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Sherwin Brook, CPA

Sherwin Brook, CPA. www.brookweiner.com. “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.

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Sherwin Brook, CPA

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  1. Sherwin Brook, CPA www.brookweiner.com March 28th 2009

  2. “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

  3. The distinction may be subtle, but it is significant • Good professional service a thriving business • Clients are not the best judge of quality professional service • Run your practice as a business March 28th 2009

  4. Essential Start Up Business Questions • 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? • Sole Practitioner • Corporation • LLC • Partnership March 28th 2009

  5. 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 • 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 March 28th 2009

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  8. The Limited Liability Company • 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) • 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. March 28th 2009

  9. The Partnership • Similar to the LLC except that it doesn’t need to file with the state and it does NOT give us creditor asset protection. • Both the multi-member LLC and partnership will file a partnership return form 1065 with the IRS March 28th 2009

  10. 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. • The P.C. is a standalone reporting entity • 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 March 28th 2009

  11. “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 March 28th 2009

  12. “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 March 28th 2009

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  14. Termination of “S” Corp Subchapter S corporation status terminates if: • 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. • 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 • 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. March 28th 2009

  15. W-2’s • Regardless of what corporate form adopted, the shareholder officer attorney must take a W-2 for reasonable compensation • 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. • 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. March 28th 2009

  16. 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/a58028d35854a2638625663a00721780?OpenDocument (information for Service Businesses) March 28th 2009

  17. 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? March 28th 2009

  18. Cash Vs. Accrual • For small business purposes , Cash basis is the most common . This typically gives the service professional the best method of tax deferral • **Caution….for accounting, budgeting, and tax planning purposes the use of accrual accounting can’t be ignored. • Other Accrual factors to consider: • 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 March 28th 2009

  19. Accounting & Tax Issues Related to Rented Facilities • Tax & accounting treatments for build out allowances • 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 • Tax & accounting rules allow for on cash basis companies to reflect rent on the average rental rate over the lease period • 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 March 28th 2009

  20. Good Billing Practices • 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 March 28th 2009

  21. 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 • We have three options when facing collection problems • Write them off • Drop the client • Institute a collection policy • Pursuing collections are very costly • Payment plans or compromised settlements might be an option • Obtaining a note from the client is another option • Non collection of the note will not result in a COD to client March 28th 2009

  22. Accounting and Billing Systems • Fully integrated general ledger, time and billing system • This is one in which the same vendor’s software is a complete system and does auto posting • Linked general ledger, time and billing system • This is where one vender provides the time and billing software and general ledger software is compatible with the time and billing system • Payroll • Make use of payroll services to process even a one person payroll • Cost effective • I’d rather earn my fees advising you then preparing payroll tax returns! March 28th 2009

  23. 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. March 28th 2009

  24. Chart of Accounts • 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 • Too little – it is hard to reference and track • Too much – can distract the reader from the purpose • Should be periodically reviewed • Building block in preparing financial statements • Basic for understanding your financial position • Have your CPA review your chart set up and financial statement design! • For detailed Chart of Accounts see Exhibit B March 28th 2009

  25. Sample Chart of Accounts (1 of 2) - Balance Sheet

  26. Sample Chart of Accounts (2 of 2) – Income Statement

  27. IOLTA • Understand your duties under IOLTA provisions • http://iardc.org/toc_main.html • 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 March 28th 2009

  28. IOLTA (cont) • Illinois has three classifications of retainers • 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. March 28th 2009

  29. 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 March 28th 2009

  30. 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 • 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 March 28th 2009

  31. 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 March 28th 2009

  32. Quick Hitters • Diligent Oversight by Partners • 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 March 28th 2009

  33. Quick Tip – Your Banker • 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: • 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 March 28th 2009

  34. Quarterly Payments Dates to Remember!!!! Estimated Tax Payments • April 15th , 2009 • June 15th , 2009 • September 15th , 2009 • January 15th , 2010 FUTA Payments Quarter endingDue Date March 31st April 30th June 30th July 31st September 30th October 31st December 31st January 31st March 28th 2009

  35. 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 March 28th 2009

  36. Employment Tax Rates and Wage Bases for 2009 (cont) Federal Unemployment (FUTA) Tax:                  *Wage Base - $7,000                  *Tax Rate - .08%               ($56.00) Re:      State of Illinois Department of Employment Security             Unemployment Insurance The rate cannot be lower than 0.6% or higher than 6.8%. March 28th 2009

  37. 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

  38. Home Office • Home office expense is deductible • Expenses deductible on schedule C – there are rules • i.e. exclusive business use of area • Limited to the businesses % of use • Reimbursed expense may require inclusion on your W-2 • 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 • 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 March 28th 2009

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  40. Other Tax Benefits • 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 • 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 • Remember that business use of your auto is an allowed business deduction based upon the prorated actual expense or the standard mileage • These expenses should be treated in a similar fashion to home office use March 28th 2009

  41. Retirement Planning • 401k • 401k IRA • 401k Simple • Integrated 401k • Profit sharing • Defined contribution plans • Defined benefit plans • SEP IRA plans • 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 March 28th 2009

  42. Retirement Planning (cont) Benefit plans are a needed tool when trying to hire • The government has specific rules • The maximum contribution levels have been increasing annually for the past several years, and will continue. • 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 • Employee contributions to these plans including owners are not subject to payroll taxes and current income taxes • This is a benefit to both the employer and employee March 28th 2009

  43. Cafeteria Plans • 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 • 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

  44. Choosing a CPA • 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 March 28th 2009

  45. 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

  46. 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

  47. 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 March 28th 2009

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