Succession Planning and Taxes: What You Need to Know

If you own a business, planning for future transitions and taxation should start now.

Key takeaways

  • Business structure matters for taxes, whether it’s a pass-through entity, S or C corporation, or another entity
  • The Tax Cuts and Jobs Act lowered the corporate tax rate, and it also created the qualified business income deduction for pass-through entities
  • The gift tax exemption was increased by the TCJA, but the increase sunsets in 2025

By now, you may have secured your estate plan and tax planning responsibilities. But what about your succession plan?

If you own a business and don’t put the right plan in place, you can leave it vulnerable to unnecessary taxes and possible conflict about who owns what. The brand, company reputation, and wealth you’ve built could be put in the balance long term. You’ve worked hard to create a successful business. So, why not ensure the company is valued and passed on properly once you’re out of the picture? 

Taxes are one of the most important factors that play a role in succession planning. Keep these considerations in mind when you’re working through your plan.

Business structure and taxation

The type of business structure you operate as matters a great deal for taxes. You want to ensure that your entity will set up your business for many years of success into the future. 

Of course, succession planning shouldn’t be the only thing to consider when deciding on the right structure, but it’s still an essential piece to the puzzle. The structure is a major factor that significantly impacts personal and business taxation when business ownership is being transferred.

Closely held businesses can be sole proprietorships, partnerships, LLCs, S corporations, and C corporations. Let’s walk through some considerations for each entity type.

Sole proprietorships (and default LLCs)

The sole proprietorship is for single business owners, and there is no separation of personal and business assets and liabilities. An LLC offers liability protection, but it is still taxed like a partnership unless the owner(s) elects to become a corporation. Sole proprietorships and some LLCs dissolve if the owner dies, but a succession plan can ensure that business assets pass to an intended inheritor.

Partnership

Partners within a general partnership have unlimited personal liability that can negatively impact personal assets. Those in a limited partnership have liability only as much as their investment. Sometimes, these reasons are enough to avoid the general partnership setup. 

However, the owner of a family limited partnership can help lower the tax burden when wealth is transferred to the next generation. Family limited partnerships help you reduce your tax burden because they minimize your taxable estate when you transfer some business value to your heirs. When you pass on limited partnership interests, they are eligible for the annual gift tax exclusion, so shares can legally be reduced when transferred. 

C corporation

Many businesses are C corporations, with an essential characteristic being that the business is a very distinct entity from the business owners. This means the liability is not on the owners, both financially and legally, so it’s a form of protection that sole proprietorships and partnerships don’t offer. For succession considerations, it can be more tax-efficient to have personal affairs completely separate from the business’s affairs.

S corporation

S corporations also offer that separate-entity protection like a C corporation. But they are taxed as a pass-through entity, meaning that the business doesn’t pay corporate taxes, and any income or losses are reported on the individual income returns of shareholders. Companies must not have more than 100 shareholders to convert to an S corporation. 

As a pass-through entity, there are several tax advantages when succession planning and transferring ownership. It’s easier to move funds from the business entity to a shareholder, and ownership transfer is easier with fewer tax and regulatory requirements. 

However, keep in mind that if an initial public offering (IPO) could be in a business’s future, the benefits of instead choosing a C corporation may outweigh these other succession considerations. 

Impacts of the Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act (TCJA) of 2017 implemented a few changes that may affect a succession plan. The C corporation federal income tax rates were lowered from 35% to 21%, and the individual tax brackets were also reduced from between 10% to 39.6% to between 10% to 37%. You can use these new numbers and estimate personal income, business income, and dividends to see which structure would benefit you the most.

The TCJA also created a qualified business income (QBI) deduction, which allows qualifying pass-through entities to deduct 20% of qualified business income, but it includes phase-out limits. There are a few ways to lower income to stay below the phase-out limit, including retirement plan deductions. 

For example, you could set up a retirement plan like a SEP or 401(k) and contribute up to the plan’s limit, lowering income to qualify for the deduction. A defined benefit plan will allow you to make the biggest contributions while taking advantage of tax deferment and additional asset protection from creditors.

Gift and estate taxes

Creating a succession plan now keeps you ahead of the game for substantial taxes associated with the business, including estate and gift taxes. The right strategy for a transfer of ownership can help you reduce or even eliminate some of them.

If you decide to sell your business before you die, you may have to pay capital gains tax. However, no matter when you sell, proceeds could help cover your current lifestyle or future estate taxes. The gift tax won’t apply to the sale as long as the price is at least equal to the full fair market value.

There is currently an increased estate and gift tax exemption from the TCJA, now at $11.7 million per person or $23.4 million per couple for 2021. Transfers of interests made within a limited partnership are eligible for the gift tax exclusion, and the value of shares can be lowered when they’re transferred. This means your heirs will be able to reduce the taxes they have to pay. However, keep in mind that the increase is currently set to sunset on January 31, 2025.

Another option of note is the grantor retained annuity trust (GRAT), which may allow you to transfer business assets to your children. They will still be able to earn income, and a GRAT may also make sure that your business isn’t subject to high taxes as its value appreciates. Just keep in mind that a GRAT must be held for a certain number of years, and you must outlive that term to receive all the estate tax benefits.

Working with a tax professional

All of these moving parts will impact how you approach succession planning. There is no one right strategy, and choosing one requires weighing multiple factors about your business structure, future plans, and family goals. 

Work with a tax professional who can help you customize a succession plan that will lower your tax burden and set up your company’s new stewards for success. You’ve worked long and hard to create your business—make sure things go smoothly when it’s time for you to step aside.

Contact Provident CPA and Business Advisors to talk with our team about succession planning and taxes. 

Should You Hire a W-2 Employee or a Contractor?

There are pros and cons to hiring a regular employee versus an independent contractor. Consider your goals and priorities and find the right answer for your business.

Key takeaways

  • The pros of hiring a regular W-2 employee include team-building and more supervision and control.
  • The pros of hiring an independent contractor include cost savings and greater flexibility. 
  • There are legal implications for both, but regular employees require more attention to tax regulations and employment laws.
  • Ask the right questions about your business’s current position to determine which option is right for you.

As your business grows, you need additional people to get everything done. You may have carved out the budget for a full-time worker who will receive benefits and be an integral part of your team. But with the influx of workers in the gig economy, you have a lot more options to hire flexible help instead of solely onboarding W-2 employees.

How do you know which is right for you? This guide will walk through the pros and cons of hiring contractors versus regular employees to help you make the right call.

Hiring a regular employee

A “regular” employee means that they work part-time or full-time and receive a W-2 tax form. These individuals are on the standard payroll, and you withhold taxes from each of their paychecks. They often have regularly scheduled working hours and go through the typical hiring and onboarding process. 

Hiring W-2 employees has many benefits for your business and each employee. They will likely receive some kind of benefits, whether health insurance, paid time off, or retirement contributions. Providing people who work for you with these benefits can contribute to employee satisfaction and productivity and build a strong company culture that drives the business. 

Another benefit is that these workers provide more consistent work and will often become masters of the business’s processes and systems. A continuous, steady role means that they may be more confident in ensuring that workflows are smooth and successful. Teams of regular employees can be more synchronized at work.

There are, however, downsides to hiring regular employees. These include:

  • There are significant costs associated with benefits.
  • Salary expenses add up fast.
  • You may have to provide work equipment, like a computer.
  • Training and onboarding may be lengthy and costly.
  • Hiring a regular staff member is a bigger commitment, which can be a con if they don’t turn out to be suitable for the job.

Care should be taken when hiring a regular employee since they will likely become a crucial part of your team. 

Hiring an independent contractor

On the other hand, hiring an independent contractor can be a wise choice for many businesses. The two primary benefits of going this route are cost savings and flexibility:

  • Cost savings: When hiring a contractor, you don’t have to pay for benefits, a regular salary, work equipment, or training. 
  • Flexibility: It’s pretty enticing to businesses to be able to hire a professional on a project-by-project basis. You only have to pay for what you need, when you actually need it. 

Another benefit is that independent contractors are often experts in their field. These professionals can usually step in and take on a project without a lot of onboarding requirements. Their business runs on their contracts’ success, so many will be reliable, committed workers throughout the contract period.

There are still drawbacks to working with independent contractors, however. While you’ll likely save money and get more flexibility, you also may not have as much control over what they’re doing. You’re not really their boss or supervisor, and they will be more autonomous than a regular employee. They’re probably working with other businesses as well, which could mean your projects aren’t always top priority.

With independent contractors, you also don’t get those team-building benefits to support a strong company culture as you would with W-2 workers.

The legal and tax implications of who you hire

You will have tax reporting requirements for both regular employees and contractors. However, your obligations will be heftier for regular workers. The company will need a payroll process in place to stay compliant with payroll regulations and tax obligations. You must follow federal and state laws that regulate how they get paid, overtime, workers’ compensation, and workplace policies like anti-discrimination and anti-harassment guidelines. 

There are many more laws and regulations to follow with regular employees than there are with contractors.

With an independent contractor, you will usually gather a W-9 from them and issue a 1099-MISC that reports everything paid. You don’t have to worry about withholding FICA taxes or paying workers’ compensation insurance.

Which option is right for your business?

Choosing an independent contractor or regular employee has both short- and long-term implications. If you still aren’t sure after reviewing these pros and cons, ask yourself questions like the following to further help you decide:

  • Is your project ongoing, or is it a one-time or infrequent project? 
  • What kind of business budget do you currently have for extra help? 
  • Can you afford to pay for a new set of benefits?
  • Can you afford to pay a competitive salary for a W-2 employee?
  • Can you afford to pay a competitive hourly rate for a contractor?
  • How important is team building in your business’s current growth stage?
  • Do you need short-term results or ongoing, long-term assistance with a business function?
  • Who will be handling training and onboarding? 
  • Do you have time to train someone?
  • Are you prepared to follow all federal and state employment laws related to W-2 workers with policies and processes?
  • Is control over working hours and schedule important to you?
  • Do you need to supervise the work being done closely?

Sometimes, the best way to determine which type of worker to hire is to ask yourself which tasks are part of your business’s core services and values. The crucial functions may be performed best by a full-time employee, while less pivotal duties are taken on by independent contractors as needed.

Getting help from a business advisor

Hiring an employee or an independent contractor is a big step, no matter which direction you choose. Ensure you’re making the right choice by discussing your business needs and financial situation with business strategy and tax professionals. 

Contact Provident CPA and Business Advisors to create the right strategy and take the correct tax-planning approach. We will help you minimize your tax burden and set you on the path toward long-term growth by identifying your critical business drivers, helping you build teams, and more.

Do I Need to Pay Estimated Tax to the IRS?

If you receive non-wage income, you may need to pay estimated taxes each quarter. Learn who must pay and how payments are calculated. 

Key takeaways

  • Estimated quarterly taxes are paid by workers who are not standard W-2 employees
  • Taxpayers who run their own business or work as an independent contractor need to pay estimated tax
  • Payments are due April 15, June 15, September 15, and January 15
  • Note the self-employment tax, which is a 15.3% tax that comprises Social Security and Medicare 
  • A tax professional can help you calculate what you owe in estimated tax

Running your own business brings lots of perks, including more flexibility and control over what you do. But there are tax implications that you need to be aware of if you are a freelancer or running a sole proprietorship, S-Corp, or another entity.

Many business owners and contractors must pay quarterly taxes throughout the year, known as estimated tax payments. Here is your guide to what these payments are, what kind of business structures need to pay them, and how to do it. We’ll also briefly discuss what the self-employment tax is.

What is estimated tax?

If you are a qualifying entity, you need to pay an estimated quarterly tax if you owe more than $1,000 each year when filing your tax return or have a qualifying corporation and owe more than $500 when filing. These are the payment due dates for each quarter: April 15, June 15, September 15, and January 15.

Because business owners and sole proprietors do not have an employer withholding tax from each paycheck, regular tax payments must be made throughout the year to make up for it. Aside from the income tax obligation, estimated taxes cover self-employment tax and alternative minimum tax. 

Next, let’s talk about who has to make these payments.

Who must pay quarterly estimated tax?

The IRS states that if you are “in business for yourself,” you will usually have to make estimated tax payments. This includes independent contractors, freelancers, and taxpayers with side gigs. These types of businesses must also pay estimated tax:

  • Sole proprietors
  • Partners
  • S corporation shareholders
  • Some corporations

If you are a regular W-2 employee, you probably do not have to pay estimated taxes unless you earn money on the side. If you are one of the above entities and earn a salary or regular wage, you may be able to have your employer withhold more tax from your wages to avoid having to make quarterly tax payments.

You also don’t have to pay estimated tax if you had zero tax liability the year before, were a U.S. citizen for the entire year, and the prior tax year covered a complete 12-month period.

How do you pay estimated tax?

If you have to pay, you can figure out how much you owe by using Form 1040-ES. You’ll need to determine your estimated adjusted gross income, taxable income, deductions, credits, and taxes for the entire year. Try taking a look at your tax information from last year if your situation is similar. Alter how much tax you expect to pay by figuring out how much you will likely earn this year, whether it’s more or less. You then divide what you expect to owe in taxes for the year by four and pay that amount per quarter.

Form 1040-ES walks you through how to figure your estimated tax for each quarter. You will enter information about: 

  • Adjusted gross income
  • Credits
  • Self-employment tax
  • Other taxes

Follow the prompts and instructions on the form to calculate the exact numbers. Then take a look at the applicable year’s tax rate schedules to determine your tax bracket.

You can pay estimated taxes using one of the following methods:

  • Paying online, via IRS Direct Pay or the IRS2Go mobile app, using a credit or debit card, electronic fund withdrawal, or Online Payment Agreement (if you cannot pay in full by the due date)
  • Paying by phone
  • Paying by cash, in person
  • Paying by check or money order using your estimated tax payment voucher

Usually, the fastest and easiest way to pay is via IRS Direct Pay, which can be found at IRS.gov/payments, or on the IRS2Go mobile app. On the IRS payments page, you will select whether you want to pay by bank account transfer or card, choose “Make a Payment” on the next page, and choose your reason for payment as “Estimated Tax.” Make sure you pay by the deadlines each quarter.

What is the self-employment tax?

Part of estimated quarterly taxes is figuring the self-employment tax you owe. The self-employment tax rate is 15.3%, which covers two types of tax: Social Security (12.4%) and Medicare (2.9%).

Because self-employed individuals do not make these contributions from their paychecks, this additional tax is included when making estimated tax payments. And they must pay the full 15.3%, whereas W-2 employers typically cover half of it. This tax is paid on top of income tax and does not replace it. 

To find out your self-employment tax obligation, subtract your business expenses from your gross self-employment income. Typically, 92.35% of self-employment earnings are subject to the self-employment tax, so multiply those earnings by the 15.3% rate. 

In 2020, the first $137,700 of earnings was subject to the Social Security tax; it is $142,800 in 2021. If you earned over $200,000 from self-employment, you might also owe an additional 0.9% Medicare tax.

Talk to a tax professional if you have questions

If you earn income from running your own business or working as an independent contractor, you will probably need to pay quarterly estimated tax payments each year. When you are unsure about your obligations or whether your work qualifies, talk to a tax expert who will make sure you file everything correctly. 

The Provident CPA and Business Advisors team can guide you through tax planning and help you figure out precisely what you need to pay in estimated taxes each quarter. We will help you file your annual tax return and ensure you take advantage of any credits and deductions for which you qualify.

Contact Provident CPA and Business Advisors to get started.

What Are the Tax Implications of Working Remotely?

Many Americans who have been working remotely don’t know state-by-state tax laws, which could mean they’ll be hit with an unexpected bill. Here’s what you need to know.

Key takeaways

  • Americans working remotely might have to pay more taxes if they worked in more than one state
  • Other tax implications for some remote workers include work-from-home tax deductions, like the home office deduction

Over the last year, businesses of all sizes shifted to remote work environments, and more employees telecommuted than ever before. Many companies have realized that remote work has its own set of benefits, and the trend isn’t going to go away anytime soon.

Of the American workers whose jobs can be done remotely, 71% have worked from home over the last year. More than half of those remote workers say they want to continue working from home, even after pandemic restrictions are completely gone.

While working remotely has perks, there are a few tax implications to be aware of. It’s not always easy to understand whether you can take the home office deduction or work in other states without making changes to tax withholding or paying more.

Here are some important points to consider if you’ve been working remotely and are trying to prepare your taxes.

Remote work in a different state

First, let’s talk about what happens when you work remotely in a different state from where the company offices are located. Each state has laws about how remote work is handled. Unfortunately, almost half of remote workers (47%) surveyed by the Harris Poll for the AICPA said they aren’t aware that each state has its own remote-work laws.

There could be significant consequences if taxpayers don’t change the state withholding taxes from their paychecks to reflect where they actually worked. If taxpayers didn’t change their withholding by the end of 2020, they could have a more significant state income-tax liability this year.

For instance, because each state’s laws vary, people who have worked in several different states this year may face a variety of filing requirements or tax liabilities.

Each state outlines the period worked there to be liable for state income taxes, including from one day of work to 60 days. Many states also have rules for when you are considered a statutory resident of the state. If you have lived in a state for usually more than 183 days, the state will require that all of your income is taxable, so you could face dual taxation if you are found to have dual residency.

There was some government focus on these matters after the pandemic, with proposals for the Remote and Mobile Worker Relief Act being part of the Senate’s COVID-19 relief bill. This legislation would create a national standard for employees working in different states than business offices, including a 90-day grace period for working in a state before an employee is subject to its tax liability. However, this proposed bill has yet to gain much traction.

If you have worked remotely in a different state than where your company’s office is located, make sure you research state and local laws to ensure you don’t get hit with a surprise tax bill. Note that your federal taxes will likely not be impacted based on the state you worked in. 

Deductions for remote workers

Other significant tax implications for remote workers are related to the work-from-home deductions you can take. Let’s walk through a few of them:

1. Home-office deduction

You may think you’re able to claim the home office deduction if you use a space in your home for work. But it’s only available to some workers. If you are a regular W-2 employee, you can no longer take this deduction, as it was eliminated as part of the Tax Cuts and Jobs Act.

Self-employed individuals who use their home office exclusively for their business—and use it regularly—can take the home office deduction.

2. Business expenses

Independent contractors can also write off many of their business expenses for working from home, including:

  • Equipment or supplies used for business
  • Utilities costs (internet, electricity, cell phone)
  • Depreciation on assets
  • Health insurance premiums
  • Business meals
  • Travel costs for travel lasting longer than a workday and requiring that you stay somewhere to rest
  • Use of a vehicle for business (mileage, depreciation, insurance, gas, oil changes)
  • Business-related subscriptions
  • Business insurance
  • Rent expenses
  • Some retirement contributions
  • Advertising costs
  • Business startup costs

Again, these expenses may only be deducted by self-employed individuals, not most regular W-2 employees. However, some employers are assisting their remote workers with stipends related to these costs.

3. Qualified business income deduction

A significant deduction available for qualifying businesses in 2020 is the qualified business income (QBI) deduction. This benefit is for small business owners or self-employed individuals and is up to 20% of QBI. The income limit is $163,300 for single taxpayers and $326,600 for joint filers.

Sole proprietorships, partnerships, S corporations, and LLCs may be eligible to take this deduction. Qualified income includes your business’s net profit but excludes income earned outside the U.S., some guaranteed payments, dividends, capital gains or losses, and interest income.

Many small business owners and self-employed workers who are working remotely may qualify for this 20% deduction, so ask a tax professional for more details. 

Work with a tax expert from Provident CPA & Business Advisors

If you have shifted to a remote-work environment this year, make sure you know if there are tax consequences or if you qualify for work-from-home deductions. The tax professionals at Provident CPA & Business Advisors are ready to walk you through your potential obligations and credits. We help our clients pay the least amount of tax legally possible and clearly explain how changing laws and regulations apply to their situation.

Contact us to learn more about our tax planning services for business owners and individuals.