Small Business

Pitfalls of Solo S Corporations: Are You Paying Yourself Enough, If At All?

Many small business owners opt for an S corporation over other entity types. It’s estimated that about 5 million American businesses operate as S corps, almost three times as many C corporations. One of the chief reasons for this entity choice is that with very few exceptions, namely New York City residents, S status confers many of the same benefits as a corporation but without the “double taxation” aspect since it is what’s known as a pass-through entity. Relevant income, deductions, and credits pass through to the owners on their individual tax returns, and there’s no self-employment tax on the profits.

However, small business owners need to carefully consider both the risks and benefits of choosing an S corporation over a single-member LLC taxed as a sole proprietorship. One of those risks is the reasonable compensation rule.

The reason why there’s no self-employment tax on S corporation profits is because officers of a corporation, even if it’s just you, are considered employees and need to be paid a reasonable salary. A recent Tax Court case, Lateesa Ward et al. v. Commissioner, (T.C. Memo 2021-32) is an excellent cautionary tale in how to properly determine reasonable compensation for a sole S corp shareholder-employee, and when it is and isn’t considered reasonable not to pay yourself. 

What is Reasonable Compensation?

Reasonable compensation is the amount that S corporation must pay an owner-employee in W-2 wages for their services before non-wage distributions (dividends, the distribution of profit) are considered.

The IRS retains the right to reclassify any payments made by an S corporation to be salary payments that should have been reported on Form W-2 instead of dividend income that is not subject to payroll taxes. The Tax Court case Joly v. Commissioner (T.C. Memo. 1998-361) is what ultimately held up this authority, and it has been used in numerous examinations ever since.

What makes compensation “reasonable” ultimately depends on the unique facts and circumstances of the business. For instance, it would be reasonable for a new business that must undergo a great deal of market research and permit requirements before accepting paying customers to not pay the owners salaries until revenue has materialized and stabilized. If a self-employed software engineer would typically earn $100,000 per year at a comparable employer but has only made $50,000 in contract revenue and wants to reinvest some of their profits in new equipment and marketing, a $30,000 salary could be seen as reasonable for those circumstances.

The IRS uses three criteria to refine what reasonable compensation is:

1) The type of services the shareholder-employee performs
2) If any services are performed by employees who are not shareholders
3) How much profit is allocable to capital and equipment

Essentially, profit generated from non-shareholder employees’ services and that can be traced to equipment and other capital assets would be classified as non-wage payments. However, services directly connected to the shareholder-employee would be considered compensation that must be reported on Form W-2.

For S corporations with just one shareholder, the IRS tends to strictly look at the total revenue and whether the shareholder took a salary at all, followed by that salary proximal to revenue. Other factors that would be considered for reasonable compensation would include comparable salaries at larger companies, if the shareholder has previous experience in their field and how much, additional credentials and training, and how much time the owner devotes to the business. 

Lateesa Ward v. Commissioner: Minor Services vs. Services Essential to the Company

Lateesa Ward is a self-employed attorney with her own firm, Minneapolis-based Ward & Ward Company, that has operated as a sole shareholder-employee S corporation since 2006 with one associate attorney as an employee. The IRS audited Ward’s business and personal tax returns for the 2011-2013 tax years. The firm reported a loss of $1,373 in 2011, with $62,388 in officer compensation to Ward and wages to the associate attorney of $33,925. However, the payroll tax return only reported $41,483.78 and Ward’s personal tax return only reported the business loss and not the wages she received. 

There were similar misreporting issues for 2012 and 2013 as well, but Ward challenged the Commissioner’s assertion that she failed to report and pay taxes on the compensation her own firm paid her. Ward claimed some of the compensation she received was salary, but that the rest constituted distributions of the profits.

Given that Ward had been a practicing attorney for 15 years prior to opening her own firm where she is the sole owner and officer, the Court found that there was no evidence to support that the payments she received were anything BUT officer compensation. Ward was instrumental in providing legal services to the firm’s clients, and did not leave most of the operations to the associate attorney on payroll. Had she only provided a minor degree of services, such as owning or another business or still being employed by a larger firm, it’s possible that the Court may have given her more of a reprieve.

There are many takeaways from this case for solo S corporation owners to think about. Ward’s level of experience and mismanagement of her personal tax matters worked against her in Tax Court in arguing how much of her compensation should have been treated as salary. While salary payments can be deducted from an S corporation’s profit, and even lead to a loss, they still need to be properly reported on your individual tax return. Moreover, the fact that Ward devoted all of her attention to her business as the sole owner and officer combined with comparable salaries for attorneys in the Minneapolis area were key deciding factors in the Court determining how much of the money received was a salary and not a dividend.

Jeff Lipsey and Associates can assist small business owners with determining the right business entity for their needs and making an accurate determination with respect to reasonable compensation. Contact us today to speak to one of our friendly and professional business tax experts.

The Taxation and Business Environment of Washington D.C.

When deciding where to move or open a business, taxes may not always be the deciding factor but certainly help inform your decision. With the rise of “Zoom towns” in other parts of the US as freelancers and entrepreneurs embrace remote work that their W-2 counterparts are now discovering, many Washington D.C. residents decide to leave the District due to housing costs or other factors and choose Virginia or Maryland to remain close by.

As of 2019 figures from the Census Bureau, it’s estimated there were almost 24,000 employer establishments within the district and a significantly larger amount of solopreneurs, with almost 63,000 non-employer establishments at the time. These numbers are likely to have dramatically shifted in the wake of the COVID-19 pandemic.

If you’re considering opening a business within the District, it’s paramount to understand the nuances of doing business and what type of taxation environment it entails.

Corporate Franchise Taxes

The District levies a corporate franchise tax on businesses formed as corporations. This includes S corporations. Similarly to New York City, Washington D.C. does not recognize S status. While you may realize the same benefits and risks that come with S status at the federal level, your business will need to pay entity-level taxes at the local level similarly to a larger C corporation.

As the District also imposes a personal income tax, income that is passed through to you with an S corporation structure will also be taxed at the local level.

Corporate franchise tax rates were last updated in 2019, and have slightly fallen over the years. As of 2021, the corporate franchise tax rate is 8.25% with a $250 minimum tax if District-based gross receipts are $1 million or less, and the minimum tax goes up to $1,000 if those receipts exceed $1 million.

Franchise Taxes on Unincorporated Businesses, and Exemptions

For businesses that are unincorporated, or are structured as any other type of entity other than a corporation, the unincorporated business tax applies.

This includes multiple and single member LLCs. If you elect to have your LLC classified as a corporation, then you would need to pay the corporate franchise tax instead.

However, there is some relief for small business owners using a non-corporate structure but has additional complexity. The unincorporated business tax applies to businesses that have gross receipts exceeding $12,000. There is a 30% salary allowance for paying the owners, plus a $5,000 exemption to help determine taxable income.

Unincorporated businesses are also exempt from paying this tax is more than 80% of the gross income is from personal services rendered by the owners. In order to qualify for this exemption, capital assets (such as vehicles, equipment, and real estate) cannot be a major factor in generating that income. While this law would exempt most self-employed people relying on providing services, it would not exempt equipment rental businesses or landlords that rely on their capital assets.

Businesses subject to the unincorporated business tax pay the same minimum taxes as corporations subject to the corporate franchise tax, at the same 8.25% rate as of 2021.

Commercial Property Tax

Like most municipalities, Washington D.C. bases property tax rates on classification. The tax rate is based on each $100 of the total assessed value of the company’s property. 

Most commercial property falls into Class 2, which is is separated into three categories based on the total assessed value of commercial and industrial real estate holdings that include hotels and motels:

  • Class 2 Tier 1: $1.65 per $100, assessed value less than $5 million
  • Class 2 Tier 2: $1.77 per $100, assessed value between $5-10 million
  • Class 2 Tier 3: $1.89 per $100, assessed value exceeds $10 million

For example, if a Class 2 storefront is assessed at $900,000 under the first tier, the property tax is $14,850 ($900,000 divided by 100, multiplied by $1.65).

To encourage active property use, Class 3 property is taxed at $5 per $100 if the property is vacant, $10 per 100 at Class 4 if the property is considered blighted by the District.

Sales Tax

Washington D.C. has the highest sales tax burden in the metropolitan area compared to northern Virginia and Maryland. The general sales tax rate is 6%, which is similar to those two regions, but deploys a multiple rate system for other items. Generally, all tangible personal property is subject to this sales tax. Most groceries and medicines (including over the counter medicines) are not subject to sales tax. There is one annual sales tax holiday in the winter when no sales tax gets collected from any purchases.

Restaurant meals, liquor, and soft drinks consumed on the premises plus vehicle rental have a 10% sales tax, while soft drinks meant to be consumed off the premises have an 8% sales tax. Alcoholic beverages with the same purpose have a 10.25% sales tax. Sporting tickets and other types of vehicle rental also carry a 10.25% sales tax, and commercial lot parking has an 18% tax.

For businesses located outside of the District, Washington D.C. follows the South Dakota model after the results of Wayfair v. South Dakota in 2018. If a business makes $100,000 in sales or 200 transactions to customers within the District in a given year, they must collect and remit 6% sales tax on goods and services subject to sales tax. This threshold only applies to sales within Washington D.C., not the entire gross.

While Washington D.C. has an overall higher tax burden compared to many states, many choose to own and operate a business within the District on account of the large and economically diverse population, and proximity to government jobs and services, in addition to the demand for a wide array of services, amenities, and skilled trades.

While the District does not recognize S status, the corporate income taxes paid at the local level are deductible on the federal business tax return. In turn, Washington D.C. allows business owners to take a percentage of the taxed business income as a deduction on your District-level personal tax return.

However, if you are a Virginia resident, the state of Virginia does not recognize Washington D.C. corporate franchise taxes at the personal level. If your business is located in the District but you live in Virginia, you will essentially face double taxation at the state level.

Jeff Lipsey and Associates can assist small business owners with navigating the taxation and overall business environments when scoping out where and when they would like to start a business. Contact us today to speak to one of our friendly and professional business tax experts.

How Did the Wayfair Supreme Court Case Impact Sales Tax Collection for Small Businesses?

In 2018, the Supreme Court ruled 5-4 in Wayfair v. South Dakota that state governments can mandate that retailers outside of their state to collect and remit sales tax from in-state customers, even if they don’t have some kind of physical presence there like a store, warehouse, server, or registered agent. In the wake of this decision that overturned over 50 years of precedent, state tax authorities swiftly enacted thresholds and timelines for sales tax compliance concerning out-of-state sellers.

It’s estimated that there are over 9,000 different sales tax jurisdictions throughout the United States and the landmark Wayfair ruling only further complicated their administration. Washington D.C. has the highest sales tax burden in the entire metropolitan area, despite being a quarter of a point lower than Maryland and northern Virginia’s 6% general rates, due to the multiple rate system used in the District. For instance, food eaten in restaurants has a higher sales tax rate than the general rate of 5.75%.

Decades ago, mail-order catalogs, home shopping TV channels, and early forms of Internet stores did not yet gain enough ground to get lawmakers’ attention until Quill v. North Dakota that was decided in 1992. Now that ecommerce is part of daily life for most people, businesses are looking to lawmakers for a more uniform, nationalized solution after the Wayfair case.

Precedent for Sales Tax Nexus in Quill Corp. v. North Dakota

Quill Corporation, an office supply company that was incorporated in Delaware with operations chiefly headquartered in Illinois, was sued by the North Dakota state tax commissioner for failure to collect and pay use tax on sales to customers within the state. Quill did a large volume of mail-order business and only collected sales tax from customers in states where they had some type of physical presence: employees, property, or a physical store or warehouse. Quill had no such presence in North Dakota.

The North Dakota tax commissioner argued that Quill established a presence in North Dakota simply because of floppy disks bearing the company’s name that were now physically located in the state. The North Dakota State Supreme Court upheld the tax commissioner’s position, but the Supreme Court disagreed and based the ruling on the Dormant Commerce Clause. This clause prevents state governments from interfering with business activity across state lines, unless they are authorized to do so by Congress.

The decision essentially barred state governments from imposing sales and use tax collection requirements on out-of-state businesses unless they had valid physical nexus. Selling products that bear the company’s name and branding and delivering them to customers in the state did not constitute nexus, per the 1992 ruling. Quill did not have offices or other physical locations in North Dakota and remote employees were rare at the time, but none of their staff was in the state.

However, Wayfair v. South Dakota has now overturned this case and states can now impose sales and use tax requirements on businesses that sell to their constituents. With the exponential rise in Internet-driven sales in the decades following the Quill decision, revenue-starved states had been pushing for “Kill Quill” actions that would authorize them to collect more sales taxes as they could not trust individual taxpayers to report use tax on their personal tax returns. Furniture giant Wayfair was brought before the South Dakota State Supreme Court, and after arguments in the Supreme Court, this authority has now been granted to state tax departments.

How is Nexus Redefined Under Wayfair?

In 2016, South Dakota passed a law requiring out-of-state Internet sellers that deliver more than $100,000 of goods or services into the state every year, or have 200 or more transactions regardless of amount, to collect and remit sales tax. Wayfair sued the state, citing Quill and declaring this action unconstitutional. However, the Court sided with the state by holding that Quill and related rulings were outdated because ecommerce and modern logistics now gave out-of-state sellers potentially unfair advantages over sellers located within the state.

45 states impose sales tax and most have used the authority granted by the Wayfair decision to model their economic nexus closely to South Dakota: $100,000 in sales or 200 transactions. At the time of writing, only Missouri and Florida have yet to enact an economic nexus threshold.

Rules for D.C. Businesses Under Internet Amendment of 2018

Washington D.C. businesses are now subject to the Wayfair nexus rules after Mayor Bowser signed the Internet Sales Tax Emergency Amendment Act of 2018 (Emergency Act) on December 31, 2018. In addition to a 6% sales tax on digital goods, businesses in the District that collect sales tax must comply with this mandate for all sales made after April 1, 2019. This law affects businesses that are not based in Washington D.C. but sell to customers who live there. Other states and jurisdictions have not taken such immediate steps, and phasing in compliance for businesses that sell to their constituents.

Washington D.C. copied South Dakota and has imposed the $100,000 in sales or 200 transaction threshold for requiring sales tax remission. This only applies to transactions within the District, not gross for the year.

As many Washington D.C. residents consider relocating to Maryland or Virginia for personal or business reasons, if they do not already live there but own a business in the District, each state has their own rules for sales tax administration. As a Washington D.C. business owner is likely to ship merchandise or perform services within the two states, you may be responsible for sales tax remittance to one or both of these states if your customer base is spread across the entire metropolitan area.

Maryland Sales Tax Nexus

Maryland has a general sales tax of 6%, 9% on alcoholic beverages, and 11.5% on passenger car and recreational vehicle rentals (8% for truck rental). Maryland expects its residents to pay use tax on purchases from merchants outside of Maryland if the purchase is subject to sales tax, even if it was made in person out of state but the product is used in Maryland.

Services are generally not taxed in Maryland, but most tangible products are.

Businesses outside of Maryland are responsible for collecting sales tax if they meet the same guidelines laid out in Wayfair: the mandate applies if there are 200 transactions within the state or $100,000 in sales within the calendar year.

Virginia Sales Tax Nexus

Most of Virginia has a 5.3% general sales tax rate, while the northern Virginia counties closer to Washington D.C. have a 6% rate as does Central Virginia. James City, Williamsburg, and York County have a 7% rate and as of July 1, 2021, Charlotte, Gloucester, Northampton, and Patrick Counties will have a 6.3% general sales tax rate. Food and personal hygiene items are subject to a statewide 2.5% reduced sales tax rate.

Similarly to Maryland, services in Virginia are generally exempt from sales tax, unless they are in connection with the sale of tangible property (such as selling handmade furniture and adding an assembly fee).

As of July 1, 2019, Virginia utilizes the Wayfair model and mandates that sellers from out of state are responsible for sales tax administration if they have 200 transactions or $100,000 or more in sales from Virginia customers. However, Virginia specifically differentiates online sellers from online marketplaces and facilitators, as direct and facilitated sales made within the state are subject to the mandate, while payment processors that do not sell merchandise are exempt.

The key takeaway from the Wayfair case is that our laws are finally beginning to catch up with technology, and it isn’t always for the better. While state governments are pleased with the Wayfair decision and this will help state budget shortfalls, many commerce groups feel this decision hurts the smallest businesses that are now faced with undue compliance burdens, which gives large corporate sellers like Wayfair and Amazon an unfair advantage. With thousands of jurisdictions that would potentially require sales tax returns, retailer advocates are seeking a federal solution to this problem.

Jeff Lipsey and Associates can assist small business taxpayers with their Washington DC and metro area sales tax compliance questions if they are out of state. Contact us today to speak to one of our friendly and professional business tax experts.

When Should You Start to Outsource Your Accounting?

With so many different apps and online accounting and recordkeeping solutions for small businesses and freelancers today, many are putting their accounting matters into their own hands. For freelancers in particular, keeping track of earnings and expenses on a spreadsheet may be sufficient recordkeeping to stay organized for tax season. It’s estimated that 62% of small business owners have some type of in-house accounting solution, whether it’s through software or a dedicated staff member opposed to fully outsourcing.

But when is it time to outsource your accounting needs to a professional? It can be difficult to afford a CPA’s fees when you’re just starting out and looking to stabilize your cash flow first. Every business is totally unique with their own goals and administrative burdens, and entrepreneurial and market trajectory can’t always be accurately predicted. However, here is a good idea of when it’s time to outsource your accounting.

You Are Unsure How to Properly Maintain Books and Records

Every entrepreneur excels at different aspects of running a business, and has weaknesses in others. Having dedicated professionals like accountants and attorneys to help you is crucial for your success. Even if math is your strong suit, it doesn’t necessarily translate to accounting knowhow as it is a complex information system that requires specialized knowledge to handle correctly.

While utilizing a bookkeeping app can help give you an idea of your overall numbers, outsourcing to a professional becomes integral if this aspect of owning a business is stressing you out and causes you to put off properly maintaining your books. If receipts and invoices are piling up, and you don’t know what to do when the bank asks for a P&L and balance sheet, it’s time to start working with an accountant who can get you on the right track.

Transaction Volume Becomes Unwieldy

When your business is just starting out, there may not be many transactions to record yet. As your business gains momentum over time, picking up more customers, clients, revenue streams, or deals means that the number of transactions has also grown. What used to take 15 minutes upon going through your bank and digital processor statements now takes hours.

Although some online accounting solutions have “smart” AI implemented to tackle changes in transaction volume, as well as copy and paste functions for recurring transactions like rent and insurance expenses, managing larger transaction volume becomes more costly simply in how much more time it takes. The more time that you spend on entering transactions and other administrative aspects of your evolving business, the less time that you have to spend on more revenue-producing activity plus your personal life.

When your business presents an ongoing need for accounting help because of transaction volume, this is when it becomes critical to outsource it.

Transactions Become More Complex

Some transactions are very simple, such as recording the receipt of payment for services or disbursing cash to pay for supplies. Other transactions can become far more complex, whether they are seldom or routine. For instance, there are business deals that entail the purchase or licensing of intellectual property with possible payment of royalties. These deals require a degree of legal knowledge to determine how to treat them for tax and bookkeeping purposes. While common in the software and games industries, most accountants have training in commercial paper that helps decipher these agreements and how they must be accounted for.

Buying and selling a businesses or components, mergers, selling property, and business deals introduce more complexities in both tax laws and accounting standards that basic bookkeeping software can’t automatically compute with its AI.

When your business transactions grow more complex than basic recording of revenue and expenses, it’s time to start working with a professional.

Your Business is Going Through Significant Changes or Growth

Both transaction volume and complexity go hand in hand with business growth. As your business matures and your goals may change, along with the business entity you originally chose, you are more likely to need to outsource accounting. Significant changes to operations are also apt to necessitate outsourcing your accounting, as you may be unfamiliar with how to properly record transactions of this nature. As regulations constantly update, accounting professionals are dedicated to staying on top of those changes so that you and your team can direct your attention to maintaining and improving business operations.

Achieving business growth is an exciting stage, but it can also be an awkward one: your administrative burden has increased, but you may not have the resources to hire a dedicated internal accountant or expensive back office stacks. In-house accounting professionals are costly to attract, retain, and train. Back office and business intelligence software meant for more robust transaction volume and complexity is equally expensive with a time-consuming learning curve. An outsourced accounting firm grants access to experienced and knowledgeable professionals, and the subsequent technologies they use, without the need to manage internal staff and costly platform subscriptions.

You’re Unsure What Financial Data is the Most Important

There’s a reason why accountants are often instrumental to helping a small business grow: they don’t just do your books so you don’t have to, they also help you determine which numbers you should be paying the closest attention to.

Different types of businesses have differing needs for parsing financial data and making more informed business decisions. Some business processes may rarely request financial statements, while others will require them to be submitted frequently. If you’re not sure which data you should pay attention to, outsourcing to an accountant can help you produce the financial reports you need on a timely basis. As it doesn’t make sense to hire in-house accounting staff at a small scale, an outsourced accountant is your best “human” solution.

Jeff Lipsey and Associates can assist small business owners with figuring out the right accounting solutions for their needs and creating a smooth transition from in-house recordkeeping to outsourced accounting. Contact us today to speak to one of our friendly and professional business tax experts.

Making Your Accountant A Long-Term Business Adviser

When assembling your team of professionals who provide support and services to your business, every business owner has different needs and circumstances. Industrial specialties, knowledge of specific technical platforms, adeptness with certain company sizes and types of businesses, and ability to best serve businesses in various growth stages come to mind.

You’re apt to only call a business consultant when you have a specific problem that needs to be solved. Or your insurance broker when you change locations or buy new property. Most small business owners communicate more frequently with their accountant due to ongoing tax and recordkeeping needs. But there’s more to that frequent communication than what meets the eye: 5 out of 6 small business owners say that they trust their accountant with long-term business advice compared to their attorneys, financial planners, or family and friends who are privy to their business dealings.

Why would entrepreneurs make their accountant more of a long-term business adviser instead of simply a professional they can count on at tax time, or properly handling debits and credits?

Accountants Can Detect Financial Problems As They Arise

Financial statement preparation is only part of the job. Recording the numbers that comprise those statements and what gets reported on your tax return requires a different degree of parsing what they actually mean.

For instance, financial statements may indicate a major change in year-over-year revenue that looks positive. But in examining expenditures more closely, your accountant can help you determine where you can save money, where you should prioritize your investing activities, and how to properly scale and maintain the growth you’re experiencing. If your business is also generating revenue but not collecting cash efficiently, accountants often detect these patterns before managers and owner-operators can.

Thanks to accounting platform technology where outsourced accountants can see udpated figures in real time as business owners enter this information, today’s accountant is more capable of accurately providing a degree of business intelligence they could not in the past. In becoming familiar with your business processes and financial patterns, this has made accountants more indispensable as a long-term business adviser.

Times of Growth Can Be Fraught with Bad Advice From Peers and Other Professionals

When your accountant has become familiar with your business goals, processes, and regularities in cash flows, this gives them more ground to better advise you when your business grows or experiences significant changes.

They can help keep your goals in check and make realistic expectations that go beyond simple market forces. In planning for your long-term tax and financial needs, your accountant will be invaluable in helping you shift from one owner to several, hiring your first employees, and other transitionary periods than can be as awkward and expensive as they are exciting. As routine transactions pile up and more lucrative transactions more complex, you may also receive conflicting advice from other professionals like attorneys and consultants who do not transact with your company as often as your accountant would.

When you invest more in having your accountant on board as an adviser you can regularly call on and see your business through growth and change, you have another frame of reference you can trust to make more informed business decisions. Because accountants have to examine your overall business environment, not just your revenue and expenses, this gives them a much more thorough picture of your company and how your goals can be refined and processes improved.

Accountants Are Required to Stay Updated on Multiple Regulatory Shifts

Every professional needs to stay updated through continuing education to maintain their licenses and better serve their clients. Accountants are no exception. However, accountants simply have a wider breadth of topics in which they must stay on top of when compared to other fields.

Changes in tax and labor laws, financial accounting standards, technology, business norms, and outcomes of Tax Court and Supreme Court cases all affect the way that businesses operate. Accountants are expressly updated on these matters so that you can focus more on business operations, while you rely on them for advice in how to handle the constant onslaught of regulatory changes that challenge business owners.

Business Finances Don’t Solely Impact Your Enterprise

Since your accountant has a “bird’s eye” view of your business operations, it inadvertently gives them a window into your personal life and finances as well. The IRS considers those factors when examining tax returns, some lenders and government agencies also consider them when deciding if they should give you business funding. Your accountant also sees how your business impacts your personal finances and even if they only prepare business financials for you and not your personal tax returns, this is why more people turn to them for long-term business advice.

What may make sense on a business standpoint can prove disastrous for your personal finances, and your accountant is there to help you through it. Many aspects of your personal life are also interconnected with your business: marriage and divorce, having children, planning for your retirement, estate planning, and relocation will impact your financial decision-making just as much as they effect your day-to-day life.

What happens to your business when you die? Will you suddenly pay thousands more in business taxes moving just 10 miles? Owning a business gives you distinct benefits and disadvantages in making the right choices for your personal financial security and/or that of your family, and your accountant can guide you as your personal life changes in turn.

With the unavoidable intersection of business and personal financial impacts, and inherently working more with your accountant than other professionals, it’s no wonder that most small business owners look to their accountants as a long-term business adviser who will be there for every triumph and challenge that their business will go through.

Jeff Lipsey and Associates can assist small business owners with figuring out the right accounting solutions for their needs, and helping their businesses grow and thrive over time. Contact us today to speak to one of our friendly and professional business tax experts.

The 3 Stages Of Filing Small Business Taxes

For accountants, this is the time of year for reflection. We’re passed all of the filing deadlines and we have about 6-8 weeks until we start to hound our clients about W9 Forms and 1099s. I remind each of my clients about 10x per year about W9 forms and I’m hoping for an easy season. I also do this because it fits neatly into Stage 1 of 3 when it comes to filing small business tax returns.

You see filing correct small business tax returns is a lot more than entering in data from a spreadsheet or accounting software and into advanced tax software. Small business owners and tax accountants both must put in hour after hour of organization just to get the data the way they want before it even goes near the tax software (the first stage). Once the data is nice and neat then we can start entering in the data and filing the return (stage two). Finally, organization plays a big role in stage 3 as tax accountants have to be prepared to back up their determinations when representing clients before the IRS.

To make it nice and neat, the 3 Stages of Filing Small Business Taxes are:

      Stage One: Getting your bookkeeping in order and maintaining it monthly
      Stage Two: Preparing your tax return correctly
      Stage Three: Representing you in front of the IRS in case of an audit

In fairness, each of these 3 stages can and should be broken down into 100 smaller steps. What makes working on each stage easier is if you keep all 3 stages in mind each stage of the way.

For example:

You went to lunch with a potential new client and you picked up the $100 meal tab at the hot new restaurant in town (it was delicious by the way). Do you know how this effects all 3 stages?

Stage One: This expense should obviously go into a Meals and Entertainment Expense (50%) category. I like to put 50% at the end of the expense for my own benefit or for the future tax accountant so there is no confusion (Not all meals go into the 50% category… do you know which don’t?). Make sure you write the name of the person you had lunch with, their company and what you discussed at the meal.

Stage 2: The expense goes into the Meals and Entertainment Expense (50%) on the corresponding Schedule C, 1065 or 1120/1120s. Stage 3: If you get audited you have sufficient documentation to back up the expense. Keep this receipt with your other tax documents for the year.

What are some other ways you can make your life easier come tax time? Here are just a few:

  • Reconcile your bank and credit cards on a monthly basis. Hire a professional bookkeeper to help out and you’ll save prep time from your (much more expensive) tax preparer. Additionally, some tax preparers provide discounted monthly bookkeeping fees if they also prepare the tax return. Do I? Yes!
  • Keep your records organized throughout the year. If you have a lot of receipts, keep them in separate folders organized by month or by statement. Use staples over paper clips as they will help you maintain all of your records without potential slip-ups.
  • Write the date paid, date mailed and check number to any and all invoices. This allows you to keep track of who hasn’t been paid and you’ll know for easy reference if you’ve mailed that pesky vendor who keeps calling about whether you’ve mailed his check or not.

These all seem like pretty simple and easy to do tasks and in fact they are. But so many small business owners just keep their receipts in a shoe box, grocery bag or, worst of all, nowhere (aka everywhere). Use your smartphone and the latest technology to your advantage–take a photo and upload quickly and easily to Google Drive or Dropbox (they’re free!). Organize by month and rename the receipt to the day it was taken (vendor name would be nice too but I’ll take what I can get) and you’re good to go.

And look, if you ever need any help working on any of the organization above, please contact us to set up a free consultation. We can help you organize your office so that you’re spending less time dealing with receipts and more time making money (or having fun, whichever is your goal).

An Easy Way For Small Business Owners To Save Money

Most small business owners already have a credit card they use for multiple transactions a month but if you don’t it could be costing you hundreds of dollars a year. Even if you already use a credit card you might not be using it to your greatest benefit! In this article I am going to discuss how you will have more money in your pocket each year by paying your vendors on your credit cards.

If you currently pay all of your vendors by check or debit card when you can be paying them by credit card you’re throwing money away.

Extra Cashback

The benefit that likely already has come to your mind is the extra cash back, points, or miles you would receive from your credit card from the extra charges. Don’t underestimate how paying an extra $1000 a month on your credit card over a check can help your bottom line. At $12,000 a year on a 2% cash back rewards card that relates to $240 in missed cash.

In addition, with the extra purchases on your credit card, upgrading to a higher cash back for a set yearly fee could become profitable. You can find many credit cards that offer 1% cash back on all purchases without a yearly fee, but 2% cash back if you’re willing to pay a $60 yearly fee (Capital One’s Spark comes to mind). This becomes an easy upgrade decision with the extra purchases on your card and it usually comes with a higher credit limit. Not only would you be able to double your rewards on your current purchases, it would come at no cost to you because of the additional payments!

Reduced Filing Expenses

Every year, business owners are required to file 1099-Misc forms for combined payments made to all unincorporated vendors over $600–with a few exceptions. One of the exceptions is that payments made via Credit Card or Paypal do not have to be reported each year–the credit card company and Paypal are required to do that work on your behalf. However, you are required to still file 1099-Misc forms for Debit Card and any other payments taken directly from your bank account.

The cost of filing 1099-Misc forms comes out to around $5/person if you use the QuickBooks filing options. This doesn’t include the cost of labor to prepare/verify these forms, the cost of printing and mailing the forms to your vendors and contractors or the time it takes for you to gather each individual’s W9 form.

On that note, don’t let your busy schedule prevent you from getting W9 forms throughout the year before you pay vendors. If your vendor refuses to fill out the form then you are required to withhold 28% of their pay. Failure to do so on your end could make you liable for their unpaid taxes.

Use Intuit Payment Network or Paypal To Pay By Credit Card

Before sending a check or paying by Debit Card, ask your vendor if he accepts payment by Paypal or Credit Card. If he uses QuickBooks, perhaps he has an account on the Intuit Payment Network (IPN); sometimes there will be a link to pay on the invoice. Definitely use either Paypal or the IPN if you have that opportunity as both will let you pay by credit card.

Drawback: Negative Vendor Feedback

In the cases where you can use your credit card, your vendors may not be as happy as you are. For starters, they will undoubtedly receive less than their invoice–the amount the credit card processor or Paypal charges to send the payment. This could be up to 3% of the total transaction and is the reason why some vendors stipulate that they will charge an additional fee if payment is made by credit card. If you have a vendor that has those terms, then do not use a credit card as the extra cost to the vendor is not worth the future savings from using the card.

Most vendors on the other hand (including us), price the credit card processing fees into their rates and consider it a cost of business. We benefit from knowing that you paid your bill on time and the fact that we don’t have to wait 60 days to receive a check. We also don’t have to drive to the bank to cash it and then wait for it to clear before using it. This doesn’t include the extra headache that is created when a check bounces.

For businesses that only receive a few checks a month we recognize the cost of the payment processor actually saves us time each month–time that could be spent working on clients.

If you would like more information on how you can save money as a small business owner or you are interested in any of the other services that we provide, please contact us!

Restaurants: An Industry Where Percentages Matter

Restaurants: An Industry Where Percentages MatterIn a conversation with a new contact last week, we discussed that in new businesses, trying to set “ideal” percentages is pretty much meaningless. In one industry where that is not the case however is the restaurant industry.

If you check my Linked-In and About Me pages, you’ll notice I mention I was both a manager and then general manager of a local successful restaurant. About halfway into my stay at the company, the owners made a shift to focus on the “best” percentages–and the results were phenomenal.

If you are getting ready to open a restaurant then a focus on Fixed Costs (Rent, Utilities, Permits, etc) as a percentage of potential sales (10-15%) is important. Restaurants with low fixed costs are able to charge a lower base price for all meals than their competitors while also maintaining profitability. In my opinion, there are 3 major percentages (cost/sales) that already-established restaurants should focus on to increase profitability: Food Cost (25-30%), Labor Cost (25-30%), and Variable Costs (10-15%).

In a restaurant with gross sales of $100,000 a month (a small to mid-size restaurant), a 1% reduction in costs is an extra $12,000 of profit each year.

Variable Costs

These expenses are not glamorous to think about but every restaurant must go through. They involve: Reducing paper usage, limiting your linens expenses and choosing the right cleaning products. When I read an article about a NY Restaurant with Zero Waste I am breath taken–their variable costs percentages must be phenomenal!

In the end, the best way to reduce these expenses is to remain vigilant with your staff, constantly search for savings with your vendors and install the most efficient fixtures that you can afford. As a restaurant owner, I would estimate your variable costs should be around 15% of your sales.

Labor Cost

Restaurants and the cost of their labor will likely always be a contentious issue. I never could just look at the labor cost as a figure of dollars and cents because for every $1 of labor you cut, you essentially reducing the salary of one of your workers by $1. Restaurant owners cite high labor cost as a main reason to not pay their employees more, when it is typically the lowest paid workers who are doing the most strenuous of tasks.

On the other hand, it is very important for owners and managers to make sure their workforce is efficient. Restaurant owners must be willing to adequately train their staff and treat them with the respect they deserve. Your staff has just as much power to influence your sales as your menu, so if you treat them well they will return the favor by selling more to your current clientele.

Don’t be afraid to pay your employees well and expect a lot out of them. Instituting and maintaining a well-paid and well-rested staff will reduce employee turnover and create goodwill with your customers.

What do I mean by well paid and well rested? Don’t pay minimum wage and make sure your wages are above average for your area. Give your employees sick days and vacation days, even if they’re only in small amounts.

As a restaurant owner, you should expect to pay around 25-30% of sales in labor costs. If you’re too low and you’re still unprofitable then expect to reduce costs in other areas; if you’re too high then wait to see if we have to raise prices then redetermine. The last thing you want to do is lay off or reduce hours, but if you notice an inefficiency then don’t be afraid to act either.

Food Cost

Every restaurant can improve their food cost percentage even if you think your restaurant already does pretty well. The first step in reducing your food costs is to determine exactly how much each item on the menu costs to make per unit. It is not an easy task to find out exactly how much each item costs but that is the only way to really reduce your food costs significantly (you have to know what your costs are first before you can change anything). If you have different portion sizes and prices for lunch and dinner then you should have separate numbers for each.

When you break down the cost of each item, keep a spreadsheet with the ingredient, portion size, and cost per ingredient for every one of your items on the menu from appetizers, main courses and yes, even drinks (especially alcoholic drinks). Then add up the cost of each menu item and then factor in a waste percentage of 10% (multiply the cost by 1.1)–this way you can account for all the times you mess up an order and have to remake it. If your error rate is less than 10% then awesome as that will only increase your profitability but it is best to error on the side of caution when setting your prices.

The next step is to divide the new cost by the price of the item on your menu; in an ideal world your percentage would be 30% or lower if you’re not a fast-food franchise. Create a new menu with your prices compared to the food cost percentage. You will probably be surprised that some items you’re selling on the menu you are making a lot of money on (food cost of 20%) and others not so much (food cost of 40% or more).

If you’re really good at tracking your sales, you can see how often each item on your menu is ordered; customers are not dumb and they know when they are getting a great deal compared to when a menu item is too highly priced. The goal is to have the average of all items to be 30% or lower so don’t go raising your prices… yet. Look at your higher food cost items to see what is the cost driver: Is it waste? Is it delivery cost? Expensive item? Before raising your prices find out if it makes sense to change the dish to make it less expensive without sacrificing the quality.

I have three examples where I significantly reduced food cost percentages while at the restaurant and I did so by 1) raising prices, 2) reducing waste and 3) reducing delivery charges.

1) Raising Prices – We were always hesitant about raising prices, as we were already viewed at having expensive (yet high quality) food for our area. There was one item I was adamant about raising prices on and that was one of our fish options. We dealt with a lot of seafood and many consumers can’t tell the difference between them (one of the many reasons seafood fraud is so rampant today), so they would typically go for the item with the lowest price. Unfortunately, this was also our lowest-margin fish option so every time they chose this item we lost money (compared to if they ordered something else). When changing prices, never raise the price of the most expensive dish (of a comparable nature) on the menu and never lower a price below the least expensive dish on the menu–but feel free to move around in between. Consumers might notice that you raised a price on one dish by as much as 15%, but as long as you kept the other prices the same they are likely to forgive you; that is exactly what happened in our case.

What happened was the demand for that dish did reduce so we only saw a minor increase in sales from the increase in price. However, the cost/dish was now below 30% and the individuals who found it too expensive to purchase that dish went on instead to purchase other, more higher-margin items, on our menu. It didn’t matter which option they chose, we were guaranteed to make our money on it.

Note: Raising your highest-priced dish even higher is how you can alienate your customers.

2) Reducing Waste – Bars and restaurants who serve fries at their restaurants literally sell them by the ton on a monthly basis. Most bars buy them pre-packaged and frozen, so their waste is already quite low (that is also why most fries taste the same). For the restaurants who still take the time each day to peel each potato by hand (a worthwhile investment), be mindful of both the size of the potato and how they are peeled. I have an excellent example on this: One of my first changes as a GM was I changed the way our workers peeled the potatoes.

What seems now like an obviously bad practice, the cooks used to peel potatoes using paring knifes. The reason? Our potatoes were pretty massive, weighing nearly a pound each and frankly they could cut through 2 to 3 times as many potatoes in the same amount of time than if they used a potato peeler. At this point I did an experiment: Use potato peelers for a week to see how much we save on waste from cutting potatoes.

The result? The cooks cut as much as 35% fewer potatoes while not taking that much longer each morning. In fact, I calculated I could have hired an additional employee to cut potatoes all day every day and it would still have saved money from the old method. Food costs were significantly reduced on a magnitude of $10,000 or more each year just from that one change alone.

3) Delivery Method – This was probably my most difficult change that I made and it involved getting two of our vendors to work together. We purchased a lot of fish every day and all of it fresh. We wanted to use the most sustainable fish we could, which involved us paying over $1.20/pound of overnight shipping using FedEx from the North Atlantic coast. Our vendor would cut up and package our fish and put it on the truck for overnight delivery. No offense to FedEx here, but that is not how food should arrive at a restaurant kitchen!

We used a couple of different vendors to get our fish, and they all worked out of the same area and drove the same routes every day. Even though these guys were competitors they all knew each other and worked well with each other, and that is how we were able to reduce our food costs. Every night, the vendor that packed the boxes for overnight delivery instead put them on a freight train to take them half way down the coast. Our other vendor, which frequented the same area, would then pick up the fish from the train and deliver the fish to our door.

The result: While we were paying $1.20/pound to FedEx every day, we instead paid the freight train $0.15/pound, we paid our first vendor an additional $0.35/pound for their trouble, and an additional $0.25/pound to the second vendor. So everyone involved increased profitability (sorry FedEx) for a total savings of $0.50/pound (about 3% on that dish alone). That doesn’t sound like a lot but when you sell thousands of pounds of fish each year, those savings are pure profit

Conclusion

You’ve made it with me this far so you will see that I have estimated return of sales for the owner of between 10-15%. Many restaurant owners and shareholders strive for 20% of sales for profit which is an excellent goal.

It does take effort to come up with solutions to reduce costs but the changes you make will add up to a lot of money when you have a lot of volume over the period of several years. But the first step in making these changes is to find out what your exact percentages are and then identifying where you need to improve. If you could save $100,000 over a 10 year period by making a few changes now, why wouldn’t you?

Why It Doesn’t Make Sense To Do Your Own Payroll

Payroll Can Be A Big Weight!Are you ready to hire your first employee? Maybe you already have a few employees on your payroll but you’re thinking of bringing the operation in house to save money each month. I’m here to tell you that you may be better served to keep it out of your hands.

Most small business owners cite cost as the biggest reason to bring payroll back under your roof rather than keeping it with one of the many payroll providers that exist. Starting at around $50/month, the costs can add up quickly over the course of the year but before you switch consider what those costs pay for. Below are just some of the options that some payroll operators provide to assist your needs:

  1. Monthly and quarterly payroll returns
  2. Cutting and mailing paychecks, as well as tracking and paying any payroll “trust fund” expenses
  3. Managing your retirement accounts, health care, vacation, sick days
  4. Paying 1099 Vendors
  5. Filing W2s each year
  6. And dozens more features!

So how much is too much for a payroll service? It depends on your business structure and the number of employees. Keep in mind that just #1 above will easily take you about an hour (or more) of your time each month, depending on how familiar you are with your state’s filing requirements. If you’re an employer in the DC metro area then it absolutely makes sense to go the payroll provider route because they keep track all of your employees’ residences and the filing requirements in each state.

There are many payroll providers in the DC metro area and most of them are pretty similar, give or take a few features. When searching, I’d look for the following features:

  • Automatic payroll form submission
  • Direct deposit and automated payments
  • Trust fund, health care, and retirement account set-up

I’m definitely a numbers guy and, when you start to think about the cost of each check, envelope, stamp and transaction fee in addition to the hourly time dump that comes with filing payroll returns, it is a no-brainer to have someone else handle those payroll returns for you.

QuickBooks Online users looking for more hands-on control should look at the Intuit Payroll options that connect directly to their online account. You’ve got to set it up initially yourself but once you’ve set it up all it takes is a click of the button each pay period to get your checks out. The handy reminders each period to pay your employees are big help too! Intuit has several payroll options but I prefer the Intuit Payroll Full Service produce for the most benefit, but you could get by with the “Enhanced Version” too. Try it for the first 30 days and see what you think!

Arlington, VA Small Business Series

Starting a small business in Arlington (and for most of Northern VA too) doesn’t have to be complicated, but I haven’t found a definitive guide anywhere of the steps necessary. While most articles available online discuss the general needs of a small business including such popular topics as creating a business plan, choosing a legal structure and finding the right location, I’m interest in digging deeper to help my clients succeed.

Those topics are very important indeed, and most first-time small business owners do research on those topics before starting their venture. The following article series will be dedicated to helping small business in Arlington (and the rest of Northern Virginia) succeed on some of the more specific details with our area.

Know Your Local Laws

I specialize in helping both established and aspiring small businesses with their bookkeeping in the Northern Virginia and DC Metro area. In my initial interview I typically ask several question including: What is your organization structure, how do you plan on filing your taxes and do you have your required permits. Even if they say they have created an LLC… there is more to it than that and way too often I get a blank look!

Here are some quick and easy steps to get most small businesses on the right path:

  1. Create an LLC (It isn’t required but usually recommended). Head to the VA SCC to sign up, it costs $100.
  2. Register an EIN with the IRS (its free!). If you want to operate as a C Corporation (Form 8832) or S Corporation (Form 2553), then you should make this election now (more on these in a later article).
  3. Apply for a Business License from Arlington County. If you’re working from home, you MUST have a Home Occupation Permit. This is negligible in cost but important for you to remain in compliance.
  4. Arlington Home Occupants make sure to read your license! I work from my home office and there are several restrictions on what I can and can’t do. If you ever wonder why I have a PO Box, it is because I am not allowed for clients to visit me at home due to Arlington County regulations. This isn’t for every type of industry, but it is for bookkeepers!
  5. Open your business checking AND business credit card accounts. If you’re using the online banking feature in QuickBooks make sure there are no fees for your bank to connect. Most banks allow access to QuickBooks Online for free, but QuickBooks Desktop may have a monthly fee. If you’re not sold on whether you should open up separate accounts, read one of my previous blog posts… I highly recommend it!
  6. Purchase all required software and hardware: Computers, Monitors, Laptops, Phones, Printers, Office Supplies, QuickBooks, MS Office, Adobe, etc. The list can get pretty long but this is what your business plan was for to start! Make sure you put all of this on your credit card too and more on that later.
  7. Hire me as a part-time bookkeeper to help you monthly with your finances. I can be very beneficial as you progress your business; I’ll remind you to pay your taxes, of outstanding bills and help you set up your accounting software as needed. In fact, you don’t even have to purchase QuickBooks–I will keep track of your finances in my office and provide you with monthly reports. This is all included in my monthly charge as low as $100.

I could keep going on that list but it goes away from being Arlington/NOVA specific to just general small business items. Many starting small business owners in Arlington (and many other counties in NOVA) don’t realize that they have to pay a business property tax every year to the county, so keep track of all of your hardware items from #6 above. These are not expenses but fixed assets! The tax itself is very minimal but it must be paid regardless at the beginning of your 2nd fiscal year and each year thereafter.

The Importance Of Your Credit Card

Their are several important benefits to using your credit card on each transaction in addition to earning rewards and higher security. One of my biggest arguments for having a business-only credit card is the ability to track expenses, and then to pay those expenses off when you want to. Cash-flow is very important to both established and starting small-business.

At the start of your small business, cash is very hard to come by; it is possible you may not receive payments on an invoice for up to 60 days from the start of your first day for your first client. Even with fast-payment options like Paypal and the Intuit Payment Network, most vendors still pay by check and send it in the mail. Having the option to put expenses on your credit card and pay them off nearly 45 days later is invaluable (in case you’re wondering, credit cards have 30 day billing cycles and give you typically 2-3 weeks to pay your bill). I don’t recommend paying credit card interest and fees unless absolutely necessary, but having a small line of credit such as a credit card has provided me much needed financial security over the years.

There is so much on your plate when you’re starting your small business that it is easy to overlook any of the above steps. You could be tempted to “put it off until later” or even “wait until you generate revenue” but that could be too late.

Contact me for your free consultation and I will help you with your monthly bookkeeping.

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