Firms Put Meal Expenses on a Diet
QUESTION: The thing I feared most about the new tax laws was the change in reporting meals and entertainment expenses to employers. I am a salesman, and my livelihood often depends on how much wining and dining I do. My fears seem misguided, though. I haven’t seen any change in attitudes among my bosses and I am still doing things the way I did before. Did I misunderstand when this takes effect? And if not, do you have any idea what the experience of other people has been?--P. A.
ANSWER: Those tough new tax reform rules governing business meals and entertainment did indeed go into effect this year. And according to the Runzheimer International consulting firm, you are one of the lucky minority.
Runzheimer, a Wisconsin firm, recently asked several hundred companies how they are coping with the new rule that companies must pay taxes on 20% of the cost of their employees’ business meals. Before, such meals were fully deductible from their taxable income on the theory that they helped companies generate or keep business.
Only a fourth of the companies surveyed said the new law hasn’t affected their practices. An additional 41% said they are monitoring their employees’ meal and entertainment expenses more closely than before. And the remainder said they have taken even harsher action--either by asking employees to try to cut spending for such items or by demanding much more rigorous accounting of these expenses.
One employer, for example, said it is no longer good enough to report that an employee took a client to lunch and spent a certain amount. Now, employees must document why they took the client out, where they went and what they hope to gain from the lunch.
Those employers who said they haven’t changed their practices generally argued that doing so would make the company look bad in the eyes of employees.
Q: I have decided to strike out on my own and open a computer repair shop. I know how to fix computers, but I don’t have any idea how to organize the business. Friends say I should choose either a sole proprietorship or an S corporation, and I suppose eventually I will have to hire a lawyer to help me draw up the papers. But it struck me as I talked to friends that this is a question a lot of people have. Is there a difference between a sole proprietorship and an S corporation? Or should I be thinking about some form that is completely different from either of those?--B. N.
A: Unfortunately, there are no simple answers. This is one of the most difficult decisions every new business owner faces. But some easier questions might lead you to your own answer.
Do you want to make sure that you aren’t held personally liable for your business debts? If so, don’t form a sole proprietorship. Because the owner of a sole proprietorship and his or her business are virtually one and the same legally, you would be personally liable for all debts incurred by the business and for any lawsuits filed against the business. If creditors came after your business, they could come after your house, your car or anything else you own. An S corporation, conversely, is like a full-fledged corporation when it comes to liability to its owners. It is a separate entity from the owner, so the owner generally cannot be held personally liable for the debts of the business.
If raising a lot of capital is essential for your new business, a sole proprietorship again may not be a good idea. As a sole proprietor, you probably will find that the amount you can raise from a bank, venture capitalist or other source is limited to the amount that you can secure personally.
That is not the case with an S corporation. These small business corporations--formerly called Subchapter S corporations because of the section of the tax law that created them--can pledge the assets of the business and so usually can raise more money, which can be a real plus to a new and growing company.
Those are the two biggest drawbacks of sole proprietorships. A third is that sole proprietors usually qualify for less lucrative retirement plans and other fringe benefits. He or she can put a maximum of only 20% of the business’s profits into a retirement fund, compared to the 25% maximum for corporate employees. And the business isn’t permitted to provide such things as tax-free life insurance to the owner, but a corporation can.
If you are less worried about raising money, retirement plans and paying off the business’s debts yourself than you are about finding a relatively easy and cheap way to start a business, then the sole proprietorship may be for you. Starting this type of business requires the least amount of paper work and the least amount of money for legal fees and accounting expenses.
Basically, all a sole proprietor has to do is get a state and local business license (some areas don’t even require both), check with the appropriate state agency to make sure his proposed company name isn’t already taken and hang out his shingle. A sole proprietor doesn’t even have to file a separate tax return for his or her business. The relevant tax schedules are simply attached to the owner’s personal tax return.
Forming an S corporation is much more expensive and time-consuming, and it has the same drawback as a sole proprietorship when it comes to retirement plans and the like. But many new businesses elect this type of organization anyway--mostly because of the tax advantages.
New businesses often lose money in the early years, and the shareholders of an S corporation can use the business losses to offset their personal income from other sources. That is because the earnings or losses of a business organized as an S corporation are divided among the owners.
When the business becomes profitable, many S corporation owners then elect to change the business form because they don’t want to increase their personal taxable income.
The two other well-known types of business organizations probably don’t fit your situation. The partnership requires at least two owners, and the corporation, while providing more protection from the business’s liabilities, is quite expensive and complex to set up and administer.
Debra Whitefield cannot answer mail individually but will respond in this column to financial questions of general interest. Do not telephone. Write to Money Talk, Los Angeles Times, 780 Third Ave., Suite 3801, New York, N.Y. 10017.
