J.K. Lasser's Small Business Taxes 2018. Barbara Weltman
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year, the IRS publishes statistics on the number and type of audits it conducts. The rates for the government's fiscal year 2016, the most recent year for which statistics are available, show a very low overall audit activity of business returns.
The chances of being audited vary with the type of business organization, the amount of income generated by the business, and the geographic location of the business. While the chance of an audit is not a significant reason for choosing one form of business organization over another, it is helpful to keep these statistics in mind.
Table 1.2 sheds some light on your chances of being audited, based on the most recently available statistics.
Table 1.1 Federal Corporate Tax Rate Schedule
Table 1.2 Percentage of Returns Audited
*Fiscal year from October 1 to September 30.
Source: IRS Data Book.
Many tax experts agree that your location can impact your audit chances. Some IRS offices are better staffed than others. There have been no recent statistics identifying these high-audit locations.
Past audit rates are no guarantee of the likelihood of future IRS examinations. The $458 billion tax gap for 2008–2010 (the most recent statistics), which represents the spread between what the government is owed and what it collects, has been blamed in large part on those sole proprietors/independent contractors who underreport income or overstate deductions. While the IRS has indicated that it would increase audits of certain sole proprietors and other small businesses, due to budgetary constraints, the number of audits is still on the decline.
How your business is organized dictates when its tax return must be filed, the form to use, and the additional time that can be obtained for filing the return. Pass-throughs (partnerships and S corporations) reporting on a calendar year must file by March 15; they can obtain a 6-month filing extension. Calendar year C corporations don't have to file until April 15 (the same deadline for individuals, including Schedule C filers); they too have an extended due date of October 15. The September 15 extended due date gives S corporations, limited liability companies, and partnerships time to provide Schedule K-1 to owners so they can file their personal returns by their extended due date of October 15.
Table 1.3 lists the filing deadlines for calendar-year businesses, the available automatic extensions, and the forms to use in filing the return or requesting a filing extension. Note that these dates are extended to the next business day when a deadline falls on a Saturday, Sunday, or legal holiday.
Table 1.3 Filing Deadlines, Extensions, and Forms for 2017 Returns
*The scheduled due date is April 17, 2018.
**The scheduled extended due date is September 17, 2018.
The tax treatment on the termination of a business is another factor to consider. While the choice of entity is made when the business starts out, you cannot ignore the tax consequences that this choice will have when the business terminates, is sold, or goes public. The liquidation of a C corporation usually produces a double tax – at the entity and owner levels. The liquidation of an S corporation produces a double tax only if there is a built-in gains tax issue – created by having appreciated assets in the business when an S election is made. However, the built-in gains tax problem disappears a certain number of years after the S election, so termination after that time does not result in a double tax.
If you plan to sell the business some time in the future, again your choice of entity may have an impact on the tax consequences of the sale. The sale of a sole proprietorship is viewed as a sale of the underlying assets of the business; some may produce ordinary income while others trigger capital gains. In contrast, the sale of qualified small business stock, which is stock in a C corporation, may result in tax-free treatment under certain conditions. Sales of business interests are discussed in Chapter 5.
If the termination of the business results in a loss, different tax rules come into play. Losses from partnerships and LLCs are treated as capital losses (explained in Chapter 5). A shareholder's losses from the termination of a C or S corporation may qualify as a Section 1244 loss – treated as an ordinary loss within limits (explained in Chapter 5).
If the business goes bankrupt, the entity type influences the type of bankruptcy filing to be used and whether the owners can escape personal liability for the debts of the business. Bankruptcy is discussed in Chapter 25.
Forms of Business Organization Compared
So far, you have learned about the various forms of business organization. Which form is right for your business? The answer is really a judgment call based on all the factors previously discussed. You can, of course, use different forms of business organization for your different business activities. For example, you may have a C corporation and personally own the building in which it operates – directly or through an LLC. Or you may be in partnership for your professional activities, while running a sideline business as an S corporation.
Table 1.4 summarizes 2 important considerations: how the type of business organization is formed and what effect the form of business organization has on where income and deductions are reported.
Table 1.4 Comparison of Forms of Business Organization
Changing Your Form of Business
Suppose you have a business that you have been running as a sole proprietorship. Now you want to make a change. Your new choice of business organization is dictated by the reason for the change. If you are taking in a partner, you would consider these alternatives: partnership, LLC, S corporation, or C corporation. If you are not taking in a partner, but want to obtain limited personal liability, you would consider an LLC (if your state permits a one-person LLC), an S corporation, or a C corporation. If you are looking to take advantage of certain fringe benefits, such as medical reimbursement plans, you would consider only a C corporation.
Whatever your reason, changing from a sole proprietorship to another type of business organization generally does not entail tax costs on making the changeover. You can set up a partnership or corporation, transfer your business assets to it, obtain an ownership interest in the new entity, and do all this on a tax-free basis. You may, however, have some tax consequences if you transfer your business liabilities to the new entity.
But what if you now have a corporation or partnership and want to change your form of business organization? This change may not be so simple. Suppose you have an S corporation or a C corporation. If you liquidate the corporation to change to another form of business organization, you may have to report gains on the liquidation. In fact, gains may have to be reported both by the business and by you as owner.
Partnerships can become corporations and elect S corporation status for their first taxable year without having any intervening short taxable year as a C corporation if corporate formation is made under a state law formless conversion statute or under the check-the-box regulations mentioned earlier in this chapter.
Before changing your form of business organization, it is important to review your particular situation with a tax professional. In making any change in business, consider the legal and accounting costs involved.
Tax Identification Number
For individuals on personal returns, the federal tax identification number is the taxpayer's Social Security number. For businesses, the federal tax identification number is the employer identification number (EIN). The EIN is a 9-digit number assigned to each business. Usually, the federal EIN is used for state income tax purposes. Depending on the state,