business? Can you use what you know to make sound business decisions? An accountant can help you not only check the box on the necessary steps, but give you a deeper level of understanding when it comes to your financial journey. If you’re thinking, “sounds great, but I don’t know what to look for,” then you should probably go here.
  • Understand the necessity and beauty in planning. If you only visit your accountant friend once a year, then you know they do one thing really well: file your taxes on a tight deadline. But, if you want to be in a deeper, more meaningful relationship, take some time to meet with them ahead of time and really map out your relationship, I mean tax plan. Tax planning is a great thing and it will give you a better picture of your finances.
  • Ask “what else can you do for me?”. ’s a lot of other things they can do for you as well? For instance, benchmarking, exit strategy and strategic planning, to name a few. In order for this to be a beneficial relationship to both parties, you’ll want to make sure they not only know about you, but you know about them too. (P.S. here’s a list of a few things you might not know that your CPA can do)
  • Use them for more than their calculator … or Ten Key. Numbers are challenging. But they’re important to understand in the context of your business. So step outside your comfort zone, and ask your accountant for something more. Ask them to be your trusted business advisor, rather than some guy or gal with a calculator who keeps you out of trouble with the IRS.
  • From all of us, we wish you a Happy Valentine’s Day, filled with cards, chocolates and possibly even a little more love for the numbers side of things.