This month we’re discussing credit card fees because the vast majority of customers pay with a credit card and we field many questions from clients about the intentionally inscrutable nature of credit-card processing fees. So let’s start at the beginning, the difference between a credit and debit card.
This week the SBA announced that the agency would provide additional deferment of principal and interest payments for existing EIDL program loans, adding a six month extension to the program’s existing 24 months deferment, for a total deferment of 30 months from the date of the loan…
This week the IRS released its guidance regarding the retroactive termination of the Employee Retention Credit (ERC). Officially retroactively terminated with last month’s signing of the Infrastructure Investment and Jobs Act, the ERC now applies only to wages paid before October 1, 2021. The only exception is recovery startup businesses (generally, businesses started after February 12, 2020, with less than $1M in annual sales).
We’ve discussed this disheartening move in previous communication, but the long and short of it is that if you’ve claimed ERC deposits for any payments after September 30, 2021, including any advance payments, you’ll need to prepare to return those funds. Failure to deposit penalties are not waived if deposits are reduced after December 20, 2021.
Here’s the IRS’s breakdown:
Generally, employers that are not recovery startup businesses and received advance payments for fourth quarter wages of 2021 will avoid failure to pay penalties if they repay those amounts by the due date of their applicable employment tax returns.
Employers that reduced deposits on or before December 20, 2021, for wages paid during the fourth calendar quarter of 2021 in anticipation of the Employee Retention Credit and that are not recovery startup businesses will not be subject to a failure to deposit penalty with respect to the retained deposits if—
The employer reduced deposits in anticipation of the Employee Retention Credit, consistent with the rules in Notice 2021-24 PDF,
The employer deposits the amounts initially retained in anticipation of the Employee Retention Credit on or before the relevant due date for wages paid on December 31, 2021 (regardless of whether the employer actually pays wages on that date). Deposit due dates will vary based on the deposit schedule of the employer, and
The employer reports the tax liability resulting from the termination of the employer's Employee Retention Credit on the applicable employment tax return or schedule that includes the period from October 1, 2021, through December 31, 2021. Employers should refer to the instructions to the applicable employment tax return or schedule for additional information on how to report the tax liability.
Alarmingly, the Senate is voting this week to defund support for jobs at small businesses that are still suffering from the pandemic.
Just as we're asked to mask up and consider potential restrictions and lockdowns again, the Senate buried a provision to terminate Employee Retention Credits at the end of next month, instead of the end of the year. These credits help pay for payroll costs for small businesses that are still suffering from significant sales declines due to COVID.
Raise your voice to your Senator or local trade group - removing support for employees and small businesses at a time of such looming uncertainty is a huge mistake.
An issue that often arises when using a passthrough entity is phantom income. Often a problem for LLCs, S Corps, and partnerships, phantom income occurs when the business entity reports a yearly profit, yet the owner or investors in the business do not receive cash reflecting the allocation. The IRS still taxes the full amount of the business’s income, making business members responsible for paying tax on income they have not received.
What is Phantom Income?
Quite simply, phantom income is a tax liability for a partnership or individual on income that has not been distributed to them.
How Does Phantom Income Occur?
Phantom income can come into play in a variety of circumstances, but we see it most commonly when a business is profitable but growing, a situation where a company will want to reinvest its profits into further growth.
Okay, Be More Specific…
Here’s a real world example: You’ve invested in ABC, LLC, which is taxed as a partnership, and you own 50% of the membership interests. At the end of the fiscal year, the LLC reports net profits of $200,000. Hooray! Wisely committing to growth, the managers of the company have decided those profits are needed to grow the company, thus they won’t be making any distributions to owners. As a member you’ll still receive a K1 that allocates $100,000 (50% of the net income) to you. Despite not having received any money, you’ll still be responsible for paying tax on that $100,000.
Yikes! What Do I Do About It?
Unfortunately for our character in the above example, it’s important to thoroughly plan ahead and exercise due diligence with any business opportunity. Harmony Group can tell at a glance from a business’s books whether there is a risk of significant phantom income.
With any passthrough entity, you should strongly consider adding a tax distribution provision to your operating agreement or shareholder agreement. This is a clause requiring a company to distribute at least some amount of any reported profit to its members or partners - a percentage allowing members to pay their tax bill.
Okay, Tax Distribution Provisions, Got It. For How Much?
It’s often recommended this amount equal the highest combined marginal rates that any member is taxed at, but we recommend setting it as a flat rate - 40%. This is for simplicity’s sake, as members may live in states with different tax laws or themselves have different financial and tax situations. A flat rate of 40% ensures that at the end of the year when you have $100,000 of taxable income as in the above example, the partnership will send you 40%, or $40,000, allowing you to cover your tax bill.
Sounds Great. Sum It Up For Me?
As a member or owner of any passthrough entity, it’s important to plan ahead for phantom income by adding a tax distribution clause to your operating agreement. This clause requires the business to make distributions to cover tax liabilities on allocated but undistributed income. These considerations are most common for entities that are profitable but still growing. More to the point, Harmony Group can help determine whether phantom income is a significant risk for you and your business and help you plan ahead to avoid all sorts of unnecessary tax headaches.
