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more taxes articles

• A Tip for Small-Business Owners
• When Your Spouse Is Your Business Partner
• What to Know About Writing Off Your Wheels
• Quick Tips: Failing to File
• Starting Up: Avoiding Business Audits

ANSWER: Well, we hate to get in the middle, but we'll point out something that neither of your trusted advisors — your accountant and your wife, in no particular order — mentioned: the possibility the Internal Revenue Service will view your business as a personal-service corporation. What's that, exactly? It's a type of corporation that is subject to a flat 35% tax rate, not the graduated tax rate that C corporations enjoy. Firms that provide services in fields such as health, law and — you guessed it — consulting are sometimes labeled a personal-service corporation, in large part to prevent the deferring of taxes that you mention. (Another test is that the firm must be 95% owned by employees performing its services, which sounds like the case here.) In recent years, the IRS has pledged to crack down on businesses that are incorrectly filing as C corps and improperly taking advantage of the C corporation's graduated tax scale that starts at 15%.

Filing as an S corporation will free you of that controversy, as S corps are "pass-through" entities and all business income is reported on your personal tax returns, and therefore taxed at your (presumably higher) personal income rate. But there are also advantages to filing as an S corp. For one, as your wife mentions, you avoid the C corp's infamous "double tax" scenario. That's when the C corp pays taxes on its profit and then you (as a shareholder) pay taxes when you get a piece of that profit in the form of a dividend. The process is different if you want to take a little extra from the S corp for, say, a dream vacation. "If you want to take cash out in excess of your salary, you take it out as a tax-free distribution," says Bob Dudzinsky, tax partner at BDO Seidman in Philadelphia. "The reason it's tax-free is that you've already paid the income tax on it."

One more thing to consider: Tax expert Aaron Eidelman says he often recommends the S corp to new business owners, as many lose money in the first few years. "The common advice is to be an S corp so they can deduct the loss on their personal income-tax return," says Eidelman, managing director of the small-business-services group at RSM McGladrey in New York. With a C corp, losses are carried forward, so you wouldn't get the immediate deduction, he says. But obviously, picking the most appropriate structure depends on many factors, including your goals for the business. "Like most things in life, nothing is black or white," Eidelman says.

QUESTION:I recently retired in 2006. During the last half of 2006, I spent about $10,000 on equipment and organization expenditures to incorporate and develop a business plan for a new small business. I will activity begin to market the business and be in "service" in the forthcoming weeks, and I expect to be profitable in 2007. However, I have had NO business income during 2006 related to this start-up. Do you see this as a problem in regard to my personal taxes for 2006 given I have start-up business-related expenses and no income for 2006?

ANSWER: Yep, we do see a problem. Unfortunately, you are only entitled to deduct business-related expenses starting in the year that the business or trade actually starts — in your case, that would be 2007. Unfair, you say? The IRS doesn't view it that way. "Someone could theoretically be 'looking into a business' for years, and searching and spending," says Bob D. Scharin, RIA Senior Tax Analyst from Thomson Tax & Accounting.

The good news is that you'll be able to capitalize expenses — such as the cost of that equipment — after the business starts. In any event, sounds like you'll have plenty to keep you busy in retirement.

QUESTION:If you run a small business from home, such as Avon, Mary Kay or PartyLite, and make under $1,000 in income, do you have to claim the income?

— Susan K. Suazo

ANSWER: Ahem, we won't tell the IRS you asked the question. There's no magic number — the government expects you to declare any income you've earned, no matter how small. But here's something to consider. Many people who run side businesses (we're assuming that's what yours is) favor keeping that extra income under the table, despite the tax rules. But you might actually be entitled to a loss, so in this case (and hopefully others) it could pay to follow the law.