Big tax changes coming for small business

Each tax season brings with it many new questions with regard to small business ownership and the type of taxes paid by certain entities.As you may have read already, there are some major changes this year with regard to small-business taxation, compensation and the ongoing contractor versus employee debate. Before you make a snap decision to shift your business from a limited liability company to a sole proprietorship or a corporation, remember that knowledge is your best defense.

Attention on sole proprietorsIf you’re running your business as a sole proprietor and expect your business to show losses in the future, you may be surprised to discover that the IRS is pushing the Government Accounting Office to consider disallowing sole proprietors from taking those losses on their income tax returns in the future. Now is a great time for sole proprietors to consider switching their tax entity (not necessarily their legal entity if they are already an LLC) to a corporation. IRS audit rates for S and C corporations are lower than sole proprietors, and new state rules regarding Interest/Dividends tax in LLCs may also make corporations a more attractive alternative.

New LLC rulesAs mentioned above, LLCs are facing new rules and scrutiny in New Hampshire. The state’s 5 percent interest and dividends tax will now include “taxation of distributions by limited liability corporations.” The operative word here is DISTRIBUTIONS. If your business shows a profit, New Hampshire law permits you to take a deduction for “compensation for personal services.” This is not a distribution. So if your small business made $200,000 (net to you as an owner), and you can argue that this is a reasonable wage for you or for each of your partners, there would be zero distributions. It’s only if the profits of your business exceed this reasonable compensation amount, that you would have a distribution.This regulation is causing considerable debate and fear among New Hampshire’s small-business owners, many of whom believe they will be affected by the new 5 percent tax. Our best advice is to contact your accountant and talk about the direct impact on your LLC before you switch business entities.

Rising payroll taxesNew Hampshire also will be looking at raising payroll taxes as a way to help rejuvenate its depleted coffers after an unprecedented year of skyrocketing statewide unemployment. The floodgates are opening on the age-old contractor versus employee debate as small businesses seek to ease their tax burden by claiming the people working for them are not employees but rather independent contractors and thus exempt from payroll tax requirements.Be very cautious about making this distinction yourself. The IRS and New Hampshire definitions for how you can treat each worker are now far more specific and vary significantly, in addition to increased scrutiny of payroll by both federal and state tax agencies.The payroll tax increase isn’t unique to New Hampshire, but will be happening nationwide. Is New Hampshire still an affordable place to start a small business? Absolutely. Our surrounding New England states have even higher payroll taxes and a far more complicated tax system.Late filing can be costlyIn previous years, filing a late tax return meant paying a $50-per-month, per-partner penalty for up to five months equaling $250 per partner. While not peanuts, the late fee was manageable and certainly reasonable. Beginning in 2010 with the new legislation extending unemployment benefits and the homebuyer credit, the penalty for S corporations and partnerships now increases to $195 per partner per month for up to 12 months. That’s $2,340 per partner or shareholder if your tax return is more than a year late.For instance, the deadline for an S corporation tax return is March 15, and the deadline for a partnership tax return is April 15. If no extension is filed, the IRS is becoming much more assertive in penalizing you, and at $195 a month, that can add up pretty quickly.If you’ve still got questions about the tax implications in your small business, you’re not alone. This is not the year to try to navigate all of the new changes single-handed. When in doubt, talk with a tax professional and keep your business and your personal finances out of trouble.CPA Steven A. Feinberg, who heads Londonderry-based Appletree Business Services LLC, is a regular blogger on NHBR Network. For more information, call 603-434-2775 or e-mail