Fixed Assets

Fixed assets are items that are used in your business’s ongoing operations for longer than a year. These items should not be “expensed” or shown on the Profit and Loss Statement; instead they should be recorded on the Balance Sheet as assets. They are expensed over time through depreciation. Examples of Fixed Assets are:

  • Machinery and equipment
  • Furniture and fixtures
  • Vehicles
  • Computers and Software
  • Land
  • Buildings
  • Building Improvements
  • Leasehold Improvements

Fixed Assets are recorded on the Balance Sheet at the purchase price plus any installation costs needed.  Once a Fixed Asset is put into service, except for land, it begins to lose value. This loss in value is accounted for with Depreciation (for tangible assets) or Amortization (for intangible assets like software).  Depreciation and Amortization are non-cash expenses in that they are included in your Profit and Loss Statement even though there is no cash transaction.

Different Fixed Assets have different useful lives so are depreciated over different periods. There are a number of depreciation methods, but the two of the most common are:

  1. Straight-line depreciation is the simplest. Take the original cost of the Fixed Asset, subtract any expected Residual Value (if you think you will be able to sell the asset once you are no longer using it), and divide the result by the number of years you expect to use the asset.
    • For example, you purchase a computer for $2,000 and expect to use it for three years, after which you think you can sell it for $200. The annual Depreciation Expense will be $600.
    • ($2,000 – $200) / 3 = $600
  2. Unit of Production method us often used for machinery used in production. Take the asset cost less any residual value and divide that by the number of units of production expected from the machine. Then multiply the Per Unit Depreciation expense by the actual number of units produced during that period.
    • For example, you purchase a printing press to print flyers for $10,000 and expect to be able to sell it for $1,000 when you dispose of it. The press will be able to print 100,000 units over its useful life. The per unit of depreciation will be .09 (nine cents).
      • ($10,000 – $1,000) / 100,000 = .09
    • During the first full year of operation, you print 10,000 flyers. The depreciation expense for that year will be $900.

The IRS has rules for fixed assets and depreciation, and those rules can change. It is important to work with an accountant who understands the proper way to classify fixed assets and the most beneficial method of depreciation.

Choosing a Business Structure

There are several different legal structures in which you can form your business. The four main types are listed here:

Sole proprietor

A sole proprietor is someone who owns an unincorporated business alone.  Basically, you are your business—there is no separate business entity.  You are automatically considered a sole proprietor if you conduct business but don’t register as any other type of business structure. You are personally responsible for all liabilities of your business.

A business run as a sole proprietorship does not pay separate income tax. The income and deductions of the business are reported on a Schedule C, Profit or Loss from Business which is filed with your Form 1040 each year. You will also need to file Schedule SE, Self-Employment Tax. Additionally, you need to pay estimated taxes on a quarterly basis using Form 1040-ES, Estimated Tax for Individuals. Consult with a tax professional to determine the appropriate estimated tax payments.

Partnership

A partnership is an agreement between two or more people to participates in a business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.

A partnership must report the business income, expenses, gains, and losses from operations on Form 1065, U.S. Return of Partnership Income, but does not pay income tax. Instead, the profits or losses are passed through to the partners, each of whom includes his or her share on his or her Form 1040. Additionally, each partner needs to file Schedule SE, Self-Employment Tax, and pay quarterly estimated income taxes.

There are two common kinds of partnerships: Limited Partnerships (LP) and Limited Liability Partnerships (LLP). Limited Partnerships have only one general partner with unlimited liability, and all other partners have limited liability. The partners with limited liability also have limited control over the company. Profits are passed through to personal tax returns, and the general partner is the only one who must pay self-employment taxes.

Limited Liability Partnerships are similar to Limited Partnerships but give limited liability to every owner. An LLP protects each partner from debts against the partnership in that they aren’t held responsible for the actions of the other partners.

Limited Liability Company (LLC)

An LLC is a business entity separate from the owners, and the owners usually do not have personal liability in case of bankruptcy or lawsuits.  Owners of an LLC are called members; members of an LLC may be individuals, corporations, or other LLCs. Most states allow “single-member” LLCs, and there is not a maximum number of members.

Depending on the number of members and the business considerations, an LLC can be treated as either a corporation, a partnership, or as part of the LLC’s owners tax return (a disregarded entity). A single-member LLC is treated as a “disregarded entity” unless it files Form 8832 and elects to be treated as a corporation. An LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and elects to be treated as a corporation.

Corporation

A corporation is a separate entity from the owners, who are called shareholders. Corporations provide the strongest protection to its owners from personal liability, but the cost to form and maintain a corporation is higher than other structures.

Any profits of a corporation are taxed separately from the owners. A corporation must file a Form 1120, U.S. Corporation Income Tax Return. Any profits paid to shareholders are called dividends and shareholders must pay income tax on any dividends they take. The corporation does not get a tax deduction when it pays dividends, consequently shareholders face “double taxation.” Additionally, shareholders cannot deduct any losses of the corporation.

S Corporation

An S Corporation is a corporation that elects to pass the business income and deductions through to the shareholders for federal tax purposes. This allows S Corporations to avid the double taxation on corporation income. To qualify for S Corporation status, a corporation must meet the following requirements:

  • Be a domestic corporation
  • Shareholders cannot be partnerships, corporations or non-resident aliens
  • Have no more than 100 shareholders
  • Have only one class of stock

 

Deciding which business structure to use for your company can be confusing. Consult with a trusted business professional if you are not sure of the best structure for you.