CPA, Tax Attorney, Tax and Legal Adviser to Startups and Established Businesses, Focused on International Tax Issues
It sounds like you are currently employed with a company, and you are spending your own money to complete tasks as an employee? If you are an employee of a company, your employer will issue you a W-2 which reports your annual wages, federal income taxes withheld, payroll taxes withheld, deductible health insurance premiums, and other employer provided fringe benefits. If an employee spends their own money on business related expenses for which the employer did not reimburse the employee, the individual is generally allowed to claim a miscellaneous itemized deduction for those unreimbursed employee expenses. The expenses are reported on IRS Form 2106 and carried over to Schedule A. However, recent U.S. tax reform has eliminated most of these expenses for employees.
If you want to be able to deduct those expenses, you'll need your employer to switch your status from an employee to an independent contractor. Your independent contractor compensation is reported on Form 1099-MISC, which is ultimately reported on Schedule C of your Form 1040. Those expenses you incurred through the LLC can then be reported on Schedule C and deducted. However, the IRS or state tax authority may challenge your independent contractor status depending upon the facts and circumstances.
Under U.S. tax rules, you are permitted to deduct the costs of your home office. The fee you pay for the virtual address is a deductible expense, similar to paying for a PO box.
If you work from home, the IRS will permit you to deduct an allocable share of the total home expenses. In order to qualify for the home office deduction, the room in your home needs to be used regularly and exclusively for business purposes.
The IRS provides two methods for computing the home office deduction. The first is the Simplified Method, which takes the square footage of your home office and multiplies it by a prescribed rate per square foot.
The second option is the Regular Method, which measures the actual expenses of the home. Divide the square footage of the home office by the total square footage of the house. Multiply the percentage by the total expenses of the home to arrive at the home office deduction. There are other rules that prohibit a home office deduction that exceeds revenue of the company, so you may have a carryover of expenses if they are not deductible in the current year.
It sounds like you are renting studio space for your company (which would be a deductible rental expense for the business), and need to pay the invoices using either funds in your business bank account or personal bank account.
If you pay for business expenses using the company funds, the payments are deducted as an expense which reduces the company's net income for the period. Anytime an expense is incurred at the company level, this is a reduction in the overall equity of the company. It doesn't impact your equity account directly. The net amount of income over expenses for the year is closed out to the company's retained earnings, which is a part of the company's total net equity.
If you pay for the studio rental expense with personal funds, the expense is still a business deduction on the company's accounting records. However, because the expense was paid using personal funds, you need to record an additional entry to evidence your contribution for the expense. This can be recorded as either an equity contribution or a loan to the company. For example, the transaction would be recorded on your general ledger as a Debit to rental expense, and a corresponding Credit entry to either "Loans to Owners" (a liability account) or to "Additional Paid in Capital" (an equity account).
If you have a business, you should have a separate operating bank account to receive income and pay expenses. As a best practice, you want to keep the finances and activities of the company separate from the owners.
If business and personal activities are commingled, it makes it difficult to prepare accurate financial records which are necessary to track company performance and prepare year-end tax filings and financial statements.
From a liability perspective, if there is a mix of personal and business use in an entity, the business may not be respected as a separate entity, and the owner can be held personally liable for the debts and obligations of the business. It's important to not oeprate the business as an alter ego of the owner.
Your investment in the business can be documented in a variety of ways. The appropriate documentation will depend upon the type of investment (equity, debt or a hybrid structure), the type of business entity (LLC, partnership, corporation, etc), and the terms of your investment.
If your investment is an equity investment in a corporation, the corporate share registry should be updated to reflect your cash contribution and the number of shares you received. Most corporations also have a shareholder's agreement which corporate shareholders use to outline their rights and obligations amongst themselves.
If the investment is an equity investment in a partnership or LLC, you'll need to sign the LLC operating agreement and update the members' schedule to evidence your investment.
A debt investment in any structure is typically evidenced by a promissory note which is signed by you and the company. The note outlines the principal amount of investment, interest rate, payment terms and other conditions.
An investment in an business is not a tax deductible expense for the investor, nor is the cash contribution considered taxable income to the business. In certain cases where your investment becomes worthless, or the promissory note is deemed uncollectible, you may be able to write off the investment as a capital or ordinary loss.
Anytime you conduct business within the U.S. or with U.S. based customers, you should consider the various federal and state tax implications that may apply to your business.
Generally, a foreign business is subject to U.S. federal income taxes if that business is engaged in a U.S. trade or business and has income effectively connected (ECI) with such U.S. trade or business. If your only connection to the U.S. are sales to U.S. customers, that is generally not enough to create a taxable nexus with the U.S.
Factors that may create a U.S. trade or business with effectively connected income may include, but are not limited to, having employees based in the U.S., a fixed office location in the U.S. and if you are personally traveling to the U.S. to perform the work.
The other issue is whether tax treaty benefits may apply. Assuming you qualify for treaty benefits under the U.S.-Canada tax treaty, Canadian businesses are only subject to income taxes in the U.S. if they operate a permanent establishment in the U.S., as defined in Article 5 of the tax treaty.
If it's determined that your company is engaged in U.S. trade or business and is subject to income taxes, you'll be deemed to operate a branch in the U.S. A foreign corporation with a U.S. branch needs to file a Form 1120-F and report it's U.S. effectively connected earnings.
You won't be able to capitalize the time you incurred and add that to your basis. The concept of "sweat equity" doesn't really exist in a sole proprietorship context.
For business entities taxed as partnership for U.S. federal tax purposes, the company will frequently grant profits or capital interests to individuals that actively participate in the company, without requiring the individual to contribute cash or other property to the company.
There are a number of advantages and drawbacks to making an S corporation election, however, most of the time it works in the favor of the owner. In situations where an LLC is owned 100% by an individual, the LLC is a disregarded entity for U.S. tax purposes, which means the LLC does not file its own tax return. The income and expense is reported on Schedule C and attached to the individual owners' Form 1040. All of the earnings are subject to federal income taxes as well as self-employment taxes.
If the owner files an S corporation election via Form 2553, the LLC is now a regarded entity for U.S. tax purposes. The LLC files an annual Form 1120-S and the net income (loss) is passed through to the individual owners' Form 1040. Earnings are subject to federal income taxes, but they are not subject to self-employment taxes. If the 100% owner of the S corporation actively participates in the business, the owner will need to pay themselves a reasonable salary, which will be subject to U.S. federal payroll taxes on the wages. Reasonable compensation issues can be complex with S corporations, so it is best to consult a tax professional when setting your salary.
You should definitely file a tax return with the IRS. Under U.S. tax rules, a single member LLC that is owned by a non-U.S. tax resident is required to file an annual Form 5472 and attach the form to a proforma Form 1120. The returns cannot be electronically filed, so you will need to mail or fax the return to the appropriate IRS office.
These filngs are required even if you have no U.S. source income or physical presence within the U.S. If the LLC filed an election to be taxed as a C corporation, the LLC would file a Form 1120 instead. In order to file the Form 5472, the LLC will need an EIN which you can apply for by submitting a Form SS-4. If you're a non U.S. resident without a SSN, you won't be able to apply for an EIN using the IRS online system. You need to fill out a paper Form SS-4 and mail or fax the form to the IRS. Non-U.S. residents should indicate "FOREIGN" on Line 7b which communicates to the IRS that the responsible party is a non-U.S. person without an SSN.
This will depend upon whether your accountant capitalized and depreciated the assets, or were the equipment purchases expensed currently in the year they were acquired? Is your consulting company taxed as a C corporation, S corporation, or something else?
If your equipment was purchased through the consulting company and expensed currently, the equipment was never recorded as an asset, so you could simply transfer the equipment into the company.
If the equipment was being carried on the company's books as an asset, you can either sell the equipment to the new company, or distribute the assets to yourself as the shareholder, and recontribute the equipment to the newly formed startup. Whenever assets are distributed out of a C or S corporation, the distribution is treated as a deemed sale, so there may be some taxable gain if the fair value exceeds the adjusted basis in the equipment.