Partnership formation: almost too easy

Due to popular demand, this is a re-post of a prior posting as posted May, 2012

Usually accountants shy away from legal topics, but one topic keeps coming up in our profession.

The creation of partnership agreements.

This is a particularly interesting topic now that the IRS has significantly increased late-filing and non-filing penalties for partnership returns...

Most people don't realize it, but a partnership is easier to create than most things in life. In most States, a partnership can be formed between two individuals with a verbal agreement. This means if you are in business, you may have a partnership formed and not even know it. In practice this creates many problems. I will give you one real life scenario:

Ryan and Matt are best friends they decide one day to open up a bicycle repair shop, out of Ryan's garage. They begin by fixing their friend's and family's bikes on the weekends. Before long their word of mouth business is making so much money that Matt and Ryan cannot keep up and perform their normal 'jobs'. For this reason, Matt quits his job and takes up the business full time.

While they are still in business together Matt and Ryan have very different definitions of who is entitled to the income and how they will split it. So they have a lot of problems, problems that could have been solved with a formal partnership agreement. One of their biggest problems, relates to how to filed their returns for 2008. Both Matt and Ryan included income on their personal returns equal to their share of the combined 'entity'. When Matt was audited on his 2008 return in 2010. The auditor working on his personal return founds something interesting, there was no partnership return completed for 2008 and 2009. 

For this reason, the IRS issued a failure to file penalty for the tax years 2008, and 2009 for failure to file partnership returns. These penalties were in addition to the items found on Matt's personal return. The penalties for failure to file the partnership returns in 2008 and 2009 amounted to over $2,100.

Matt and Ryan would have been in a better position had they filed accurate returns for 2008 and 2009, however, most people are not aware of the ease at which they can create a partnership. But, now you have no excuses!

Take control of your financial life!

To celebrate financial literacy month (not nearly as cool as cupcake month) financial advisors, estate planners, CPAs and attorneys are teaming up to talk about finances and how being in charge of your financial life is essential.

Did you know your credit score impacts a lot more than just your ability to secure a loan. In most cases your insurance company will run your credit score and base part of your monthly auto and homeowners insurance upon your credit score! Also, renters beware, many rental companies are basing whom they rent to upon your credit score! Being financially responsible is the baseline for getting ahead with your personal finances.

Businesses are also effected by financial metrics. Here are two examples:

1. Many businesses that are in the start-up phase do not have enough business history in order to qualify for a business loan without personally guarantying that loan. For this reason, it is often hard for businesses to secure start-up financing if the owners have less than perfect credit. Also, business loans often require much more paperwork and oversight, so many small business owners take out personal loans or lines of credit to avoid this hassle.

2. As a small business owner you may know that there are certain breaks businesses get when they have a favorable history. Price breaks on insurance rates for months without a claim, or zero percent financing from preferred vendors are just a few tools businesses use to save money. When you have the opportunity to make money using financial leverage you have to seize those chances! Using other peoples money is the ultimate tool in your kit bag for financial success.

If you have other ideas, please feel free to share!

Happy Taxing

Also...

If you are interested on my most recent post relating to starting a business you might also be interested in a former posting regarding partnership returns. See: Partnership formation: almost too easy
 

Started a business, now what?

Congratulations you are now the person in charge of your very own LLC, Partnership or Corporation. Whether you formed a limited liability company, started a partnership or created a Corporation, you now have more responsibilities than ever. So you may find yourself asking, now what?

For some of you the answer is nothing, for some of you the answer is a lot of things, but to keep things simple we will keep the conversation to the most basic level. Assuming that you have no employees and have just opened your LLC, Partnership or Corporation and need to know about your year end filing requirements.

1. Limited Liability Company or LLC:

An LLC is not a federal recognized organization, and for this reason, when you open an LLC (also known as organizing) you may not have any additional filing requirements beyond filing your personal return and including a Schedule C with that filing for this entity. However, if you have an LLC with more than one owner, then the default taxation treatment is a partnership. In this case, you would be required to file a partnership return annually and your year end is usually December 31st, unless you make an election for an alternative year end (see below for more information). You can also make a separate election to be taxed differently than your default tax status.

2. Partnerships

Partnerships are one of the oldest forms of business organization and may not even require a formal legal document (from a tax perspective). Partnerships are also formed at the state level, but these organizations are recognized under federal statute. For this reason, the default annual filing for a partnership is a partnership return annually with a year end of December 31st. You can file for an alternative year end, and you can also file to be taxed differently than as a partnership (this does not change your legal status only your return filing requirements). While you have to file an additional return annually, you do not pay taxes with this return, but rather the earnings are passed through to your personal return. When you file your personal return you either pay tax, or apply expenses against your income (and maybe) receive a refund.

3. Corporations

Corporations are also a very old form of business organization and although there are fewer corporations formed now (as compared to LLCs and Partnerships) this form of business structure is still very popular. There are three most common forms of Corporations, C-Corps ( C- Corporations ), S- Corps ( S Corporations ) and Not for profit entities ( Non-profits). These three types of entities have very different taxation, and usually are formed for much different reasons. I am going to focus on C- Corporations in this article. In the C Corporation status you have created a separate legal entity with an indefinite life. This separate entity has a different tax structure than you personally and also has a separate return annually. It is interesting that this legal status is nearly the only legal status that affords you an automatic year end in any month you choose. It is also the only structure that allows a different tax structure than your personal tax structure.

There are many other accounting and tax rules that may apply to you, depending upon how you organize your business, but we will skip past those for this article.

Starting an LLC or Corporation

If you ever wondered about the legal steps you should take to propel your idea from a concept to a legal entity. You have to check out this article. You may have many reasons why you want to start an LLC or open a corporation, but may have worried about the process. Click on this link to connect to the article.

Also, if you ever wondered about the tax effects of creating one of these entities, check out my blog post tomorrow: Started a business, now what?

Three instances when you should amend your return

With tax season over we turn our focus to other things in our life, like more taxes :)

Seriously, now that tax season has come to a close we have a chance to reflect on tax seasons now past. For most of us, we assume when the return is filed that the case is closed and we look forward to next year when we can get our taxes out of the way (yeah right). But, if you have one of these instances you might want to seriously consider having someone review your return, before you get a love letter from the IRS.

1. You did not report your stock sales on your return. Stock sales, bond sales, and sales of investments outside of retirement accounts are like the gift that keeps giving for the IRS. I cannot tell you how many times during the year I get that phone call. It usually starts out like this, " Hey Tony, yeah, I forgot to tell you that I sold some stock (bonds, whatever) during the year, but I lost money on the sale and the IRS says I owe a bunch of money. What's the deal?" Recently there have been changes in tax reporting due to stock sales that are designed to eliminate these issues. But generally speaking, if you have sold investments and not reported them on your return, you should strongly consider the advice of an expert.

2. You did not understand the questions from your tax preparation software, and now you are thinking that you either paid way too much, or not nearly enough in taxes during the year. Did you know that your return, once filed usually has a three year audit window. This is important when you are filing incorrect information. But more important, if you have a situation where the information on your return was fraudulent, then the audit window does not close...Bad news for all you scammers out there (just kidding).

3. If you did not report all of your withholding for the year. This might sound obvious. But you would be surprised, how often we review prior returns and find that someone overpaid due to a clerical error (usually if you underpay the IRS or local government is more than willing to point out your mistake for you).

If you think you fall into one of these categories, or you have your own, I would love to hear it.

Until next time, happy taxing.

State of Michigan warns Michigan businesses of scam

The State of Michigan has alerted business owners of a new scam designed to trick businesses out of $125.

The Michigan Licensing and Regulatory Affairs Department issued a release that reminds business owners that they are not required to send in annual minutes of meetings, and under no circumstance should you reply to correspondence received from the "Michigan Corporate Compliance Company". This is not a State of Michigan regulatory body, but is a scam set up by a company that is trying to defraud businesses.

The State also warns taxpayers and businesses to be diligent in their review of forms, noting that fraudsters are able to make these and other forms look very official. These types of scams are a new and growing business for fraudsters, so the State is reminding individuals to be hyper-vigilant.

ANY BUSINESS THAT RECEIVES A NOTICE TO HAVE ANNUAL MEETING MINUTES PREPARED AND PAY A FEE TO AVOID DISSOLUTION OF THEIR CORPORATION ARE ADVISED TO DO THE FOLLOWING:

1. Keep the notice, mailing envelope and return envelope.
2. Contact the United States Postal Inspection Service to report mail fraud at: (877)876-2455 or the following email address: https://postalinspectors.uspis.gov/forms/mailfraudcomplaint.aspx
3. OR contact the Michigan Office of the Attorney General at P.O. Box 30212, Lansing, MI 48909.

This correspondence should not be confused with the Michigan Annual Report, which is an annual filing required by the State of Michigan.