Small Business Tax Briefs: August 2019
The IRS is targeting business transactions in bitcoin and other virtual currencies
Bitcoin and other forms of virtual currency are gaining popularity. But many businesses, consumers, employees and investors are still confused about how they work and how to report transactions on their federal tax returns. And the IRS just announced that it is targeting virtual currency users in a new “educational letter” campaign.
The nuts and bolts
Unlike cash or credit cards, small businesses generally don’t accept bitcoin payments for routine transactions. However, a growing number of larger retailers — and online businesses — now accept payments. Businesses can also pay employees or independent contractors with virtual currency. The trend is expected to continue, so more small businesses may soon get on board.
Bitcoin has an equivalent value in real currency. It can be digitally traded between users. You can also purchase and exchange bitcoin with real currencies (such as U.S. dollars). The most common ways to obtain bitcoin are through virtual currency ATMs or online exchanges, which typically charge nominal transaction fees.
Once you (or your customers) obtain bitcoin, it can be used to pay for goods or services using “bitcoin wallet” software installed on your computer or mobile device. Some merchants accept bitcoin to avoid transaction fees charged by credit card companies and online payment providers (such as PayPal).
Virtual currency has triggered many tax-related questions. The IRS has issued limited guidance to address them. In a 2014 guidance, the IRS established that virtual currency should be treated as property, not currency, for federal tax purposes.
As a result, businesses that accept bitcoin payments for goods and services must report gross income based on the fair market value of the virtual currency when it was received. This is measured in equivalent U.S. dollars.
From the buyer’s perspective, purchases made using bitcoin result in a taxable gain if the fair market value of the property received exceeds the buyer’s adjusted basis in the currency exchanged. Conversely, a tax loss is incurred if the fair market value of the property received is less than its adjusted tax basis.
Wages paid using virtual currency are taxable to employees and must be reported by employers on W-2 forms. They’re subject to federal income tax withholding and payroll taxes, based on the fair market value of the virtual currency on the date of receipt.
Virtual currency payments made to independent contractors and other service providers are also taxable. In general, the rules for self-employment tax apply and payers must issue 1099-MISC forms.
The IRS announced it is sending letters to taxpayers who potentially failed to report income and pay tax on virtual currency transactions or didn’t report them properly. The letters urge taxpayers to review their tax filings and, if appropriate, amend past returns to pay back taxes, interest and penalties.
By the end of August, more than 10,000 taxpayers will receive these letters. The names of the taxpayers were obtained through compliance efforts undertaken by the IRS. The IRS Commissioner warned, “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics.”
Last year, the tax agency also began an audit initiative to address virtual currency noncompliance and has stated that it’s an ongoing focus area for criminal cases.
Implications of going virtual
Contact us if you have questions about the tax considerations of accepting virtual currency or using it to make payments for your business. And if you receive a letter from the IRS about possible noncompliance, consult with us before responding.
What to do if your business receives a “no-match” letter
In the past few months, many businesses and employers nationwide have received “no-match” letters from the Social Security Administration (SSA). The purpose of these letters is to alert employers if there’s a discrepancy between the agency’s files and data reported on W-2 forms, which are given to employees and filed with the IRS. Specifically, they point out that an employee’s name and Social Security number (SSN) don’t match the government’s records.
According to the SSA, the purpose of the letters is to “advise employers that corrections are needed in order for us to properly post” employees’ earnings to the correct records. If a person’s earnings are missing, the worker may not qualify for all of the Social Security benefits he or she is entitled to, or the benefit received may be incorrect. The no-match letters began going out in the spring of 2019.
Why discrepancies occur
There are a number of reasons why names and SSNs don’t match. They include typographical errors when inputting numbers and name changes due to marriage or divorce. And, of course, employees could intentionally give the wrong information to employers, as is sometimes the case with undocumented workers.
Some lawmakers, including Democrats on the U.S. House Ways and Means Committee, have expressed opposition to no-match letters. In a letter to the SSA Commissioner, they wrote that, under “the current immigration enforcement climate,” employers might “mistakenly believe that the no-match letter indicates that workers lack immigration status and will fire these workers — even those who can legally work in the United States.”
How to proceed
If you receive a no-match letter telling you that an employee’s name and SSN don’t match IRS records, the SSA gives the following advice:
- Check to see if your information matches the name and SSN on the employee’s Social Security card. If it doesn’t, ask the employee to provide you with the exact information as it is shown on the card.
- If the information matches the employee’s card, ask your employee to check with the local Social Security office to resolve the issue.
- Once resolved, the employee should inform you of any changes.
The SSA notes that the IRS is responsible for any penalties associated with W-2 forms that have incorrect information. If you have questions, contact us or check out these frequently asked questions from the SSA: https://bit.ly/2Yv87M6
Should you elect S corporation status?
Operating a business as an S corporation may provide many advantages, including limited liability for owners and no double taxation (at least at the federal level). Self-employed people may also be able to lower their exposure to Social Security and Medicare taxes if they structure their businesses as S corps for federal tax purposes. But not all businesses are eligible — and with changes under the Tax Cuts and Jobs Act, S corps may not be as appealing as they once were.
Compare and contrast
The main reason why businesses elect S corp status is to obtain the limited liability of a corporation and the ability to pass corporate income, losses, deductions and credits through to shareholders. In other words, S corps generally avoid double taxation of corporate income — once at the corporate level and again when it’s distributed to shareholders. Instead, tax items pass through to the shareholders’ personal returns, and they pay tax at their individual income tax rates.
But double taxation may be less of a concern today due to the 21% flat income tax rate that now applies to C corporations. Meanwhile, the top individual income tax rate is 37%. S corp owners may be able to take advantage of the qualified business income (QBI) deduction, which can be equal to as much as 20% of QBI.
In order to assess S corp status, you have to run the numbers with your tax advisor, and factor in state taxes to determine which structure will be the most beneficial for you and your business.
S corp qualifications
If you decide to go the S corp route, make sure you qualify and will stay qualified. To be eligible to elect to be an S corp or to convert, your business must:
- Be a domestic corporation,
- Have only one class of stock,
- Have no more than 100 shareholders, and
- Have only “allowable” shareholders, including individuals, certain trusts and estates. Shareholders can’t include partnerships, corporations and nonresident alien shareholders.
In addition, certain businesses are ineligible, such as financial institutions and insurance companies.
Base compensation on what’s reasonable
Another important consideration when electing S status is shareholder compensation. One strategy for paying less in Social Security and Medicare employment taxes is to pay modest salaries to yourself and any other S corp shareholder-employees. Then, pay out the remaining corporate cash flow (after you’ve retained enough in the company’s accounts to sustain normal business operations) as federal-employment-tax-free cash distributions.
However, the IRS is on the lookout for S corps that pay shareholder-employees unreasonably low salaries to avoid paying employment taxes and then make distributions that aren’t subject to those taxes.
Paying yourself a modest salary will work if you can prove that your salary is reasonable based on market levels for similar jobs. Otherwise, you run the risk of the IRS auditing your business and imposing back employment taxes, interest and penalties. We can help you decide on a salary and gather proof that it’s reasonable.
Consider all angles
Contact us if you think being an S corporation might help reduce your tax bill while still providing liability protection. We can help with the mechanics of making an election or making a conversion, under applicable state law, and then handling the post-conversion tax issues.
The tax implications of a company car
The use of a company vehicle is a valuable fringe benefit for owners and employees of small businesses. This benefit results in tax deductions for the employer as well as tax breaks for the owners and employees using the cars. (And of course, they get the nontax benefits of driving the cars!) Even better, recent tax law changes and IRS rules make the perk more valuable than before.
Here’s an example
Let’s say you’re the owner-employee of a corporation that’s going to provide you with a company car. You need the car to visit customers, meet with vendors and check on suppliers. You expect to drive the car 8,500 miles a year for business. You also expect to use the car for about 7,000 miles of personal driving, including commuting, running errands and weekend trips with your family. Therefore, your usage of the vehicle will be approximately 55% for business and 45% for personal purposes. You want a nice car to reflect positively on your business, so the corporation buys a new luxury $50,000 sedan.
Your cost for personal use of the vehicle will be equal to the tax you pay on the fringe benefit value of your 45% personal mileage. By contrast, if you bought the car yourself to be able to drive the personal miles, you’d be out-of-pocket for the entire purchase cost of the car.
Your personal use will be treated as fringe benefit income. For tax purposes, your corporation will treat the car much the same way it would any other business asset, subject to depreciation deduction restrictions if the auto is purchased. Out-of-pocket expenses related to the car (including insurance, gas, oil and maintenance) are deductible, including the portion that relates to your personal use. If the corporation finances the car, the interest it pays on the loan would be deductible as a business expense (unless the business is subject to business-interest limitation under the tax code).
In contrast, if you bought the auto yourself, you wouldn’t be entitled to any deductions. Your outlays for the business-related portion of your driving would be unreimbursed employee business expenses that are nondeductible from 2018 to 2025 due to the suspension of miscellaneous itemized deductions under the Tax Cuts and Jobs Act. And if you financed the car yourself, the interest payments would be nondeductible.
And finally, the purchase of the car by your corporation will have no effect on your credit rating.
Providing an auto for an owner’s or key employee’s business and personal use comes with complications and paperwork. Personal use will have to be tracked and valued under the fringe benefit tax rules and treated as income. This article only explains the basics.
Despite the necessary valuation and paperwork, a company-provided car is still a valuable fringe benefit for business owners and key employees. It can provide them with the use of a vehicle at a low tax cost while generating tax deductions for their businesses. We can help you stay in compliance with the rules and explain more about this prized perk.