There have been many extensive books written about this subject, but I will try to summarize the differences and how they apply to us as the independent operator of a route.

Sole Proprietorship. A sole proprietor starts his business by opening a “business” checking account and simply keeps track of his income and expenses. A sole proprietor accounts for this profit by filing a Schedule C on his annual federal income form, 1040, and pays income tax and self employment tax on the profit. For example, a sole proprietor who makes $40,000 in his business will pay a self employment tax of 15.2% (FICA/Medicare) and an income tax of about 5% effective rate (After a standard deduction and exemptions for husband, wife and two children). The total tax would be about $8000. The advantages of a sole proprietor is that there is nothing to do to start your business and as a sole proprietor your children can work for your business and they are exempt from Social Security and Medicare withholding until they are 18 years old. The major disadvantage of a Sole Proprietorship is that you have to pay Social Security and Medicare as an employer and an employee (15.2%) (FICA/Medicare) on all income from your business. As a sole proprietor you are personally liable for all debts and obligations of the business. If you had an accident and lost found liable, you could not only lose your business, but also personal property. In some states, this could include your home.

Partnership A partnership usually requires an agreement between two or more people and the income from a Partnership is taxed to you as a partner and subject to both income tax and FICA/Medicare. Additionally, there is an annual Form (1065) that must be filed with the federal government and usually one in your state of residence. This is the least desirable form of doing business. Generally, partners are liable for business debt.

C Corporation A C Corporation or Regular Corporation is a state created being and offers the shareholders protection from personal liability. Unlike sole a proprietorship, generally, if a corporation is liability and can not meet an obligation, the shareholders are not liable for that obligation. A C corporation must file an annual return with the federal government (1120) and pay a tax on its income. Subsequently, any profits distributed to the shareholders are taxed again to the shareholders as dividends. C corporations must also file a state return and pay state income or franchise tax on the profit. The protection of a C corporation is overwhelmed by the federal and state corporate income tax and the subsequent federal and state income tax on the dividends.

Small Business Corporations Sub S Corporations offer the protection of a corporation without the double taxation. All of the income from a Sub S corporation flows to the shareholders personal tax return as Income From Sub S Corporations (K-1 income). Additionally, this income is subject to Income tax only and not subject to FICA/Medicare. In the example about where the Sole Proprietor made $40,000 as a Schedule C Sole Proprietor, if this income were reported as K-1 income the liability would be less than $3,000, a savings of almost $5,000. Income from a Sub S is not subject to FICA/Medicare. For this reason, the IRS has invoked the “reasonable salary” concept on Sub S to require that a reasonable salary be paid to someone to operate the corporation. At DSA, we feel that based upon what it would cost to hire and employee to run the company and what the company earns, a “reasonable salary” is about $20,000. The tax savings because the Sub S income ($40,000-20,000=$20,000) is not subject to FICA/Medicare would be about $3,000 ($20,000@15.2%). Many of the companies that are turning over distribution of their product to independents are requiring the operator to incorporate because of “independent contractor” issues, but as it turns out, we feel this is currently the best form for independent contractors.

Summary: We recommend that the independent operator (i/o) conduct his or her business as either a sole proprietor or as a Small Business Corporation. A sole proprietorship only requires setting up a business checking account and as a sole proprietor you have the advantage of being exempt from withholder FICA/Medicare when you hire your children up to the age of 18 yrs. The cost of set up and compliance is less than a corporation, but a Sub S corporation has more tax advantages. Even though corporations are not exempt from withholding FICA/Medicare from their children, you can pay a consulting fee to your spouse and he/she can then, as a sole proprietor, be exempt from the withholding requirement. Currently, for all of the reasons we stated, we recommend to our new clients that they conduct their business as a Sub S corporation.

If I am a Sole Proprietor should I change to a Sub S? Unless the amount of income you are making as a sole proprietor exceeds the additional cost of being a corporation, then it may make more sense to continue as a Sole Proprietor and make sure your liability insurance can cover your limited liability. Your additional cost include fees to incorporate, annual state filing fees for Sub S corporations, higher accounting fees to cover payroll filings, annual federal and state corporate forms. Unless you are showing Schedule C income of $50,000 or more, it’s not worth changing the form in which you do business.

How do you estimate my Quarterly Liability for estimated payments?

For Sole Proprietorships, we take your average monthly income and project your annual estimated income. We take the estimated annual income and multiply it by 25% (15.2%FICA/Medicare plus 10% Income tax) to get you estimated tax liability. We suggest that you pay one quarter of this amount each quarter when it is due (April, June, Sept, Jan). We don’t use past years income because we feel our method is more accurate since we adjust the annual projection based upon information you supply to us monthly. For Sub S corporations, we annualize income and project an Income tax liability based upon a 10% rate. This should be adequate to cover your year end income tax liability due to your K-1 income.

Should I take advantage of “Office in the Home” Yes, Yes, Yes. To qualify for a Home Office deduction, the space in your house must be used “regularly” and “exclusively” for business. You calculate the percentage of you house that you use as your office and you can get a deduction on your Schedule C for all of the cost of maintaining your home. If your office is 5% the square footage of you home, you get a deduction on your Schedule C for 5% the cost of taxes, insurance, repairs, mortgage interest, repairs and any other cost of maintaining your home. Plus you can depreciate that portion of your home (5%) that is your home office. Even though some of these expenses are already deductible as an itemized expense on your tax return, Schedule C income is subject to FICA/Medicare and income tax and by reducing this income you save about 20 - 25% .Additionally, since you will visit your “Home Office” every morning before driving to work, your drive to the depot is not non deductible commutation, but deductible business miles to the tune of $.445 per mile.

A Home Office deduction is also available to you as an employee of your Small Business Corporation. This deduction is recorded as a Miscellaneous Itemized Deduction subject to a 2% Adjusted Gross Income threshold.

I report my income on Schedule C of my Form 1040. How does DSA Tax and Bookkeeping calculate my profit and loss?

Each month our Schedule C i/o’s send to us a Monthly Recap and a Monthly Settlement Sheet. The Monthly Recap is a summary of you money received and money spent from your business checking account. It is basically a Cash Receipts/Cash Disbursement Journal. We have written a program that records “Deposits” to the Sales Income column and all checks written to the applicable expenses. In addition to this, we record all settlement items as Sales Income and depending on the reason the account was charged, we record the applicable expense. We add the settlement items to Income because this is money that should have been received but was withheld by the company to pay for agreed expenses of the i/o. These settlements items include but are limited to: insurance, accounting fees, truck lease payments, route loans payments, vacation driver and other assorted charges. All of the charges are added to income and depending on the charge some or all are expensed. For example a settlement charge for insurance is added to income because it was money withheld at the settlement and added to insurance expense because it is a deductible expense. However, the charge for your route or truck loan is only partially deductible. Only that portion that relates to interest is a legitimate business expense. The principle amount of the payment is non deductible. However, when we set you up as a client, we amortize your route over 15 years (180 months) and depreciate your truck. We update this information if you send us a change form. We also accumulate information pertaining to your “Home Office” and the miles you use that qualify as “business mileage”. From all of this information, we calculate a monthly and year to date Income Statement. For Schedule C clients, a Balance Sheet is not required.

Why don’t you show Cost of Goods Sold on the monthly financials?

DSA Tax and Bookkeeping prepares monthly Profit and Loss Statements for hundreds of individual who own and/or operate a delivery route. Generally these individuals own a bread or cookie route with defined territorial rights that have been purchased from a company and operate as a Sole Proprietor or as a Sub S Corporation At the time of purchase a buyer of a route purchases a territory that gives him exclusive sales rights, with some exceptions, and he also purchases (or leases) a delivery truck and an inventory hand-held computer.

Each new tax and bookkeeping client is set-up in our records to reflect the purchase of his route, which allows us to amortize the route and depreciate his truck and inventory/sales computer device. At this time we also record his loan that allows us to calculate the interest he/she is incurring to finance the route and equipment

If the route driver simply paid for product and sold this product on the open market, it would be easy to calculate his gross sales and cost of goods sold on a monthly basis. However, almost all route drivers have a weekly settlement with the company whereby the route driver receives various credits and charges before a check is written to the company or received from the company. Typically the driver can receive credit for product sold to customers that pays its bill directly to the company. A credit could be received for the damaged or stale product, an advertising allowance to the driver who wears a company logo uniform or has his truck painted with the company logo. Additionally there are promotional credits at certain times of the year, and in some instances there are market support credits for routes that are underperforming because of territorial changes.

The company charges or debits these accounts for product purchased, lease charges for a truck or vending machines, payment on the note the driver used to purchase his route and other assets, a supply credit for non-inventory supplies used by the driver, and sometimes for a relief driver if the route owner is sick or on vacation. Some routes sell all of these products to stops that pay the receivable to the company, some routes have only part of their customers on direct payment to the company, and some routes, such as vending routes do not have any payment made directly to the company. The weekly settlement process varies widely.

The settlement process varies from company to company and individual to individual. The mark up on the goods purchased also varies by company and product. For example, bread mark-up can be as little as 8-10% and vending sales can be in the 40% range.

For these reasons we report the monthly financials on a net sales basis. All sales and credits are reflected by deposit and cost of sales and charges are netted against sales to reflect a net sale. Because the sales and cost of sales figures can be misleading because of the various credits and charges that occur during the weekly settlement we report on a net sales basis on the monthly financials and adjust the figure at the end of the year when calculating the route driver’s Gross Sales based upon information (1099’s) supplied to us by the company relating to the actual cost of goods sold.

What happens if I loose a 1099 or fail to send it to you when you are preparing my taxes?

This happens more than we like. However, we usually hear about it when you receive a letter form the IRS requesting more taxes on unreported sales. We usually reply with an explanation along with this letter:

How does DSA T&B calculate my estimated tax payments?

For Sole Proprietors we annualize your income and multiply that amount by 25% and then divide it into four payments. Estimated taxes are due 1/15, 4/15, 6/15, and 9/15. For example, if an i/o’s taxable income, as reported on his monthly financials that we prepare based upon the information that he sends to us, is $1000 in January, we annualize his income to be $12,000 for the year. If he reports $2000 in February, the average monthly income is $1500 and the annualized income is $18,000. We constantly update the annualized income to suggest a monthly reserve to pay for your taxes and each quarter we suggest a payment that should cover your tax liability. For sole proprietors, we use 25% reresenting15.2% for FICA/Medicare and the balance for income taxes (approx 10%). We feel that 10% is adequate because we are paying based upon 10% of taxable income before deductions for dependants, itemized deductions, or standard deduction. In most cases, this is slightly more than is due, but we feel and most of our clients agree that rather slightly overpay and receive a refund check than underpay and have to make a payment with their tax return.

For our corporate clients, we estimate your tax liability at a rate of 10% of projected or annualized income. Income from Sub S corporations flow to the Individual Income Tax Form and is not subject to FICA/Medicare.

If Sub S income is not subject to FICA/Medicare, why am I taking a salary and paying those taxes?

It is because the IRS requires that a “reasonable Salary” be paid. Years ago, in an effort to avoid corporate tax (about 35%), corporations would declare a year end bonus or raise salaries so that there would be little or no profit in the corporation. Therefore, there would be no corporate tax. The IRS argued successfully that salaries were too high and said part of the payment was actually dividends. They then said corporate tax was due on the excess salary and the excess was categorized as taxable dividends. In some cases the amount due after interest and penalties was more that 100% of the amount reclasses. The IRS is now using the same concept of “reasonable Salary” to force Sub S corporations to take a salary and pay FICA/Medicare and withhold income tax on that salary. Until we can estimate the correct salary, we are using $20,000 as an annual salary that we consider to be “reasonable”.

How do I pay my payroll taxes?

Each quarter we prepare a Form 941 and the state equivalent if applicable and mail it to you with instructions to pay the payroll taxes due on those forms. These payments represent your liability as an employer and employee for taxes due on your quarterly salary ($5000). At the end of the year, we will send your payroll forms to sign and mail that summarizes your annual wages (W-2) and payroll liabilities.

Why do I have to pay a second tax?

Let’s take the example where the business makes $45,000 before any “reasonable salary” is paid to you. If you take a $20,000 salary, we will prepare all of your paper work that pertains to your $20,000 payroll. However, after you pay the salary you will still have about $25,000 profit in the corporation. This is not subject to FICA/Medicare but it is still subject to Income Tax. As noted before, we feel that 10% is a reasonable estimate of the tax effect of your Sub S (K-1) income. Therefore we would estimate that you would owe $2500 on your K-1 income. We would recommend a quarterly payment of $625 – a 1040ES due 1/15, 4/15, 6/15 and 9/15.

If you do not see your questions or an answer does not meet your needs please call or email. See Contacts.