Sherwin Brook, CPA
www.brookweiner.com
March 28th 2009
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“The most important element in starting a service practice is to accept that you
are not a professional but instead you are a business person who provides
legal services”
The distinction may be subtle, but it is significant
March 28th 2009
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The distinction may be subtle, but it is significant
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Good professional service
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Clients are not the best judge of quality professional service
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Run your practice as a business
a thriving business
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Essential Start Up Business Questions
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Where do I want to practice?
What area do I want to concentrate my practice?
Will I practice as a sole practitioner or in a small partnership?
Should I share space or rent my own space?
* What kind of legal entity should I become?
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Sole Practitioner
Corporation
LLC
Partnership
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The Sole Proprietorship &
The Dreaded Schedule C
Pros
• This is the easiest to form
• Minimal cost to set up
Cons
• Filing on 1040 schedule C – contributes significantly to the frequency of IRS
audits
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The latest statistics indicate that 1040’s with a “Sch C” are 12 time more likely to be selected
for audits than 1040’s without that schedule.
Home office expenses on 1040’s also increase the likelihood of audits.
A proprietorship form of business does NOT afford asset protection from
creditors
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The Limited Liability Company
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Asset Protection treatment of a Corporation and Tax treatment of a
Partnership
Can be a single member LLC
– Sole member LLCs are treated by the IRS as Disregarded entities and the
business activity is reported on the member’s 1040 schedule C.
• (con – Higher chance for IRS audit)
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In a non-licensed business we frequently suggest that a family member or
friend be given a 1% interest in order to have a multi-member LLC
– Two or more members of a LLC must file a 1065 partnership return and submit
articles of organization and file annual reports and an operating agreement. This
can be done online at:
• http://www.cyberdriveillinois.com/departments/business_services/home.html
• There is no need for any attorney other than yourself to form this legal entity. The site
also has articles of incorporation and access to organizing a legal corporation on line.
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The Partnership
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Similar to the LLC except that it doesn’t need to file with the state and it
does NOT give us creditor asset protection.
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Both the multi-member LLC and partnership will file a partnership return
form 1065 with the IRS
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The Corporation
If an attorney wishes to practice solo but doesn’t want to prepare a schedule C
in his/her personal return, incorporation is an option.
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The P.C. is a standalone reporting entity
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File as a taxable entity under sub chapter “C” of the IRC. Form 1120C
Elect to file as a pass through entity under sub chapter “S” of the IRC. Form 1120S
Once filed this election is binding unless terminated by election or for cause
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“C” Corps’
Pros
• Election of Fiscal or Calendar Year
• Fringe Benefits to shareholder
Cons
• Excess compensation
• Taxable distributions
• Double taxation
• Limitations on current use of Operating Losses
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“S” Corps
Pros
• This type of Corporation is treated as a pass-through entity similar to a
partnership, the shareholder can absorb losses currently to the extent of their
tax basis
• An “S” corporation also avoids the potential of double taxation inherent in a “C”
corp. The “S” corporation is preferable for most P.C.’s
Cons
• Requires a Calendar year
• Limitations on benefits to shareholders with 2% or greater ownership
NOTE:
To become an “S” Corp an election must be filed with the IRS within 75 days of the
date of the formation of the Corporation and/or within 75 days of the beginning
of any tax year
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Termination of “S” Corp
Subchapter S corporation status terminates if:
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Shareholders agree to revoke the Subchapter S corporation election
Corporation ceases to qualify as a Subchapter S corporation, or
Corporation violates the passive investment income restrictions on Subchapter S
corporations with pre-Subchapter S corporation earnings and profits.
A Subchapter S corporation violates the passive investment income restrictions above if
both of the following conditions occur for three consecutive tax years.
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It has pre-Subchapter S corporation earnings and profits at the end of each tax year
(that is, it has accumulated retained earnings from when it was a C corporation, or
when it was a Subchapter S corporation prior to 1983, or had earnings and profits
from an acquired C corporation), and
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Its passive investment income for each tax year is more than 25% of gross receipts.
For purposes of this rule, the definition of passive income includes income from
passive activities, royalties, dividends, interest, annuities, and gains from the sale or
exchange of stock or securities.
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W-2’s
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Regardless of what corporate form adopted, the shareholder officer attorney
must take a W-2 for reasonable compensation
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The single greatest reason for an “S” corporation being selected for audit by
the IRS is the failure of the shareholder to take a W-2.
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A common practice was and still is for the shareholder of the company to
take a small salary and treat the excess earnings as non-self employment
income
– i.e. Dividend distribution (which minimizes payroll taxes)
Note:
Recently, the service has been challenging this practice, especially in
companies where the aggregate income is in excess of the FICA max and
the shareholder’s salary is significantly below that threshold.
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Filings with regulatory agencies
Federal Employer Identification Number
• http://www.irs.gov/businesses/small/article/0,,id=98350,00.html
Illinois Department of Employment Security Number
• http://www.ides.state.il.us/employer/uitax/default.asp
If you elect to be a P.C. or LLC, you will be required to file an Annual Report with the
secretary of States office.
• http://www.cyberdriveillinois.com/publications/pdf_publications/llc501.pdf
Business License
Department of Financial Institutions and Professional Regulations
• http://www.idfpr.com/
• http://spinotew1.commerce.state.il.us/dfsim.nsf/0/a58028d35854a2638625663a
00721780?OpenDocument (information for Service Businesses)
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Now the Fun Begins
You have decided on your legal form, organized it under state law, applied for your
FEIN, and your Illinois Department of Employment Security employer’s number.
– Next you need to open a bank account
– Under the requirements of homeland security you must present your FEIN and the
State documents of good standing in order to open a business bank account
– If your company is going to handle client funds, you will need to open a client trust
account
What’s Next?
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Cash Vs. Accrual
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For small business purposes , Cash basis is the most common . This
typically gives the service professional the best method of tax deferral
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**Caution….for accounting, budgeting, and tax planning purposes the use of accrual accounting can’t be ignored.
Other Accrual factors to consider:
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Managing billings and receivables as well as work in progress will help you to evaluate the
profitability of your business, the value of your clients, the performance of your staff, and
evaluating year to year growth
Accrual basis statements will be meaningful when discussing your firm’s performance with
your bank
When you decide to bring in a new partner you will want to know what your deferred income
was prior to the addition of the partner
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Accounting & Tax Issues Related to Rented Facilities
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Tax & accounting treatments for build out allowances
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Tax & accounting rules allow for on cash basis companies to reflect rent on the average
rental rate over the lease period
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Build-out paid directly by landlord
Build-out paid by leasee in excess of allowance – need to be capitalized and amortized over life of lease
Unused allowances
Need to total the rent paid over the life of the lease – less any unused build-out and divide by the term of the lease
Longer term leases build in escalations – making earlier years of a lease more attractive
The IRS recognizes such as a marketing issue and allows a cash basis taxpayer to accrue rent expense
The taxpayer has a greater rent expense deduction in the earlier period
In later periods, the deduction will be less then the cash outlay
Recording rent on the books results in accrued rent liability in earlier periods. A portion of
this accrual needs to be written off as a reduction of rent expense in the later years of the
lease
Leases also allow for an operating and RE tax escalator. These increases in rent expense
are not typically estimated in the calculation of average rent and are deemed to be a period
cost
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Good Billing Practices
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Consideration must be given to the use of progress billing and timely billing
at or shortly after completing a project
Invoices need to be clear as to the work performed
Invoice detail is a firm/client decision on the amount of detail
Litigation and bankruptcy invoices typically require more detail
General matters are frequently presented in a more condensed manner
It is important to remember that your billing invoice should be presented in a
manner to raise issues or suppress client inquires
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Accounts Receivable & Collection issues
It is a fact of business life that from time to time we will have a collection issue
with a client
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We have three options when facing collection problems
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Write them off
Drop the client
Institute a collection policy
Pursuing collections are very costly
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Payment plans or compromised settlements might be an option
Obtaining a note from the client is another option
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Non collection of the note will not result in a COD to client
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Accounting and Billing Systems
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Fully integrated general ledger, time and billing system
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Linked general ledger, time and billing system
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This is one in which the same vendor’s software is a complete system and does auto posting
This is where one vender provides the time and billing software and general ledger software
is compatible with the time and billing system
Payroll
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Make use of payroll services to process even a one person payroll
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Cost effective
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I’d rather earn my fees advising you then preparing payroll tax returns!
March 28th 2009
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Payroll Warning!
A strong word of warning……..employee payroll withholdings, including
FICA represent a fiduciary responsibility and as a business owner
you have no right to use such to operate your business. You can be
held personally liable for such out of trust amounts and the liability is
not subject to bankruptcy protection.
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Chart of Accounts
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Accounting software is directly related to your Chart of Accounts
A Chart of Accounts is a list of all account names in the businesses General
Ledger
Needs to be consistent
Provide sufficient level of detail
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Too little – it is hard to reference and track
Too much – can distract the reader from the purpose
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Should be periodically reviewed
Building block in preparing financial statements
Basic for understanding your financial position
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Have your CPA review your chart set up and financial statement design!
• For detailed Chart of Accounts see Exhibit B
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Sample Chart of Accounts (1 of 2) - Balance Sheet
Assets
100.02
LaSalle - Cost Acct
100.04
LaSalle - General - closed
100.05
Charter One - AH 697
100.07
Charter One - New Payroll Acct
100.09
Charter One - JAS 689
100.11
Charter One - MVF 670
100.12
Charter One - IOLTA
100.13
Charter One - Fee Income
101.01
Charter One - Client Funds Acct
101.05
Charter One - Money Market
101.06
Charter One - Payroll - closed
101.07
Charter One - New Client Funds
101.08
Charter One Distribution
101.09
Washington Mutual - Money Market
101.10
Undeposited Funds
110.00
GGG Loan
111.00
MKG Loan
150.01
Furniture and Fixtures
150.03
Office Equipment
160.01
Accum. Depr. - Furniture and Fixtures
160.03
Accum. Depr. - Office Equipment
185.00
Security Deposits
Liabilities
210.00
Client Escrow Funds
220.05
Accrued Payroll Taxes
220.06
Employees' Flex Account
221.00
Withholding for 401(k) Loan Repayment
Equity
280.00
Beginning Owner's Equity
295.00
Draw - GGG
295.01
Draw - MKG
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Sample Chart of Accounts (2 of 2) – Income Statement
Income
300.00
300.01
310.00
Expense
350.00
355.00
360.00
363.00
365.00
365.01
365.02
370.00
385.01
385.02
385.03
400.00
405.00
410.00
425.00
435.00
435.10
440.00
450.01
450.02
450.03
455.00
460.00
470.00
475.00
476.00
480.00
481.00
550.00
600.00
999.00
Fee Income
Refund
Interest Income
Advertising
Bank Service Charges
Client Expenses
Computer Expense
Donations
Donations - Charitable
Donations - Political
Dues and Subscriptions
Insurance - General
Insurance - Group
Insurance - Dental Group
Office Supplies and Expense
Outside Services
Postage and Delivery
Rent
Salaries
Payroll Processing Fee
Seminars
Taxes - Federal UC
Taxes - FICA Expense
Taxes - State U/C
401K Employer Contribution
Telephone
Travel and Auto
Utilities
Client's Fee Discount
Depreciation
Sec 179
Expense Reimbursements
Taxes
Suspense
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IOLTA
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Understand your duties under IOLTA provisions
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http://iardc.org/toc_main.html
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Duty to segregate
Duty to maintain complete records
Duty to prompt deposit of client funds
Duty to preserve the integrity of client trust fund
Duty to account to client
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IOLTA (cont)
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Illinois has three classifications of retainers
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Classic retainers which secures an attorneys services for a period of time or specific matter
is recognized as income by the attorney at the time of receipt and is not deposited in the a
trust account
A security retainer is deposited directly into the client trust account and is not considered
revenue until the services are performed
The advance payment retainer is relatively new and its treatment is dictated by the
consensus between the attorney and the client. If agreed to be a classic arrangement then
the moneys are recognized as income immediately. Otherwise, it must be deposited in the
trust account. These agreements must be writing.
Client trust funds belong to your clients and cannot be comingled with your
firm’s funds or uses any purpose that what was intended.
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IOLTA (cont)
Funds must be deposited in an interest bearing, IOLTA designed account. The
interest net of the related bank charges are for the benefit of the client.
– When setting up the account you will need to execute an IOLTA enrollment
agreement
– The checks will need to be readily distinguishable from those of your general
business account
– Signatories must be restricted and monitored
– Accounts need to be reconciled on a regular basis and differences reconciled
– ATM’s should not be used for these accounts
– Don’t share an account with lawyers from other firms
– Errors will happen and when they do notify the bank promptly
– You should withdraw your fees against the client’s trust account only if retainers
have been deposited. In order for your billing system to properly track your
performance, you need to prepare an invoice.
– Finally, you need an accounting system
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Accounting for Trust Account Activities
Client trust accounts can be interfaced together into your business’ chart of
accounts or you can monitor and record them separately from your General
Ledger
Client related matters, for which funds are received, must be accounted for in detail.
Each client account must be accounted for, this can be done manually or by
computer system. But, use a computerized system for tracking account activity.
Documentation and Retention
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Receipts must be deposited promptly
Deposit slips must contain detailed descriptions of clients and file numbers
Client’s subsidiary ledger are opened and transactions are recorded
Checks need to be made payable to the client or third party with proper notation for matter and
purpose
Client subsidiary ledger needs to be constantly updated
Copies of bills, receipts and other related documents must be retained and identified with the
related matter
You must inform your client of payment of your fees from the trust account. These payments must
be made payable to your firm and deposited promptly in your business account
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Accounting for Trust Account Activities
You must keep all records relating to the client trust accounts for not less than 7
years.
It is important to be mindful of FDIC coverage for your client’s trust accounts,
recent legislation has expanded the FDIC coverage amount. Make sure
you discuss current FDIC limits with your banker
Occasionally, there will be a balance left in the trust account for a closed matter
and the client cannot be located. Such funds are subject to the uniformed
unclaimed property act and you are required to remit any remaining funds to
the state
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Quick Hitters
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Diligent Oversight by Partners
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Review all expenses prior to signing
Have cash controls in place
Know your vendors
Adopt proper internal controls and anti-fraud policies
Adopt proper accounting, time and billing software
Design a “Presentable Website”
Talk to a labor lawyer
Be aware of employee rights and employee practice coverage
Always consider Cost savings
Separate payroll account
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Quick Tip – Your Banker
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Bank relations should be more than having a bank account or a loan
When choosing a bank, make sure that you are assigned a bank officer
Meet with him/her. Let him/her know who you are and that you would like to
develop a long term business relationship with the bank
This approach has many advantages to you including:
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Potential for referrals
Access to funds
A source for your clients
The cultivation of these relationship is more than business development…………it is
building credibility with the bank, so when you need them they will be receptive to
your needs
It is rare today that at some time in the operation of any business that bank
financing will not be needed. It is easier to secure financing if you have a good
standing relationship with your banker
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Quarterly Payments
Dates to Remember!!!!
Estimated Tax Payments
• April 15th , 2009
• June 15th , 2009
• September 15th , 2009
• January 15th , 2010
FUTA Payments
Quarter ending
March 31st
June 30th
September 30th
December 31st
Due Date
April 30th
July 31st
October 31st
January 31st
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Employment Tax Rates and Wage Bases for 2009
Illinois Department of Employment Security (IDES phone # 312-793-4880)
Social Security Tax:
*Tax Rate - 6.2% each for employers and employees
*Wage Base - $106,800.00.
Max Amt. $6,621.60
Medicare Tax:
*Tax Rate - 1.45% each for employers and employees
All wages subject to Medicare tax
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Employment Tax Rates and Wage Bases for 2009 (cont)
Federal Unemployment (FUTA) Tax:
*Wage Base - $7,000
*Tax Rate - .08%
Re:
($56.00)
State of Illinois Department of Employment Security
Unemployment Insurance
The rate cannot be lower than 0.6% or higher than 6.8%.
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Employment Tax Rates and Wage Bases for 2009 (cont)
NEW WAGE BASE FOR 2009 is $12,300.
An Employer whose rate is 5.5% or higher and whose total wages for a
particular quarter are less than $50,000 pays contributions at 5.4% for that
quarter.
First Time new employers will have a different rate
Their rate will be 3.1%, that is the Standard New Employer Entry Rate.
IRS publications
• Including Circular E and other withholding schedules
• http://www.irs.gov/publications/index.html
March 28th 2009
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Home Office
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Home office expense is deductible
Expenses deductible on schedule C – there are rules
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Reimbursed expense may require inclusion on your W-2
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Make sure that payroll services is informed of the inclusions. It is expensive to revise!
For multi member firms or corporations, bill the company for expenses
incurred and reimburse yourself
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i.e. exclusive business use of area
Limited to the businesses % of use
This allows the company to deduct that from its results of operations, the k-1 will show this
If you don’t reimburse yourself, the home office deduction could become an itemized
deduction subject to the 2% miscellaneous deduction limitation
I typically do not recommend taking depreciation of home use
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Other Tax Benefits
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Other areas of the IRS code allow for immediate write off of business asset
purchases up to the limit
– Currently, the limit is $250,000 in any one year
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Section 179 deduction does not apply to business real property and
personal auto and is an aggregate limit based upon all section 179 sources
for the year
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Remember that business use of your auto is an allowed business deduction
based upon the prorated actual expense or the standard mileage
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These expenses should be treated in a similar fashion to home office use
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Retirement Planning
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401k
401k IRA
401k Simple
Integrated 401k
Profit sharing
Defined contribution plans
Defined benefit plans
SEP IRA plans
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Each of these plans has specific features and various limitations and should
be reviewed with a qualified benefits expert prior to being adopted. It is
important to remember that certain plans work better for one person then
than they would in a firm with multiple employees
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Retirement Planning (cont)
Benefit plans are a needed tool when trying to hire
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The government has specific rules
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The maximum contribution levels have been increasing annually for the past several
years, and will continue.
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Retirement plans are an effective deferral of income and allow the funds invested to
grow on a tax deferred basis until drawn for retirement needs
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Employee contributions to these plans including owners are not subject to payroll
taxes and current income taxes
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This is a benefit to both the employer and employee
March 28th 2009
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Cafeteria Plans
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Sec 125 plan, to non shareholder employees
– Employees can elect to reduce salary to cover, health insurance, transportation,
medical out of pocket expenses, and childcare costs.
– Employees are able to reduce both taxable income and FICA expenses by the
allotted amount.
• If the amount the employee elects to contribute to the plan is not fully expended during
the plan year then the excess is not reimbursable to the employee and cannot be cared
forward to future periods.
• The employer must track and reimburse employees for qualified expenditures which will
require administration attention
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Other plans
– In addition to the benefit plans; other payroll reduction plans have in recent years
been established by legislation, including HSA (health saving plans).
• It is best to discuss these with a benefits specialist prior to being established
March 28th 2009
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Choosing a CPA
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Choose one you trust
Make sure he/she understands your business
Determine that they have the expertise to help you, your business, and your
client’s needs
Just as you don’t want to be looked at as a commodity by your clients, don’t
select a CPA on that basis
Use the contacts that an experienced CPA can offer you
Use the CPA as a sounding board for your business and related ideas
Your CPA should be willing to be used as a 3rd party resource for your
clients
It is commonly known that attorneys and CPAs are great referral sources
and to a large extent over time that is true, however, over the years I have
learned that we are actually better sources for introductions than for
referrals.
– You should mutually exploit that relationship
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BrookWeiner LLC – Website
An Excellent Source!
• ANY IRS form or Instruction can be viewed and
downloaded or filled out from our website
• Full Tax Publication Library where you may
view/print/ save all tax publications
• Recent Tax updates and Tax news
• Tax Calendars for important filing dates
• Financial Tools including numerous Tax Calculators
March 28th 2009
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Use your professional business team of Accountants, Lawyers,
Bankers, Insurances brokers, and Financial advisors as a
resource. Take advantage of their contacts!
It is cheaper to avoid a problem then to fix a problem!
March 28th 2009
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Exhibits
Schedule C
• Schedule C.pdf
IRS Forms
• Form 2553 – Election by a small business company
• Form 8829 – Home Office Deduction
Detailed Chart of Accounts
• Chart of Accounts Example.doc
Definition of Terms
• Definition of Terms.doc
What kind of Legal Entity? – Article
• What Kind of Legal Entity Should I Choose 1-16-09.doc
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What Kind of Legal Entity Should I Choose For My New Business?
Why This is Really Two Questions.
One of the most basic questions new business owners have long asked their
professional advisors is “as what kind of legal entity should I operate?”
This has never been an easy question. In addition to the fact that there are a
number of possible choices for type of legal entity (such as sole proprietorship,
partnership, LLC, S corporation and C corporation), there are also various different legal,
administrative and tax advantages and disadvantages among the choices. Whatever
choice is made, we are always giving up some advantages that a different choice would
have given us.
As of several years ago, the IRS made a change to their rules that has a significant
and positive impact on our entity selection decision making process. Specifically, it is
now possible to create a legal entity of one type, but to elect to be treated as a different
type of entity for tax purposes.
Why would we do this? Clearly, if we thought that one type of entity was the first
choice based on legal considerations, but a different entity was best from a tax
perspective, we now get the best of both worlds. We choose both.
So, the entity choice question is really two questions:
What kind of entity should I choose to get the best possible legal answers?
What kind of entity should I choose to get the best possible tax answers?
The two questions could have the same answer, or two different answers.
If we believe that our ideal situation would, in fact, be to operate as one kind of
entity for legal purposes and a different type of entity for tax purposes, we would take the
following steps:
First, we would establish our legal entity as the type of entity we would prefer for
legal purposes. For example, (and probably the most common situation) if we want to
operate as an LLC for legal purposes, we establish our entity as an LLC.
Second, we file IRS Form 8832, Entity Classification Election, to elect which
type of entity we choose to be for tax purposes. In our example, where we are legally an
LLC, we could choose to be taxed as a corporation. As far as the IRS is concerned, we
are then a corporation.
There is one important exception to the above second step. If we want to be an S
Corporation, we do NOT file Form 8832. Instead we file Form 2553, Election by a Small
Business Corporation. The Form 2553 functions as both our entity election and our S
Corporation election.
March 28th 2009
BrookWeiner LLC
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