Taxes

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.

Understanding the FICA Tip Credit for Restaurants, Bars, and Other Food and Drink Establishments

With the official name of Credit for Portion of Employer Social Security Paid with Respect to Employee Cash Tips, the informally-dubbed “FICA tip credit” is a tax benefit for employers in the food and beverage industry. This tax credit can save restaurant owners a significant amount of money as it directly reduces the amount of taxes owed.

The FICA tip credit was codified in 1993 after the restaurant industry lobbied against a rule reversal in 1987, where restaurant employers were held responsible for FICA taxes on employee tips up to the minimum wage but the employees had to pay taxes on the full amount. When the minimum wage ceiling was removed in 1987, the FICA tip credit was introduced. It was enacted in 1993 to increase revenue to Social Security, but allows restaurant owners to reduce their federal income tax.

Eligible employers in the restaurant industry can still claim the FICA tip credit if these payroll taxes are paid on their employees’ tips.


Do Employers Have to Pay FICA On Tips?

Yes. According to the IRS, employers with tipped employees are obligated to report tip income and pay the employer’s share of Social Security and Medicare taxes (FICA). Employers have this obligation regardless of what type of business they own and whether tips are received through cash, credit cards, or other electronic payments, and whether tips are individually received by employees or split under a tip-sharing or tip jar arrangement with the entire staff.

Until 1987, employers in the restaurant business in particular only had to pay the FICA portion up to minimum wage at the time. After the minimum wage cap was eliminated, employers needed to start paying their share of FICA on wages and tips regardless of the amount.

Are Tips Subject to FICA Tax?

Yes, both the employee and employer must pay FICA taxes on tip income, even though the customers are paying the tips.

FICA must also be paid by the employee and employer on non-tip income that is often mistaken for tips, such as:

  • Gratuity or “auto-grat” charges for large parties and special orders
  • Delivery fees charged to the customer regardless of tips
  • Bottle service charges

If any of these charges are paid to the employee, they are considered wages and not tips, and cannot be used for the FICA tip credit.

Employees must report their tips to you if they receive more than $20 in a calendar month. The IRS suggests using Form 4070A, Employee’s Daily Record of Tips, inside Publication 1244 to keep daily records of tips received so that they can correctly report the amounts in a timely manner, but other systems may be used to account for both cash and electronic tip reporting. If an employee receives less than $20 in tips for the month, it is their responsibility to report these tips on their personal tax return and pay the appropriate FICA portion, but they do not need to report it to you for FICA withholding.

The gross amount of the tips within the designated pay period, typically a weekly paycheck in the restaurant industry, is used to compute both the employer’s and employee’s share of FICA taxes.

Who is Eligible For the FICA Tip Credit?

Currently, only businesses in the restaurant industry are eligible for the FICA tip credit.

Your business must have tipped employees and customarily provide, deliver, or serve food and/or beverages. This would include restaurants, cafés, bars, coffee shops, and other establishments where it is common for employees to receive tips from customers. While hotels, spas, and hair salons are also likely to have tipped employees and may offer food and drink for purchase, it is not the focal point of the business. Therefore, these types of businesses are ineligible for the FICA tip credit. The same rules for reporting employee tips and ensuring both the employer and employee pay their share of FICA tax are still mandated.

Provided that your business is an eligible food and drink establishment and the employer’s share of FICA taxes were paid for at least one tipped employee during the year, you can claim the FICA tip credit. If none of your employees earned at least $20 per month in reportable tips which would necessitate this tax payment, you cannot claim the FICA tip credit.

How is the FICA Tip Credit Calculated?

The FICA tip credit is calculated by determining the amount of creditable tips. Since the tipped wage tends to be below the federal minimum wage, the creditable tips is the portion that exceeds the difference between the tipped wage and federal minimum wage that was in effect in 2007 ($5.15 per hour).

For instance, if your employee worked 120 hours and received $500 in tips in December 2020 at a tipped wage of $3.75 per hour, they received $450 in wages. Had they received $5.15 per hour, the employee would’ve received $618 not counting tips. To compute the tip credit, the $500 in tips is reduced by $168 (the difference between the $618 federal minimum wage and $450 tipped wage) so $332 is the creditable tip amount for December 2020 for that employee.

The credit is worth 7.65% of the creditable tips (with additional calculations if any employee’s total compensation exceeded the FICA cap, which was $137,700 for 2020). For this example using just one employee, the FICA tip credit is $25. The credit must be calculated to include all tipped employees. If employees are paid more than $5.15 per hour, the creditable tips portion increases.

Jeff Lipsey and Associates can assist restaurant and bar owners, and other business owners in the food and beverage industry, with properly calculating FICA tip credits and ensuring that employee tips are correctly reported. 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.

What Taxes Do 1099 Employees Pay?

What Taxes Do 1099 Employees Pay?

According to one recent study, about 36% of all workers in the United States are currently involved in the gig economy. In 2018, Americans spent literally billions of hours per week freelancing – a trend that shows absolutely no signs of slowing down, especially given the uncertainty created by the ongoing pandemic in the last year.

All of these people will receive not a W-2 to file their income taxes, but an IRS From 1099. The difference is enormous as far as the Internal Revenue Service is concerned, which is why if you’re interested in becoming a 1099 worker yourself there are a few key things you need to be aware of moving forward. 

How 1099 Employees Differ From “Regular” Payroll Employees

The biggest difference between a 1099 employee and a payroll employee is that the former usually has full control over where, how and why they work. There is nobody in a leadership position telling them where to go or what to do. They can make their own hours and they are usually contracted out to perform specific tasks. Once those tasks are completed, the relationship with their client has ended. Because of this, freelancers usually have multiple clients that they’re doing work for at any one time.

In addition to determining their own rates, 1099 employees are not “employed” by any one particular person or entity.

Payroll employees, on the other hand, work for one company and are paid either hourly wages or a salary. They typically work directly from company offices and they’re entitled to certain benefits and protections that 1099 employees are not. Payroll employees usually get both unemployment and workers’ compensation insurance, for example.

But the biggest difference is that a payroll employee will have FICA taxes automatically deducted from their wages, while a 1099 employee will not. 

The Tax Filing Requirements of 1099 Employees

One of the most important things that 1099 employees need to understand is that the IRS expects them to file quarterly estimated payments every year. The United States has always used a “pay-as-you-go” income tax system – that’s why in a traditional employment environment, money would be taken out of every paycheck to go to the IRS.

When you’re a 1099 employee you have no such luxury, which is why the IRS expects you to send them money four times per year. If you fail to do so, or if you fail to calculate the amount you should pay with each check correctly, you’ll be hit with an underpayment penalty. This will be equivalent to roughly 6% of the money you were expected to send for the period. It is possible to avoid this penalty if you qualify for an exemption, however. 

Tax Rates for 1099 Employees

Acting as a freelance or 1099 employee means that you’ll need to pay self-employment taxes, which right now works out to approximately 15.3% of your total earnings. This is because you’ll be paying for the portion of Medicare and Social Security that would be taken care of by your employer in a more traditional employment situation. 12.3% of the above number will go to your Social Security tax, while the remaining 2.9% will go to your Medicare tax.

It’s also important to know that the Medicare portion of the tax will always apply, regardless of how much you earn. The Social Security side applies to all money you made up to $137,700 as of 2020. The good news is that you can deduct half of this tax as an expense when you file your taxes the following year. 

What Taxes Do 1099 Employees Pay – The Lipsey & Associates Approach

At Lipsey & Associates, we understand that keeping track of your finances and financial obligations as a freelance employee can quickly feel like a full-time job – which is an issue, since you already have one of those monopolizing a lot of your time. But if you’re not careful, you could miss critical deductions that could save you quite a bit of money when tax time rolls around. You could also make a few common mistakes that could lead to some unfortunate negative attention from the IRS, too.

Whether you just need assistance handling your monthly budget or you want someone to come in and balance your books, the team at Lipsey & Associates has decades of combined experience and we’re ready to help in any way that we can. More than anything else, we want you to have the peace-of-mind that only comes with knowing your tax needs are taken care of thanks to a team of passionate accountants who have the skills and the training needed to handle your unique situation.

So if you still have any additional questions about 1099 employees and taxes, or if you’d just like to discuss your own needs with someone in a bit more detail, please don’t delay – contact Lipsey & Associates today. 

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.

In Fairfax County, How Solar Energy Equipment Can Cut Your Business Taxes

More and more local small business owners are looking at adding solar energy equipment to their facilities, and with good reason. Solar allows them to cut their electricity costs by producing power on site. Solar installations can increase the value of their buildings. It can mean more reliable power in areas that are subject to blackouts and power disruptions related to adverse weather events. It is also a sustainable source of energy that can cut down greenhouse emissions and conserve fossil fuels. In addition to all these benefits is that solar equipment can help take a bite out of your tax bill through the Fairfax County’s Solar Energy Equipment Tax Exemption.

What Solar Equipment Qualifies for the Exemption?

Property owners can qualify for the exemption when they install solar equipment that fills a need otherwise provided for with conventional energy sources. Most people realize that systems that include solar water heating, air conditioning, heating and electricity for the facility qualify for these sorts of clean energy exemptions. However, many are surprised to learn about less obvious equipment that could save them money, such as south-facing windows that heat your building in winter or shades that cut down cooling costs during summer heat. A few examples of systems include:

  • passive solar systems.
  • solar hot water heaters.
  • solar heating.
  • south-facing windows that function as solar collectors.
  • shading devices that assist in summer cooling.
  • greenhouses that are integrated into the heating system.
  • thermal storage systems (also known as thermal batteries).
  • trombe walls that act as thermal mass heaters for the structure.
  • movable insulation.

The exemption is available for both residential and commercial properties. Both the cost of equipment and installation qualify for the exemption.

How Does the Exemption Work?

The exemption is a percentage that is outlined in Virginia’s Administrative Code. On some items, like solar panels and hot water systems, you can use the exemption for 100% of the cost of your equipment and its installation. On other items, like south-facing windows, you are able to take off a percentage of the cost. The exemption is deducted from your property tax bill every year for five years.

Consider a scenario where you are having a solar hot water heater installed at your place of business. Imagine the water heater costs $10,000 and installation costs $3,000, for a total cost of $13,000. Your tax savings would be based on your tax rate. So, if you pay $1.09 per hundred dollars of assessed value, the exemption each year would come to around $141.70. This becomes a tax credit that is deducted from your property tax bill each year until the exemption period runs out.

How Do I Sign Up?

To sign up for this exemption, you’d have to full out an application form and send it in with the required back-up documents. You’ll need to submit the plans and specifications for your solar device, as well as receipts, canceled checks or other documents that show the cost. Additionally, you must write a brief narrative that describes what your solar equipment does. You’ll also need any applicable permits that are required.

Once all of those have been submitted and your equipment is installed, Land Development Services will forward your application to the Department of Tax Administration. The Tax Administration reviews your application and estimates the value of your tax exemption. You’ll receive a letter confirming that your application has been accepted and how much your exemption is worth.

Help with Tax Exemption Applications

Managing all of the forms and documentation for this and other tax credits can be onerous. As experienced small business tax preparation and accounting professionals, we are familiar with the requirements for this credit and can help you ensure you dot every I and cross every T. Our careful team members will help you ensure that you identify every item that qualifies for the credit and that you have the proper documentation to back up your claims and get the tax credits you have coming to you. Get in touch to learn more our this solar tax exemption and other programs that your business might qualify for.

What Business Tax Deductions Can My Small Business Claim in Virginia?

At Lipsey and Associates, our phone rings daily with questions from small and midsized business owners asking whether specific expenses may qualify as a tax deduction – and for a good reason. 

Claiming appropriate tax deductions is an essential aspect of managing a small business’ finances and maximizing profit. 

However, every once in a while, we see an instance of an overly aggressive list of deductions, or the work of a DIYer earn the attention of the Internal Revenue Service. Not good. 

If you run a small business in Virginia, there are many potential tax deductions that your business might be able to claim. Here are some of the most common and important ones.

Home Office Deduction

One of the most useful tax deductions for home-based businesses is the home office deduction. If you’re able to qualify for this deduction, you can deduct a proportionate amount of your mortgage or rent expenses on your business taxes.

For example, assume you maintain a home office that’s 10 percent of your house’s total square footage and you pay $1,200 a month in qualifying housing costs. This would net you a $120 per month deduction — or a $1,440 annual deduction — for your home office.

With housing costs so high in Northern Virginia, this is an especially helpful deduction for home-based business owners in this part of the state. In order to claim a home office, though, the office can only be used for work. Home office/play space and home office/bedroom combinations don’t count.

Mileage Deduction

Whenever a vehicle is driven for work-related purposes, the miles that are driven on account of business can be deducted. This deduction is unfortunately mileage-based, which might not be a great calculation when you’re stuck on the Beltway for 3 hours, but it still amounts to a sizeable deduction if you drive for work.

The mileage deduction is calculated via either of two methods. The standard mileage rate method multiples the miles driven by the rate set by the IRS for that year. 2020’s rate is 57.5 cents per mile. The actual expense method requires keeping track of all your driving expenses, but then you can deduct all of those expenses even if they exceed the standard rate.

Importantly, the deduction can be taken whether you drive a personal or commercial vehicle for work. If you drive a personal vehicle, however, you need to keep especially accurate records that show what was driven for work and what was driven for personal use. An accountant can help set a record-keeping system up.

Capital Expense Depreciation

If you make a capital investment in equipment or other physical assets, your investment can be depreciated as a deduction on your business’ taxes. This is an especially generous deduction, because the tax law allows for a 100 percent depreciation of up to $1 million in capital expenditures in the year when the equipment is made. Few small businesses in Virginia will exceed that level of investment.

Education for Your Business

One of the best investments a small business owner can make is in themselves, and education that directly helps your business is generally a tax-deductible expense. Classes, seminars, webinars, books, workshops and more materials can all qualify as long as they’re connected to what you do.

Of course, there is some gray area with some educational courses and materials. If you’re unsure whether a particular education expense’s association with your work is close enough to claim the deduction, a certified public accountant can help you decide.

Bonus Depreciation vs Section 179
Businesses in Virginia must be mindful on which depreciation method to use if they want to take advantage of the IRS’s advanced depreciated methods. Virginia does not recognize Bonus Depreciation and will require you to add back any Bonus Depreciation taken on the federal return that wouldn’t normally be allowed under the MACRS tables. Virginia does recognize the IRS advanced depreciation methodology under Section 179 and will not require you to add back the Section 179 depreciation unless that amount is over $25,000.

Because Bonus Depreciation is taxed more favorably upon disposal than Section 179, most tax software defaults to Bonus Depreciation and most individuals do not know to decipher the difference on their state return. We can. This is why by default we choose Section 179 over Bonus for small businesses to get the maximum benefit now. How much? Virginia’s top tax rate is 6%–which means its a current tax savings of $1500 on Virginia taxes alone just by that one switch.

Get Help with Small Business Taxes

If you need help filing taxes for a small business in Virginia, contact the team at Lipsey and Associates. Our team will carefully review your business’ situation, and we’ll help you get every deduction for which your business qualifies for.

Do Teleworking and Remote Employees Trigger Income Tax Nexus

A few months ago, as an employer, you may not have given much thought to where your employees live. Perhaps your main concerns were over commute times and where to send their tax forms at the end of the year.

Now, amidst COVID-19, many employees are working from home using teleworking technologies. Not only is this forcing many businesses to adapt their business models on the fly, but it is also raising some important tax-related questions.

For example, if a business based in Northern Virginia now has employees teleworking from their home located in Maryland, West Virginia, and the District of Columbia because of COVID-10, what are the business tax and accounting implications?

Does your business now have a business connection with these states?  Let’s look at the impact that your employees working from home can have on your business.

WHAT IS TAX NEXUS?

Nexus means that your company has established a business connection in that state, and if nexus is established, your business may now be eligible to be taxed in that state.  The criteria are typically based on whether or not your business has a substantial presence in that jurisdiction.

Recent legislation has removed the physical presence as a requirement for nexus, though it is still looked to first when considering nexus.

It is important to note that nexus is defined separately for both income tax purposes and sales tax purposes. They are slightly different when it comes to defining nexus as it relates to teleworking and remote employees.

            INCOME TAX

For income tax purposes, nexus is established if an employee’s activity goes beyond mere sales activity in the state. For employees working exclusively from home, this standard is likely to have been met. 

            SALES TAX1

For sales tax purposes, merely having employees in the state may be enough to establish nexus.  Recent legislation in South Dakota v. Wayfair helped to clarify some of these provisions.

Having employees in a state, even temporarily, can be enough to trigger nexus in that state.

HOW MIGHT YOUR COMPANY HAVE ESTABLISHED NEXUS WITH NEW STATES?3

Before the COVID-19 pandemic, some of your employees may have commuted from a neighboring state each day to get to the office.

If stay-at-home orders have forced you and your employees to work from home, they may now be temporarily working full-time in that neighboring state.

According to the legislation of many states, you have now established nexus for income tax purposes in that state and may have additional tax obligations and filing requirements.

This could change how your employees’ compensation is classified for income tax purposes. In addition, this could affect how revenues are categorized and taxed for your business.

Where an employee may have previously been taxed as if the income was earned in the state where your business is headquartered, they may now be taxed as if the income is earned in their home state.  Applying the nexus rules could have a significant impact for payroll tax withholding purposes.

This could also have an effect on your company’s filings, such as corporate business tax filings.

Each state has its specific provisions for handling state tax nexus for teleworking and remote employees, so it is important to review your state’s regulations for further guidance.4

ARE THERE EXCEPTIONS TO THE NEXUS RULES?2

Some states and jurisdictions have taken the time to issue legislation related to the COVID-19 pandemic and how it affects the establishment of nexus for employees who are working from their homes.

As of the time of this writing, Indiana, Mississippi, New Jersey, Pennsylvania, and the District of Columbia have all issued legislation related to working from home due to the coronavirus crisis.

These states have determined that employees who have been required to work from home as a result of the COVID-19 pandemic will not trigger corporate tax nexus in their home state for that company.

This means that at least temporarily, companies and employees with connection to these states can continue with “business as usual”.  It remains to be seen what guidance will be released by other jurisdictions at this time.

For residents of Washington D.C., who typically work in surrounding states and are currently working from home, the nexus rules will not apply.  Income earned while the employee is working from home will still be sourced to the state where the resident is typically employed.

Additionally, the employee working from home in Washington D.C. will not result in tax nexus for their employer.

No special rules have been made for Virginia, West Virginia, or Maryland at the time of this writing, however, the team at Lipsey and Associates actively monitors for any changes in legislation.

The current health crisis has temporarily changed the way that we work, live, and relate to one another a way few of us have experienced in our lifetimes.

In times like this, it is especially important to keep your business operating smoothly and in compliance with current legislation. 

If you have any questions about how having teleworking and remote employees will affect you and your business, please feel free to reach out to us for more information.

For more information on whether your business is subject to tax nexus in various states, please contact Lipsey and Associates at 1-703-988-6573 or using the contact form below.

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1https://www.salestaxinstitute.com/sales_tax_faqs/what_is_nexus

2https://tax.thomsonreuters.com/blog/nexus-waivers-for-covid-19-telecommuting/

3https://www.insidesalt.com/2020/04/the-nexus-implications-of-teleworking/

4https://www.nge.com/portalresource/lookup/poid/Z1tOl9NPluKPtDNIqLMRV56Pab6TfzcRXncKbDtRr9tObDdEnCZCn0!/arFile.name=/Establishing%20State%20Tax%20Nexus%20Through%20Telecommuting%20Employees.pdf


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