Efficiently Getting Cash Out Of Your Business

Efficiently Getting Cash
Out of Your Business
Sarah Anderson CPA, MST
Bonnie Trochim CPA

Introductions
 EisnerAmper, LLP
 Participant
 What do you want out of class?
 What type of business do you own?

Course summary
 Cash flow basics
 Business structures
 Accounting methods
 Timing of income and expenses
 Getting cash out by entity type / Basis
 Other ways to get cash out
 Self employment taxes and planning
 Special tax deductions
 Useful web resources

Cash-in minus cash-out does not equal profit
 Important concepts:
 Cash-in minus Cash-out = Cash left-over
 Basics:
 What counts as income?
 What counts as expenses?
 Taxability depends on:
 Forms of businesses
 Accounting methods

What counts as income?
 Cash-in normally = income
 There are some exceptions – examples:
 Rebates or refunds for products reduce the
expense
 Deposits other people pay you
 Sales tax collected is a liability owed to the state
 Borrowed funds are liabilities
 Owner’s contributions

What counts as expense?
 Cash-out normally = expenses
 There are some exceptions:
 Capital Assets
 Deposits to others
 Partial/non-deductible expenses
 Loan re-payments
 Distributions to Owners

Cash flow vs. net income example
Description Amount
Receipts from Services 10,000
Loan from Bank 20,000
Business Insurance Payment 1,500
Loan Repayment 1,000 Principal
500 Interest

Cash flow vs. net income answer
Description Cash Flow Net Income
Receipts from Services 10,000 10,000
Loan from Bank 20,000 -0-
Business Insurance Payment (1,500) (1,500)
Loan Repayment (1,500) (500)
Total 27,000 8,000

Types of business structure
 Sole Proprietorship/SMLLC – Schedule “C”
 Partnership/LLC (& entities tax as partnership)
 Corporation:
 C Corporation
 S Corporation (C-Corp with special election)

Types of business structure (continued)
 Sole proprietors or SMLLC – Income reported
on owner’s income tax return (Schedule C)
 Partnerships (and LLCs) and S-corporations -
Income reported on a business return and will
flow through to the owner’s individual income
tax return (via K-1)
 C-corporations - Income taxed on the corporate
return.

Where does income get reported?
Wages (from Corp)
Schedule C
Income/(Loss)
S Corp / Partnership
Income/(Loss)

Accounting methods
 Selection required
 Determines the timing of income and expenses
 Chosen when you file your initial income tax
return
 Requires IRS approval to change your method

Accounting methods (continued)
 Two basic types :
 Cash basis
 Accrual basis
 Same method used for income and expenses
 Business with inventory require accrual.
(Exceptions)
 Gross receipts amounts can prohibit using the
cash method

Cash basis of accounting
 Definition:
 Income - Payment received from customers
 Expense - When paying vendor bills
 NO AR, AP or Accruals.

Accrual basis of accounting
 Definition:
 Income - When you bill a customer.
 Expense - When you receive vendor bills.
 Accounting records include AR, AP and
Accruals.

Timing of income and expenses
Strategies to control tax liability for the cash basis
taxpayer
 Timing when income is recognized
 Timing when deductible expenses are paid
 Deferring your income taxes to increase your cash
flow

Timing misconceptions
 Receipt of payment via check is income when
received not when deposited.
 Expenses are recorded when mailed not when
checks are cut and put in your drawer.
 Credit cards are the exception

Timing example – cash basis
Description Cash Flow
Check received for services 12/30/10.
Deposited 1/4/11.
15,000
Business insurance check cut and mailed
12/29/10. Cleared 1/5/11.
2,000
Mailed invoice to client 12/30/10. Check
not received until 1/15/11.
5,000
Utility bill received 12/28/10. Payment
made 1/3/11.
500

Timing example – cash basis answer
Description 2010 2011
Check received for services 12/30/10.
Deposited 1/4/11.
15,000
Business insurance check cut and
mailed 12/29/10. Cleared 1/5/11.
(2,000)
Mailed invoice to client 12/30/10. Check
not received until 1/15/11.
5,000
Utility bill received 12/28/10. Payment
made 1/3/11.
(500)
Net Income Impact 13,000 4,500

Timing example – planning
Description Year w/ High
Income
Year w/ Low
Income
Invoice customers / collection
calls immediately
X
Delay invoicing customers X
Pre-pay bills X
Delay payment of bills X

Getting cash out – sole proprietor
 Business is your alter ego, one and the same
 Cash can be freely taken out of and put into the
business.
 Owner does NOT take a salary.
 There are no loans to and from the company
with the owner
 Distributions are never taxable.
 **Need to keep a separate bank account**
 Don’t forget estimated tax payments

Unique to sole proprietorship
 Sole proprietor can hire his or her minor child
and not pay any payroll taxes
 Additionally, the earned income of the minor
child under 18 is not subject to federal income
tax if the child earns less than his standard
deduction ($5,700 for 2010)
 A child may qualify to contribute $5,000 to a
deductible IRA or nondeductible Roth for 2010
 Deductible by business if:
 Child actually performs the work
 Payments are actually made

Tax consequences of owner withdrawal example
Description Amount
500 Interest
Withdrawal by Owner 7,000

Tax consequences of owner withdrawal results
Withdrawal by Owner (7,000) -0-
Total 20,000 8,000

Tax consequences of owner withdrawal example
Description Amount
500 Interest
Withdrawal by Owner 27,000

Tax consequences of owner withdrawal results
Withdrawal by Owner (27,000) -0-
Total -0- 8,000

Distributions
 Distributions – S Corporations, partnerships
and LLCs
 Withdrawals from the business of cash or property
 Generally are non-taxable since shareholders,
partners & members are taxed on income when it is
earned or received
 Taxable in certain situations

Basis
What is “basis” and why is it important?
 Your cumulative investment in the business
 Losses may be disallowed if you do not have
sufficient “basis” in the S Corporation,
partnership or LLC
 Distributions may become taxable
 Determination of the gain or loss on the sale of
your business ownership interest

Basis (continued)
How is it computed?
 A shareholder or member’s basis is determined
as followed:
 Original investment
 +- Contributions/Distributions
 +- Net income/ Loss
 +- Debt/Liabilities
 Can never be less than zero

S corporation basis example year 1
Description Amount
Net Income 100,000
Capital Contributions from Owner 20,000
Distributions to Owner 50,000

S corporation basis solution year 1
Description Amount
Net Income 100,000
Distributions to Owner (50,000)
Basis at Year-end 70,000
Note: Taxable income is $100,000.

S corporation – basis example year 2
Description Amount
Beginning Basis 70,000
Net Income 20,000

S corporation basis solution year 2
Description Amount
Beginning Basis 70,000
Net Income 20,000
Basis at Year-end Pre Gain (10,000)
Distributions in Excess of Basis – Capital Gain 10,000
Basis at Year-end -0-
Note: Taxable ordinary income is $20,000
and taxable capital gain income is 10,000.

Avoid distributions that may be taxable
 Losses with limits – If only this were true
 Make sure you consider the taxability of
distributions from the business before the funds
are withdrawn from the business

Basis – impact of debt
Impact of debt/liabilities on basis
 A shareholder’s basis in a S-corporation is
increased by the amount of monies the
shareholder directly loaned to the corporation.
 A partner or member’s basis in a partnership of
LLC is increased for the amount of partnership
or LLC’s loans it personally guarantees or is “at
risk” for.

Shareholder, partner & member loans
S Corporations, partnership and LLCs
 May borrow monies from their company.
 These loans should be properly documented
and should include the following:
 Written promissory note
 Bear a AFR interest rate
 Have specific repayment terms or a schedule

Shareholder, partner & member loans
(continued)
 The IRS may reclassify the payment as a
taxable dividend or compensation if it
determines the arrangement is not a bona fide
loan
 Even with proper paperwork in place, if the
payment has characteristics of compensation or
a dividend payment, the IRS can re
characterize it as a distribution to the
shareholder (making it non-deductible)

S corporation basis example w/ debt
Description Amount
Net Income/(Loss) (60,000)
Loan to Corporation from Shareholder 15,000
Shareholder guaranteed bank debt 40,000

S corporation basis solution w/ debt
Description Amount
Note: The debt guarantee does NOT give
the shareholder basis.

Partnership basis example w/ debt
Description Amount
Shareholder guaranteed bank debt 40,000

Partnership basis solution w/ debt
Description Amount
Loan to Corporation from Partner 15,000
Partner guaranteed bank debt 40,000

Basis planning opportunities
 If the business has losses
 Make the contribution before year-end
 Plan withdrawals after year-end
 If a partnership or LLC will be borrowing soon,
consider having them obtain the new loan
before year-end.

Getting cash out - S corporation
 Salary
 Shareholders that perform services.
 Can take a salary from the corporation.
 Salary is a deduction for the corporation and is ordinary
income for the shareholder.
 The wages are subject to the normal payroll taxes.
 Compensation from the corporation – it must be
reasonable
• The character & financial condition of the corporation
• The role of the shareholder-employee
• The corporations compensation policy/history
• Comparison to similar companies
• Independent investor view.

Getting cash out - S corporation (continued)
 Distributions
 Must be pro-rata based on shareholder ownership
interest
 Can trigger capital gain income to shareholder if
there isn’t sufficient basis.

Getting cash out – C corporation
 Salary (same as S Corporation)
 Shareholders that perform services.
 Can take a salary from the corporation.
 Salary is a deduction for the corporation and is ordinary
income for the shareholder.
 The wages are subject to the normal payroll taxes.
 Compensation from the corporation – it must be
reasonable
 The character & financial condition of the corporation
 The role of the shareholder-employee
 The corporations compensation policy/history
 Comparison to similar companies
 Independent investor view.

Getting cash out – C corporation (continued)
 Dividends
 Taxed at 15% (for US Corporations & certain foreign
corporations)
 Double taxed income
 No distributions like S corporation and Partnerships

Getting cash out – partnership/LLC
 Guaranteed Payments
 Payments for services (a partnership’s version of
salary)
 The partnership gets a deduction for the total
guaranteed payments.
 The payments are specifically allocated as income
to the partner or member to which it was paid.
 Subject to self-employment taxes
 Reported on K-1, not W-2

Getting cash out – partnership/LLC (continued)
 Distributions
 Do NOT need to be made pro-rata. They are
based upon partnership agreement
 Can trigger capital gain income to partner/member
if there isn’t sufficient basis.
 In certain situations distributing property from a
partnership may be beneficial though the basis in
the property distributed will never be higher than
the basis in the partnership

Other ways to get cash out
 Rents between related entities
 Fringe-benefits
 Retirement plans

Rents between related entities
 Forming a entity with rental
property/equipment/intangibles.
 The operating entity realizes tax deduction for the
rent paid, and owner avoids the payroll tax liability
 The owner reports the rental income and expenses
on personal income tax return
 Liability shield for operating entity.
 Isolates a valuable asset

Rents between related parties
 Deductibility of rents between related parties is
cash basis
 Additional factors to consider:
 Rents should be reasonable – document the
commercial practices of rents paid for similar
properties in the area at the time the lease is
entered into
 Lease should be in writing
 Rents should be paid on time

Fringe benefits
 Fringe benefits such as
 health insurance
 medical reimbursement
 travel, education
 group term life insurance
 Costs that would otherwise be non-deductible
personal expenses can be converted into tax
deductions

Fringe benefits (continued)
Employer sponsored educational assistance
programs can deliver up to $5,250 in annual
tax-free reimbursements to each eligible
employee
 Can benefit S or C corporation, partnership,
sole proprietorship or LLC
 The education need not be job related
 Graduate-level courses qualify
 Program must be set up under a written plan
of the employer for the exclusive benefit of
employees (Sec. 127(b)(1))

Fringe benefits (continued)
There is a benefit for any child who is:
 Age 21 or older and a legitimate employee of
the parent’s business;
 Not a more-than-5% owner of the business in
his own right; and
 Not a dependent of the parent (business owner)

Qualified retirement plans
 Tax advantages of qualified retirement plans
 Immediate tax deduction/defer payment
 Income earned within the plan fund is tax deferred
 Employees incur no tax liability until amounts are
distributed
 Qualified distributions can be rolled over tax free

Qualified retirement plans (continued)
 One of the best tools for tax savings
 Qualified retirement plans fall into two basic
categories
 Defined-contribution plans
 Defined benefit plans

Defined contribution plans
• Based on the amount contributed to an
employee’s individual account plus an earnings
or forfeitures of other employees that are
allocated to that account.
• Plan contributions are determined by a formula
and not by actuarial requirements

Defined contribution plans (continued)
Types of plans:
 Profit sharing plan (discretionary contribution)
 Savings incentive match plans for employees
(SIMPLE)
 401(k) / Solo 401(k)
 Simplified Employee Pensions (SEPs)
 Individual Retirement Arrangements (IRAs)

Defined benefit plans
 Any qualified retirement plan that is not
considered a defined-contribution plan.
 Contribution actuarially computed.
 Useful for business owners in their 50s who are
looking to retire over the next 10 to 15 years but
have not saved much towards retirement
 Guarantees the business owner a specific
retirement plan based on age, years of service
and pay

Retirement plans – useful link
 http://www.retirementplans.irs.gov/

Reduce self-employment taxes
 Taxable income passed through by an S
corporation (via K-1) to its shareholder-
employee is not self-employment income for SE
tax purposes
 This has led to the tax planning idea of
minimizing SE taxes by characterizing a small
portion of S corporation income as salary, and a
large portion as distributions.
 IRS can recharacterize the distributions as
“disguised wages” subject to SE tax

SMLLC vs. S Corporation
 T owns an existing sole proprietorship. She is
considering contributing the business to a newly
formed SMLLC or S corporation.
 Taxable income is expected to be $100,000.
 T expects to contribute $10,000 to a SEP.
 T expects to pay $5,000 for medical insurance
premiums.
 T is the only employee.
 T will have sufficient basis in S corporation
stock and take a $35,000 distribution.

Results with SMLLC
 It will be treated as a sole proprietorship for tax
purposes.
 No change on reporting on tax return.
 T’s SE income is $92,350 ($100,000 x 0.9235).
 SE tax liability is $14,130 (15.3% of $92,350).

Results with S corporation
 T pays herself a “reasonable salary of $50,000.
 The corporation will make contributions of
$10,000 to the company retirement plan.
 The corporation will pay medical insurance
premiums of $5,000.
 FICA taxes are due only on the salary of
$50,000.
 The medical premiums are taxable, but not
subject to FICA tax.
 FICA tax liability is $7,650 (15.3% of $50,000).

Partnership vs. S Corporation
 S & B are forming a new business as 50/50 co-
owners. It can be operated as either an
partnership or S corporation.
 Taxable income is expected to be $200,000.
 Retirement contributions will be $10,000 for
both S & B.
 Medical insurance premiums will be $5,000 for
both S & B.
 S & B will have sufficient basis in S corporation
stock and take a $35,000 distribution each.

Results with partnership
 Each owner’s SE income is $92,350 ($100,000
x 0.9235.
 SE tax liability for both S & B is $14,130 (15.3%
of $92,350).

Results with S corporation
 S & B pay themselves a “reasonable salary of
$50,000 to each.
 The corporation will make contributions of
$10,000 to the company retirement plan for
each owner.
 The corporation will pay medical insurance
premiums of $5,000 for each owner.
 FICA taxes are due only on the salary of
$50,000.
 The medical premiums are taxable, but not
subject to FICA tax.
 FICA tax liability is $7,650 (15.3% of $50,000).

Special tax deductions
 Automobile expenses
 Home office deduction
 Self-employed health premiums
 Depreciation
 Start-up expenses

Special tax deductions (continued)
Automobile Expenses
 Deductible auto expenses for a business can
be accounted for by using one of two methods:
 Standard mileage method
 Actual expense method
 Taxpayers that qualify for both methods may
choose the most beneficial method.

Automobile Expenses - actual
 Percentage related to business use
 Track business miles/total miles
 Keep complete and accurate mileage records

 Deduction disallowed if unable to produce
contemporaneous records

Standard mileage method – company deducts a
standard rate for each business mile driven
 50 cents per mile for 2010
 Additional expenses allowed for deduction that
are not included in the standard mileage rate
include
 Business parking fees and tolls
 Local transportation such as bus, cab, train

 Election to use the Standard Method
 made in the year the car is placed in service
 In a later year, you can switch to the actual
method
 Straight-line depreciation required
 Leased vehicles
 elections to use standard mileage method must be
used for the entire lease period.

Home Office Deduction
 To qualify for the deduction a portion of the
home must be used EXCLUSIVELY on a
regular basis as:
 The principal place of any business
 A place of business that is used by clients or
customers in meeting or dealing with the taxpayer
in the normal course of business.

 If these tests are met than the taxpayer needs
to determine what percentage of the home is
used for business.
 Take the square footage of the business use
section over the total square footage of the home.
 Multiply this percentage by the qualifying indirect
expenses to come up with the home office
deduction.

 Examples of qualifying expenses subject to allocation
are
 Real estate taxes
 Mortgage interest
 Rent
 Utilities
 Repairs & maintenance
 Depreciation, etc.
 Direct expenses are 100% deductible

 Sale of a residence with home office
 Attached home offices
 Do not need to allocate the gain on sale
 “Recapture” of depreciation allowed or allowable on
the home office after May 6, 1997
 Designed to prevent a double benefit
 Detached home offices
 Allocate gain and treat as two separate properties

Example
 T sold his home in 2009 at a $30,000 gain.
 T used part of the home as a business office in
2008 and claimed $500 depreciation.
 Because the business office was part of his
home (not separate) T does not have to allocate
gain. T also does not have to report any gain
on Form 4797. However, T must recognize the
$500 of the gain as unrecaptured 1250 gain.
He reports his gain, exclusion, and taxable gain
of $500 on Schedule D.

Self Employed Health Insurance Premiums
 SEHIP are not subject to the normal medical
expense limitations – However, watch income
limitations
 ‘S’ Shareholders and partners are considered
self employed for this purpose

 Tax year 2010
 100% of SEHIP is deducted on page 1 of the
1040 with no limitation.
 The Small Business Jobs Bill allows self-
employed individuals to take the health
insurance deduction into account in calculating
net earnings from self-employment

Depreciation
 Depreciation is allocation of cost, not loss of
value
 Total cost divided by estimated useful life
equals yearly depreciation
 Non-cash expense
 Depreciation creates difference between cash
flow and profit/loss statement

 Small Business Jobs Act of 2010 raised
maximum Section 179 expensing limit for tax
years beginning in 2010 and 2011 to $500,000
(formerly $250,000)
 Maximum expensing amounts (beginning of
phase-out amount) s raised $2,000,000 (from
$800,000)
 Needs to be placed in service
 Can be new or used property
 Includes qualified real property expensing
(qualified leasehold improvement, restaurant
property and retail improvement property)

 Bonus first-year depreciation extended through
2010
 In 2010, Bonus Depreciation – 50% of cost after
any Section 179 Depreciation. Available for
new property only. Extended under Small
Business Tax Relief
 Portion after 179 and Bonus, subject to regular
depreciation

Start-up expenses
 Must be capitalized unless election made
 Includes investigation, acquisition, or
establishment of a trade or business
 Immediate write-off of certain amounts incurred
 The Small Business Jobs Act increases the
Section 195 deduction for trade or business
startup expenses from $5,000 to $10,000 for
tax years beginning 2010 & 2011
 The start of the limitation on the deduction is
increased from $50,000 to $60,000

Net operating loss carry-back
 Small business with deductions exceeding their
income in 2008 and 2009 can use a new net
operating loss tax provision to get a refund of
taxes paid over the past five years instead of
the usual two
 Examine your earlier returns to see if you had
income that could be offset by a loss carry
back. This could result in a tax refund to you

Some useful websites
 Internal Revenue Service
 www.irs.gov
 www.sbrg.irs.gov
 United States Government
 www.business.gov
 New Jersey
 http://www.state.nj.us/treasury/taxation/
 http://www.state.nj.us/nj/business/

QUESTIONS?
Thank you for coming!

Contact information
Sarah Anderson CPA, MST
EisnerAmper LLP
750 Route 202 South, Suite 500
Bridgewater, NJ 08807
908-218-5002 ext 2235
sarah.anderson@eisneramper.com
Bonnie Trochim CPA
EisnerAmper LLP
750 Route 202 South, Suite 500
Bridgewater, NJ 08807
908-218-5002 ext 2327
bonnie.trochim@eisneramper.com

IRS Circular 230 disclosure: To ensure compliance with requirements
imposed by the IRS, we inform you that any U.S. federal tax advice contained
in this document is not intended or written to be used, and cannot be used,
for the purpose of (i) avoiding penalties under the Internal Revenue Code or
(ii) promoting, marketing or recommending to another party any tax-related
matter(s) addressed herein.

EisnerAmper LLP is an independent member firm of PKF International Limited

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