Why Should I Have an LLC?

When Should I Apply for an LLC?

First off, lets dispel this notion that there is a minimum threshold to become an LLC.  An owner can become an LLC at any time, and the only consideration that should be made is whether the own plans on continuing this business going forwards.  Even if the owner only plans to operate the business for a limited duration, there is an option on the application to record a closing date for the entity. 

From the moment an owner receives the first dollar from a client, they are now self-employed in the eyes of the state, and it is at that moment that the owner can benefit from the LLC structure.

What are the Benefits of Having an LLC?

The main benefit received from an LLC is a measure of liability protection for the owner’s personal assets.  An LLC creates a small barrier between an owner’s business dealings, earnings, and debts, and their personal assets such as a house and a car.  Think of it as a very basic firewall – If a client were to sue the business, the owner’s assets have a measure of protection.

Additionally, an LLC helps to legitimize an operation.  Instead of having checks written out to Shelly Banks, clients can now receive invoices from and pay checks to Banks Designs, LLC, giving an owner an added sense of professionalism.

One of the other large benefits of forming an LLC is that doing so allows an owner to apply for an Employer Identification Number (EIN), which the owner can then take to a bank to use in opening a business bank account which will be connected to the EIN instead of the owner’s SSN.  This business bank account can then be used as the tool to separate business and personal transactions in a very clear, defined manner.

How do I Form an LLC?

Forming an LLC is quite easy to do.  Assuming the owner already has a state business license with the business name registered with the state, the next step is to fill out the LLC application often offered through the state’s official website.  For Washington State, the application can be found on the Secretary of State’s website, and can be submitted via the mail or online.  Simply fill out the application, pay the fee, and wait for the acceptance notice from the state.

Next Steps for My Business

Once the LLC, EIN, and business bank account are established, an owner has the base tools to help their business run more smoothly; however, there are many resources that can help as well.  Cloud accounting tools have taken great leaps over the past few years, and tend to be both user-friendly and robust.  Consider employing an accounting software to help organize bank transactions.  Need to track time?  TSheets is easy to set up and use, and plugs into many accounting software services.  If there is a lot a driving required, check out MileIQ to help track business miles throughout the year.  Lastly, consider paying for accounting services the same way we all pay for auto and health insurance, or a real estate agent to sell our properties.  Paying an expert to help your business be less of an audit risk, as well as to provide insight and advice about your operations can save you a lot in penalties and fees.

Accrual Accounting versus Cash Accounting?

To account for variations in entity type, reporting requirements, tax requirements, and other considerations, two methods of accounting were created – Cash basis and Accrual basis.  The main difference between the two has to do with the timing and ways that income and expenses are recorded in relation to actual cash inflows and outflows.

What is Cash Basis?

Cash basis accounting closely follows actual cash movement, since the recording of transactions is tied directly to the bank account. That means that income and expenses are recorded in the same period as the cash moves in and out of the bank account, making it easy to track and attribute income and expenses monthly.  However, because the method is tied to the bank account, it is difficult to track Liabilities and Accounts Receivables (Money owed and income earned). If work has been performed, either by you for a client, or by a vendor for you, the impending income and expenses will not be reflected on financial statements until money changes hands.

Another struggle with cash basis accounting is that this method does not match expenses to the period in which revenue is earned, creating a disconnect on a per-job basis.  It becomes more difficult to track whether a job spanning multiple reporting periods is truly profitable or not.

What is Accrual Basis?

The Accrual method aims to ensure that income and expenses are recorded on financial statements in the period in which they are incurred, instead of when the cash changes hands.  With this method, Accounts Receivable and Accounts payable and other liabilities are more visible on the financial statements, because transactions are recorded now, while the actual cash transactions will happen at a future time.

The accrual basis allows for a clearer picture of full earnings and expenses, and can track unpaid income.  The ability to record income and expenses when they are incurred and earned allows per-job costs analysis to be performed.  The accrual method monitors the actual position of the company, separately from the bank statement, and is more accurate.

However, the accrual method tends to require more management on the owner/accountant’s part, and there are additional closing and adjusting entries to be entered each month.

Which Accounting Method should I Use?

For most small operations, small LLCs and S-corps, using the cash basis method is usually sufficient.  If the owner is involved in more complicated activities, tracking inventory, job costing, extending credit, etc, they may consider converting to accrual basis.  C-corporations are required to use accrual accounting, as it allows for more detailed financial reports, whereas cash basis only provides simple reports.  However, it is possible to convert from one method to another with a few adjusting entries, though the IRS does not allow too much flip flopping.

As an owner, deciding which accounting method is better for your business can have an important impact on your financial reports.  Be sure to ask any questions you have related to this to your accountant, as they can provide benefits and issues specifically related to your business.

How to Expense Vehicles & Mileage

One of the most popular questions we get asked is about vehicle costs, and whether they count as business expenses.  While, as an owner, it seems natural to include vehicle expenses as a cost of doing operations, the best practices can be more complicated.  In order to maintain the best possible tax position, mileage should be made a priority for owners.

Personally or Company Owned?

The easiest question to address is whether the vehicle is owned personally or by the business.  Whose name is on the lease?  Which entity pays the payments?  If the car is owned personally, the costs should all be captured personally. 

Additionally, which entity gains the most benefit?  If the vehicle is used occasionally to meet clients, but is mostly used to drive the family around, commute to school or work, and few business-related trips are recorded, the vehicle should remain on the personal side.  It is very hard to justify a vehicle in this situation as being a company vehicle.  On the other side, if the vehicle is used in the majority for business related trips and meetings, and is only occasionally used for personal drives, it could be worth it to look into claiming it as a business vehicle, or purchasing the next replacement car under the business name.  This second scenario is more feasible if the owner owns multiple cars that can be partitioned in that way.

IRS Mileage Policies

In 2017, the IRS Mileage Reimbursement Rate is $0.535/business mile driven.  This means that, for every 100 miles driven, $54.50 can be added to your books as mileage expense, ultimately lowering your Net Income, and thusly your overall tax burden.  This rate, however, is only for business related miles driven.  An owner’s commute from home to the office is not a business trip.  The IRS stipulates that an employee’s “reasonable commute” must be counted towards personal commuting miles, not business miles.  Once the owner is at the office, any trip to a business meeting, coaching session, networking event, or similar, can be tracked and recorded as business miles.  However, the last trip ending at home must be commuting miles. 

Example – Fuel vs Mileage

Say an owner drives 15,000 business miles in a year – This high number of miles could be appropriate for a traveling notary, a real estate agent, or someone else who drives to meet clients on a regular basis.   The average gas price in Washington as of May 2017 was $2.861/gallon, and the average fuel economy for 2016 was 24.8 miles/gallon.  If we calculate a per mile gas price using these figures, we get an average price of $0.115/mile.  At 15,0000 miles, calculated at estimated actual fuel prices, you are looking at a total fuel expenses of $1,725.00.  If we calculated 15,000 miles at the IRS rate of $0.535, we get a total fuel expense of $8,025.  

Mileage as the Winner

The IRS mileage rate is designed to also take into account an average, per mile maintenance and repair cost.  While you could, theoretically exceed the mileage calculation amount with actual repairs, it is highly unlikely. The bottom line is that you should track all your business miles throughout the year to better your tax position.

Mileage Tracking Resources

Beyond the classic paper methods for mileage tracking, the bourgeoning world of FinTech (Financial Technologies) has given us more cloud-based resources than ever before.  From cloud accounting software, to receipt management, to expense tracking, we are in a new age of solutions.  For instance, Intuit’s Self-Employed Quickbooks version has a mileage tracking module built into the app.  It will automatically track trips for you. 

However, if you are at a point where the self-employed version of QBO is not robust enough, we recommend MileIQ instead.  MileIQ is a Microsoft acquired product that, similarly to Intuit’s module, will use the GPS to automatically track when drives are happening, and will store each trip for the owner to sort into business and personal miles later.  Their dashboard makes sending mileage reports simple, as well as gives the user some basic analytics.  The most motivating one is that the app will track the dollar amount of the total business miles driven, so you can see how much expense you have built up so far. 

Last Thoughts

To best effect your tax situation, use an easy, reliable tracking method to keep records of all business-related mileage.  This should be just one of many business expenses that you keep track of, as an owner.  It is important to take the correct deductions for vehicles, advertising, services, and other business related expenses, while making sure to properly separate between personal and business activity.

Estimated Tax Payments and Federal Withholdings

What are Quarterly Estimated Tax Payments?

Quarterly Estimated Tax Payments are a method used by the IRS to collect tax on a variety of incomes that are not subject to Federal Tax Withholdings – Essentially non-payroll related income.  The IRS sets these payments up to be made in four equal instalments throughout the calendar year.  The total estimated tax payment is usually calculated based off 110% of the previous tax year’s income.  IE, if you made $75,000 in 2016, your estimated tax payment is based off a projected income of $82,500 for 2017.

Typically, when your tax return is filed, the finalized copy will have payment vouchers included for you to use in the following year.  These vouchers include the due date, as well as the amount due for the payment.  Simply include this slip in your remittance to the address provided, and send both the slip and a check off in the mail.

What Happens if I Don’t Pay the Estimated Tax Payment?

The IRS will levy an underpayment penalty if you fail to pay enough estimated tax throughout the year.  The amount of the penalty varies depending on the situation, and it is difficult to estimate the penalty ahead of time.  Typically, if you end up owing $1,000 or less after all withholdings and deductions are applied, the IRS will waive the fee.  However, it is a good policy to aim to pay taxes on 110% of last year’s income if you made more than last year, or pay taxes on 90% of last year’s income if you made less. 

Alternatives to Making Quarterly Payments

Much of the time, self-employed owners find that paying the estimated taxes on a quarterly basis is still a major cramp on their cash flow, and they are right.  Coupled with not knowing what you will be making over the whole year, making these payments can seem daunting and unfair.   The same goes if you have a cyclical business (IE, painting houses, or renting paddleboards).  Instead, S-corp owners can utilize the required payroll to increase their Federal Withholdings to act as their estimated tax payment.  If the owner is already paying a salary, Federal Withholding is automatically calculated and taken out of the net check on a per-paycheck basis.  This withholding covers the personal tax obligation for the W2 income, and the owner can increase the withholding amount to cover K-1 earnings from the S-corp.

Benefits for the Federal Withholding Method

One of the benefits of this method is that the IRS does not track precisely when the withholding occurs and is paid, beyond recognizing what calendar year it is contributed in.  This means, if no estimated taxes or additional withholdings have been paid out, and its December, an owner can run an additional payroll, and pay the net check to federal withholding to boost the estimated taxes paid.  The IRS will not penalize the owner for having made a “late” payment. 

Alternatively, the main attraction of this federal withholdings method, is that it allows the owner to spread the payments over the full year. Instead of making one or four large payments, owners can break it out over 12 months to ease cash flow.  If an owner has a bad month, it is alright to skip the payroll that month, and get back on track the following period – Happily, the rate and schedule is not locked in, and is far more flexible when drawn out over the entire year.

Using the Federal Income Tax Withholding as your estimated tax payments is one of the hidden benefits of the required owner’s salary.  Additionally, if the owner utilizes the payroll method, the payroll company will ensure that the withholdings get paid out on time and to the correct place – No more worrying about whether your check got lost or if you wrote your account number incorrectly.

Quarterly Estimated Tax payments are an important compliance element, and there are several methods that can be used to follow the guidelines.  No matter which method you choose, don’t forget to pay those taxes!