For Jones to meet the Qualifying Small Business Exemption Jones gross receipts

For jones to meet the qualifying small business

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For Jones to meet the Qualifying Small Business Exemption, Jones’ gross receipts mustnot exceed $5 million for the current tax year and the two prior tax years, and be an eligiblebusiness as defined by the IRS. The IRS uses the North American Industry ClassificationSystem (“NAICS”) to determine which type of industry meets this exemption. Because theBusiness falls under NAICS code 44, it does not meet the definition of an eligible business, andJones will not be able to utilize the cash method even if his gross receipts are less than $5million.Because the Business not fall under the Qualifying Taxpayer Exemption, the Businesswill be required to use the Accrual Method. One benefit to Jones for utilizing the Accrual Method, is that last in, first out (“LIFO”)inventory accounting will be available to Jones. Even though each used vehicle has a uniquecost associated with it, using LIFO may produce a higher cost of goods sold and a lower net7
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income. For example, if the Business bought a compact car for $20,000, a sedan for $30,000 anda pickup truck for $50,000, then sold the sedan and truck, then the Business dealership incurred$80,000 in cost of goods sold under the LIFO method.The IRS has produced detailed guidancein the use of LIFO in the used vehicle industry.4Cost to Prep ReturnsThe cost to prepare the tax returns for the Business are minimal and are expenses for theBusiness. Those expenses are fully deductible for financial reporting purposes, and may be fullydeductible for tax purposes as well. Because the Business is converting to a corporation, theexpenses related to starting up the Business may be deductible subject to 26 US Code 195.Section 195 permits Jones to deduct the first $5,000 of startup costs in the initial tax year, and toamortize the remaining costs over 180 months. With the exception of those costs associated withissuing stock, the remaining costs appear to be both deductible and amortizable for tax purposes. In those costs, Jones should include any costs related to the purchase of any AccountingInformation System, which may be fully deductible under 26 US Code Section 179, the costsassociated with forming the corporation in Florida, and any legal or accounting fees related tosame. Tax BenefitsBecause Jones will be receiving a salary from the Business, he will not have to pay bothparts of self-employment tax. 50 % will be paid by him, and 50% will be paid by the Businessup to an annual threshold of $127,200 in salary. Second because the Business will be retainingany profits not paid to Jones or his daughter as salary, the tax savings to Jones is the differencebetween the corporate tax marginal rate of 34% (on net income of $1.2 million) vs. an individualrate of 39.6% to Jones. Plus, if Jones’ compensation does not exceed $413,200, his individual4 See Revenue Procedure 2001-23 8
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marginal rate of 35% is about equal to the corporate marginal rate for the remaining retainedearnings.
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