Filing your tax return late, or not filing at all, can result in IRS penalties and interest in addition to your unpaid tax burden. CEO David King and Lead Tax Attorney Philip Hwang provide helpful insight on important tax deadlines you should know about – and how you can resolve your tax liability with the IRS.
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Partnerships are a popular business structure for entrepreneurs looking to combine resources, expertise, and share profits. However, the taxation of partnerships can be complex, as the partnership itself isn’t taxed like a corporation. Instead, partnerships are subject to “pass-through” taxation, where the profits and losses pass through to individual partners. This guide explores how partnerships are taxed, the reporting requirements, and the key factors that partners should be aware of.
Partnerships are considered “pass-through” entities, meaning they do not pay income tax at the business level. Instead, the income or loss is passed through to the individual partners. The partners then report their share of the profits or losses on their personal tax returns. This structure avoids double taxation (taxing both the entity and the owners), which is a feature of corporate taxation.
Each partner’s share of the partnership’s income, deductions, and credits is determined by the partnership agreement. If no partnership agreement exists, the default rules provided by state law. For example, if Partner A has 50% ownership and Partner B has 50% ownership, they will each claim 50% of the company’s profits or losses. However, if Partner A has 70% ownership, they would claim 70% of the company’s profits or losses, while Partner B would claim the remaining 30%.
For tax purposes, partnerships must file an informational return, Form 1065, U.S. Return of Partnership Income, with the IRS each year. This return is due by the 15th day of the third month following the date the tax year ended for the business. For example, if your business follows a calendar year (January 1 – December 31), the due date would be March 15. However, if your company has a fiscal year of July 1 – June 30, the due date would be September 15.
Form 1065 reports the partnership’s total income, deductions, and other tax-related information. Along with Form 1065, the partnership provides each partner with a Schedule K-1, which details the partner’s share of the partnership’s taxable income, deductions, and credits. Schedule K-1 is due by March 15th for S-corps and LLCs, and by April 15th for trusts and estates. Alternatively, it is due on the 15th day of the third month after the company’s tax year ends. Each partner uses the K-1 to report their share of the partnership’s tax attributes on their individual tax return (Form 1040).
In a partnership, the distribution of income and deductions is typically governed by the terms outlined in the partnership agreement. This agreement specifies how the partnership’s profits and losses are allocated among the partners. If no partnership agreement exists, or if it doesn’t specify how income and deductions are divided, the default rule under most state laws is that profits and losses will be split equally among the partners, regardless of their contributions.
The income distributed to each partner is subject to taxation. This is true whether or not the partnership distributes the profits to the partners in cash. This means that even if the partnership retains its profits in the business, partners must still pay taxes on their share of the income. In addition to reporting income, the Schedule K-1 may include other items that affect a partner’s tax liability, such as:
A key aspect of partnership taxation is that general partners are considered self-employed for tax purposes. This means they must pay self-employment tax on their share of the partnership’s income. The self-employment tax rate is 15.3%, which includes both the Social Security (12.4%) and Medicare (2.9%) portions.
Limited partners, however, generally are not subject to self-employment tax on their share of the partnership’s income unless they are actively involved in managing the business. The income allocated to limited partners is typically passive income and may include dividends, interest, capital gains, or other investment-related earnings. Despite this exemption, limited partners still pay income taxes on their share of the partnership’s profits, which is reported on their personal tax return using Schedule K-1. This income is usually taxed at the ordinary income rate unless it qualifies for capital gains treatment or other tax-favorable categories.
A partner’s basis in the partnership refers to the amount of their investment in the business and is important for determining the taxability of distributions and gain or loss on the sale of a partnership interest. In simpler terms, think of it as your “ownership value.” Here’s how basis works in simple terms:
Your basis helps the IRS figure out how much tax you’ll owe when you take money out or sell your interest in the business. For example, if you sell your share for more than your basis, you’ll have a taxable gain. However, if you take money out of the business, it’s usually not taxable as long as it’s less than your basis.
Partnerships can also pass through losses to their partners. These losses can offset the partners’ other income on their personal tax returns. However, the ability to deduct partnership losses is subject to limitations such as:
Losses can only be deducted to the extent of the partner’s adjusted basis in the partnership. For example, let’s say you invest $10,000 in a partnership, making your basis $10,000. The partnership incurs a $15,000 loss for the year and your share of that loss is $12,000. Since your basis is only $10,000, you can only deduct $10,000 of the loss this year. The remaining $2,000 cannot be deducted now but can be carried forward to future years, when your basis increases (e.g., through additional investment or profits).
Partners can only deduct losses to the extent they are financially at risk for the partnership. This usually means the amount of money or property you personally invested and any amounts you’ve personally guaranteed. You invest $10,000 in a real estate partnership, but you also personally guarantee a $20,000 loan the partnership takes out. This puts your total at-risk amount at $30,000. The partnership then generates a $35,000 loss for the year, and your share of the loss is $25,000. You can deduct up to $30,000 (your at-risk amount) even though the partnership loss exceeds it. The remaining $5,000 loss can’t be deducted and is carried forward to future years when your at-risk amount increases.
Losses from passive activities, such as a rental business, can generally only offset income from other passive activities, not wages or other earned income. For example, say you invest in a rental property that generates a $10,000 loss for the year. You also have a full-time job, earning $60,000 in wages. Under the passive activity loss rules, you can’t use the $10,000 rental loss to reduce your $60,000 in wages because the rental property is a passive activity. However, if you also have $8,000 in passive income from another rental property or business, you can use part of the $10,000 loss to offset that passive income. The remaining $2,000 loss can be carried forward to future years when you have more passive income.
While partnerships do not pay income taxes directly, they still have several important filing responsibilities. The first of which is Form 1065, U.S. Return of Partnership Income. Again, this informational return reports the partnership’s total income and deductions for the year. Next, the partnership will need to issue Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc. to each partner. This will provide the necessary information for their individual tax returns. It’s also crucial to stay on top of state tax filings. Some states require partnerships to file their own returns or pay entity-level taxes. Additionally, if the partnership operates in multiple states, it may be subject to tax filings in each of those states.
The taxation of partnerships can be complex. Understanding how pass-through taxation works, the role of Schedule K-1, and the treatment of self-employment taxes, basis, and losses is crucial for partners. By staying informed and working with tax professionals, partnerships can navigate these rules effectively and ensure they comply with their federal and state tax obligations. Optima Tax Relief is the nation’s leading tax resolution firm with over $3 billion in resolved tax liabilities.
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Understanding worker classification is crucial for both employers and workers, as it directly affects tax obligations and benefits. The way a worker is classified—whether as an employee or an independent contractor—determines who is responsible for various tax payments, what deductions are available, and how the worker must report income to the IRS. This article will explore the implications of worker classification on taxes and the criteria used to differentiate between employees and independent contractors.
The IRS recognizes two primary worker classifications: employees and independent contractors. Workers classified as employees have taxes withheld from their paychecks, including federal income tax, Social Security, and Medicare taxes. Employers also pay a share of Social Security and Medicare taxes, and may provide additional benefits such as health insurance, retirement plans, and workers’ compensation. Independent contractors, on the other hand, are self-employed individuals who typically provide services to multiple clients or businesses. Unlike employees, they do not have taxes withheld from their payments. Instead, they are responsible for calculating and paying their own income taxes, self-employment tax (which covers both the employee and employer portions of Social Security and Medicare taxes), and other applicable taxes.
The IRS uses three main categories to determine whether a worker is an employee or an independent contractor.
Misclassifying employees as independent contractors can result in significant tax liabilities for employers, including:
For workers, misclassification can lead to unexpected tax bills, loss of unemployment benefits, and denial of workers’ compensation. That said, it’s essential to make sure you classify correctly the first time around. However, if a business realizes that it has misclassified workers, it can correct the situation by reclassifying them correctly and paying any past due taxes. The IRS also offers the Voluntary Classification Settlement Program (VCSP), allowing eligible businesses to reclassify workers as employees for future tax periods and pay a reduced amount of past employment taxes.
For employees, the tax process is relatively straightforward. Employers withhold federal income tax, Social Security, and Medicare taxes from employees’ wages. The employer also contributes to the employee’s Social Security and Medicare taxes, effectively covering half of these taxes on behalf of the employee. Employees receive a W-2 form at the end of the year, which summarizes their earnings and the taxes withheld. This information is used to file their annual income tax return.
Paying taxes as an employee has its perks, the biggest of being that taxes are automatically withheld. This greatly simplifies tax compliance. Employees are also eligible for employer-provided benefits like health insurance, retirement plans, and paid leave. Another major benefit is having potential eligibility for unemployment benefits and workers’ compensation.
Employees likely will not have as many tax deductions as independent contractors. However, there are some key tax deductions they can keep in mind. For example, employees can deduct 401(k) contributions. You can deduct up to $23,000 in contributions, or up to $30,500 if you are aged 50 and older. This also applies to 403(b), most 457 plans, and Thrift Savings Plans. Roth 401(k) contributions are not eligible for tax deductions.
IRAs follow a different set of rules. Contributions to a Traditional IRA can be tax-deductible. However, it depends on several factors, such as your income, tax filing status, and whether you (or your spouse, if you’re married) are covered by a retirement plan at work. For example, if you’re covered by a retirement plan at work, and are single with a MAGI of $77,000 or less in 2024, you can take a full deduction up to the contribution limit of $7,000. However, if your MAGI increased to $87,000 or more, you’d be ineligible for a deduction.
Independent contractors have more tax-related responsibilities than employees. They must calculate and pay their own taxes, including the self-employment tax, which covers both the employee’s and employer’s portions of Social Security and Medicare taxes. They receive a 1099-NEC form from clients who paid them $600 or more during the year, but they are responsible for tracking all income, even if they do not receive a 1099 form for smaller payments.
While being your own boss comes with greater responsibilities, it also has its perks. Besides the obvious perk of greater control over work hours, methods, and clients, there is also the ability to claim a wider range of business expenses, reducing taxable income. You also have more control over the timing of your income and expenses. For example, if you’re close to year-end, you might delay billing a client until the next year, which can push taxable income into a later tax year. Alternatively, if you need to reduce your tax liability in the current year, you can make business purchases or pay for expenses in advance to claim the deduction immediately.
Independent contractors can deduct a wide variety of business expenses to significantly reduce taxable income. Some of the most common expenses include:
If you use part of your home exclusively and regularly for business, you can deduct a portion of your home-related expenses, such as rent, mortgage interest, utilities, and insurance. The IRS offers a simplified home office deduction of $5 per square foot, up to 300 square feet, or you can calculate your actual expenses.
Any supplies, materials, or equipment you purchase for your business are tax-deductible. This includes computers, printers, software, and office furniture.
If you use your personal vehicle for business purposes, you can deduct the business-related mileage or a percentage of actual vehicle expenses, such as fuel, maintenance, and insurance. You can also deduct travel expenses for business trips, including airfare, lodging, and meals.
Costs related to promoting your business, such as website development, social media advertising, and business cards, are deductible.
Fees paid to accountants, lawyers, or other professionals that help you run your business are deductible.
Expenses for education or training courses that improve or maintain your skills as an independent contractor are tax-deductible.
Self-employed individuals can also deduct half of their self-employment tax as an adjustment to income on their tax return. If you’re self-employed and pay for your own health insurance, you may be eligible to deduct the cost of your premiums. Independent contractors may also benefit from the Qualified Business Income (QBI) deduction. This allows you to deduct up to 20% of your qualified business income. Insurance premiums, such as liability insurance or bonding costs required to run your business, are fully deductible as business expenses. Independent contractors can deduct the full cost of certain business equipment in the year of purchase using Section 179 depreciation, rather than spreading out the deduction over several years. The list goes on and on, and it could be widely beneficial to speak to a knowledgeable tax professional about what you are eligible for.
Worker classification significantly affects how taxes are handled, who is responsible for paying them, and the availability of certain benefits. Employers must carefully assess their relationships with workers to ensure proper classification, while workers should understand their status and its tax implications. Proper classification not only ensures compliance with tax laws but also protects the rights and benefits of both workers and employers. Remember, if ever unsure, it’s best to consult a tax professional. Optima Tax Relief has over a decade of experience helping taxpayers with tough tax situations.
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Receiving a notice from the IRS can be unsettling, and if you’ve received IRS Notice CP71C, it’s important to understand what it means and how to respond appropriately. This notice is a reminder from the IRS regarding an outstanding tax debt and offers information about what actions you can take to address the issue. Here’s what you need to know about Notice CP71C and the steps you should take if it arrives in your mailbox.
IRS Notice CP71C is an annual statement sent to taxpayers who owe federal tax. It’s not a bill but a reminder notice, typically sent out once a year, outlining the unpaid balance, including interest and penalties accrued on the account. The notice is a way for the IRS to keep you informed about the status of your debt and to remind you of the various options available for resolving it.
You received IRS Notice CP71C because the IRS has records indicating that you have an outstanding tax debt that has not been fully resolved. The notice serves several purposes:
Notice CP71C contains essential information about your tax debt. Here’s what you’ll typically find on the notice.
Receiving any IRS notice can be intimidating. However, it’s crucial to remember what actions need to be taken to fully understand your tax situation.
Read through the notice thoroughly to understand the amount owed and the breakdown of any penalties and interest. Compare the information on the notice with your own tax records to ensure its accuracy.
Ensure that the tax debt mentioned on the notice is correct. If you believe there is an error or you have already paid the debt, you may need to gather supporting documentation and contact the IRS for clarification.
The notice will outline different payment options available to you, such as paying the full amount, setting up a monthly payment plan, or exploring other options like an Offer in Compromise. Choose the option that best fits your financial situation:
If you need to discuss your options, dispute the debt, or set up a payment plan, contact the IRS using the phone number provided on the notice. It’s essential to reach out to the IRS promptly to avoid further penalties or enforcement actions.
If you’re uncertain about how to handle the notice or if the amount owed is substantial, consider seeking help from a tax professional. They can provide guidance tailored to your situation and help you navigate the process.
Keep a copy of the notice and any correspondence or payment confirmations related to your tax debt. Proper documentation is essential in case there are any disputes or issues in the future.
Ignoring this IRS notice won’t make the debt go away. If the tax debt remains unpaid, the IRS can take more aggressive actions to collect the amount owed. These actions can include placing a lien on your property, garnishing your wages, or levying your bank account. Addressing the notice promptly can help you avoid these potential consequences.
Receiving IRS Notice CP71C is a reminder of an existing tax debt, not an immediate threat. However, it does indicate that the IRS expects you to take action to resolve the outstanding balance. By reviewing the notice carefully, verifying the debt, exploring payment options, and possibly seeking professional help, you can take the necessary steps to address the situation and avoid further complications. If you need help understanding or addressing your IRS notice, we can help. Optima Tax Relief is the nation’s leading tax resolution firm with over $3 billion in resolved tax liabilities.
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We often hear that the tax professionals qualified to represent you before the IRS are CPAs, tax attorneys, and enrolled agents. While the first two roles are more well-known, many are still confused about what exactly an enrolled agent is. An Enrolled Agent (EA) is a federally authorized tax practitioner who has technical expertise in the field of taxation. Enrolled agents are empowered by the U.S. Department of the Treasury to represent taxpayers before the IRS for audits, collections, and appeals. They are the only taxpayer representatives who receive their right to practice from the federal government. Here is an overview of enrolled agents, including what it takes to become one, how they differ from CPAs and tax attorneys, and the advantages of hiring one for help with the IRS.
Enrolled agents are equipped to handle a wide range of tax matters. Some of their key responsibilities include the following.
EAs are tax experts who assist individuals, businesses, and other entities with preparing and filing their tax returns. They can navigate complex tax situations and ensure compliance with tax laws.
EAs help clients make strategic decisions to minimize their tax liability. This may involve advising on investment strategies, retirement planning, or business decisions that have tax implications.
One of the primary roles of an enrolled agent is to represent taxpayers before the IRS. EAs can advocate on behalf of their clients during audits, appeals, and collections. They can also negotiate with the IRS to resolve issues such as back taxes or penalties.
EAs help clients understand their tax obligations and ensure they comply with federal and state tax laws. This includes advising on record-keeping, reporting requirements, and other tax-related matters.
Clearly, enrolled agents carry a lot of responsibility and authority. That said, it’s important to note that there are two primary paths to becoming an enrolled agent.
After becoming an EA, individuals must complete continuing education courses to maintain their status. This requirement ensures that EAs stay up-to-date with the ever-changing tax laws and regulations.
While enrolled agents, Certified Public Accountants (CPAs), and tax attorneys can all represent taxpayers before the IRS, there are key differences in their training and areas of expertise. Enrolled agents specialize in taxation and have a deep understanding of the tax code. Their primary focus is on tax preparation, planning, and representation. CPAs are accountants who have passed a state licensing examination. They offer a broader range of services, including auditing, accounting, and financial planning, in addition to tax services. Not all CPAs specialize in taxation, but those who do often provide similar services to EAs. Tax attorneys are lawyers who specialize in tax law. They are well-versed in legal issues related to taxes, such as tax disputes, litigation, and estate planning. Tax attorneys are often sought for complex legal matters and can represent clients in tax court.
There are several benefits to working with an enrolled agent.
Enrolled agents are highly qualified tax professionals who specialize in taxation and have the unique authority to represent taxpayers before the IRS. Whether you need assistance with tax preparation, planning, or navigating an audit, an EA can provide expert guidance and representation tailored to your specific needs. Optima Tax Relief has a team of knowledgeable tax professionals, including enrolled agents and tax attorneys, with experience helping taxpayers with tough tax situations.
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