Timing is usually everything when it comes to entities because in most cases, the tax savings can’t happen until the entity is set up. Usually in the rush to set up the entity, there are details missed that can jeopardize the tax savings.
Whether your entity is new or has been around for years, use this checklist to make sure you have the details in place to protect the tax savings from your entity.
#1 Does your entity deal directly with its vendors?
Take a look at the expenses your entity has.
You may find expenses like telephone, utilities, supplies, insurance, rent, taxes, legal, vehicle, management fees or wages to name a few.
With most expenses, there is usually a written agreement with the vendor. For example, with a telephone, there is a written agreement with the telephone provider.
Review your expenses and determine if there is a written agreement with the vendor. If there is, review the agreement to determine if it is with your entity.
What you may find is that some of the agreements are not in your entity’s name but rather in your personal name. Some agreements you may be able to transfer into your entity’s name without any hassle. Other agreements may be a little more challenging.
Of course, before making any changes to written agreements, you’ll want to discuss the non-tax implications with your vendor and / or attorney.
From a tax standpoint, it’s important to be able to show that the entity is responsible for the expense and the entity is the one receiving the goods and services. A written agreement between the vendor and the entity is the easy way to do this.
But, as I mentioned, sometimes this can be a little challenging so what do you do in those cases where you cannot easily have the agreement be directly between your entity and the vendor?
One option is to document the arrangement you have with your entity as to why you entered into the agreement instead of your entity. You’ll want to document the entity’s responsibilities and your responsibilities so it is clear that the entity is responsible for the expense. You’ll also want to document why this arrangement is necessary from a business standpoint.
#2 Does your entity deal directly with its customers?
Just as an entity should deal directly with its vendors, it should also deal directly with its customers.
Michael Urban
A simple example of this is an entity that owns rental property. The rent check should go directly to the entity.
If the entity has a property manager, then the rent check should go to the property manager and the property management agreement should be with the entity. If income is collected in your individual name and not in your entity’s name, it opens the door for the government to make a case that the income is yours and not your entity’s.
Review the income your entity has collected recently and make sure it is coming directly from the customer.
#3 Does your entity avoid commingling of business and personal funds?
Most people are well aware that commingling funds should be avoided.
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Personal expenses should never be paid with entity funds. Doing so is inviting the government and others to make the case that your entity is really just you since you are treating its checkbook like your personal checkbook.
Business expenses are a little different. It is a standard business practice for a business to reimburse its owners or employees for certain expenses. In these cases, it is fine to pay for these expenses with personal funds and have your entity reimburse you.
This reimbursement policy should be well documented and followed. Only the specific business expenses allowed in the policy should be paid personally. An expense report should be submitted timely and reimbursement should be made timely.
#4 Who owns your entity’s assets?
Review your entity’s balance sheet. In the assets section, common assets include bank accounts, investment accounts and other investments, such as property.
Most assets have some form of documented ownership. For example, to open a bank account, paperwork is filled out that indicates the owner’s name.
Review the forms for the assets you see on your entity’s balance sheet to verify your entity is the named owner.
You may find that some assets are not in your entity’s name. In these cases, assess the non-tax implications of changing the ownership to your entity. You’ll want to discuss this with your attorney before making any changes.
If you find that there are non-tax implications that prevent ownership to be in the entity’s name, then it will be very important to document why the entity is considered the owner for tax purposes. Without this documentation, the asset and income and expenses related to the asset could be treated as if the entity does not own them.
#5 Does your entity keep meeting minutes?
You may have gathered from the above points that additional documentation is highly recommended to protect your entity for tax purposes.
Without additional documentation, there may be room for the government (and others) to make the argument that the entity form is not being respected which puts the tax savings at risk.
Minutes are an ideal way to provide further support as to why expenses, income or assets are treated the way they are by the entity.
While minutes are usually done to document annual meetings, they can also be used to document any meeting.
Review the meeting minutes for your entity and make sure they are up to date and document the details of your tax strategy.
The Details Matter
The reason entities provide such great tax savings is because they can be treated as a completely separate taxpayer from the owner. Because of this, it’s very important that the line between the owner and the entity don’t get crossed.
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It’s the details that provide the best support that the entity and owner are indeed separate.
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