S Corporation Transition: Does State Matter?
One listener asked about the benefits of moving to an S Corporation and whether the state you live in affects this decision. This is a nuanced question. While an S Corporation can offer substantial federal tax benefits by avoiding self-employment tax, state-specific rules can change the overall advantage.
Federal vs. State Tax Treatment
Generally, an S Corporation helps business owners by reducing the burden of self-employment tax. For most clients, this transition makes sense if profits exceed $60,000 to $70,000. However, states like Tennessee complicate this decision. Tennessee has no personal income tax but imposes a franchise and excise tax on S Corporations, which could partially offset federal savings.
For example, Tennessee’s excise tax is around 6.5%. Although this adds a layer of tax, the benefits of avoiding federal self-employment tax usually outweigh these state taxes, making the S Corporation structure beneficial for most businesses even in Tennessee.
Specific State Considerations
Each state has unique tax regulations. In New Hampshire, for instance, businesses face both a Business Enterprise Tax (BET) and a Business Profits Tax (BPT). These states do not differentiate between S and C Corporations, complicating the decision further. Despite these additional state taxes, the federal savings from an S Corporation often still justify the transition, though the exact benefits can vary based on individual circumstances.
Renting to Yourself: Evaluating Fair Market Value and Tax Implications
Next up, the topic of renting property to yourself and ensuring you’re paying a fair market value to avoid future complications when selling your business came under the spotlight.
Determining Fair Market Rent
It’s crucial to keep your rent in line with market values. For instance, if your property is valued at $500,000, aim to charge around 10% of this value annually, i.e., $50,000 per year. This ensures your business remains attractive to potential buyers, who will need to pay market rates after acquisition.
Triple Net Leases and Deducting Expenses
A triple net lease, where the tenant (your business) pays for property taxes, insurance, and maintenance, is standard practice. This setup maximizes tax deductions within your business entity. For significant renovations or expansions, these should be handled by the rental LLC to optimize tax benefits and maintain compliance with lease agreements.
A triple net lease, where the tenant (your business) pays for property taxes, insurance, and maintenance, is standard practice.
Sales Tax on Internal Transactions: What You Need to Know
Finally, the episode addressed a common concern about charging sales tax on internal transactions, such as warranty work or internal use of parts.
Sales Tax vs. Use Tax
Typically, when you purchase items for resale, you don’t pay sales tax. However, if these items are used internally, a use tax may apply. This ensures that the state still receives tax revenue on items consumed within the business.
Practical Approach to Compliance
For internal transactions, many businesses take a practical approach by not charging sales tax, considering the low probability of audits and the minor financial impact. However, being diligent and consulting with your accountant is always advisable to ensure compliance and avoid future penalties.
Conclusion
These topics highlight the complexities of tax planning and business structuring. Each decision, from electing S Corporation status to managing internal transactions, requires careful consideration of both federal and state tax implications. Paar Melis and Associates is committed to helping businesses navigate these decisions to optimize financial outcomes. To learn more about Tenessee’s Franchise Tax Property Measure, visit the TN Dept of Revenue Here
If you have further questions or need personalized advice, reach out to Paar Melis and Associates at podcast@paarmelis.com. Stay tuned for more insights and discussions on Business by the Numbers.
