This section includes frequently encountered topics relating to small businesses. It discusses business deductions, how to avoid underpayment penalties, 1099s and much more.

Health Savings Accounts Offer Tax Breaks

A Health Savings Account (HSA) is a trust account into which tax-deductible contributions can be made by qualified taxpayers who have high deductible medical insurance plans. Income earned on the HSA balance is tax-free. The funds from these accounts are then used to pay “qualified medical expenses” not covered by the medical insurance for an “eligible individual.” If these funds are not used, they roll over year to year. Once the taxpayer turns 65, the funds can be used like a retirement plan (taxable when withdrawn, but not subject to a withdrawal penalty) or saved for future medical expenses. Since the contribution is an above-the-line deduction, a taxpayer need not itemize to take advantage of this tax break. The rules discussed here are applicable to federal tax returns and may not apply to your particular state.
  • Eligible Individual – For HSA purposes, the law defines an eligible individual as one who is covered by a “high deductible plan” and, while covered by that plan, is not also covered by another plan that does not have a high deductible. For purposes of determining if a plan does or does not have a high deductible, the law allows certain types of coverage, such as workers’ compensation, insurance for a specific condition, dental care, vision, long-term care and certain others, to be disregarded.

  • High Deductible Plans – For 2016 and 2017, high deductible plans are defined as those with the following deductible amounts:

    o Self-only coverage with an annual deductible of $1,300 or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, of no more than $6,550; or

    o Family coverage with an annual deductible of $2,600 or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, of no more than $13,100.

  • Qualified Medical Expenses – Qualified medical expenses that can be paid from these accounts are generally defined as those that would be allowable as a medical deduction on your tax return.

  • Contribution Limits – The eligibility and contribution amounts for these accounts are determined monthly. Therefore, during any month in which you qualify, you would be entitled to contribute up to one-twelfth of the annual limits. For 2017, the annual limits (note these values are adjusted annually for inflation) are:

    o $3,400 (up from 3,350in 2016) for single coverage plans;  
    o $6,750 (as in 2016) for family coverage plans; and
    o $1,000 additional for individuals age 55 or older.

    Individuals entitled to benefits under Medicare and those claimed as a dependent on another person’s tax return cannot make contributions. Contributions can be made as late as the due date of the tax return without extensions; contributions in excess of the allowable amounts are subject to an annual 6% excise penalty. If your employer makes the contributions for you through a payroll deduction plan, the contributed amounts are not subject to normal payroll withholdings such as FICA and taxes.

    Example: John, a single taxpayer, age 58, begins a high deductible health plan with an annual deductible of $5,000 starting in March of 2017. We need to determine his maximum annual contribution limit, which is $4,400 ($3,400 plus $1,000 for being over 55). Next, we divide the annual limit by 12 to determine the monthly limit; in John’s case, it is $366.67 ($4,400/12). Since John was in a high deductible health plan for 10 months during 2017, his maximum contribution limit for 2017 would be $3,666.70  $366.67 x 10). If John were in the 25% tax bracket, he would realize a tax savings of $916.

  • Non-Qualified Distributions - Distributions from an HSA are permitted at any time, and if used exclusively to pay for qualified medical expenses of the account beneficiary, his or her spouse, or dependents, are excludable from gross income. Amounts not used to pay for qualified medical expenses are includible in the account beneficiary’s gross income and are subject to a 20% penalty tax. However, the penalty does not apply if the distribution is made on account of the beneficiary’s:

    o Death;
    o Disability; or
    o Attaining age 65.

  • Qualified Medical Expenses – are unreimbursed expenses paid by the account beneficiary, his or her spouse, or dependents for medical care, generally the same definition used for itemized-deduction medical expenses. The qualified medical expenses must be incurred only after the HSA has been established. Medical expenses paid or reimbursed by HSA distributions cannot also be claimed as a medical expense for itemized deduction purposes.  
If you have questions related to Health Savings Accounts or how an HSA might suit your particular medical or retirement plans, please give this office a call.

Tax Credits for Small Employers Offering Health Coverage

The Patient Protection and Affordable Care Act provides a tax credit for an eligible small employer (ESE) for nonelective contributions to purchase health insurance for its employees. The term "nonelective contribution" means an employer contribution other than an employer contribution pursuant to a salary reduction arrangement.

Qualified small employers, generally those with no more than 25 full-time employees with an average annual full-time equivalent wage of no more than$51,800 (for 2016; adjusted annually for inflation) will be eligible for a tax credit of up to 50% (35% for tax-exempt 501(c) organizations) for up two years, of the cost of non-elective contributions to purchase health insurance purchased through a state or federal marketplace (SHOP) for its employees.  (Note, however, that the phase-out of the credit operates in such a way that an employer with exactly 25 full-time equivalent employees or with average annual wages exactly equal to $51,800 for 2016 is not eligible for the credit. The maximum credit is available to employers with no more than 10 full-time equivalent employees with annual full-time equivalent wages from the employer of less than $25,000.)

The credit percentage that can be claimed varies with the number of employees and average wages. 

Calculating the credit amount - The credit is equal to the lesser of the following two amounts multiplied by the applicable tax credit percentage and subject to the phase-outs discussed later:

(1) The amount of contributions the eligible small employer made on behalf of the employees during the tax year for the qualifying health coverage.

(2) The amount of contributions that the employer would have made during the tax year if each employee had enrolled in a plan with a premium equal to the average premium for the small group market in the rating area in which the employee enrolls for coverage, also referred to as the small business benchmark premium. Contributions under this method are determined by multiplying the benchmark premium by the number of employees enrolled in coverage and then multiplied by the uniform percentage that applies for calculating the level of coverage selected by the employer. 

To figure the reduction of credit when the limits are exceeded, the number of the employer’s full-time equivalent employees and average annual full-time equivalent wages (AAEW) for the year must be determined.

Figuring the number of full-time equivalent employees - An employer's full-time equivalent employees (FTEs) for 2016 is determined by dividing the total hours the employer pays wages during the year (but not more than 2,080 hours per employee) by 2,080. The result, if not a whole number, is then rounded down to the next lowest whole number if any (unless the result is less than one, in which case, the employer rounds up to one FTE).

Calculating average annual wages (AAEW) - Average annual equivalent wages is determined by dividing the employer’s total FICA wages (without regard to the wage base limitation) for the tax year by the number of the employer's full-time equivalent employees for the year (rounded down to the nearest $1,000 if need be).

Credit reduction - If the number of full-time equivalent employees exceeds 10 or if AAEW exceed $25,000, the amount of the credit is reduced (but not below zero).  Both reductions can apply at the same time!

Example – Joe owns a small wood working business and has 12 employees, not counting himself or family members.  The total FICA wages (without regard for wage base limitations) for the year were $297,500 and total hours worked by his employees during the year were 24,400.  None of his employees worked more than 2,080 hours during the year.   Joe made non-elective contributions to purchase health insurance for his employees in the amount of $49,800 for the year. He has not claimed the small business health insurance credit in any other year.  Joe’s credit is determined as follows (the $25,900 amount used in the AAEW reduction formula is for 2016; this amount is adjusted annually for inflation):
  • Small Business Benchmark Premium (estimated for this example. In actual practice the benchmark premiums are included in the instructions for Form 8941) = 12 x 5,345 = $64,140
  • Smaller of actual premium paid or Benchmark premium = $49,800
  • Tentative credit = $49,800 x 0.50 = $24,900
  • Full-time equivalent employees (FTEs) = 24,400/2080= 11.7 rounded down = 11
  • Average annual full-time equivalent wages (AAEW) = $297,500/11 = $27,045 rounded down = $27,000 
  • FTE Reduction = ((11-10)/15) x $24,900 = $1,660
  • AAEW Reduction = ((27,000-25,900)/25,900) x $24,900 = $1,058
  • Joe’s health insurance tax credit = $24,900 - $1,660 - $1,058= $22,182

Other Issues:

  • The credit reduces the employer's deduction for employee health insurance.  
  • Special rules apply if the employer benefits from state tax credits or a premium subsidy paid by the state for providing health insurance for its employees.
  • Aggregation rules apply in determining the employer. 
  • Self-employed individuals, including partners and sole proprietors, 2% shareholders of an S Corporation, and 5% owners of the employer are not treated as employees for purposes of this credit. 
  • There's a special rule to prevent sole proprietorships from receiving the credit for the owner and their family members.  
  • The credit is a general business credit that can offset the taxpayer’s income tax, and if the amount of the credit is greater than the tax, the excess can be carried back one year and forward for 20 years. However, because an unused credit amount cannot be carried back to a year before the effective date of the credit, any unused credit amounts for taxable years beginning in 2010 can only be carried forward.
  • The credit is available to offset tax liability under the alternative minimum tax.  
Please call this office if you have questions related to Tax Credits for Small Employers Offering Health Coverage.

When 1099s Must Be Filed

If you use independent contractors to perform services for your trade or business and you pay them $600 or more for the year, you are required to issue them a Form 1099 at the end of the year to avoid facing significant penalties and the loss of the deduction for their labor and expenses. It is not uncommon to use the services of a repairman early in the year, pay him less than $600, then use his services again later and have the total for the year exceed the $600 limit. As a result, you may have overlooked getting the information needed to file the 1099s for the year (service providers name, address and tax ID number). Therefore, it is good practice to always have individuals who are not incorporated complete and sign the IRS Form W-9 the first time you use their services. Having a properly completed and signed Form W-9 for all independent contractors and service providers eliminates any oversights and protects you against IRS penalties and conflicts.

IRS Form W-9, Request for Taxpayer Identification Number and Certification, is provided by the government as a means for you to obtain the data required to file the 1099s from your vendors. It also provides you with verification that you complied with the law should the vendor provide you with incorrect information. We highly recommend that you have a potential vendor complete the Form W-9 prior to engaging in business with them. The form, available from this site, can either be printed out or filled onscreen and then printed out. The W-9 is for your use only and is not submitted to the IRS.

In order to avoid a penalty, copies of the 1099-MISCs must be sent to the recipient and filed with the IRS by January 31.  Other types of 1099s need to be the recipients by January 31 and filed with the IRS by February 28 (February 29 in a leap year). They must be submitted electronically or on optically scannable forms (OCR forms). This firm prepares 1099s in OCR format for submission to the IRS with the 1096 submittal form. This service provides recipient copies and file copies for your records. Copies to recipients must be sent by the last day of January to avoid a penalty. Use the worksheet to provide us with the information we need to prepare your 1099s. Note: If the due date falls on a Saturday, Sunday or legal holiday, the due date is the next business day.

The penalties for failure to file the required information returns are $260 for each informational return, up to a maximum of $3,193,000 ($1,064,000 for small businesses).  The amounts shown are for 2016 filings and are annually adjusted for inflation.

What Happens When I Default on a Business Loan?

What does it mean to default on a loan?

A loan default is the failure to meet the financial obligations indicated in the loan agreement that is signed by you and your lender. Often, a loan default translates into the business owner's inability to pay their debts on time. Due to the differences in each loan agreement, default penalties vary. However, the effects of defaulting on the loan fall into two general categories- immediate repercussions and future implications for both you and your business.
What are the immediate effects to my business if I default on a loan?

Drop in business and/or personal credit score. Missing your payments and defaulting on your loans negatively impacts your business credit score. Your personal credit score may be affected, depending on the type of business structure that you have in place. 

Increased interest rates. Your business interest rates (and possibly your personal interest rates) may increase if your credit score dips. Depending on your loan agreement, a higher interest rate could affect the loans that you currently have, as well as future loans you plan to seek.

Foreclosure or seizing of property and collateral. Foreclosure may be the most severe repercussion due to a loan default, allowing lenders to recuperate losses from loan defaults. In this situation, your lender will have the full right to take control and ownership of your property and collateral that you have included in your contract. They normally will sell your property privately or by a public auction, depending on the profit margin.

What steps should I take next?

Negotiate terms with your lender. If you default, you can try renegotiating the terms of your loan contract with your lender. While lenders may not always be willing to renegotiate, if you are successful you can minimize the damage to your business's financial health. Ways to reduce the negative impacts of the loan default include:

 Changing the terms of payment, e.g., paying less per installment but for a longer period of time
• Paying less over more time with a higher interest rate
• Asking your lender to forgive a portion of your late payment and agree to pay on time in the future

Consider government debt relief options. The federal government’s Small Business Administration (SBA) can help facilitate business loans with a third party lender, guarantee a bond, or help a business find venture capital. During severe financial crises, the government often creates specific programs for a limited time to help faltering small businesses.

Cut costs. Minimize your expenses. Though this may not be an ideal situation, you can consider laying off part of your staff and downsizing your business, among others. If you are paying rent for your place of business, consider moving to smaller quarters or to a locale where rents are less expensive, if doing so won’t harm your business’ sales or  a move won’t be too costly.

Sell business assets. Liquidating business assets or converting your assets into cash may temporarily help you pay off your loans until you can afford to pay your bills on time again.

Consult a lawyer. Consulting a lawyer about your options may also help you through the process. 

What does this mean for the future of my business?

Difficulty finding new loans. After you default on one loan, it will make it much more difficult to find a new loan. If loans are the chief means of financing your business, then you will be running into some difficult hurdles. You may want to start looking into other methods of funding your business.

Bankruptcy. If your business cannot repay its loans, you may need to file for bankruptcy.
What Can I Do to Avoid a Loan Default?

Of course, the best way to avoid defaulting is to pinpoint the pitfalls of bad loans and avoid them at all costs. To avoid loan defaults, business owners should remember the following best practices:

• Have a concrete payment plan before you decide to borrow.
• Do not offer collateral and property in your contract that you cannot afford to lose.
• Read the fine print and thoroughly understand the terms of the contract.

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