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LLC owners are called members.

• Single-member LLCs have one owner, although spouses who jointly own an LLC in a community property state can elect treatment as a single member LLC for federal income tax purposes.
• We will call LLCs with two or more members multimember LLCs.

Key point: LLCs are not corporations. But LLCs can offer similar legal protection to their members (owners).

Here are the most important things to know about LLCs.

LLCs Offer Legal Protection

Using an LLC to conduct a business or investment activity generally protects your personal assets from LLC-related liabilities—similar to the legal protection offered by a corporation.

As you know, liabilities can arise from simple things—like the Federal Express guy slipping on the banana peel someone left on your front steps—or in seemingly endless and complicated ways if you have employees.

Key point. As a general rule, no type of entity (including an LLC) will protect your personal assets from exposure to liabilities related to your own professional malpractice or your own tortious acts.

Tortious acts are wrongful deeds other than by breach of contract—such as negligent operation of a motor vehicle resulting in property damage or injuries. The issue of liability protection offered by an LLC is a matter of state law. Seek advice from a competent business attorney for details.

Single-Member LLC Tax Basics

Single-member LLC businesses owned by individuals are treated as sole proprietorships for federal income tax purposes unless you elect to treat the single-member LLC as a corporation.

In other words, the default federal income tax treatment for a single-member LLC business is sole proprietorship status. Under the default treatment, you simply report all the single-member LLC’s income and expenses on Schedule C of your Form 1040.

If the single-member LLC business activity generates net self-employment income, you will report that on Schedule SE of your Form 1040.

Rental. If the single-member LLC activity is a rental activity, you report the rental income and expenses on Schedule E of your Form 1040.

Farm or ranch. You report the numbers for a farming or ranching activity on Schedule F.

Simple. You don’t need to file a separate federal income tax return for the single-member LLC. And other things being equal, simple is good.

Three key points

1. The big federal income tax advantage of operating as a single-member LLC is extreme simplicity.
2. The big non-tax advantage is liability protection, under applicable state law.
3. As mentioned, you can elect to treat a single-member LLC as a corporation for federal income tax purposes, but we don’t recommend that, for reasons we explain later.

Multimember LLC Tax Basics

Multimember LLCs are treated as partnerships for federal income tax purposes unless you elect to treat the LLC as a corporation.

In other words, the default federal income tax treatment of a multimember LLC is partnership status. Under the default treatment, you must file an annual partnership federal income tax return on Form 1065.

From the Form 1065 partnership return, the LLC issues an annual Schedule K-1 to each member to report that member’s share of the LLC’s income and expenses. The member then takes those taxable and deductible amounts into account on the member’s own return (Form 1040 for a member who is an individual).

The LLC itself does not pay federal income tax. This arrangement is called pass-through taxation, because the income and expenses from the LLC’s operations are passed through to the members who then take them into account on their own returns. (The same pass-through taxation concept applies to entities set up as “regular” partnerships under applicable state law.)

Electing to Treat the LLC as a Corporation for Tax Purposes

You have the option of electing to treat a single-member LLC or multimember LLC as a corporation for federal income tax purposes. You do that by filing IRS Form 8832, Entity Classification Election, to change the default classification of the single-member LLC or multimember LLC to the new classification as a corporation.

If your desire is to have your LLC treated as an S corporation, it can elect S corporation status directly using IRS Form 2553, or it can elect C corporation treatment on Form 8832 and then S corporation treatment on IRS Form 2553.

While there may be valid non-tax reasons for electing to treat an LLC as a corporation, we think tax reasons generally dictate against taking that step.

If you conclude that there are tax advantages to electing corporate status, why not just actually incorporate your operation in the first place? That’s simpler. Keeping your tax matters simple is generally good policy.

Electing corporate status from the LLC could have unintended tax consequences. For example, you can potentially collect federal-income-tax-free gains from selling stock in a qualified small business corporation (QSBC). But you must own shares and hold them for over five years to cash in on this super-favorable deal. Can an LLC membership (ownership) interest count as QSBC stock for this purpose? Apparently not. It’s not stock.

If you are looking for the QSBC stock break, just set up as a corporation in the first place.

Here’s another example: a special federal income tax break allows you to annually deduct up to $50,000 of losses from selling eligible small business stock, or $100,000 if you’re a married joint filer, and treat the loss as a tax-favored ordinary loss instead of a tax-disfavored capital loss.

Can an LLC membership interest count as eligible stock for this purpose? Apparently not. It’s not stock. Avoid the problem—set up as a corporation in the first place.

To be better understand the Limited Liability Companies’ detailed information. We are here to help you. Don’t hesitate to call our office:415-860-6288 (San Francisco), 917-397-0949 (New York) and 713-396-0107 (Houston), and e-mail us at info@flextcg.com.

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And hopefully, in this next package they will include a provision that allows you to deduct business expenses that you pay with your PPP money.

Let’s explain. In the CARES Act, Congress said:

For purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income.

From what we know, lawmakers thought this meant that the PPP loan forgiveness was tax-free for you. You probably thought that too. We did.

But then in late April, the IRS issued Notice 2020-32 that prevents PPP loan recipients from deducting business expenses that were paid using the PPP monies that gave rise to forgiveness (defined payroll, rent, utilities, and interest).

Two things to know here:

1. The PPP loan and forgiveness is a good deal even if the expenses are not deductible.
2. When the CARES Act was passed, it appears that lawmakers thought the PPP monies were tax-free and had not considered that the expenses paid with the loan proceeds would not be deductible.

Good-Deal Example

ABC Inc., an S corporation, receives a $100,000 PPP loan, spends it all on defined payroll, and the lender forgives the $100,000.

On its 2020 tax return, ABC reports no PPP income (remember, it was tax-free), but it may not deduct $100,000 of payroll expenses. The non-deduction creates $100,000 of net taxable income that ABC, the S corporation, passes on to its sole shareholder, Bob.

Let’s say Bob is in the 45 percent tax bracket when you consider both his federal and state income taxes. Bob pays taxes of $45,000 on this income.

And let’s say that ABC passes to Bob the $100,000 of tax-exempt income. This puts Bob ahead by $55,000 ($100,000 – $45,000).

A good deal—sure!

But with passage of the CARES Act, Congress was not making a good deal—it was providing ABC with money for it to remain afloat and continue paying its employees during the COVID-19 pandemic.

What If It’s Like We Thought It Was?

If the payroll were deductible, ABC would be ahead by both the $100,000 and the tax benefit of the payroll being deductible—giving the company a better chance of continuing to pay its employees after the PPP loan and its forgiveness.

Since the S corporation doesn’t pay income taxes, let’s look at Bob. He would have the $100,000 plus the tax benefit of the payroll deduction ($45,000).

Here’s the comparison:

• $145,000 if the PPP is as we thought it was
• $55,000 as the IRS has it now

Unfair—Schedule C Taxpayer Suffers No Tax Bite

To add one more reason to why the business expenses paid from PPP loan forgiveness monies should be tax deductible, consider this: the self-employed taxpayer with no employees has his or her loan forgiven based on his or her 2019 net income.

There’s no spend on payroll.

The self-employed person does not have to spend any PPP monies on interest, rent, or utilities. He or she can achieve full forgiveness in 10.8 weeks based solely on the 2019 tax return.

In its “you can’t deduct it” notice (IRS Notice 2020-32), the IRS invokes IRC Section 265, but Section 265 does not consider how the PPP treats forgiveness for the self-employed. It applies to expenses incurred for the purpose of earning or otherwise producing tax-exempt income.

For the Schedule C taxpayer, no such expenses to produce tax-exempt income need to be paid to achieve 100 percent forgiveness.

Lawmakers Upset with the IRS

Let’s start with the fact that the IRS has a tough job. In many cases, the IRS is nothing more than a referee. If lawmakers fumble the tax law, the IRS has to call it. No choice.

In a letter to Secretary of the Treasury Mnuchin, Senator Chuck Grassley, chairman of the committee on finance; Senator Ron Wyden, ranking member on the committee on finance; and Richard E. Neal, chairman of the committee on ways and means, jointly stated that the IRS got this wrong and that the intent of the CARES Act was for the PPP to be a tax-free grant.

The IRS has held firm. That puts the ball back into lawmakers’ hands, and now it’s their turn. This is where you come in.

To be better understand the PPP Expenses Tax Deductible. We are here to help you. Don’t hesitate to call our office:415-860-6288 (San Francisco), 917-397-0949 (New York) and 713-396-0107 (Houston), and e-mail us at info@flextcg.com.

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Ah, new tax deductions!

Yep. Say you don’t claim a home-office deduction but now you are working at home and sitting in the fancy chair you inherited from your grandmother.

Let’s say you use the fancy chair 85 percent for business purposes. Can you depreciate 85 percent of that chair?

Yes.

Let’s say that grandma’s estate was appraised and this chair had a value of $10,000 when you inherited it about a year ago. It’s an antique, so it’s not gone down in value since you inherited it.

Depreciating a Formerly Personal Asset

When you convert the fancy chair to 85 percent business use, the law sees you as placing the item in service in your business at that time. That means you can begin depreciating the asset and claiming your tax deductions.

To determine the basis to use for depreciation, use the lesser of

• fair market value on the date of conversion from personal to business use, or
• adjusted basis of the property (generally the amount you paid for the asset plus the cost of any improvements).

With the fancy chair, your adjusted basis is the inherited value.

But say you bought the chair for $8,000. Suppose it was worth $10,000 when you converted it to personal use. You would use the $8,000 figure to determine your depreciation deductions.

Bonus Depreciation and Section 179 Expensing

Unfortunately, unlike assets directly purchased for your business, you may not use Section 179 to immediately expense assets that you convert from personal to business use.

Bonus Depreciation Is a Different Story

If you acquire bonus depreciation qualified property for personal use after September 27, 2017, and convert it to business use this year (or anytime before 2027), you must use 100 percent bonus depreciation if you don’t elect out of it.

Example. You purchased an antique clock for $9,300 in January 2018. Yesterday, you placed the clock in business service by moving the clock from your entryway to your home office. If you don’t make a formal election in your tax return to elect out of bonus depreciation, you must claim a $9,300 depreciation deduction on the antique clock this year.

Basis When You Sell

There’s a trick to basis when you sell converted property—you use a different rule for calculating losses than you do for calculating gains:

• Losses. To calculate losses, use your adjusted basis (conversion basis as discussed above minus depreciation).
• Gains. To calculate gains, use original cost basis minus post-conversion depreciation. In most cases, original cost gives you a higher basis and thus less tax. So don’t accidentally use adjusted basis.

Note. For inherited assets, your cost basis is the estate value (generally, the date of death value).

Clarifying Examples

Let’s say you bought a personal use desk/credenza/bookcase set for $8,000 and then converted it to business use when its fair market value had fallen to $6,000. Here are the tax consequences for three different sales scenarios (to make the examples clear, we ignored depreciation):

• Loss. If you sell the desk/credenza/bookcase set for $4,000, you have a $2,000 deductible loss ($6,000 – $4,000). Note. This is much better than if you sold the desk/credenza/bookcase set as a personal asset, which would create a zero deductible loss.
• Gain. If you sell the desk/credenza/bookcase set for $10,000, you have a $2,000 gain ($10,000 – $8,000).
• Gray area. If you sell the set for $7,000, you have neither gain nor loss on the sale. That’s a decent result—it means no taxes for you (but no deductible losses either).

To be better understand the home office deduction. We are here to help you. Don’t hesitate to call our office:415-860-6288 (San Francisco), 917-397-0949 (New York) and 713-396-0107 (Houston), and e-mail us at info@flextcg.com.

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A lot, a whole lot.

And how much is making things easier worth? Of course, it’s a lot, a whole lot, too.

We now have both the new (a) clarity and (b) easy road to Paycheck Protection Program (PPP) loan forgiveness for the self-employed with no employees. Get ready to smile.

New Easy Road to 100 Percent Forgiveness

Say thanks to the Paycheck Protection Program Flexibility Act of 2020. This new law creates a 24-week period for you to spend your PPP loan proceeds.

If you obtained your loan proceeds before June 5, you can elect to use the eight-week period to spend your PPP loan proceeds.

Here’s the big difference:

• If the 24-week covered period applies, your loan forgiveness for your deemed payroll is capped at 2.5 months of your 2019 Schedule C net profit, not to exceed $20,833.

• If you elect the eight-week covered period, your loan forgiveness for your deemed payroll is capped at eight weeks, not to exceed $15,385.

Why Is This Important?

When you file as a Schedule C taxpayer and have no employees, your PPP loan is based on 2.5 times your 2019 Schedule C, line 31, net profit, limited to $20,833.

Here’s how the loan amount works:

Okay, you have your loan proceeds either in hand or in play at this point.

Let’s keep our eyes on the “easy road” to forgiveness. Under the new 24-week rule, you achieve 100 percent forgiveness when you pay yourself the total loan amount within 10.8 weeks of the date you received your loan proceeds. Let’s round the 10.8 to 11 weeks.

Yes, you are reading this correctly. By simply using the loan proceeds on yourself during the first 11 weeks, you achieve total forgiveness.

Note this. By using the 11 weeks, you achieve total PPP loan forgiveness without having to spend any money on rent, utilities, or interest.

When Can I Apply for Forgiveness?

According to SBA guidance issued on June 22, 2020, you may submit your loan forgiveness application anytime on or before the maturity date of the loan—including before the end of the covered period—if you used all the loan proceeds for which you requested forgiveness.

Example. Ron receives his $20,833 PPP loan on May 15, 2020. He puts the money in his business checking account. During the 11 weeks beginning with May 15, 2020, Ron writes checks to himself that total $20,833. Ron can apply for $20,833 of loan forgiveness anytime after the 11th week.

Is It Really This Easy?

Yes.

What About Interest, Rent, and Utilities?

With the 11-week program described above, you don’t have to consider interest, rent, or utilities to achieve 100 percent forgiveness.

In fact, why bother? By simply using the 11 weeks, you have less paperwork and worry.

Of course, you might want to consider interest, rent, and utilities if this takes you to earlier forgiveness. To obtain full forgiveness, you could spend as little as 60 percent on payroll and the balance on interest, rent, and utilities.

Example. Jane files a Schedule C and has no employees, and on June 1, 2020, she obtains a PPP loan of $20,000. During the first eight weeks, Jane spends $12,000 on herself and $8,000 on qualified Schedule C deductible business interest, rent, and utilities. Jane can elect the eight-week period and qualify for 100 percent forgiveness.

Here are the basic PPP forgiveness requirements that apply to your 2020 Schedule C business deduction payments for interest, rent, and utilities:

• Interest payments on any business mortgage obligation on real or personal property where such obligation was in place before February 15, 2020 (but not any prepayment or payment of principal).

• Payments on business rent obligations on real or personal property under lease agreements in force before February 15, 2020.

• Business utility payments for the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020.

Meet the Paid Rule

On page 2 of the 3508EZ instructions, you find this:

Enter any amounts paid to a self-employed individual. For a 24-week Covered Period, this amount is capped at $20,833 (the 2.5-month equivalent of $100,000 per year) for each individual or the 2.5-month equivalent of their applicable compensation in 2019, whichever is lower.

We may suffer from unfounded paranoia because we find the word “paid” a word to be reckoned with. But in our opinion, you should have your Schedule C business write you checks from its business account. If there’s no separate business account, make sure the business writes checks that pay your personal expenses in the amount of the deemed compensation.

Special allocations are tricky business. We are here to help you. Don’t hesitate to call our office:415-860-6288 (San Francisco), 917-397-0949 (New York) and 713-396-0107 (Houston) and e-mail us at info@flextcg.com.

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