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2 ways spouse-owned businesses can reduce their self-employment tax bill

If you own a profitable, unincorporated business with your spouse, you probably find the high self-employment (SE) tax bills burdensome. An unincorporated business in which both spouses are active is typically treated by the IRS as a partnership owned 50/50 by the spouses. (For simplicity, when we refer to “partnerships,” we’ll include in our definition limited liability companies that are treated as partnerships for federal tax purposes.)

For 2017, that means you’ll each pay the maximum 15.3% SE tax rate on the first $127,200 of your respective shares of net SE income from the business. Those bills can mount up if your business is profitable. To illustrate: Suppose your business generates $250,000 of net SE income in 2017. Each of you will owe $19,125 ($125,000 × 15.3%), for a combined total of $38,250.

Fortunately, there are ways spouse-owned businesses can lower their combined SE tax hit. Here are two.

1. Establish that you don’t have a spouse-owned partnership

While the IRS creates the impression that involvement by both spouses in an unincorporated business automatically creates a partnership for federal tax purposes, in many cases, it will have a tough time making the argument — especially when:

• The spouses have no discernible partnership agreement, and
• The business hasn’t been represented as a partnership to third parties, such as banks and customers.

If you can establish that your business is a sole proprietorship (or a single-member LLC treated as a sole proprietorship for tax purposes), only the spouse who is considered the proprietor owes SE tax.

Let’s assume the same facts as in the previous example, except that your business is a sole proprietorship operated by one spouse. Now you have to calculate SE tax for only that spouse. For 2017, the SE tax bill is $23,023 [($127,200 × 15.3%) + ($122,800 × 2.9%)]. That’s much less than the combined SE tax bill from the first example ($38,250).

2. Establish that you don’t have a 50/50 spouse-owned partnership

Even if you do have a spouse-owned partnership, it’s not a given that it’s a 50/50 one. Your business might more properly be characterized as owned, say, 80% by one spouse and 20% by the other spouse, because one spouse does much more work than the other.

Let’s assume the same facts as in the first example, except that your business is an 80/20 spouse-owned partnership. In this scenario, the 80% spouse has net SE income of $200,000, and the 20% spouse has net SE income of $50,000. For 2017, the SE tax bill for the 80% spouse is $21,573 [($127,200 × 15.3%) + ($72,800 × 2.9%)], and the SE tax bill for the 20% spouse is $7,650 ($50,000 × 15.3%). The combined total SE tax bill is only $29,223 ($21,573 + $7,650).

More-complicated strategies are also available. Contact us to learn more about how you can reduce your spouse-owned business’s SE taxes.

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Should your business use per diem rates for travel reimbursement?

Updated travel per diem rates go into effect October 1. To simplify recordkeeping, they can be used for reimbursement of ordinary and normal business expenses incurred while employees travel away from home.

Per diem advantages

As long as employees properly account for their business-travel expenses, reimbursements are generally tax-free to the employees and deductible by the employer. But keeping track of actual costs can be a headache.

With the per diem rates, employees don’t have to keep receipts for covered travel expenses. They just need to document the time, place and business purpose of the travel. Assuming that the travel qualifies as a business expense, the employer simply pays the employee the per diem allowance designated for the specific travel destination and deducts the per diem paid.

Although the per diem rates are set by the General Services Administration (GSA) to cover travel by government employees, private employers may use them for tax purposes. The rates are updated annually for the following areas:

• The 48 states in the continental United States and the District of Columbia (CONUS),
• Nonstandard Areas (NSAs) that are in CONUS but have per diem rates higher than the standard CONUS rates,
• Certain areas outside the continental United States, including Alaska, Hawaii, Puerto Rico and U.S. possessions (OCONUS), and
• Foreign countries.

The rates include amounts for lodging and for meals and incidental expenses (M&IE) but not airfare and other transportation costs.

What’s new?

For October 1, 2017, through September 30, 2018, the per diem standard CONUS rate is $144, an increase of $2 over the prior year. This rate consists of $93 for lodging and $51 for M&IE. Also effective October 1, there are 332 NSAs. The following locations have moved from NSAs into the standard CONUS rate:

• California: Redding
• Iowa: Cedar Rapids
• Idaho: Bonners Ferry / Sandpoint
• North Dakota: Dickenson / Beulah
• New York: Watertown
• Ohio: Youngstown
• Oklahoma: Enid
• Pennsylvania: Mechanicsburg
• Texas: Laredo, McAllen, Pearsall and San Angelo
• Wyoming: Gillette.

There are no new NSA locations.

What’s right for you?

As noted earlier, the per diem changes go into effect on October 1, 2017. During the last three months of 2017, an employer may switch to the new rates or continue with the old rates. But an employer must select one set of rates for this quarter and stick with it; it can’t use the old rates for some employees and the new rates for others.

Because travel expenses often attract IRS attention, they require careful recordkeeping. The per diem method can help, but it’s not the best solution for all employers. An even simpler “high-low” per diem method is also available. And, in some cases, a policy of reimbursing actual expenses could be beneficial, despite the recordkeeping hassles. If you have questions regarding travel expense reimbursements, please contact us.

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Tax planning critical when buying a business

If you acquire a company, your to-do list will be long, which means you can’t devote all of your time to the deal’s potential tax implications. However, if you neglect tax issues during the negotiation process, the negative consequences can be serious. To improve the odds of a successful acquisition, it’s important to devote resources to tax planning before your deal closes.

Complacency can be costly

During deal negotiations, you and the seller should discuss such issues as whether and how much each party can deduct their transaction costs and how much in local, state and federal tax obligations the parties will owe upon signing the deal. Often, deal structures (such as asset sales) that typically benefit buyers have negative tax consequences for sellers and vice versa. So it’s common for the parties to wrangle over taxes at this stage.

Just because you seem to have successfully resolved tax issues at the negotiation stage doesn’t mean you can become complacent. With adequate planning, you can spare your company from costly tax-related surprises after the transaction closes and you begin to integrate the acquired business. Tax management during integration can also help your company capture synergies more quickly and efficiently.

You may, for example, have based your purchase price on the assumption that you’ll achieve a certain percentage of cost reductions via postmerger synergies. However, if your taxation projections are flawed or you fail to follow through on earlier tax assumptions, you may not realize such synergies.

Merging accounting functions

One of the most important tax-related tasks is the integration of your seller’s and your own company’s accounting departments. There’s no time to waste: You generally must file federal and state income tax returns — either as a combined entity or as two separate sets — after the first full quarter following your transaction’s close. You also must account for any short-term tax obligations arising from your acquisition.

To ensure the two departments integrate quickly and are ready to prepare the required tax documents, decide well in advance of closing which accounting personnel you’ll retain. If you and your seller use different tax processing software or follow different accounting methods, choose between them as soon as feasible. Understand that, if your acquisition has been using a different accounting method, you’ll need to revise the company’s previous tax filings to align them with your own accounting system.

The tax consequences of M&A decisions may be costly and could haunt your company for years. We can help you ensure you plan properly and minimize any potentially negative tax consequences.

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When businesses provide meals to their employees, generally their deduction is limited to 50%. But there are exceptions. One is if the meal qualifies as a de minimis fringe benefit under the Internal Revenue Code.

A recent U.S. Tax Court ruling could ultimately mean that more employer-provided meals will be 100% deductible under this exception. The court found that the Boston Bruins hockey team’s pregame meals to players and personnel at out-of-town hotels qualified as a de minimis fringe benefit.

Qualifying requirements

For meals to qualify as a de minimis fringe benefit, generally they must be occasional and have so little value that accounting for them would be unreasonable or administratively impracticable. But meals provided at an employer-operated eating facility for employees can also qualify.

For meals at an employer-operated facility, one requirement is that they be provided in a nondiscriminatory manner: Access to the eating facility must be available “on substantially the same terms to each member of a group of employees, which is defined under a reasonable classification set up by the employer that doesn’t discriminate in favor of highly compensated employees.”

Assuming that definition is met, employee meals generally constitute a de minimis fringe benefit if the following conditions also are met:

1. The eating facility is owned or leased by the employer.
2. The facility is operated by the employer.
3. The facility is located on or near the business premises of the employer.
4. The meals furnished at the facility are provided during, or immediately before or after, the employee’s workday.

The meals generally also must be furnished for the convenience of the employer rather than primarily as a form of additional compensation.

On the road

What’s significant about the Bruins case is that the meals were provided at hotels while the team was on the road. The Tax Court determined that the Bruins met all of the de minimis tests related to an employer-operated facility for their away-game team meals. The court’s reasoning included the following:

• Pregame meals were made available to all Bruins traveling hockey employees (highly compensated, non-highly compensated, players and nonplayers) on substantially the same terms.
• The Bruins agreements with the hotels were substantively leases.
• By engaging in its process with away-city hotels, the Bruins were “contract[ing] with another to operate an eating facility for its employees.”
• Away-city hotels were part of the Bruins’ business premises, because staying at out-of-town hotels was necessary for the teams to prepare for games, maintain a successful hockey operation and navigate the rigors of an NHL-mandated schedule.
• For every breakfast and lunch, traveling hockey employees were required to be present in the meal rooms.
• The meals were furnished for the convenience of the Bruins.

If your business provides meals under similar circumstances, it’s possible you might also be eligible for a 100% deduction. But be aware that the facts of this case are specific and restrictive. Also the IRS could appeal, and an appeals court could rule differently.

Questions about deducting meals you’re providing to employees? Contact us.

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