Tag Archives | IRS

What is an Employer Identification Number?

imagesAn employer identification number (EIN), also known as a federal tax identification number (TIN), is used to identify a business entity.  Generally businesses need an EIN.  If you answer yes to any of the following questions, your business must get an EIN:  Do you have any employees?  Do you operate your business as a corporation or partnership?  Do you file an employment, excise or alcohol, tobacco and firearms tax return?  Do you withhold taxes on income, other than wages, paid to a non-resident alien?  Do you have a Keogh plan?  Are you involved with any of the following:  Trusts, except certain grantor-owned revocable trusts, IRAs, Exempt Organization Business Income Tax Returns; estates; real estate mortgage investment conduits; non-profit organizations; farmers’ cooperatives; or plan administrators?

It’s important to remember that a business entity is separate and distinct from its owner(s), and as such needs its own identification.  You can apply for an EIN online, for free, and receive your EIN immediately.  The application is fairly straightforward and takes only minutes to complete.

 

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Donating Property

As the year-end donor season approaches, we want to remind you that the donor is required to pay for an appraisal for any property, real or personal, for which the donor wants to take a deduction of $5,000 or more.

We often see agreements between a donor and non-profit organization whereby the non-profit agrees to pay for a qualified appraisal of the property to be donated.  IRS rules does not permit this, notwithstanding the terms of any such agreement.  More specifically, the donor is required to file Form 8283 with her tax return to take a charitable deduction for donated property, which requires her to get a qualified appraisal of real and personal property.  Not all donations require an appraisal, such as cash or marketable securities.  But where an appraisal is required, it is up to the donor to obtain and pay for it.

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Define Your Charitable Purpose

We receive many calls from people thinking about starting a nonprofit organization to help solve a particular problem or address a particular issue.  The idea is that a nonprofit will allow people to raise money to fund a defined need.  Sometimes, though, the very real problem or issue to be addressed isn’t one that can be funded with a charitable organization.  For example:

  • Something that will benefit a single individual, like a wheelchair ramp to provide easy access to the individual’s home, or
  • Expenses that are someone’s personal or parental obligation, like fees for sports or other extracurricular activities.

hatinhandWhen considering the need for a new nonprofit organization, keep in mind that the charitable purpose must be broad and the organization’s work must benefit a whole community, not just the members of the nonprofit or a specific individual.

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Help From the IRS

irspubsDid the title of this post catch your attention?  Yes, the IRS really can be helpful to nonprofits with many commonly asked compliance questions.  The IRS publishes tons of material each year, much of it very technical and very much geared toward tax professionals.  But they also publish some very clearly written, plain language documents that can help us as nonprofit board members and staff leaders.  These documents are referred to as IRS Publications (as opposed to Forms, Technical Advice Memoranda, Opinions, etc.), and are easily accessible by searching the IRS website.  You can enter the publication number if you know it, or just search by keywords.

Some of the most common issues and questions for charitable organizations are addressed by the following:

  • Publication 526, for rules regarding charitable contributions.
  • Publication 557, for information on how to obtain and keep your tax exempt status.
  • Publication 1771, for rules on receipts and acknowledgements of gifts and contributions.
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Creating a New Non-Profit

orgThere are a lot of issues to consider when you’re thinking about starting a new non-profit organization to run your community or charitable activities.  One of the first is, are you prepared to run a business?  When you start a new organization, keep in mind there are lots of filing and compliance requirements, both with the IRS and with your state, that will apply no matter how small you are, and that last for the life of the organization.  To avoid trouble, you’ll need to take your new organization seriously, and run it like a small business.

Speaking of small business, also keep in mind that your non-profit status is a tax election.  Successful non-profits are still run like a business.  And they make money, too!  A non-profit organization simply can’t distribute its proceeds to individuals such as shareholders or partners.  All of a non-profit’s proceeds must to be used for its charitable purposes.

The form of your non-profit business organization matters, too.  While the IRS does allow various forms of organizations, such as partnerships or LLC’s, to achieve non-profit status, choosing this type of form will create lots of complications and add lots of time to the process of achieving your tax exempt status with the federal government.  So when you form your organization at the start, choose the basic corporate form in your state.  It will save time and aggravation, and allow you to run and grow your charitable business over time.

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What is an S Corporation?

An S corporation (sometimes referred to as an S Corp) is a special type of corporation created through an IRS tax election. An eligible domestic corporation can avoid double taxation (once to the corporation and again to the shareholders) by electing to be treated as an S corporation.

To be considered an S corp, you must first charter a business as a corporation in the state where it is headquartered. According to the IRS, S corporations are “considered by law to be a unique entity, separate and apart from those who own it.” This limits the financial liability for which you (the owner, or shareholder) are responsible.

What makes the S corp different from a traditional corporation (C corp) is that profits and losses can pass through to your personal tax return. Consequently, the business is not taxed itself. Only the shareholders are taxed. There is an important caveat, however: any shareholder who works for the company must pay him or herself reasonable compensation. Basically, the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as wages.

Before you form an S Corporation, determine if your business will qualify under the IRS stipulations, eg domestic corporation, no more than 100 shareholders, shareholders must be individuals, certain trusts, or estates, and a shareholder cannot be a partnership, corporation or non-resident alien..

To file as an S Corporation, you must first file as a corporation. After you are considered a corporation, all shareholders must sign and file Form 2553 to elect your corporation to become an S Corporation.

Once your business is registered, you must obtain business licenses and permits. Regulations vary by industry, state and locality.

There is always the possibility of requesting S Corp status for a limited liability company, even a sole owner LLC. You’ll have to make a special election with the IRS to have the LLC taxed as an S corp using Form 2553. And you must file it before the first two months and fifteen days of the beginning of the tax year in which the election is to take effect.

The LLC remains a limited liability company from a legal standpoint, but for tax purposes it’s treated as an S corp.

Most businesses need to register with the IRS, register with state and local revenue agencies, and obtain a tax ID number or permit.

All states do not tax S corps equally.

Your corporation must file the Form 2553 to elect “S” status within two months and 15 days after the beginning of the tax year or any time before the tax year for the status to be in effect.

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What is a Limited Liability Company?

Limited Liability Company

A limited liability company is a hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.

The “owners” of an LLC are referred to as “members.” Depending on the state, the members can consist of a single individual (one owner), two or more individuals, corporations or other LLCs.

Unlike shareholders in a corporation, LLCs are not taxed as a separate business entity. Instead, all profits and losses are “passed through” the business to each member of the LLC. LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would.

Forming an LLC

While each state has slight variations to forming an LLC, they all adhere to some general principles:

Choose a Business Name. There are 3 rules that your LLC name needs to follow: (1) it must be different from an existing LLC in your state, (2) it must indicate that it’s an LLC (such as “LLC” or Limited Company”) and (3) it must not include words restricted by your state (such as “bank” and “insurance”). Your business name is automatically registered with your state when you register your business, so you do not have to go through a separate process.

File the Articles of Organization. The “articles of organization” is a simple document that legitimizes your LLC and includes information like your business name, address, and the names of its members. For most states, you file with the Secretary of State. However, other states may require that you file with a different office such as the State Corporation Commission, Department of Commerce and Consumer Affairs, Department of Consumer and Regulatory Affairs, or the Division of Corporations & Commercial Code. Note: there may be an associated filing fee.

Create an Operating Agreement. Most states do not require operating agreements. However, an operating agreement is highly recommended for multi-member LLCs because it structures your LLC’s finances and organization, and provides rules and regulations for smooth operation. The operating agreement usually includes percentage of interests, allocation of profits and losses, members’ rights and responsibilities and other provisions.

Obtain Licenses and Permits. Once your business is registered, you must obtain other necessary business licenses and permits. Regulations vary by industry, state and locality.

LLC Taxes

In the eyes of the federal government, an LLC is not a separate tax entity, so the business itself is not taxed. Instead, all federal income taxes are passed on to the LLC’s members and are paid through their personal income tax. While the federal government does not tax income on an LLC, some states do.

Since the federal government does not recognize LLC as a business entity for taxation purposes, all LLCs must file a corporation, partnership, or sole proprietorship tax return. Certain LLCs are automatically classified and taxed as a corporation by federal tax law. For guidelines about how to classify an LLC, visit IRS.gov.

LLCs that are not automatically classified as a corporation can choose their business entity classification. To elect a classification, an LLC must file Form 8832. This form is also used if an LLC wishes to change its classification status. Read more about filing as a corporation or partnership and filing as a single member LLC at IRS.gov.

You should file the following tax forms depending on your classification:

  • Single Member LLC. A single-member LLC files Form 1040 Schedule C like a sole proprietor.
  • Filing as a Partnership. An LLC filing as a partnership requies the members to file a Form 1065 partnership tax return like owners in a traditional partnership.
  • LLC filing as a Corporation. An LLC designated as a corporation files Form 1120, the corporation income tax return.

Combining the Benefits of an LLC with an S-Corp

There is always the possibility of requesting S-Corp status for your LLC.  You’ll have to make a special election with the IRS to have the LLC taxed as an S-Corp using Form 2553. You must file prior to the first two months and fifteen days of the beginning of the tax year in which the election is to take effect. For more information about S-Corp status, visit IRS.gov or read Should My Company be an LLC, an S-Corp or Both?

The LLC remains a limited liability company from a legal standpoint, but for tax purposes it can be treated as an S-Corp. Be sure to contact the state’s income tax agency where you plan to file your election form. Ask about the tax requirements and if they recognize elections of other entities (such as the S-Corp).

Advantages of an LLC

  • Limited Liability. Members are protected from personal liability for business decisions or actions of the LLC. This means that if the LLC incurs debt or is sued, members’ personal assets are usually exempt. This is similar to the liability protections afforded to shareholders of a corporation. Keep in mind that limited liability means “limited” liability – members are not necessarily shielded from wrongful acts, including those of their employees.
  • Less Recordkeeping. An LLC’s operational ease is one of its greatest advantages. Compared to an S-Corporation, there is less registration paperwork and there are lower start-up costs.
  • Sharing of Profits. There are fewer restrictions on profit sharing within an LLC, as members distribute profits as they see fit. Members might contribute different proportions of capital and sweat equity. Consequently, it’s up to the members themselves to decide who has earned what percentage of the profits or losses.

Disadvantages of an LLC

  • Limited Life. In many states, when a member leaves an LLC, the business is dissolved and the members must fulfill all remaining legal and business obligations to close the business. The remaining members can decide if they want to start a new LLC or part ways. However, you can include provisions in your operating agreement to prolong the life of the LLC if a member decides to leave the business.
  • Self-Employment Taxes. Members of an LLC are considered self-employed and must pay the self-employment tax contributions towards Medicare and Social Security. The entire net income of the LLC is subject to this tax.
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