Monthly ArchiveApril 2017

How to Effectively Manage Business Risks

Risks are normal in any business. Even the most successful businesses today had to deal with certain threats in the past that almost laid their success on the line. Sometimes, it is tempting to wish that your business no longer has to take any calculated risk and be as smooth sailing as possible, but that just cannot be.

In the real world, business is tantamount to risk-taking and you can’t just wish to keep risks at bay. Why? Because business does not work that way. Taking risks is necessary in any business for without it, growth is never possible. Remember, it is through risks that you get to meet new clients, discover new sectors and learn new things. Without risks, business loses its essence.

Risk Management

 People in the business sector are pretty familiar with the term risk management. By definition, risk refers to the probability of an event and its consequences. When you manage risks, you use certain methods, processes and tools to deal with these risks.

Running a business involves different types of risk, and while some risks can go only as far as causing serious but manageable damage to your business, there are risks that are beyond repair and have the potential to destroy your business. That is why businesses, no matter how big or small, need to be equipped with the right methods and tools to prepare for these risks before they strike. While preparing for risks does not guarantee 100% that your business will be free from risks, such preparations can moderate their impacts on your business.

Risk management involves determining what could go wrong with your business and evaluating which of the possible risks you should deal with. After doing so, you implement strategies that will help you manage those risks. Managing risks before they strike is the most cost-effective way of dealing with them.

Potential Business Risks

 Before you try to understand Risk Management as a process, it is important that you familiarize yourself with the different types of risk that businesses usually face.

  • Strategic Risks. Strategic risks are risks that have to do with how you operate in the industry where your business is in. These risks usually arise from changes in demand, mergers and acquisitions and other changes in the industry. For instance, a big U.S. company is acquiring your major Canadian competitor. If the acquisition activity happens, then your competitor will have the potential to have a distribution arm in the U.S. So, what should you do?

 Now that you know that this potential acquisition activity can pose a risk on your business, you have to prepare how you will respond once the risk is already at hand. As you do this, you may consider researching if there is any U.S. company that is big enough to do the acquisition and which among your Canadian competitors might be a target of this U.S. company.

  • Compliance Risks. As the name suggests, these risks have to do with your need to comply with certain regulations, as well as your need to act in such a way that your customers and potential investors will be pleased. To manage compliance risks, you must consider whether certain safety or health legislations can force charges in your business or increase your overheads.

When it comes to legislative risks, you may want to ask yourself if certain legislations, particularly tax laws, can make your products and services less marketable. For instance, some tobacco businesses were threatened when legislations pushing up the costs of tobacco products were passed. The significant increase in the cost of their products reduced their appeal and made it difficult for tobacco business owners to promote and sell their products.

  • Financial Risks. Financial risks are associated with the overall finances of your business, including your financial systems and the transactions that your business enters into. Some examples of financial risks are customers who did not pay you for your services, or the growing interest of your business loan. But how do you prevent such risks?

The first and most important thing you should do to prepare your business for financial risks is by regularly examining your financial operations, most especially your cash flow. Being too dependent on one customer is not good for your business, because if that customer fails to pay you, that could have some serious implications when it comes to the viability of your business. Aside from cash flow, some of the other things you should examine are the ones who owe you money, the way you extend credit to your customers, and the things you should do to recover your owed money.

  • Operational Risks. Operational risks are the risks that have to do with the operations and administrative procedures taken by your business, including recruitment of employees, supply chain, IT systems, accounting controls, regulations and the composition of your board.

As you run your business, it is necessary for you to examine each aspect of your operations and make provisions for every possible risk that may turn up. For instance, being too reliant on just one supplier may pose operational risks for your business. Imagine if your sole supplier goes out of business. Where does that leave you? You can minimize this risk by looking for some other suppliers that you can do business with and not depending too much on the one that you currently have.

One of the most common operational risks today has to do with information security. As a business, you keep track of necessary information. That is why part of your responsibilities as a business owner is ensuring that every bit of information is protected from hackers who may break into your IT system and steal valuable data from you. Many business owners have experienced losing large sums of money from their accounts to hackers due to poorly secured IT systems.

Aspects of the Risk Management Process

 The process of managing risks is one of the most crucial parts of any business. It is often considered an indispensable part of strategic management because it helps you identify the risks confronting your business and address them. By doing so, you are able to increase the likelihood of your business’ success.

The risk management process basically involves micro processes, such as systematically identifying the risks facing your business, evaluating the possibility of the occurrence of an event, understanding how you should respond to these events, setting up systems to tackle the consequences of these events, and monitoring how effective or ineffective your risk management processes are.

 How Risk Management Benefits Your Business

 While risk management does not totally guarantee the success of your business, it makes the risks manageable enough. Among the common results of the risk management process are the following:

  • It allows you to allocate your resources more efficiently
  • It allows you to project or expect what may go wrong with your business, hence minimizing the impact of risks and preventing considerable financial loss
  • It helps improve your planning and decision-making
  • It increases the chances that you will be able to conduct your business according to your business plan and budget

 If you are the type of business owner who always loves to try something new, knowing how to manage risks efficiently can benefit your business a lot. For instance, you plan on launching a new product. Two of the risks that you should consider in this case are the competitors that follow you in the market and the existing technologies that can possibly make your new product redundant.

Evaluating Risks

Part of the risk management process is risk evaluation. This technique particularly lets you identify the significance of potential risks to your business and decide whether you are going to accept these risks or prevent them. But how do you evaluate these risks?

Evaluating risks basically involves identifying them and ranking them afterwards. You can do this by determining the consequence and probability of each risk, such as asking yourself if their consequences and probabilities are low, medium or high. Businesses that efficiently assess their risks can attest to the advantages of this practice.

It helps to include a risk evaluation in your business plan, in which you determine the risks that can impact your objectives and assess them in the light of costs, concerns of investors and even legal requirements. In cases when the cost of preventing a potential risk is too high, not preventing the risk at all makes more sense. So, it is important that you assess these risks and weigh which will cost you more—preventing them or mitigating them once they’re already at hand?

In evaluating potential risks and assessing them based on cost, concerns and legal requirements, it is best to plot a risk map and include there the likelihood of the risk’s occurrence. In this risk map, you rate each risk on a scale of 1 to 10, with 10 meaning that the risk is of major concern to your business. You can also include in the risk map the probability scale of each risk, which you do by assessing if the risk:

  1. Is very likely to occur
  2. Has some chance of occurrence
  3. Has small chance of occurrence, or
  4. Is not likely to occur

By plotting this map, you are easily able to visualize all the possible risks in relation to each other and see the extent of damage they can do to your business.

 Four Ways to Deal with Risks

 Since risks are normal in every business, they are not supposed to make you nervous. As a business owner, you have all the freedom to plan around these risks, limit their impacts and prevent the worst from happening. You only have four options when dealing with risks—mitigate it, avoid it, transfer it, or accept it.

  • Mitigating the Risk. To mitigate a potential risk, you should come up with contingency plans before the risky situation arrives. So, when it’s already there, you can easily carry out your Plan B. For example, you have an upcoming promotional event for your new product and you expect several investors to attend. Since the event is set in an open area, the risk is that it might rain. Rain can be considered a risk since that may affect the number of people to attend the event. To mitigate the risk, you may consider renting a large tent to shelter your guests or giving out free umbrellas to them.
  • Avoiding the Risk. There are certain instances when you find the risk consequences to be too high. In such cases, it is best for you to cancel that high-risk initiative altogether. One example would be a product launch that could exhaust all of your company’s finances. Instead of letting this new product cripple your business financially, cancel the launch and avoid the risk of being broke.
  • Transferring the Risk. This strategy is very common in insurances. Since it involves passing the risk on to someone else, it mainly applies to risks and situations that you can put in black and white, such as in contracts. A good example is insuring yourself against the risk of a car accident. In this case, your insurer will carry the financial risk in case you get caught in such an accident.
  • Accepting the Risk. In managing risks, remember that you always have the choice of doing nothing. However, you have to make every conscious effort possible to understand the risk and to decide whether it is fine to accept it. If you think the risk is insignificant and won’t have any impact on your business, then you can choose to take no action at all.

When you manage potential risks to your business, you can take advantage of any of these four strategies independently or in combination. Just like in any endeavor, business requires careful planning. Even if you think that a risk is not likely to happen, it is still best to prepare yourself for it.

Employment Matters: The Difference Between Contractors and Employees

When there’s extra work that needs to get done and there are no sufficient employees to do the job, companies usually hire more workers to keep up with the customer rush. If you happen to find a job in a company, make it a point that you understand your status in that company. That way, you will know how you are supposed to be treated by your new employer.

More often than not, problems arise because independent contractors think of themselves as employees, and vice-versa. For some, knowing whether they are contractors or employees doesn’t matter because all that matters to them is that they got a job and an income. However, they don’t realize that not knowing which classification they belong to—independent contractor or employee—will put them at the risk of tax troubles in the future.

But how does the law classify contractors vs. employees?

Telling Between Contractors and Employees

On the surface, you probably cannot tell what sets contractors apart from employees because most of the time, they do the same work. However, the law views them differently. The law also views the companies that hire them just as differently.

Basically, the thing that makes contractors different from employees is their degree of independence and control over the work that’s assigned to them. Usually, while an employee performs tasks that are dictated by others and are provided trainings to effectively do the job, an independent contractor has more than one client and sets his own hours at work. A contractor typically does not have a boss and he uses his own tools in performing his job. Also, his salary doesn’t automatically come at a definite date because he invoices for each of his completed assignments.

While that seems pretty much understandable, there can sometimes be gray areas, too.

In many cases, companies prefer hiring contractors instead of employees so they can save on labor costs. Financial-wise, hiring contractors makes more sense because contractors are not entitled to benefits. Also, companies save considerably on taxes since in hiring contractors, it no longer becomes necessary for the employer to pay portion of the state unemployment taxes.

Companies that follow the law and take the employee route usually regret their decisions at some point in the future because of the cost that making someone an employee entails. That explains why small businesses that operate on tighter margins are often tempted to hire contractors instead of employees, even when the job that needs to get done calls for an employee.

To minimize their costs, business owners make people believe that it is more advantageous to be a contractor than an employee since contractors’ take-home pays are bigger. While that may be true on the surface, that is not as simple as it seems.

The Tax Implications of Contractual Work 

If you are an employee, your employer is the one that pays half of your Social Security and Medicare taxes and withholds half of these taxes from your salary. That and the withholding of your federal and state income taxes are the reasons why those employees who work at $9 per hour at fast-food restaurants take home less every payday.

So, does that prove that being a contractor is better than being an employee?

The answer is not necessarily. Why? Because independent contractors pay 100% of all their Social Security and Medicare taxes when they file their tax returns, and pay all the income taxes that were not withheld. And if you are a contractor and you failed to make estimated tax payments every quarter to cover your taxes, prepare yourself for an unfortunate surprise come April. This only goes to show how tax responsibilities affect the amount that employees take home during payday versus the amount taken home by contractors.

Contractors Escaping Taxes

 Sounds common, doesn’t it? Many contractors believe that one of the advantages of being an independent contractor is that they get to escape taxes. Actually, they don’t. Well, that’s always possible. But that is not legal.

If you are a contractor and are paid in cash, don’t think that that already lets you get out of paying taxes and not report it. Whether your pay comes in the form of a check, cash, digital transfer or barter, and regardless of its amount, remember that every pay you get for each work that you do is taxable income.

Many contractors get all the more confused about taxable contract income because of the amounts that the IRS uses to require reporting of earnings. Remember that when you are a contractor, you get Form 1099-MISC to lay down the details of how much you have made for each job. Form 1099-MISC is what you need, not a W-2. However, as a contractor, an employer does not need to send you a form 1099 if your earnings during the tax year in question is less than $600.

The law can’t stress enough that the abovementioned rule is just a reporting requirement and has nothing to do with your taxable income. However much you earn, your earnings are always legally taxable and should be reported either on Schedule C or as other income on Form 1040.

For your FICA taxes, which refer to your Social Security and Medicare taxes, these taxes are self-employment taxes which you are responsible for in full. If you are an independent contractor, you should report the amount of your FICA taxes and pay them via Schedule SE.

While being an independent contractor has its share of advantages when it comes to taxes, there are instances when a business hires a contractor who is eventually deemed as an employee. In such cases, both parties lose significant amount of taxes, interests, penalties and premiums.

Since the relationship between a company and a worker sometimes tends to be a gray area, it is imperative that you protect your status as an independent contractor. Well, that is if you are really an independent contractor. To make sure that your work as a contractor remains independent of your employer, it should be able to pass the Four Point Test.

Determining Your Status

 If one asks you now whether you are a contractor or an employee and what makes you think so, do you know how to answer?

In Canada, a four-point test helps workers to determine their relationship with the business that you are working for. The agency clearly sets out a method that lets tax payers and workers identify the nature of their relationship with their companies.

The four-point test makes clear-cut distinctions between contractors and employees based on their control, tool ownership, risk of loss and integration.

  • Here, the issue is who controls the worker. If the employer has all the right to hire or fire you, determine your salary, decide on the time and place of your work as well as the manner in which you should perform your work, then you are an employee. Even if the employer does not directly control how you do your job, if he still has the right to do so, then an employer-employee relationship exists between the two of you.

 On the other hand, if you are a contractor, it is not necessarily the employer that runs the ship. As a contractor, you decide how you are going to perform your job and you maintain your right to decide where and when you are going to get the work done. In short, you are the only person responsible for planning the job that you need to get done.

  • Ownership of Tools. When it comes to tool ownership, the common notion is that what sets contractors apart from employees is that contractors supply their own tools. While that may be true, the problem is that it is also customary for other employees to provide tools for themselves so they can perform their jobs, such as in the case of garage mechanics and painters.

If that is the case, then how does tool ownership differentiate a contractor from an employee? According to CRA, the cost of using the tools is a better indication of whether you are a contractor or an employee. As per the CRA rule, you are considered an independent contractor if you purchase or rent large tools that call for major investment and expensive maintenance. Otherwise, you are an employee. Another good example of a self-employed, independent contractor is a home-based IT worker who uses his own computer to perform his job.

  • Chance of Profit/Risk of Loss. Here, determining which type of relationship exists between the business and the worker heavily depends on the financial involvement of the latter. Take a look at these questions:
  •  Do you have a chance of gaining profit?
  • Are you at risk of incurring losses due to damage to materials, delays or bad debts?
  • Do you cover the operating costs?

If your answer to all of these three questions is a Yes, then you are considered an independent contractor.

  • This criterion seems to be an attempt to presume the intention of the involved parties. According to CRA, a business relationship exists if the worker integrates the payer’s activities to his own commercial activities. On the other hand, an employer-employee relationship exists if the worker integrates his activities to the commercial activities of the payer.

The CRA does not lay out how to determine such integrations. However, an obvious way of proving that you integrate your own commercial activities is by having multiple clients. If you have only one client, it becomes easy for others to presume that you share an employer-employee relationship with that client. But be careful when having a single client, because that puts you at risk of being declared as a personal services corporation by the CRA.

Deciding Whether to Become an Employee or a Contractor

 Based on the facts discussed, it looks like being a contractor can be beneficial for you in terms of earnings and taxes, so long as you are prepared. However, remember that being an employee or a contractor is not really one of those decisions that you make when you look for a job. In reality, it is the business or company that decides whether you are a contractor or an employee.

Most of the time, employees are carried on the books, unlike contractors. So as a contractor, it is your responsibility to enshrine your relationship with the company you are working for through a contract. This contract should focus on the first three points of the four-point test and set out the intentions of both parties. Since you are an independent contractor, you have to make sure that such a written agreement is carefully crafted so your status is protected in case the other party subsequently changes his mind and argues that your relationship is not what you think it is.

At the end of the day, it is the business’ responsibility to weigh certain factors to determine whether a worker is an independent contractor or an employee. While other factors may indicate that one is an employee, other factors may indicate that he is an independent contractor. Apparently, there is no magic that stands alone in determining one’s status, but the key to making the right determination is by looking at the entire relationship that the person has with the company he is working for.

In a nutshell, what makes a worker an independent contractor is his being his own boss, although his work should still stay within the definitions of a contract with the party he is working for. Also, he is not eligible for benefits provided by the employer and retains a certain degree of independence and control. On the other hand, a worker is an employee if he treats the business as his stable source of income, is eligible to benefits and pensions, and gives up elements of control to his employer. He should also be working within the time and place specified by the employer.

How to Simplify Business Taxes

If the only purpose of the tax system is to raise the government’s revenue, it could have been simpler. Unfortunately, its goals include ensuring efficiency, fairness and enforceability, influencing social policy and delivering benefits for certain industries, so simplicity in taxes seems out of the question.

While the current tax system is already too complicated, it gets even more complex year after year. Oftentimes, tax simplicity contradicts certain policy goals. While most people think that taxes should be equally conductive, fair, enforceable and simple, it is a fact that even those people who agree on these goals also disagree when it comes to their relative importance. Consequently, policies serve to balance the competing goals and simplicity ends up being least prioritized.

If you own a small business and are unfortunately not a tax expert, you may find it hard to deal with your business taxes. Because of the complexity of the tax system, it is very common for business owners to spend their tax time in panic and stress as they scramble to get their documents together in hopes of meeting deadlines and avoiding penalties.

Business owners often experience tax woes since they are supposed to treat business taxes as a process that needs careful attention throughout the year. The complexity of the tax system makes business tax preparation just as difficult that business owners sometimes feel like preparing for the tax season is an all-year burden that they have to carry.

Business taxes may be a bit complicated, but the good news is that there are ways through which you can simplify them. But before you know how to simplify business tax, it is better to understand first what business taxes are all about.

Business Taxes

 Business taxes have five general types, and the type you pay depends on the form of business that you operate. The give general types of business taxes are:

  • Income Tax. Except partnerships, all types of business are required to file an annual income tax return. The form that you use in filing depends on the organization of your business or your business structure. This type of tax is a pay-as-you-go tax, which means that you pay it as you earn or receive your income. Usually, this is withheld from your pay. Otherwise, you might be required to pay estimated tax.
  •  Estimated Tax. It is by making regular payments of this type of tax during the year that you pay your taxes on income, including your self-employment tax.
  •  Self-Employment Tax. This business tax is primarily for those who work for themselves. Whatever self-employment tax you pay contributes to your social security system coverage, which is responsible for providing you with disability benefits, retirement benefits, survivor benefits and hospital insurance benefits. The law requires you to pay your SE tax if you meet any of the following requirements: (1) your net earnings from being self-employed were $400 or more; (2) you work for a church or any organization controlled by a church which elected an exemption from the FICA taxes.
  •  Employment Tax. You should pay your employment tax if you have employees whose social security and Medicare taxes, as well as federal income tax withholding and federal unemployment (FUTA) tax you are responsible to file.
  •  Excise Tax. You need to pay your excise tax if you do manufacture or sell products, operate different businesses, use various kinds of facilities, products or equipment, or receive payment for certain services. This tax has several tax programs, and one of the major components of these programs is motor fuel.

 Now that you know the different business taxes that you need to pay, and considering how complicated filing and paying them are, it is time to understand how to simplify your business taxes.

 Preparing for the Tax Season

 The key to simplifying your business taxes is to treat them as something that requires your attention throughout the entire tax year. As you begin to see it that way, preparing for tax time won’t be as burdensome for you anymore and it will no longer have to take your time away from your business.

Business taxes are manageable if you know how to prepare them right. Basically, you will need a reliable technology to help you automate your finances. Other things that you need will be—

 Establish better habits for next year and beyond. After completing your taxes for the current year, commit to establish better habits for the following years. You may have promised yourself to do the same last tax year and in the years prior, but this time, make sure that you will stand by your commitment to do better.

 Your business finances need your attention as much as your family finances do. If you are not the type of business owner who keeps track of your business income and expenses, then you are one of those business owners who see tax time as a nightmare.

  •  Track your Business Income and Expenses. To save yourself the trouble, make it a habit to track your income and expenses all the time. That may sound a bit demanding, but it definitely works. To keep track of your finances as they happen, use a spreadsheet or a software program. Reconstructing all your income and expenses for months at once will not only lead to an erratic report but will also leave you drained.

Another advantage of keeping track of your income and expenses in a simple spreadsheet is that you get to see the profit you make and all the numbers you need for tax time.

  • Set Aside Money for Taxes. One of the easiest ways to avoid getting hit with a surprisingly hefty tax bill is to make it a habit to allot money for your business taxes each month. For most businesses, that is equivalent to 30% of your total income. If you set aside this percentage, you will be better off than business owners who don’t set aside anything for tax time.

If you make a conscious decision now to set aside money for your taxes, you don’t only get to avoid considerable penalties but also ease the burden of having to pay a huge sum when the due date for filing taxes comes. That may seem difficult to do at first, but it positively forces you to not procrastinate your taxes until the crazy tax time arrives.

Record everything electronically. Most business owners keep piles of receipts and other important documents in a box, particularly a shoebox. Such a practice is highly inefficient because when the receipts pile up, everything becomes a mess and things become even more stressful for you since you will end up not even knowing what’s in that box. Why don’t you ditch it and start learning how to record everything electronically? That way, you can be sure that your archive is automatically ready when the filing time next year comes.

It is also best to set aside one time to sort out your records. If you plan to do this once a month, a good date would be the time you get your monthly statement for your business checking account. Come up with a checklist that includes your bank account reconciliation and look through all of your transactions to make sure that you don’t commit errors.

Back up your records. Have you ever thought of what may happen to all your data in case a huge disaster hits your place? That is why it is important that you back up all your files and records regularly to a remote location, such as in the cloud. You may also do the backing up on-site, but make sure that you store away all valuable business information from the office. Remember that the law does not find lost records as an excuse when the auditing time comes.

Find a good accountant/ tax advisor. If you think you can’t handle all the paperwork by yourself, you can get an accountant. Accountants are trusted advisors that you can rely on throughout the year. They can help you plan and prepare for the tax season.

If you have just started your business, it is better if you talk to a tax advisor as soon as now. You can explain the basics of your business to your accountant and tax advisor so he can clue you in on the tax deductions you are entitled to. You may not appreciate having a tax advisor by your side straightaway, but when the demands of tax time get more complicated, you will. Since they are savvy about business taxes, they can help you go about every stage of the process.

In the months leading up to tax time, accountants and tax advisors are business owners’ best friends. Ahead of this dreaded season, request from them a tax preparation document to ensure that you have enough time to prepare and that you get all the deductions and breaks you are entitled to.

Use online banking. In most cases, banks allow their clients to download all of their transactions. To help you prepare for the tax season, you can visit the bank every month to mark all your tax-deductible transactions. That way, you can prepare a comprehensive list of all your tax deductible items before the tax season comes.

As you prepare for the tax season, it also helps to use reminders and alerts. You may consider having a specific calendar that’s especially dedicated to your business finances. There, you can set up all your financial reminders for all the payments, transfers and other transactions that you need to perform. This way, you don’t let your financial tasks get lost in the rush of your daily business reminders. It is also advisable that you put alerts on your business checking account so the calendar can alert you when your balance gets too low, or when a new transaction is made.

Automate accounting process. If you own a business, considering an accounting solution is a big help to your tax woes. Finding an accounting solution will help you drive accuracy and efficiency throughout the year and ease your burden during tax time. When you use online accounting for your finances, you don’t only get the latest version of the accounting tool but you also remove the need to invest a large sum of money upfront.

If you own a small business, you can easily pull the transactions you had from your business bank accounts and automatically update them. That way, you can come up with customized financial reports and view your balances more straightforwardly, especially if you use a software that features customizable reports. This is a big time-saver, you’ll see.

Another benefit of automating your accounting process is that you get to plan ahead for your important deadlines. Most accounting software today don’t only keep track of your income and expenses but also have alert features to ensure that you are up-to-date with your business finances and deadlines.

File online. Filing your taxes online is not only faster for you but also ensures that it your filing is less prone to errors. In most cases, tax agencies also require online than manual filing.

When you start having your business financial tracking set in place, you will discover that it actually takes so little time to accomplish your financial review and just a bit of effort to get rid of tax woes that are usually experienced by delinquent business owners. The business tax system is complicated, yes, but there is always something you can do to streamline the process.

If you have just started out your business, it’s normal if your expenses outweigh your income. Setting up a system to track your finances may seem unnecessary at this point, but you shouldn’t make the mistake of waiting until all your financial records have already piled up. Simplifying your business tax is a result of easy habits that you need to learn from the beginning. Try it. When the tax time comes around, you’ll be grateful you’re prepared.

When to Incorporate and When Not to Incorporate

It is true that operating as a corporation has its share of drawbacks in certain situations. For example, as a business owner, you would be responsible for additional record keeping requirements and administrative details. More important, in some cases, operating as a corporation can create an additional tax burden. This is the last thing a business owner needs, especially in the early stages of operation.

You do not have to incorporate to be in business. You can be in business just by being paid for a service or a product. You are then a sole proprietor as well as a self-employed freelancer. But there are certain pros that you and your business can benefit to incorporating.

 Advantages of Incorporating

Founders of startup companies often wait to incorporate a company until they are confident that their concept is viable or fundable.  At some point, however, an entrepreneur will need to formally incorporate a company.

Aside from tax reasons, the most common motivation for incurring the cost of setting up a corporation is the recognition that the shareholder is not legally liable for the actions of the corporation. This is because the corporation has its own separate existence wholly apart from those who run it. However, there are four other reasons why the corporation proves to be an attractive vehicle for carrying on a business.

  • Unlimited life. Unlike proprietorships and partnerships, the life of the corporation is not dependent on the life of a particular individual or individuals. It can continue indefinitely until it accomplishes its objective, merges with another business, or goes bankrupt. Unless stated otherwise, it could go on indefinitely.
  • Transferability of shares. It is always nice to know that the ownership interest you have in a business can be readily sold, transferred, or given away to another family member. The process of divesting yourself of ownership in proprietorships and partnerships can be cumbersome and costly. Property has to be retitled, new deeds drawn, and other administrative steps taken any time the slightest change of ownership occurs. With corporations, all of the individual owners’ rights and privileges are represented by the shares of stock they hold. The key to a quick and efficient transfer of ownership of the business is found on the back of each stock certificate, where there is usually a place indicated for the shareholder to endorse and sign over any shares that are to be sold or otherwise disposed of.
  • Ability to raise investment capital. It is usually much easier to attract new investors into a corporate entity because of limited liability and the easy transferability of shares. Shares of stock can be transferred directly to new investors, or when larger offerings to the public are involved, the services of brokerage firms and stock exchanges are called upon.
  • Limited Liability. The main advantage to incorporating is the limited liability of the incorporated company. Unlike the sole proprietorship, where the business owner assumes all the liability of the company, when a business becomes incorporated, an individual shareholder’s liability is limited to the amount he or she has invested in the company.

Owners of a corporation may only be liable for business losses and obligations up to their investment in the company. As explained on the Entrepreneur website, the shareholder’s personal assets may not be taken to cover liabilities of the corporation. However, shareholders of an incorporated business may be liable for the company’s debts if they sign a personal guarantee on a corporate loan. In addition, shareholders that engage in criminal activities will be individually held responsible for their acts.

If you’re a sole proprietor, your personal assets, such as your house and car can be seized to pay the debts of your business; as a shareholder in a corporation, you can’t be held responsible for the debts of the corporation unless you’ve given a personal guarantee.

On the other hand, a corporation has the same rights as an individual; a corporation can own property, carry on business, incur liabilities and sue or be sued.

Disadvantages of Incorporating

Incorporating a business can seem like a good idea, but the process and requirements of incorporation can actually hinder an organization’s growth and success, especially for smaller start-up companies. Incorporating a business provides some benefits, but the corporation definitely pays the price for these benefits in fees and legal hurdles. The main reasons not to incorporate include a sizeable initial investment, tax disadvantages, increased complexity in bookkeeping and public disclosure mandates.

  • Corporations require annual meetings and require owners and directors to observe certain formalities. Corporations are more expensive to set up than partnerships and sole proprietorships. The process costs money. You can do it on your own, technically, but it’s more advisable to get the help of a lawyer and an accountant. It also requires periodic filings with the state and annual fees. Incorporating later in the life of a business is always an option but a little more expensive, depending on the complexity involved in transferring business assets into the corporation and registering the accompanying tax elections.
  • No Personal Tax Credits and Less Tax Flexibility. Another disadvantage of incorporating is that being incorporated may actually be a tax disadvantage for your business. Corporations are not eligible for personal tax credits. Every dollar a corporation earned is taxed. As a sole proprietor, you may be able to claim tax credits a corporation could not. A corporation doesn’t have the same flexibility in handling business losses as a sole proprietorship or a partnership. As a sole proprietor, if your business experiences operating losses, you could use the loss to reduce other types of personal income in the year the losses occur. In a corporation, however, these losses can only be carried forward or back to reduce the corporation’s income from other years.
  • Ongoing fees. You must file articles of incorporation with the state, plus applicable fees. Many states impose ongoing fees—which are steeper for a corporation than for a sole proprietorship or general partnership.
  • More record keeping. Corporations must follow initial and annual record-keeping requirements—which sole proprietorships, general partnerships and limited liability companies (LLCs) avoid. There is a lot more paperwork involved in maintaining a corporation than a sole proprietorship or partnership. Corporations, for example, must maintain a minute book containing the corporate bylaws and minutes from corporate meetings. Other corporate documents, that must be kept up to date at all times, include the register of directors, the share register and the transfer register.
  • Liability May Not Be as Limited as You Think. The prime advantage of incorporating, limited liability, may be undercut by personal guarantees and/or credit agreements. The corporation’s much vaunted limited liability is irrelevant if no one will give the corporation credit. When a corporation has what lending institutions consider to be insufficient assets to secure debt financing, they often insist on personal guarantees from the business owner(s). So although technically the corporation has limited liability, the owner still ends up being personally liable if the corporation can’t meet its repayment obligations.
  • Added Requirements. Another reason to avoid incorporation is the increased complexity of organizations operating under a corporate shield. Besides the financial and document requirements, corporations are forced to operate with a formal organizational structure of stockholders, a board of directors and officers; these members are required to conduct annual, timed meetings. The last disadvantage of corporations is the amount of information that must be made public. Corporations are publicly traded companies, therefore requiring more business information to be disclosed for the benefit of investors. Besides being required to make accounting records public, the organization must also identify all directors and officers publicly.

 Process of Incorporating

To start the process of incorporating, you can contact your attorney or CPA.  If you wish to do it yourself than contact the secretary of state or the state office that is responsible for registering corporations in your state. Ask for instructions, forms and fee schedules on business incorporation. It is possible to file for incorporation without the help of an attorney by using books and software to guide you along. Your expense will be the cost of these resources, the filing fees, and other costs associated with incorporating in your state.

If you do file for incorporation yourself, you’ll save the expense of using a lawyer, which can cost from $500 to $1,000. The disadvantage of going this route is that the process may take you some time to accomplish. There’s also a chance you could miss some small but important detail in your state’s law. You may also choose to use an incorporation service company to prepare and file the documents with the state.

One of the first steps you must take in the incorporation process is to prepare a certificate or articles of incorporation. Some states will provide you with a printed form for this, which either you or your attorney can complete. The information requested includes the proposed name of the corporation, the purpose of the corporation, the names and addresses of the parties incorporating, and the location of the principal office of the corporation.

You’re not required to incorporate in the state where your business operates; you can choose from any one of the 50 states or the District of Columbia.

Note that simply transacting business via mail order or the Internet typically does not equal transacting business; however, the determination is made on a case-by-case basis. Again, consult your attorney for specifics, as this list is not intended to be comprehensive.

The corporation will also need a set of bylaws that describe in greater detail than the articles how the corporation will run, including the responsibilities of the shareholders, directors and officers; when stockholder meetings will be held; and other details important to running the company. Once your articles of incorporation are accepted, the secretary of state’s office will send you a certificate of incorporation.

 After You’ve Incorporated

Once you’re incorporated, be sure to follow the rules of incorporation. If you don’t, a court can pierce the corporate veil and hold you and the other owners personally liable for the business’s debts.

To make sure your corporation stays on the right side of the law, practice these exercises:

 Get Documents and Records in Order

After incorporating a business, you’ll need to prepare bylaws that describe how your new corporation will operate. A few states also require you to publish a newspaper notice of your incorporation.

You should set up a corporate minute book and a file or binder where you will keep important corporate documents such as your certificate of incorporation, bylaws, shareholder information and resolutions. Some states require you to file an initial report after incorporation and you will generally need to hold shareholder and director meetings at least once a year.

 

  1. Get an Employer Identification Number

An employer identification number, or EIN, is a number that the Internal Revenue Service uses to identify businesses—sort of like the business version of a Social Security number. Most businesses need an EIN, though solo business owners who don’t have employees or pay excise taxes can use their Social Security Number instead.

  1. Open a Business Bank Account

A business bank account will help you keep your business finances separate from your personal finances. This makes record keeping and tax preparation easier and helps preserve your business’s separate identity.

 

For most businesses, the question is not if, but when, to incorporate. There are many pros and cons of incorporating a small business, depending a lot on individual situations. But too many businesses fail to revisit the question of whether to incorporate. As your business matures, and the realities of your legal and tax situations change, asking the question again may bring a different answer. A business with anticipated losses and little legal risk can likely start as a sole proprietorship, but increasing risk and more significant earnings will favour incorporating later on.

Deciding whether or not to incorporate is much more than just understanding the disadvantages of incorporation; the decision also requires knowledge about the advantages and disadvantages of other legal business formation options, such as sole proprietorships, partnerships and limited liability companies.

You should definitely discuss your personal situation with your accountant and lawyer before you decide. He or she will be able to give you a much more exact picture of how incorporation could benefit your business, and help you see whether or not the trouble and expense of incorporation will be worth it to you.

What is Incorporation and How Does It Work?

One of the first decisions you have to make in creating an incorporation is the type of business you want to create. A sole proprietorship? A corporation? A limited liability company? This decision is important because the type of business you create determines the types of applications you will need to submit. You should also research liability implications for personal investments you make into your business, as well as the taxes you will need to pay. It is important to understand each business type and select the one that is best suited for your situation and objectives. Keep in mind that you may need to contact several federal agencies, as well as your state business entity registration office.

The first step in understanding how businesses can be set up comes with knowing that, even though they may all seem similar from the outside, not all businesses are structured identically. Even within the same industry, some owners might opt for one setup while another owner will decide that a different type of arrangement is more suitable. It all depends on the individual needs, preferences, and requirements of the potential business and the business owner. This article will give you a glimpse of how an Incorporation works and how a business owner can use this model to further his or her ventures.

How does Incorporation Work?

A business becomes incorporated when the company’s organizers file incorporation paperwork with the state. For example, corporations in Texas must file a certificate of formation with the Texas Secretary of State’s office, as a condition of its formation. Incorporating a business requires activities, such as selecting individuals to serve as directors, and creating a unique business name. In most cases, a fill-in the blank certificate of formation, also known as articles of incorporation, will be provided by the Secretary of State’s office where the corporation is organized. The fee to file a certificate of formation will vary from state to state.

When a business becomes incorporated, a separate and distinct legal entity is created. An incorporated business acts independently of its business owners. According to the Entrepreneur website, incorporating a business provides the company with most of the legal rights granted to an individual, with the exception of voting privileges. Incorporated businesses must hold shareholder and director meetings, and keep company minutes, as described on the Companies Incorporated website. In addition, corporations must keep accurate banking records that are separate from the personal funds of its owners. Furthermore, an incorporated business must file taxes and annual reports with the state where the company is organized. This new business entity – corporation or limited liability company (LLC) – transforms the way the business is seen through the eyes of the law and often has more credibility with potential customers, vendors, and employees.

When it comes to business taxes, owners of an incorporated business may pay taxes twice on the same corporate dollars, also known as double taxation. This occurs when the company pays business taxes on its earnings. If dividends are issued to shareholders of the corporation, the shareholder pays taxes on those dividends at their individual tax bracket. Dividends issued to shareholders of a corporation aren’t deductible and don’t reduce the corporation’s tax liability. Lastly, for company Stocks, unlike a sole proprietorship or a partnership, an incorporated business has the ability to issue stock to employees and investors. Corporations with unissued shares of stock can sell shares to raise money for the company. Because an incorporated business has limited liability protection, investors may be more likely to invest in a corporation in comparison to a sole proprietorship or partnership. Employee stock incentives may be used to attract talented individuals to work for the corporation.

In any case that the venture hits some financial hurdles, corporations normally file one of two different types of bankruptcy – Chapter 7 or Chapter 11. Alternatively, corporate creditors may force a corporation into bankruptcy. When a corporation enters Chapter 7 bankruptcy, the bankruptcy court appoints a trustee to oversee the liquidation of corporate assets. Assets are then distributed to external creditors according to their priority and the amount that they are owed. Shareholders are the lowest priority unless, for example, the corporation borrowed money from a shareholder. Unlike an individual debtor, the corporation receives no discharge of debt – it simply dissolves and ceases to exist after its assets are liquidated and distributed. On the other hand, when a corporation enters Chapter 11 bankruptcy, corporate representatives negotiate with a creditor’s committee for favorable payment terms, reduced interest rates and, sometimes, a reduction in the principal balance of its debts. The corporation must usually pay its outstanding debts within five years. Both the creditors and the corporation may submit payment plans to the bankruptcy court, but the court must approve it. Once the corporation complies with the settlement, it receives a discharge of any remaining debt.

The Incorporation Doctrine

The incorporation doctrine is a constitutional doctrine through which selected provisions of the Bill of Rights are made applicable to the states through the Due Process clause of the Fourteenth Amendment, the Legal Information Institute explains. This means that state governments are held to the same standards as the Federal Government regarding certain constitutional rights. The Supreme Court could have used the Privileges and Immunities Clause of the Fourteenth Amendment to apply the Bill of Rights to the states. However, in the Slaughter-House Cases 83 US 36, the Supreme Court held that the Privileges and Immunities clause of the Fourteenth Amendment placed no restriction on the police powers of the state and it was intended to apply only to privileges and immunities of citizens of the United States and not the privileges and immunities of citizens of the individual states. This decision effectively put state laws beyond the review of the Supreme Court. To circumvent this, the Supreme Court began a process dubbed as “selective incorporation” by gradually applying selected provisions of the Bill of Rights to the states through the Fourteenth Amendment Due Process clause.

Selective and Offshore Incorporation

To give you a breakdown on what “selective incorporation,” it is a constitutional doctrine that ensures states cannot enact laws that take away the constitutional rights of American citizens that are enshrined in the Bill of Rights. Selective incorporation is not a law but has been established over time through court cases and rulings by the United States Supreme Court. In actuality, selective incorporation is the process that has evolved over the years, through court cases and rulings, used by the United States Supreme Court to ensure that the rights of the people are not violated by state laws or procedures. Moreover, according to Law Teacher, it does not consider all rights in the Bill of Rights fundamental not all rights in the Bill of Rights and some rights outside the Bill of Rights are fundamental. This approach rejects the totality of circumstances to decide whether phases of rights or particular portions of Instead if a right was fundamental, drafters incorporated it into the Fourteenth Amendment through the Due Process Clause and deemed applicable to the states and the federal government. At its heart, selective incorporation is about the ability of the federal government to limit the states’ lawmaking powers.

Meanwhile, Offshore incorporation is a corporation or limited liability company that has been formed outside of your country of residence. One is well advised to choose the country of incorporation wisely. The great thing, however, about having an offshore corporation company that has been established properly is that it will give you, the owner financial confidentiality. If one has an offshore bank account in one’s own name, the name of the account holder is easy to trace. Many people who have an offshore corporation have several companies. Having more than one offshore company allows funds to be transferred between companies that are free from government reporting. There is usually a significant reduction in paperwork because there may be no requirements by the government to report transfers of money between one foreign account and another.

Filing Articles of Incorporation

Starting your own business is a big step, and the legal issues involved can be confusing.  Thinking of a business idea is hard enough, but then there are forms to fill out and technicalities to deal with, especially if you’re structuring your company as a corporation. Here’s what you need to know about one of the first and most important steps of incorporating your business: filing your articles of incorporation.

The articles of incorporation sometimes called a certification of formation or a charter, is a set of documents filed with a government body to legally document the creation of a corporation. This type of document contains general information about the corporation, such as the business’s name and location.

Articles of incorporation can easily be confused with bylaws, which lay out the rules and regulations that govern a corporation and help establish the roles and duties of the company’s directors and officers. Articles of incorporation are also sometimes called a certification of formation or a charter. The articles of incorporation contain general information about a corporation, such as the name and location of the business. Bylaws, on the other hand, contain information about the rules and regulations that govern a corporation. In addition, corporate bylaws help to establish the roles and duties of the company’s directors and officers.

 Forms and Legal Documents

 The first step in the process is structuring a business as a corporation. The specific documents vary by state, but each will include a number of questions about the business and its owners. The forms are easily found online but don’t be alarmed if they are called something other than articles of incorporation.

Despite a state-by-state filing, the forms will all ask pretty much the same questions and will be in a fill-in-the-blank format. The most crucial information that is required will be corporate name, recipient of all legal notices and official mailings, the purpose of the business, the duration of the business, the incorporator, the directors, how many shares of stock can be issued, and how many classes of stock the corporation will be allowed to issue.

Articles of incorporation must be submitted to the secretary or department of state in order to establish a company as a corporate entity. Depending on the state of incorporation, articles of incorporation may be submitted in person to the secretary or department of state’s office, by mail or electronically to the secretary or department of state website. A corporation is not required to file the company’s bylaws with any government agency. Instead, corporations are required to maintain their bylaws at the company’s primary business location. Corporate bylaws are an internal document, establishing operating procedures for a corporation.

Legally, the answer is no. In fact, over 70 percent of U.S. businesses are owned by sole proprietors and operate successfully without incorporating. However, if you need liability protection to protect personal assets if a client sues you, potential tax savings (at a price), or a loan to grow your business in the future, then incorporation might benefit you.

Typically, if you only operate in one state, you should incorporate in that state. If you operate in multiple states, you should determine which state is the friendliest to corporations and incorporate in that state.  File your articles of incorporation in the state where you intend to incorporate – usually with the Secretary of State’s office and for a fee, depending on where you live. Check your state website for more information.

The primary benefit to business incorporation is limited liability. When you own a small business, you will invest a lot of money into not only getting it launched but in keeping it running smoothly as well. As the owner, you are responsible for any debts and losses your business may accumulate along the way. However, when you incorporate, you are typically only held responsible for the amount of money you personally invest. Your personal assets typically cannot be used to satisfy the debts and liabilities of your business.

Choosing the Right Business Structure

 Out of all the choices you make when starting a business, one of the most important is the type of legal structure you select for your company. Careful consideration of which structure is right for you is crucial because it will have implications for how the IRS taxes your business profits. It’ll also determine whether your personal property is protected when others demand money from your business. Other considerations, including the management of the new business and your long-term plans for it, come into play as well.

It’s not a decision to be entered into lightly, either, or one that should be made without sound counsel from business experts. Mark Kalish, co-owner and vice president of EnviroTech Coating Systems Inc. in Eau Claire, Wisconsin says it’s important for business owners to seek expert advice from business professionals when considering the pros and cons of various business entities. Usually a business owner chooses either a sole proprietorship, a partnership, a limited liability company (LLC), or a corporation. While some businesses choose to operate as cooperatives. There’s no right or wrong choice that fits everyone. Your job is to understand how each legal structure works and then pick the one that best meets your needs. The best choice isn’t always obvious. You may, after reading this section, decide to seek some guidance from a lawyer or an accountant.

For many small businesses, the best initial choice is either a sole proprietorship or, if more than one owner is involved, a partnership. Either of these structures makes good sense in a business where personal liability isn’t a big worry – for example, a small service business in which you are unlikely to be sued and for which you won’t be borrowing much money.

Cooperation Types

 A corporate structure is more complex than other business structures. It requires complying with more regulations and tax requirements. It may require more tax preparation services than the sole proprietorship or the partnership. Corporations are formed under the laws of each state and are subject to corporate income tax at the federal and generally at the state level. In addition, any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal tax returns.

C Corporation

A corporation is a separate legal entity set up under state law that protects owner (shareholder) assets from creditor claims. Incorporating your business automatically makes you a regular, or “C” corporation. A C corporation (or C corp) is a separate taxpayer, with income and expenses taxed to the corporation and not owners. If corporate profits are then distributed to owners as dividends, owners must pay personal income tax on the distribution, creating “double taxation” (profits are taxed first at the corporate level and again at the personal level as dividends). Many small businesses do not opt for C corporations because of this tax feature.

A C Corporation has the widest range of deductions and expenses allowed by the IRS, especially in the area of employee fringe benefits. A C Corporation can set up medical reimbursement and other employee benefits, and deduct the costs of running these programs, including all premiums paid. The employees, including you as the owner/shareholder, will also not pay taxes on the value of those benefits.

 S corporation

Once you’ve incorporated, you can elect S corporation status by filing a form with the IRS and with your state, if applicable, so that profits, losses and other tax items pass through the corporation to you and are reported on your personal tax return (the S corporation does not pay tax).

The “S” also refers to an IRS code section. This type of taxation, the S election, allows the shareholders to be taxed only at the individual level instead of at both the corporate and individual level, thus avoiding the double taxation like the C Corporation. There is no federal income tax levied at the corporate level, unlike C Corporations which are taxed at both the corporate level and the individual level, thus earning the description “double taxation.” S Corps are favored by many business owners for their single taxation (as opposed to the double taxation of a C Corp) is limited liability protection – especially with a Nevada corporation with charging order protection extended to corporate shares – make the S Corp an attractive entity choice.

 Non-profit Corporation

A Nonprofit corporation is a special type of corporation that has been organized to meet specific tax-exempt purposes. A business organization that serves some public purpose and therefore enjoys special treatment under the law – nonprofit corporations, contrary to their name, can make a profit but can’t be designed primarily for profit-making.  To qualify for Nonprofit status, your corporation must be formed to benefit: (1) the public, (2) a specific group of individuals, or (3) the membership of the Nonprofit.

Unlike a for-profit business, a nonprofit may be eligible for certain benefits, such as sales, property, and income tax exemptions at the state level. The IRS points out that while most federal tax-exempt organizations are nonprofit organizations, organizing as a nonprofit at the state level doesn’t automatically grant you an exemption from federal income tax.

Another major difference between a profit and nonprofit business deals with the treatment of the profits. With a for-profit business, the owners and shareholders generally receive the profits. With a nonprofit, any money that’s left after the organization has paid its bills is put back into the organization. Some types of nonprofits can receive contributions that are tax deductible to the individual who contributes to the organization. Keep in mind that nonprofits are organized to provide some benefit to the public.

Examples of Nonprofits include religious organizations, charitable organizations, political organizations, credit unions and membership clubs such as the Elk’s Club or a country clubs.

Other Business Structure Options

 Sole Proprietorship

This is by far the most common and popular form of business in the United States – mostly because it’s easy to start and manage. Simply put, a sole proprietorship is an unincorporated business where there is no legal distinction between the company and the individual who owns it and runs it. This is the business model most eCommerce merchants are using.

This business type is especially good for new eCommerce companies that have a low risk of liability. The sole proprietorship can evolve into another business type later but is the fastest and easiest way to start.

One of the primary disadvantages of a sole proprietorship is the self-employment (SE) tax of 15.3 percent on the ordinary net income generated by your business. Ordinary income includes items such as sales of products or services, commissions, or short-term income in real estate if you are a real estate professional. SE tax doesn’t apply to passive income, such as rent, dividends, interest, or capital gain. When evaluating the possible tax ramifications and planning options of your sole prop, it’s critical to distinguish between ordinary income and passive income.

As every business structure, taxes do need to be filed under the individual owning the sole proprietorship. The risk here is that because there is no difference between the individual and the company, the individual is personally liable for everything the company does. The sole proprietorship is the owner’s personal responsibility for the liabilities of the business. If you have exposure to risks, you may want to consider setting up an entity even if it’s unnecessary for tax purposes or any other reason. Thus, the individual’s personal assets are on the line. Also, once the business grows to more than one person, it can no longer be a sole proprietorship.

 Partnership

Partnerships are single businesses that have two or more owners. Each of these owners or partners contributes to the business either with funding, property, labor, skill, or similar. A general partnership assumes that the business is evenly divided or that specific percentages of ownership are documented if there is a partnership agreement. A limited partnership can limit both control and liability for specified partners. Because partnerships entail more than one person in the decision-making process, it’s important to discuss a wide variety of issues up front and develop a legal partnership agreement. This agreement should document how future business decisions will be made, including how the partners will divide profits, resolve disputes, change ownership (bring in new partners or buy out current partners) and how to dissolve the partnership. Although partnership agreements are not legally required, they are strongly recommended and it is considered extremely risky to operate without one.

Partnerships will require registration but are still relatively easy to set up. Partners share responsibility and profits. Each state will have slightly different requirements for forming a partnership, but in many, if not most cases, it is a matter of filling out a form and paying a small fee.

 Cooperative

It would be somewhat unusual to find an eCommerce store merchant organized as a cooperative, but it’s not impossible. Cooperatives are businesses created to service and benefit the owners. Typically, an elected board of directors and officers run the cooperative while regular members have voting power to control the direction of the cooperative. Members can become part of the cooperative by purchasing shares, though the amount of shares they hold does not affect the weight of their vote. Put another way, its customers are its owners.

It is important to note that in some states, cooperatives are treated as a type of nonprofit corporation since a cooperative’s primary orientation is to benefit members by providing goods or services at cost. However, this type of nonprofit business is different from organizations incorporated under general nonprofit statutes, which legally have no owners, and must retain any net earnings within the organization. Nonprofit cooperative business statutes provide for member patron ownership, member voting rights for boards of directors, profit distributions to members, and member rights to assets sold if the cooperative should dissolve. Cooperatives are common in the healthcare, retail, agriculture, art galleries, and restaurant industries.

LLC Limited Liability Company

A lot of people don’t know what an LLC is, or how to get an LLC. Now it’s important to note that LLCs can differ from one state to another, but generally speaking, they are a hybrid business structure, combining the ease of a partnership with the liability protection found in corporations. Owners, frequently called members, pay taxes on the LLCs profits directly and the LLC itself does not file taxes as a separate legal entity.

LLCs require a lot less record keeping than corporations do, provide some protection for the member’s personal property, and are burdened with fewer profit sharing requirements than corporations. Conversely, LLC members will have to file additional forms for both federal and state taxes depending on the number of members, local laws, or even the LLC’s articles of organization. Often the members of an LLC pay payroll tax too.

The “owners” of an LLC are referred to as “members.” Depending on the state, the members can consist of a single individual (one owner), two or more individuals, corporations or other LLCs. Unlike shareholders in a corporation, LLCs are not taxed as a separate business entity. Instead, all profits and losses are “passed through” the business to each member of the LLC. LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would.

Depending on the state, LLCs may also have a limited lifetime. In some jurisdictions when a member leaves the LLC, that LLC is dissolved. Starting an LLC requires significantly more effort than forming a partnership and a business will probably want to employ a lawyer or at least consult a certified public accountant.

 Conclusion

 Your initial choice of a business structure isn’t set in stone. You can start out as sole proprietorship or partnership and later if your business grows or the risk of personal liability increases, you can convert your business to an LLC or a corporation.

After learning the basics of each business structure and considering your options, you may still find that you need help deciding which structure is best for your business. A good small business or tax lawyer can help you choose the right one, given your tax picture and the possible risks of your particular situation.

FBAR: Who Should File?

Under the American tax law, if you are a U.S. citizen who has either signature authority over or a financial interest in any foreign financial account, you are required to report your account annually to the Department of Treasury via electronic filing.

May your foreign financial account be a bank account, trust, or mutual fund, you have the obligation to file both the Financial Crimes Enforcement Network (FInCEN) 114 and Report of Foreign Bank and Financial Accounts (FBAR).

Unfortunately, many U.S. citizens are not very familiar with the FBAR so before they know it, the U.S. government is already there to go after them and their penalties have already piled up.

Cases of U.S. citizens residing outside the U.S. being up the creek for not filing their FBARs are rampant these days, thanks to these people’s ignorance of the law. But since ignorance of the law excuses no one, you can’t just say no one told you about this FBAR thing and expect to be absolved at the end of the day.

Case in Point

Recently, a U.S.-Canadian citizen was in trouble for failure to file his Report of Foreign Bank and Financial Accounts (FBAR).

Jeffrey Pomerantz, a dual citizen who currently resides in Vancouver, Canada, is now being sued by the U.S. Justice Department for failing to file to the U.S. government his FBAR. The department filed the case in the U.S. District Court in Seattle and is now seeking civil and late payment penalties amounting to $860,300.

While Pomerantz filed his income tax returns to both the Canada Revenue Agency (CRA) and Internal Revenue Service (IRS) in 2007, 2008 and 2009 he failed to file the other form known as the FBAR.

According to Toronto-based lawyer Hari Nesathurai, the past couple of years have seen an increase in cases of Canadian residents being chased by the U.S. government for failure to file their FBAR reports. The lawyer said FBAR is a problem for many Canadian residents who are subject to U.S. tax laws, because they do not realize that even a Registered Retirement Savings Plan (RRSP) calls for a disclosure.

“Many people don’t realize that and it’s troubling because it’s a penalty which applies on a non-disclosure even though there may be no tax payable,” he said, adding that the FBAR is particularly a major concern among Americans and U.S. citizens or green card holders who do not fully understand their reporting obligations.

Going back to Pomerantz’s case, the lawsuit against him filed in May 2016 indicates that the events that led to the U.S. government chasing him for his failure to file his FBAR seem to have begun in 2010 with an audit, which is now before a different court.

The lawsuit reveals that even before the income tax examination commenced, Pomerantz had already failed to file a Treasury Form TD F 90-22.1 (FBAR) for the three years in question to offer a disclosure of his existing foreign accounts. However, the U.S. Justice Department said Pomerantz opened at least two personal checking accounts at the Canadian Imperial Bank of Commerce prior to Jan. 1, 2001, and both accounts were active from 2007 to 2009.

The Justice Department also said in 2003, Pomerantz established a corporation in the Turks and Caicos Islands named Chafford Ltd., which held his personal investments. That same year, he also opened three bank accounts in Sal Oppenheim JR & Cie in Switzerland, and in 2007, he opened two more accounts in the same country and the same bank.

The lawsuit also reveals that during each of the three years, he incurred balances not only in the CIBC bank accounts but also in different Swiss accounts over $10,000.

Although the complaint of the U.S. Justice Department says that Pomerantz resided in the United States from 2007 to 2009, the documents presented by his camp claim that he and his wife, also a dual citizen of Canada and Norway, had only resided in California for part of 2008 and 2009 before they moved back to Canada.

The documents prepared by the department read, “The petitioners were residents of Canada during the tax years in question and cannot be liable to double taxation and are entitled to relief under the U.S.” Contrary to that, those prepared by Pomerantz’s side pointed out that the Justice Department’s documents contained several mistakes, both on the IRS’s information and the calculations made in relation to his bank accounts.

In the midst of the controversy, Pomerantz’s camp maintains that whatever mistake or omission was found in his IRS filings was purely unintentional and would not count as fraud, since he filed everything he knew he had to file to the best of his abilities.

On March 3, the U.S. Justice Department issued the last entry in the court file in Pomerantz’s FBAR case by seeking an order to the serve the complaint on Pomerantz and his lawyer.

Meanwhile, a controversial agreement has reportedly caused the CRA to transfer to the IRS information about Canadian bank accounts. This transfer has been an issue for many Canada-based U.S. citizens under the American tax law, as this could result in the U.S. government pursuing more Canadian residents for failure to file their FBAR reports.

 Should You File an FBAR?

 Pomerantz’s FBAR woes stemmed from his failure to know that considering his status, he was actually required to file an FBAR.

Like Pomerantz, there are many others out there who do not know what an FBAR is, what it is for and who should file it. If you are not sure whether to file it or not, here’s the rule. As per the American tax law, you are required to file an FBAR if you are any of the following:

  • You are a U.S. person who had a signature authority over or financial interest in at least one financial account outside the U.S.
  • At any time during the calendar year, you had foreign financial accounts whose aggregate value exceeded $10,000.

But how do you know if you are a “U.S. person?”

 U.S. Person

 According to the law, you are considered a U.S. person if you are a U.S. citizen, U.S. resident, an entity such as a corporation, partnership, or limited companies created and organized in the U.S. or under U.S. laws, and trusts or estates created under U.S. laws.

The IRS rule also specifies certain exceptions to the FBAR reporting requirements, such as the following:

  • Certain foreign financial accounts jointly owned by spouses
  • S. persons included in a consolidated FBAR
  • Correspondent/Nostro accounts
  • Government-owned foreign financial accounts
  • International financial institution-owned foreign financial accounts
  • S. IRAs owners and beneficiaries
  • Tax-qualified retirement plans beneficiaries and participants
  • Certain individuals with no financial interest in but have signature authority over a foreign financial account
  • Trust beneficiaries who are U.S. persons reporting the financial account on an FBAR filed on behalf of the trust
  • Foreign financial accounts maintained in a U.S. military banking facility

In Pomerantz’s case, he is a U.S.-Canadian citizen who owns a foreign financial account so he is required to file an FBAR.

 How to Report and File Your FBAR

Reporting and filing your FBAR is required regardless of the taxability of your income. The law states that if you hold a foreign financial account, you are obliged to report even when your account produces no taxable income. You meet your reporting obligation by answering questions about tax returns in foreign accounts and by filing an FBAR.

Since the FBAR is considered a calendar year report, you need to do the filing on or before April 15 of the year following the year in question. You need to file electronically through the e-filing system of FinCEN.

Filing FBAR with a Federal Tax Return

In any case, you should not file the FBAR with a federal tax return. Even when the IRS extends the filing period for the income tax return, that does not mean that the period for filing an FBAR is extended as well. The good news though is that the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 has already been passed, granting taxpayers a maximum six-month extension to file their FBARs. So, should you fail to meet the April 15 deadline for FBAR filing, you have until Oct. 15 of each year to file.

 Why You Need to File a Complete and Accurate FBAR

If you want to save yourself from possible civil monetary penalties, make sure that you file your FBAR properly by ensuring its correctness and completeness. FBAR-related penalties depend on whether the violations are willful or non-willful.

For the penalties assessed by the IRS after Aug. 1, 2016 for violations committed after Nov. 2, 2015, the IRS assesses an inflation-adjusted penalty so that it won’t exceed $12,459 per violation for non-willful violations. On the other hand, the inflation-adjusted penalty for willful violations may go above $124,588 per violation.

For violations that occurred on or before Nov. 2, 2015, civil penalties usually do not exceed $10,000 per violation for non-willful violations and greater than $100,000 for willful violations.

 When You Are a U.S. Taxpayer Who Holds Foreign Financial Assets

If you are a taxpayer who has foreign financial assets exceeding certain thresholds, you need to file another form in addition to the FBAR—the Statement of Specified Foreign Financial Assets (Form 8938). You file this form with an income tax return.

 When You Have Offshore Financial Accounts

Today, the Offshore Voluntary Disclosure Program of the IRS allows those who have unreported taxable income from their foreign assets or other offshore financial accounts the chance to fulfill their reporting obligations, and that includes the FBAR. While this program does not have a particular closing date, you need to do your reporting obligations the soonest time possible as the IRS has all the mandate to close this program anytime.

When You are a Non-Resident U.S. Taxpayer Who Failed To File Required U.S. Income Tax Returns

For U.S. taxpayers who don’t reside in the U.S. and have failed to file the required U.S. income tax returns, the IRS implements certain streamlined filing compliance procedures. These procedures are exclusive to non-resident U.S. taxpayers, whose submissions are reviewed on varying degrees, depending on the response of the taxpayer to a risk questionnaire and on the amount of tax due.

In 2014, the IRS expanded these streamlined procedures to certain taxpayers residing in the U.S. The new procedure stipulates that penalties of eligible U.S. taxpayers who are non-residents should be waived, while penalties of eligible U.S. taxpayers who are U.S. residents will include a miscellaneous offshore penalty. This penalty is equivalent to five percent of the foreign financial assets of the taxpayer in question that caused the tax compliance issue.

 When You Failed to File FBAR and Are not Under a Civil/Criminal Investigation by the IRS

If there are streamlined filing compliance procedures in FBAR filing for U.S. taxpayers who are non-residents, there are also procedures that are exclusive to taxpayers who did not file the required FBAR and are not under any criminal investigation by the IRS. If the IRS has not contacted you about a delinquent FBAR, then you need to file any delinquent FBAR through FinCEN’s BSA E-Filing System.

When you enter the system, you need to choose a valid reason for your late filing and enter an explanation using the “Other” option. If your income from your foreign financial accounts are properly reported and you paid your taxes on your U.S. tax return, rest assured that the IRS will not impose any penalty for your failure to file the delinquent FBAR.

For the last handful of years, U.S. taxpayers, residents and non-residents alike, have been grappling with various changes on the IRS’ reporting requirements. Despite these changes, the need for U.S. taxpayers to disclose their foreign assets remains. Criminal and civil penalties as a result of not filing an FBAR have been alarmingly high in the last years and the U.S. government is now more stringent than ever in going after those who fail in this part of the IRS law. So if you don’t want to be in dire straits with the IRS, report when and what you should.

Applying for a U.S. Visa? Follow These Easy-to-Follow Steps

Whether you are coming to the U.S. for tourism, pleasure or medical treatment, you have to get hold of a US Visitor Visa. You need to present this non-immigrant visa if you are entering the country and won’t be staying there for good.

If you are a foreign citizen who has relatives in the U.S. and want to pay a visit, then you are qualified to apply for this visa. Under the U.S. Visa Waiver Program (VWP), however, there are certain countries which do not require this document if the trip won’t last longer than 90 days. Check out this waiver program first to see if your country is one of them.

 Salient facts about the U.S. Visitor Visa:

 It is more commonly known as the B1-B2 or simply B2 visa for U.S.A.

  • You may apply for it and get it stamped in your passport.
  • You may be granted this visa for one specific purpose only, including medical treatment or tourism. If you are entering the U.S. for business purposes, then you should apply for a B1 visa and not B2 instead.
  • Once you have your B1 visa, it means you can only stay in the U.S. for six (6) months or less. If you want to extend a little longer than 6 months, you need to request for an extension, which you may apply for at the USCIS.

How do I apply for a B2 visa?

 Just like any other travel document, the B2 visa is applied for. Should you wish to apply for this visa, you need to have your valid passport, submit the application form, pay all the necessary fees and make sure that you appear for the visitor visa interview at the nearest U.S. consulate in your country.

Here are the steps:

Step 1. Get your digital photograph. This photo is one of the requisites when applying for a U.S. visitor visa. However, you need to make sure that it meets the criteria set by the U.S. consulate. Most photo studios automatically know how a digital photo should be if it’s needed for a U.S. visa application so you don’t necessarily have to mention each and every criterion to them. Otherwise, mention these digital photo requirements:

  • It must be square in shape.
  • Its minimum dimensions should be 600 pixels by 600 pixels.
  • Its maximum dimensions should be 1200 pixels by 1200 pixels.
  • It must be colored, particularly a resolution of 24 bits per pixel.
  • It must be in JPG format.
  • Its file size must be equal or less than 240 kilobytes.

What if your consulate does not require you to upload a digital photo when filling out the DS-160 form?

If that is the case, wait for your photo to be taken at the ASC (Application Service Center) or OFC (Offsite Facilitation Center).

If you normally wear eyeglasses, you can wear them in the photo as long as their lenses are not tinted and they do not obscure your eyes. Also, avoid glare on the eyeglasses by tilting your head slightly upward or downward. You cannot wear dark sunglasses or other decorative items, unless you have hats or head coverings that you normally wear for religious purposes.

Step 2. Completely fill out the visitor visa application form DS 160. Before coming to the consulate for the next part of the application process, make sure that you have already completed this application form. You fill out this form over the internet and not anywhere else. After filling out this form, wait for the 10-digit barcode that will be sent to you as a confirmation. Then, print the page as you will need it during your visa interview appointment.

The DS 160 form is an online form required by most US consulates in the world, including India. It should be completed online prior to printing. Take note of the following that you will need before filling out this form:

  • You need to have your digital photograph in a specific format. If you haven’t uploaded or provided a photo during the online application submission, you may bring your printed photo when you go to the consulate for your personal visa interview.
  • You should confirm the consulate where you will appear for the interview.
  • You should have a reliable internet connection since you will fill out the form online.
  • You need to get your passport details ready, including the issue date and expiration date.
  • You need to specify an address where you will stay in the U.S.
  • You need to specify your social security number and U.S. tax ID number.

As for the technical requirements, here are the things that you need:

  • Your Internet Explorer (Windows) must be at least 5.0 service pack 2.
  • Your Internet browser must be able to support 128-bit encryption and should have JavaScript enabled.
  • Your Netscape must be version 6.2 or higher.
  • You must have a laser printer linked to your system so you can readily print out the confirmation page. Otherwise, you may simply take a screenshot of the page and paste it in Microsoft Word for later printing.

I already have the necessary information and technical requirements ready. What’s next?

If you already have the abovementioned requirements, it’s time to fill out the form. Here are the things that you should remember when filling out the DS 160:

  • Provide honest information–no more, no less. In the appropriate spaces provided, enter the requested information in English.
  • You will notice that most of the questions are self-explanatory. Provide the correct information all the time. When it comes to fields where an answer from you is not applicable, choose the “does not apply” option.
  • In case you plan to be away in the course of your online application, you may save your application temporarily until you are back so you may start where you previously left off. Remember that if the online application remains inactive for 20 minutes or more, your session will expire and all the data you previously entered will be lost.
  • If you are using a public computer, make sure that you delete the file after you are done.
  • Print the confirmation page and bring it with you in the succeeding parts of the application process.

How long does it usually take to fill out the form online?

Usually, if you are ready with all the requirements before filling out the form, you may complete the online application within 15 to 40 minutes. Take note that the system will not allow you to submit the form unless you have filled in all the mandatory fields.

Step 3. Pay the B2 application fee. Presently, the visa fee is $160 and is non-refundable.  When paying for this fee, you have several options. It’s either you pay it electronically as a bank transfer or you pay it in cash at the designated CitiBank or Axis Bank in your place. It’s better if you create a profile at the U.S. visa service website first and select the Schedule Appointment option before making a payment if you want to make sure that you are paying the right amount and that your payment gets activated at the right time. Once you do this, the screen will show to you the payment options and will detail how you can initiate the payment. This fee is good for one year, so you have to take an appointment schedule within the year for your visa interview.

If you are from India, you can make your payment by any of the following ways:

  • Bank Electronic Payment via NEFT. Most Indian banks support the National Electronic Funds Transfer (NEFT). Log into your profile and get a unique account number where you will send your NEFT payment. Keep this number as you will need this in your interview appointment.
  • Mobile Payment. You may also pay your visa fee using the IMPS system on your mobile phone. The problem with this, however, is that you must be preregistered with your bank and have a valid MPIN. If you choose this payment option, you can initiate your IMPS payment by sending a text to the bank or by mobile banking application. As much as possible, enter the exact amount flashed on the payment confirmation screen to avoid delays in your scheduling appointment. Make sure also that you enter the correct Beneficiary MMID number and Beneficiary Mobile Number.

Once you have made the payment, wait for a text message reflecting your 12-digit IMPS reference number. You will use this number in scheduling your interview appointments. Make sure that you are able to finalize your schedule within three (3) hours of payment.

  • Over the counter Cash Payment. If the first two options don’t work for you, you may pay your fee at any CitiBank or Axis Bank branch in India or the DRUK Bank in Bhutan. Before going to any of these banks to make your payment, print first a U.S. visa fee collection slip from your online application profile. Bring this slip with you when you make your payment and wait for the bank to give you a receipt. You need the receipt number in setting up your visa interview online.

Step 4. Schedule your visa interview. After paying your fees, the next thing that you have to do is to schedule two (2) appointments. This part of the process includes your appointment with someone from the Offsite Facilitation Center (OFC) who will facilitate you in the Biometrics, including taking your fingerprints and photo; and your appointment with the Consulate or Embassy for the actual visa interview.

Here are the documents that you need in setting up your visa appointment:

  • Your passport, which should be valid for at least six (6) months beyond your intended period of stay in the U.S.
  • Your visa application fee payment receipt.
  • Your DS 160 confirmation page, which you printed out during the online application.
  • Your email address.

Once your documents are ready, you can finally set up a visa appointment. To do this, you may go to the US visa online appointment system to take an appointment schedule, or call the following numbers: +912267209400/ +911206602222 /+13106165424 (USA local number). If you want to get your preferred date and time, then don’t wait until the last minute to book your interview.

Step 5. Schedule your fingerprinting appointment at the Visa Application Center (VAC). Once you have taken an appointment schedule with the embassy or consulate for the personal interview, it’s time to schedule the fingerprinting appointment. You must schedule this appointment at least one or two days before your actual interview at the consulate. You may ask, what about the fingerprints taken in step 4?

Under the new rules, your fingerprints must be taken not just at the Offsite Facilitation Center (OFC) but at the Visa Application Center (VAC) as well. This rule was introduced to ease the usual congestion at the U.S. consular facilities, as well as to expedite the processing of applications. Make sure that you schedule your visa interview appointment at the embassy or consulate first before your appointment at the VAC.

Step 6. Appear at the US consulate for your personal visa interview. On the date and time of your scheduled appointment at the US consulate, go to the consulate with all the required documents. Don’t forget to bring any of the following on the day of your interview:

  • Your photograph
  • Your passport, including your old passport/s
  • The DS 160 confirmation page stamped at the VAC
  • The receipts verifying your visa application fee payments
  • Your interview appointment letter
  • Other supporting documents

Today, around 7 out of 10 applications for a U.S. visa get approved, which is equivalent to 70% approval rate. If you worry about not getting your U.S. visa, just keep in mind that honesty is the key. Usually, individuals who fail to get approval from the U.S. consulate are those who falsify their documents and commit fraud in their applications. Just be true in disclosing all the required information in your application process and you can be almost sure that you are one step closer to getting to the U.S.

A Business Owner’s Guide in Deducting Business Travel Expenses

You’ve worked hard all year long that you can’t find time for some vacation. You’re worried that your business will suffer when you go away for several days. Or you may be concerned about the expenses that you will incur.

But did you know that as a business owner, you can attend a convention or seminar, squeeze in some days of pleasure, and then deduct certain expenses in your next tax return?

Sure, you won’t be able to deduct the travel expenses of your spouse or children, but with good planning, you’ll be able to get a free ride to and from your destination. You can also write off certain expenses like your lodging, meals, and even the cost of cleaning your clothes.

Think about the possibilities. You can spend a week in the Bahamas for a convention or conference and then deduct your expenses accordingly.

But before you start booking a trip to the Bahamas, it is imperative to get familiar with the rules first.

Writing Off Expenses during a Convention

The IRS is very clear about deducting travel expenses for a business convention— the participation or attendance of the taxpayer to the activity should benefit his or business.  This also applies

Let’s say you own a computer software shop. You attend a three-day IT conference in Puerto Rico, where you were able to meet some clients and bag new deals along the way.

Because the participation in the convention benefited your business, you can write off the expenses related to the said trip.

But if the convention is held for a purpose that isn’t related to your business such as political, investment, or social issues, then you won’t be allowed to deduct your travel expenses.

You can claim travel expenses related to your participation in a convention held within the United States, and other North American territories such as:

  1. Bahamas
  2. Aruba
  3. American Samoa
  4. Baker Island
  5. Bermuda
  6. Micronesia
  7. Canada
  8. Costa Rica
  9. Dominican Republic
  10. Guam
  11. Jamaica
  12. Puerto Rico
  13. S. Virgin Islands
  14. Mexico
  15. Kingman Reef
  16. Barbados
  17. Jarvis Island
  18. Netherlands Antilles
  19. Palau
  20. Saint Lucia
  21. Antigua and Barbuda
  22. Johnston Island
  23. Panama
  24. North Mariana Islands

 

However, there are two things that the IRS will look for in determining whether you can write off your expenses during a conference or convention held outside the US.

Aside from the meeting directly related to your business, the IRS will also determine the reasonableness of the convention or conference being held outside the US.

The following factors will be considered when determining the practicality of a conference or convention held within the North American region:

  1. Purpose of the meeting as well as the activities that took place
  2. Purpose of the sponsoring groups
  3. Homes of the active members of the sponsoring organization or group

Going back to our example, you can argue that the three-day conference held in Puerto Rico is reasonable because most of the active members of the group that sponsored the event are based in Puerto Rico, Mexico, Cuba, and nearby territories.

The IRS will likely call for an audit in case the sponsoring organization and all of the participants in the convention work or live in the United States. Obviously, the tax authorities will feel that the convention isn’t necessary because the participants and the sponsoring group are based in the US.

Here’s a tip–keep the official agenda or program of the convention or workshop which you are participating in. This can prove that your claim is warranted, especially if you can show that the official agenda of the convention is related to your business or trade.

Allowable Deductions

If you are able to satisfy the requirement of the IRS on business travel, particularly participation or attendance in conventions, you will be able to write off the following expenses:

  1. Transportation
  2. Lodging
  3. Baggage and Shipping
  4. Meals
  5. Cleaning
  6. Communication expenses
  7. Others

Most of these expenses are 100% deductible, except for meals.

Transportation covers your travel expenses from your home and business destination. It doesn’t matter if you used your car, took a bus, rode a train, or traveled by airplane. You are legally allowed to claim 100% of your transportation expenses for a legitimate business travel.

Obviously, you can’t claim a free ticket or a free ride as a reward for being a frequent traveler.

In case you had to take a cab or rent a car to shuttle back and forth from your hotel to the place where the convention was held, you can also claim those expenses as tax deductible. The same goes for the taxi or car rental costs for bringing you from the airport or station to your hotel.

If you brought your own car, you can deduct costs of gasoline, toll, and parking.

You can also claim 100% of your lodging expenses during the entire business trip.

You can also claim the costs of laundry and dry cleaning, in case you needed those services while at a convention. Business call expenses may also be written off.

In fact, you may even deduct tips that you pay for the above mentioned services.

Cruise Ship Conventions

You may wonder what deductions you can claim if you attended a convention onboard a cruise ship.

You may claim the same deductions, but you are limited to a ceiling of $2,000 every year if you attended a cruise ship convention.

Moreover, there are certain requirements that you will have to meet if you want to qualify for a tax deduction for a cruise ship convention or similar meeting.

First, the cruise ship where the convention or seminar was held should be registered in the US. This is a tough requirement to meet, as there are only a handful of ocean-worthy ships that are registered in the US.

Thus, you should check first the registry of the ship before signing up for a cruise ship convention. If not, then the expenses you will incur won’t be tax deductible.

Another requirement that you should meet if you are to write off your attendance in a cruise ship convention is that the ship must make all its ports of calls in the US.

Moreover, you are required to show a written statement that details the number of days you spent on the cruise ship, a breakdown of the number of hours spend each day to business activities, and a program of activities of the entire convention.

You will also have to attach a written statement signed by an officer of the group that sponsored the said activity. The statement should detail the daily schedule of business activities of the convention, as well as your hours of attendance at the said activities.

As you can see, it is quite a task for business owners to write off cruise ship conventions. The IRS obviously does not want taxpayers to deduct their vacations in their tax returns.

Foreign Travel

If business travel within the US is closely scrutinized by the IRS, you can expect the same for foreign travel.

Foreign travel spent solely for business is 100% deductible. This means that if you spend 100 percent of your waking time on foreign soil for business-related activities, then you can claim all your travel related expenses.

What if you didn’t spend all your time abroad for business? Can you still make a claim?

Yes, provided you meet any of these exceptions:

  1. You don’t have substantial control over the trip. Employees who were reimbursed for their travel expense allowance as well as those who aren’t related to the employer are allowed to claim their travel expenses under said circumstance.

But since you are the business owner, then it means you can control the timing of your trip. Hence, you won’t be able to write off your travel expenses abroad.

  1. Prove that vacation wasn’t the primary consideration in arranging the trip. Even if you are the business owner who has control over arranging the trip, you can write off your expenses if you can prove that vacation wasn’t the main consideration in the trip.
  1. You were abroad for less than a week. Your trip may be considered solely for business if you were outside the US for 7 days or less. The IRS says you should count the day you return to the US, and not the day that you left the country.
  1. You spent 75 percent of your time for business. You may be outside the country for more than a week, but you can still deduct expenses during your business travel if you can prove that you spent less than 25 percent of your time on personal activities.

For instance, you spent 20 days in Europe. After 15 days of non-stop meetings, you spent four days going around. The final day was then for your travel back to the US.

Since you spent 75 percent of your time in Europe for business activities, you can deduct your business-related expenses during the trip. This includes the cost of round-trip plane fare, and 50 percent of your meal expenses during the 15 days.

Travel Primarily for Personal Reasons

It should be clear by now that you can’t claim deductions for a vacation or personal trip. Yet there are times when you are on vacation and fortunately stumble upon a business opportunity. Can you make a claim on the expenses that you incurred on a business-related activity?

The answer is yes. You can if you can prove that the expenses are directly related to your trade, or even better, can boost your business.

Let’s go back to our example.

You were on a vacation with your family in Miami when you heard of a three day Internet security seminar.  Since you run a computer software business, you felt that attending the seminar can update you on the latest in Internet security. Or that you can get new clients by participating in the said activity.

You can deduct registration fees, transportation costs, and meal expenses that you incurred while you were at the seminar. You can even charge your hotel fees, in case you booked one during the course of the activity.  The same goes for your laundry and dry cleaning expenses.

But can you charge your airfare? No, since you had traveled to Miami primarily for personal reasons.

How to Avoid an Audit

Now that you have an idea on the deductible expenses that you can claim during a legit business travel, you may wonder—how can I avoid getting audited by the IRS?

Here are some tips that you should keep in mind:

  1. Record everything you did during your business travel. The last thing that you want to happen is for the IRS to conduct an audit after you had written off travel expenses you had incurred two years ago. By then, you would likely have forgotten the details of your meetings, or lost hotel bills and receipts.

For example, write down the names of the people you had lunch with at the back of a receipt issued by a restaurant. You should also keep all the hotel receipts you had.  And take photos of your meetings to prove that you indeed had business activities during your trip.

  1. Don’t deduct travel expenses of your spouse. If you brought your significant other with you, then you won’t be able to claim a deduction for her expenses unless she’s your employee or she played an essential role during the business travel. And no, that doesn’t mean taking down notes for you or socializing with your clients.

You must prove that your spouse’s presence during the travel was necessary, like serving as your translator.

  1. Be reasonable. The tax authorities would know if you claim extravagant expenses. So unless you’re treating a client who’s a billionaire, then you probably don’t want to expense a fancy dinner at the Ritz.

So, are you ready to mix business with pleasure on your next travel.