Author: Leon Clinton

The IRS noticed that average gas prices across the United States exceeded $5.00 a gallon and took action.

Small businesses that qualify to use and do use the standard mileage rate can deduct 62.5 cents per business mile from July 1 through December 31, 2022. That’s up 4 cents a mile.

This brings up a practical question: what do you do if you track business mileage using the three-month sample method?

Three-Month Sample Basics

As a reminder, here are the basics of how the IRS describes the three-month test:

• The taxpayer uses her vehicle for business use.
• She and other members of her family use the vehicle for personal use.
• The taxpayer keeps a mileage log for the first three months of the taxable year, showing that she uses the vehicle 75 percent of the time for business.
• Invoices and paid bills show that her vehicle use is about the same throughout the year.

According to this IRS regulation, her three-month sample is adequate for this taxpayer to prove her 75 percent business use.

Sample-Method Solution to New July 1 Mileage Rate

To use the sample rate, you need to prove that your vehicle use is about the same throughout the year. Your invoices and paid bills prove the mileage part, and your appointment book can add creditability to consistent business and personal use.

Keep in mind that the sample is just that—a sample—it’s pretty exact for the three months but not that exact for the year, although it must adequately reflect the business mileage for the year.

If you have a good three-month sample, you take your business mileage for the year and apply the 58.5 cents to half the mileage and the 62.5 cents to the remaining half to find your deductions.

For example, say you drove 20,000 business miles for the year. Your deduction would be $12,100 (10,000 x 58.5 cents + 10,000 x 62.5 cents).

Mileage Record for the Full Year

If you have a mileage record for the entire year, no problem. Your record gives you the mileage for the first six months and the last six months.

If you have questions about your vehicle deductions, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 5, 2022

Are you loving the 21 percent corporate tax rate and now keeping more money inside the corporation?

If so, beware of the accumulated earnings tax. You can easily overlook it. You likely don’t have the proper documentation to avoid it. And it’s expensive.

The accumulated earnings tax is a 20 percent corporate-level penalty tax assessed by the IRS, as opposed to a tax paid voluntarily when you file your company’s corporate tax return.

To trigger the tax, you need to suffer an IRS audit that notes your failure to pay dividends when

• the corporation’s accumulated earnings exceed $250,000, or $150,000 for a personal service corporation, and
• the corporation cannot demonstrate an economic need for the “excess” accumulation of earnings.

Here’s the question: Why do you need more than $250,000 ($150,000 if you are a personal service corporation) in accumulated earnings?

If you can answer this question to the satisfaction of the IRS, you have no problem.

But don’t wait for the audit and the question. Be proactive. Get your reasons and dollar amounts into the corporate minutes. Here are some prompts to get you started on why you need to keep the earnings in the corporation:

• You need the money to pay a deceased shareholder’s death taxes, funeral, and administrative expenses under IRC Section 303. After all, shareholders do die.
• You need the money to shut down operations, sell the business, and otherwise deal with corporate needs caused by the owner’s (shareholder’s) death.

Let’s move away from death. The IRS in Reg. Section 1.537-2 gives you a nice list of reasons for accumulating C corporation earnings, as follows:

• Provide for bona fide expansion of business or replacement of plant
• Acquire a business
• Retire indebtedness of the corporation
• Provide for investments in or loans to suppliers or customers if necessary to maintain the business of the corporation
• Provide for reasonably anticipated product liability losses

From this same regulation, the IRS lists the following as likely unreasonable reasons for accumulating the earnings:

• Making loans to the shareholders
• Making loans to other corporations and business entities owned by the shareholders
• Investing in properties unrelated to the corporation’s activities
• Investing in securities unrelated to the corporation’s activities
• Citing needs for unrealistic contingencies and hazards

If you would like to discuss the accumulated earnings tax, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 1, 2022

I know you report your business on Schedule C of your Form 1040.

Have you noticed that the self-employment tax significantly drains your cash? The S corporation may plug a good chunk of that leak because only the W-2 wages that the S corporation pays to you would suffer federal employment taxes.

Here’s the big picture: The S corporation

• deducts the W-2 wages;
• passes the remaining taxable income to you—the shareholder who reports the income on his Form 1040; and
• makes cash distributions to you—the shareholder.

The passed-through S corporation taxable income increases the tax basis of your stock; therefore, distributions of corporate cash flow are usually federal-income-tax-free.

This tax regime places S corporations in a potentially more favorable position than equivalent businesses conducted as sole proprietorships, single-member LLCs that are treated as sole proprietorships for federal tax purposes, partnerships, and multi-member LLCs that are treated as partnerships for federal tax purposes.

That’s because S corporations can follow the tax-smart strategy of paying modest salaries to shareholder-employees while distributing most or all of the remaining corporate cash flow to them in the form of federal-employment-tax-free distributions.

If you would like to examine the potential tax savings available to you with a switch to the S corporation, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• July 28, 2022