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Small Business Taxes & Investments

June 21, 2019
Small Business

For once, investors want to see the bright side of their invested capital. Besides, investment is often vulnerable to various risks and unexpected market implications despite the fearless mannerism of investors.

And investors can enjoy numerous benefits offered by the U.S government.

With effective tax strategies, investors can keep their well-deserved earnings. As a result, investors can divest funds in new startups and other potential opportunities.

The calculation of the small business taxes is done to determine the profit or loss on income taxes. Afterward, the net information ends up in personal tax returns.

Clients of Halon Tax Grow Their Revenue by 18%/yr on Average

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Small Business Taxes in 2018

Small businesses have to be more compliant when it comes to meeting the set deadlines.  And filing after the due date often results in fines and even legal complications.

Sole proprietorships and LLC firms file their tax return on April 15. However, partnership and S corporations file their tax returns on March 15.

Although the federal income tax law is complicated, your top priority should be to evaluate the potential of the investment as a whole. And of course, choose the appropriate parties for conducting business.

Is Investing in Someone Else’s Business Tax Deductible?

Whether you’re running a small business or handling a large corporation, you ultimately have two methods to raise the capital. That is; borrow the money or sell your ownership share. Subsequently, you can buy out the entire business or lend money to appropriate parties.

Here’s a guideline to help you understand criteria under which your investment in another business can be tax deductible.

The Nature of Your Investment

As an investor, you have to ask questions, such as the type of investment? Do you have any stock options? And figuring out whether you're investing in a C corporation or a pass-through entity?

These questions will provide you vital information regarding what type of benefits you can avail through present income tax regulations.

Regain Your Investment Losses

Statistically, more than half of your investment is bound to suffer the loses. Therefore, learn to protect your investment as instructed by the Internal Revenue Code (IRC) Section 1244 of the federal tax code.

What does IRC Section 1244 can do for investors? It allows investors an opportunity to get income deduction on losses instead of facing deductions from total capital loss. However, the rules of the game dictate you to have first $1 million for the investing company.

Investors who qualify for a 1244 deduction reap the benefits via monetization of losses.

Usually, investors are liable to take a capital loss of $3,000 on their investment, but the downside is that time could be stretched to several years before you can regain any loss. And through 1244 deduction, you can monetize your losses up to $100,000.

The trick is to assemble the 1244 documentation before any losses occur on your investment.

Successful Investments Decrease Taxes

The IRC Section 1202 or also known as Qualified Small Business Stock (QSBS) allows investors to get rid of taxes on successful investment exits completely. Furthermore, QSBS can decrease a 50-100% gain on qualifying companies.

The purpose of the Qualified Small Business Stock (QSBS) is to boost the investment for new businesses, job creation, and compensate the risk investor.

The applicability of the QSBS requires individuals, partners, or C Corporations to invest assets of less than $50 million. Additionally, the stock requires a direct purchase, and you have to keep it for five years before evaluation.

But things can get confusing for investors as Alternative Minimum Tax (AMT) has been revised by the Congress several times over the past decade. Thus, align your gains with the current legislative amendment.

What is Exclusion Rate on Your Stock Options?

At the moment, the 2014 exclusion rate is 50%. However, investors enjoyed a 100% exclusion rate between 2010-2013.

The full exclusion rate means investors didn’t pay taxes on gains made from purchased stock options. Congress intends to bring back the full exclusion policy to increase growth and investment opportunities.

Investors are frequently advised by industry professionals to follow the trail of their QSBS investment stock to analyze the mechanism of reporting on time, and figuring out exactly how much tax to pay on your gains.

Forming Partnership

Forming a partnership is another way of buying into a particular business. For example, if your close friend has a unique business idea, but lacks capital investment; you can invest the remaining percent and enjoy the profits from the business.

The partnership income and expenses are reported on Schedule C. Similarly, losses are part of Schedule C and later on deducted from your income.

Lending Loans

Money lent by investors to startups without the company's intentness is personal debt. And you can claim your personal debt in the form of a tax write-off.  And you can only collect such debt if you failed to collect the money in the first place.

Report bad debts as short-term capital losses. Generally, you're obligated to provide a rational explanation and reasons as to why the debt didn’t pay off.

Additional Write-Offs

The total costs incurred to manage and track your investment are deductibles. For instance, you can depreciate your computer, which is used to research and make investments.

Also, a 2% deduction applies to your investment expenses. And the added write-off refers to the 2 percent subtraction from your adjusted gross income.

Conclusion

Investors should seek the guidance of an accountant to understand the contemporary tax programs that allow maximum gains on your investment. And provide the right information to your tax accountant to get the accurate expected return on investment.

What's the take away for investors? The more you're familiar with tax laws before any investment, the more you can benefit from investing in a startup company.

Christopher Ragain, CPA

Christopher Ragain, CPA is the founder of Halon Tax and one of the industries top authorities on micro-business taxation and tax planning.

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