Archive for the ‘Entity Formation’ Category

When the IRS “Helpfully” Changes Your EIN…

Thursday, May 7th, 2020

Your personal tax records are noted under your Social Security Number. That won’t work for businesses, so years and years ago the IRS came up with Employer Identification Numbers (EIN) to track business accounts. If you form a new business entity, you can obtain an EIN online. The system works well most of the time.

One of our clients, call him James Smith, formed an LLC back in 2007 in Arkansas: James Smith LLC. The LLC made a timely election to be treated as an S-Corporation, and all was well.

In 2010 Mr. Smith got married and moved south to Texas. He closed the first LLC and formed a new LLC, James Smith LLC. Yes, he used the same name. This LLC had two owners (Mr. & Mrs. Smith), and all was well. It was assigned a different EIN—as it should, given it was a different legal entity. This LLC, too, made an election to be treated as an S-Corporation.

Unfortunately, the marriage didn’t last, and Mr. & Mrs. Smith divorced in 2011. They agreed to close the LLC, and they did so, filing final tax returns in 2011. Mr. Smith, though, decided to continue his business and moved back to Arkansas. He formed a new LLC, and, yes, you’re already a step ahead of me, it was called James Smith LLC. He received a new EIN. This LLC also made an election to be taxed as an S-Corporation.

All was well until mid-2017. James Smith LLC was doing well, tax returns were all filed, and all taxes paid. In July 2017 the IRS made an inquiry regarding a payroll tax filing. My client uses one of the large payroll services for payroll, but somehow on a filing the information on one item got garbled in transmission. We replied, the IRS responded a few weeks later saying, “Thank you. We’ve closed our investigation into this matter.”

What we didn’t know is that the IRS employee who received the paperwork decided to help my client. He saw that there were previous EINs issued to James Smith LLC and changed the EIN within the IRS computer system back to the EIN of the Texas entity. Adding to the helpfulness, we were not notified of the change.

We discovered there was a problem when I attempted to efile the 2017 tax return (in 2018). The return would not be accepted. I called the IRS’s efile help desk and was told only what was on the IRS rejection notice was, “There’s a name/EIN mismatch.” Of course, neither I nor my client could figure that out, so we paper-filed the returns (federal and Arkansas).

A few months later we received a letter from the IRS saying we filed the tax return with the wrong EIN, and the EIN we should use is the Texas EIN. We wrote back protesting this, noting that EIN referred to a closed entity in a different state, and the new EIN is what should be used. The IRS’s response? “Use the old EIN.”

This has caused multiple issues with the IRS. We have multiple prior (to 2018) payroll tax mismatches. We were just notified this week by an IRS Revenue Officer that my clients Form 941 for the fourth quarter 2018 wasn’t filed. It was filed–timely—by one of the large payroll firms…but not under the Texas EIN. I explained everything to the Revenue Officer, but we still had to prepare a new Form 941.

There are multiple lessons here. First, if you close an entity and start a new one, change the name slightly. If my client had used James Smith & Associates, LLC for the Texas entity and James L Smith LLC for the new Arkansas entity, it’s probable none of this would have happened.

Second, the IRS absolutely should ask taxpayers before changing an EIN. Had that IRS employee asked us we would have explained why the old EIN couldn’t be used.

Finally, when a mess like this happens it will tend to linger for years. We still have four unresolved issues with the IRS all stemming from this helpfulness. While I do expect them to all be successfully resolved, this has added costs and stress for my client for no good reasons. And if you are reading some sarcasm in what I’m saying in this post, you’re right.

Tax Law Signed; New Year Likely to Bring Lots of New S-Corporations

Friday, December 22nd, 2017

President Trump signed the tax reform legislation into law. While there are many changes for 2018, one of the biggest is the new Section 199a deduction. This allows a 20% writeoff of net income for sole proprietors, owners of S-Corporations, and members of partnerships/LLCs, limited by wages paid (unless income is less than $157,000 (single)). I suspect tax professionals will see lots of S-Corporations in the future.

First, wages paid to owners counts in calculating the Section 199a deduction. Imagine you’re a consultant with income of $300,000 structured as a sole proprietorship. You’re ineligible for the Section 199a deduction (your income is too high). Now, convert to an S-Corp (or an LLC taxed as an S-Corp), pay yourself a reasonable salary (say $80,000), and:
– You get the Section 199a deduction ($44,000); and
– You avoid self-employment tax on a large part of the net income of your business.

Maybe I’m missing something, but for successful businesses there are now two factors leading toward an S-Corporation as the solution. And given the way the deduction is written, reasonable salary likely won’t be an issue—owners have an incentive to pay themselves!

As a reminder, there is no one right form of business entity. Though S-Corporations appear to be an excellent choice based on Section 199a, the choice of type of business entity should always be discussed with your tax professional and attorney prior to selecting it.

To C Or Not To C, That Is The Question

Tuesday, November 9th, 2010

Robert Flach announced his newsletter, The Schedule C Letter. Robert notes,

THE SCHEDULE C LETTER is a bi-weekly newsletter that provides tax planning and preparation advice, information, and resources for sole proprietors and one-person LLCs who report their business activity on IRS Schedule C

The newsletter, which will be sent via US mail, costs $24.95 for 6 issues. The newsletter will begin publishing in January 2011.

Peter Pappas doesn’t like Schedule C businesses. His view, which I share to some degree, is that any business worth having should be either incorporated or in an LLC that does not file a Schedule C. The primary reason for his view is, I believe, that a Schedule C business has ten times the risk of audit of a non-Schedule C business (all other factors being equal).

Well, I agree to a point. Unfortunately, I deal with one group of individuals who cannot incorporate (or form an LLC) in all jurisdictions. Many states disallow professional gamblers from incorporating because gambling is against public policy (even though it’s legal in that state). My guess is that Mr. Pappas would say that those clients are the exception that proves his rule.

Well, who is right? Mr. Pappas is absolutely correct about the risk of audit. Additionally, for a business that is grossing $100,000 or more, and especially any business of any size with any liability exposure, a business structure (LLC or corporation) is nearly mandatory. Yet what if you are a single member LLC, and you do not want to be taxed as a corporation? You’re going to file a Schedule C.

Perhaps it’s just two individuals looking at an issue from their perspectives. That said, businesses of significant size should definitely look at not filing a Schedule C. And if you do file a Schedule C you should definitely look at Mr. Flach’s publication because making mistakes on your return will cost you time and money.

Ask Your Attorney and Accountant and Then Act

Wednesday, June 18th, 2008

Joe Kristan has an excellent post this morning on why your first should talk to your business attorney and accountant and then act on a change to your business entity. If you act first you may very well end up having tax troubles.

What Kind of Business Entity is Right For You (Part 1)

Friday, January 19th, 2007

You’ve decided to go into business for yourself! Congratulations. If you’re like most new entrepreneurs, you start your business first, and ask questions later. If you do that, I can guarantee that unless you’re incredibly lucky, you’ll have a bunch of headaches down the road.

In this series I’m going to look at the various types of business entities: sole proprietorships, partnerships, C Corporations, S Corporations, LLCs, and other business entities. Many tax preparers and attorneys believe that “one size [entity] fits all.” That’s just not the case. What may be right for you might not be right for me.

It’s important that before you start your business, you meet with an attorney and a tax professional. There are three different individuals who need to come together to determine which business entity is right for you: the attorney, a tax professional, and you. It’s like an Isosceles triangle, and somewhere in the middle is the right entity.

Your goals are extremely important. What do you want from the business? Some entrepreneurs want to be the next Microsoft; others just want a nice, steady income. Do you want health insurance payments to be made from your business? How many (if any) employees do you want/need? Is your business local, regional, or national? Do you want to franchise it? What kind of income do you need from it to live off of? These are just a sampling of the questions that I ask new business owners.

The attorney is needed because liability questions can mandate different types of entities. Does your business have significant product liability risks, such as food, small toys (they can be swallowed by small children), pharmaceuticals, etc.? Do you have backers (investors) who want a specific agreement/entity? Does your business location present legal risks? Do you have partners/investors, such that a buy/sell agreement needs to be drafted? There are many other legal issues when you form a business. A business attorney familiar with your business idea(s), and the community you will be operating in, is a must.

A tax professional is also a must. Depending on your goals, and the legal issues involved with your business, the tax professional can recommend a business entity. The attorney will also likely recommend a type of entity. Usually, these recommendations sync.

There can be major issues when you rush into your business. I have a new client in San Diego. She formed her business in 2005 as a sole proprietorship. There are just a few problems, though: she has a silent partner, entitled to 50% of the income that’s not on the books; this partner is in Hong Kong, so there are foreign withholding requirements; the company has significant liability exposure (it’s in the food industry); she formed an LLC and an S Corporation, but she’s operating her business in the name of the sole proprietorship; and she first saw an attorney (at my urging) in late 2006. In other words, it’s a mess, and will take time (and money) to straighten out. It’s much, much easier to spend a little bit of money up front then have to spend a lot on the back end.

In part two (coming next week) I’ll take a look at the advantages and disadvantages of a sole proprietorship. Sole proprietorships are the easiest businesses to start. But ease comes with a price.

LLCs vs. S Corps in California

Monday, January 23rd, 2006

In my practice, I see a lot of S Corporations, but very few LLCs (I can count the number on one hand). Yet, according to Christopher Hoyt of the University of Missouri at Kansas City (writing in the TaxProf Blog), this is the opposite of what’s being recommended in law school. So why the difference?

Hoyt notes the statistics, and presents a graph showing that S Corps remain twice as popular as LLCs (based on new S’s vs. new LLCs). Joe Kristan of Roth Tax Updates then speculates on the reasons behind this. His points on salaries, and the uncertainty of how LLCs are to be treated for self-employment taxes are on point.

Kristan also notes that state issues have a material impact. He notes that in Iowa (his home state), LLCs are tax-disfavored (versus S Corps) for multi-state operations.

In California, there are two major factors working against LLCs. First, all S Corps and LLCs in California must pay a minimum state franchise (income) tax of $800 per year (or 1.5% of net income, whichever is greater). But LLCs also face a gross receipts tax, so LLCs in California are triple-taxed! The current minimum gross receipts tax (called an LLC fee) is $865 per year. Second, some businesses are prohibited from being in an LLC. These include professionals, such as architects and accountants. (They can form LLPs, though).

If you’re at all interested in forming an LLC read the articles. They’ll enlighten you about some of the tax issues facing LLCs.

Hat Tip: TaxProf Blog & Roth Tax Updates