Author: Leon Clinton

Tax

Self-Employed with No Employees? Get Your COVID-19 Cash Now

Get ready for this: “I’m from the government, and I’m here to help.”

Here’s the deal: “I’m going to give you $20,833 today. I want you to give me $5,448 no later than two years from now. You can keep the $15,385 difference, tax-free—no strings.”

It’s true. The lucky recipient could be you. To obtain the full $15,385 tax-free cash result in this deal (one of many COVID-19-related assistance programs), you must

  • be self-employed,
  • have no employees, and
  • have self-employment net profits of $100,000 or more.

If you are self-employed, you have no employees, and your net profits are

  • $75,000, you pocket $11,538, tax-free.
  • $50,000, you pocket $7,692, tax-free.
  • $25,000, you pocket $3,846, tax-free.

The results above come from the COVID-19 Payroll Protection Program (PPP). When you are a self- employed taxpayer with no employees, the PPP treats you as the one and only employee, and treats your net profits as your payroll.

Big Picture

Under the PPP, you go to your bank or another Small Business Admistration (SBA) bank or lender and obtain the PPP loan based on your 2019 net profits. It’s a no-doc loan—super easy. No credit report, no nothing.

Here’s a link to the SBA application that we downloaded to our website (your bank may have its own version).

Do This Now

Two steps:

  1. Read this article.
  2. Get your bank (or another bank) to accept your application.

Don’t Procrastinate

The SBA runs out of PPP money in a hurry. The second round of funding started a few days ago.

If you snooze, you lose. And then you’ll have to wait until round 3 of funding, should it take place. (We think it will.)

If you are self-employed, with no employees, you absolutely need to qualify for this loan and its forgiveness. Think free money. Think cash help during this crisis.

Here are three questions and answers from the new SBA Interim Final Rule that will help you understand this program during these COVID-19 times. Read on.

Q&A 1

Question 1. I have income from self-employment, have no W-2 employees, and file a Form 1040, Schedule C. Am I eligible for a PPP loan?

Answer 1. You are eligible for a PPP loan if2

  • you were in operation on February 15, 2020;
  • you are an individual with self-employment income (such as an independent contractor or a sole proprietor);
  • your principal place of residence is in the United States; and you have filed or will file a Form 1040 Schedule C for 2019.

Q&A 2

Question 2. Since I have no employees, how do I calculate the maximum amount I can borrow, and what documentation is required?

Answer 2. Follow the three steps listed below:3

  1. Find your 2019 IRS Form 1040 Schedule C line 31 net profit. (If you have not yet filed your 2019 tax return, don’t fret. Fill out the Schedule C now. You need it for the loan.) If the net profit amount is over $100,000, reduce it to $100,000.
  2. Calculate the average monthly net profit amount (divide the net profit by 12).
  3. Multiply the average monthly net profit amount by 2.5.

Q&A 3

Question 3. What amount of the loan qualifies for forgiveness (remember, I don’t have any employees)?

Answer 3. You are going to like this. With no employees, your loan forgiveness is4

  • eight weeks’ worth (8/52) of your 2019 net profit (yes, last year, from that Schedule C you used for the loan amount—you don’t have to consider your 2020 profits);
  • mortgage interest paid during the covered period (eight weeks from loan receipt) on real or personal business property (the interest you will deduct on Schedule C);
  • rent payments during the covered period on lease agreements in force before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C (business rent payments); and
  • utility payments under service agreements dated before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C (business utility payments).

The SBA will reduce your loan forgiveness by any COVID-19 qualified sick or family leave tax credit you claimed. Your loan is for two years, but you don’t have to wait much longer than the eight weeks to apply for forgiveness. There are no prepayment penalties.

Example

Loan amount. Say your Schedule C shows $120,000 of net profit. Your limit is $100,000. Divide that by 12, and your monthly amount is $8,333. Multiply that by 2.5, and your loan amount is $20,833.

Loan forgiveness. Your loan forgiveness is $15,385 (8/52 of $100,000) plus qualifying interest, rent, and utilities, not to exceed total loan forgiveness of more than $20,513.

In the SBA loan application, the amounts from this example show as follows:

  • Average monthly payroll: $8,333
  • x 2.5 = $20,833

Number of employees: self

Paperwork

The paperwork is easy:

  • Your 2019 1040 Schedule C (if you have not filed yet, complete Schedule C now)
  • Proof that you were self-employed during 2019, such as a 2019 Form 1099-MISC, invoice, bank statement, or other book of record
  • Proof that you were operating as a Schedule C business on or around February 15, 2020 (a 2020 invoice, bank statement, or book of record)
  • Completed application with an SBA lender

Other Facts to Know

How can I request loan forgiveness?

You submit your forgiveness request to the lender that is servicing the loan. The lender must make a decision on the forgiveness within 60 days.

What is my interest rate?

1.00 percent fixed rate.

When do I need to start paying interest on my loan?

All payments are deferred for six months, but interest will continue to accrue over this period.

When is my loan due?

In two years.

Can I pay my loan earlier than two years?

Yes. There are no prepayment penalties or fees.

Do I need to pledge any collateral for these loans?

No. No collateral is required.

Do I need to personally guarantee this loan?

No. There is no personal guarantee requirement.

Takeaways

It’s true: the government is here to help your self-employed business during these difficult times, even when the only worker is you. The funds you receive and the minimum amount forgiven are automatic— based solely on your 2019 Schedule C net profit.

You need to move quickly. The government’s newest (round 2) PPP funding will be used up in a matter of weeks.

Get in the game now. Even if you miss out on this round 2 of funding, having your application on file for a possible round 3 of funding would give you a head start.

 

 

Tax

If You Don’t Want 100 Percent Depreciation, Elect Out or Else

If You Don’t Want 100 Percent Depreciation, Elect Out or Else

As you likely know, the TCJA increased bonus depreciation to 100 percent. Unlike most tax provisions that involve a tax election, this one requires you to elect out if you don’t want it.

For example, you (or your corporation) buy two $50,000 trucks, each with a gross vehicle weight rating of 6,500 pounds and a bed length of 6.5 feet. You use the trucks 100 percent for business. Because of the weight and bed size, the trucks are exempt from the luxury passenger vehicle depreciation limits.

You have five choices on how to deduct the vehicles on your 2019 tax return (the one you are filing or about to file—we are in tax season):

  1. Do nothing. This forces you to use bonus depreciation and deduct the entire $100,000 cost in year one. In addition, you deduct your operating expenses such as gas, oil, and insurance.
  2. Elect out, choose Section 179 expensing of any amount of your $100,000 cost of the trucks, and depreciate the balance. For example, you could elect to deduct $30,000 of Section 179 expensing on each truck and then depreciate the remainder using MACRS. In addition, you deduct your operating expenses such as gas, oil, and insurance. (Note. The trucks are not subject to the $25,000 SUV ceiling because of their weight and bed length.)
  3. Elect out, don’t use Section 179, and depreciate the trucks using the five-year MACRS depreciation schedule (which takes six years).
  4. Elect out, don’t use Section 179, and depreciate the trucks using the five-year straight-line depreciation schedule (which also takes six years).
  5. Use the 57.5 cents IRS standard mileage rate for each business mile driven. The 57.5 cents per mile rate includes operating expenses and 27 cents a mile for depreciation.

Okay, you get the big picture. Two trucks, each with a cost of $50,000 and both exempt from the luxury vehicle limits. Five choices as to the deduction.

Luxury Vehicles

Because of their gross vehicle weight, the vehicles mentioned above were exempt from the luxury vehicle depreciation limits that apply to

  • cars with curb weight of 6,000 pounds or less, and
  • SUVs, pickups, and crossover vehicles with a gross vehicle weight rating of 6,000 pounds or less.

Had the vehicles failed the weight test, their bonus depreciation for 2019 would have been limited to $18,100.

Tax

Husband-Wife Partnerships: The Tax Angles

Husband-Wife Partnerships: The Tax Angles

When both members of a married couple participate in an unincorporated business venture, must it be treated as a husband-wife partnership for federal tax purposes? Answer: maybe, or maybe not. Figuring out the answer is important because it can have a huge impact on the couple’s self-employment tax situation.

Husband-wife partnerships must also file annual federal returns on Form 1065 along with the related Schedules K-1. As you know, partnership returns can be a pain. For these reasons, you generally want to avoid husband-wife partnership status when possible.

Example: Self-employment Tax Hit on Profitable Husband-Wife Partnership

Your husband-wife partnership will produce $250,000 of net self-employment income in 2020 (after applying the 0.9235 factor that reduces net income to taxable self-employment income on Schedule SE).

Assume the $250,000 is properly split 50/50 between you and your spouse ($125,000 for each). You owe $19,125 of self-employment tax (15.3 percent x $125,000), and so does your spouse, for a combined total of $38,250.

The problem with husband-wife partnership status in your situation is that the maximum 15.3 percent self-employment tax rate hits $125,000 of net self-employment income not once but twice (first on your Schedule SE and again on your spouse’s separate Schedule SE).

In contrast, if you could say that your business is a sole proprietorship run only by you, only you would be on the hook for the self-employment tax.

You would pay the maximum 15.3 percent self-employment tax rate on the first $137,700 of your 2020 net self-employment income, but the self-employment tax hit would be “only” $24,325 [(15.3 percent x $137,700) + (2.9 percent x $112,300) = $24,325]. That’s a lot better than the $38,250 self-employment tax hit if your business is classified as a 50/50 husband-wife partnership.

When Does the Husband-Wife Partnership Actually Exist for Tax Purposes?

Good question. As you can see from the preceding example, the self-employment tax can make the husband-wife partnership an expensive proposition. Of course, the IRS would love it if you had to treat it that way.

Not surprisingly, several IRS publications attempt to create the impression that involvement by both spouses in an unincorporated business activity usually creates a partnership for federal tax purposes.

IRS Publication 334 (Tax Guide for Small Business) says the following:

If you and your spouse jointly own and operate an unincorporated business and share in the profits and losses, you are partners in a partnership, whether or not you have a formal partnership agreement.

In other words, you don’t have to believe that you have a husband-wife partnership to have a husband-wife partnership for tax purposes.

Similarly, IRS Publication 541 (Partnerships) says:

If spouses carry on a business together and share in the profits and losses, they may be partners whether or not they have a formal partnership agreement. If so, they should report income or loss from the business on Form 1065.

But in many (if not most) cases, the IRS will have a tough time prevailing on the husband-wife partnership issue. Consider the following direct quote from IRS Private Letter Ruling 8742007:

Whether parties have formed a joint venture is a question of fact to be determined by reference to the same principles that govern the question of whether persons have formed a partnership which is to be accorded recognition for tax purposes. Therefore, while all circumstances are to be considered, the essential question is whether the parties intended to, and did in fact, join together for the present conduct of an undertaking or enterprise.

The following factors, none of which is conclusive, are evidence of this intent:

  1. the agreement of the parties and their conduct in executing its terms;
  2. the contributions, if any, that each party makes to the venture;
  3. control over the income and capital of the venture and the right to make withdrawals;
  4. whether the parties are co-proprietors who share in net profits and who have an obligation to share losses; and
  5. whether the business was conducted in the joint names of the parties and was represented to be a partnership.

In many (if not most) real-life situations where both spouses have some involvement in an activity that has been treated as a sole proprietorship, or in an activity that has been operated using a disregarded single-member LLC that has been treated as a sole proprietorship for tax purposes, only some of the five factors listed in Private Letter Ruling 8742007 will be present. Therefore, in many such cases, the IRS may not succeed in making the husband-wife partnership argument.

Regardless of the presence or absence of the other factors listed above, the husband-wife partnership (LLC) argument is especially weak when (1) the spouses have no discernible partnership agreement and (2) the business has not been represented as a partnership to third parties (for example, to banks and customers).

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