The credit for increasing research activities, often referred to as the research and development (R&D) credit, is a valuable tax break available to eligible businesses. Claiming the credit involves complex calculations, which we can take care of for you. But in addition to the credit itself, be aware that the credit also has two features that are especially favorable to small businesses:
Let’s take a look at the second feature. Subject to limits, you can elect to apply all or some of any research tax credit that you earn against your payroll taxes instead of your income tax. This payroll tax election may influence you to undertake or increase your research activities. On the other hand, if you’re engaged in — or are planning to undertake — research activities without regard to tax consequences, be aware that you could receive some tax relief.
Why the election is important
Many new businesses, even if they have some cash flow, or even net positive cash flow and/or a book profit, pay no income taxes and won’t for some time. Thus, there’s no amount against which business credits, including the research credit, can be applied. On the other hand, any wage-paying business, even a new one, has payroll tax liabilities. Therefore, the payroll tax election is an opportunity to get immediate use out of the research credits that you earn. Because every dollar of credit-eligible expenditure can result in as much as a 10-cent tax credit, that’s a big help in the start-up phase of a business — the time when help is most needed.
To qualify for the election a taxpayer must:
In making these determinations, the only gross receipts that an individual taxpayer takes into account are from the individual’s businesses. An individual’s salary, investment income or other income aren’t taken into account. Also, note that an entity or individual can’t make the election for more than six years in a row.
Limits on the election
The research credit for which the taxpayer makes the payroll tax election can be applied only against the Social Security portion of FICA taxes. It can’t be used to lower the employer’s lability for the “Medicare” portion of FICA taxes or any FICA taxes that the employer withholds and remits to the government on behalf of employees.
The amount of research credit for which the election can be made can’t annually exceed $250,000. Note, too, that an individual or C corporation can make the election only for those research credits which, in the absence of an election, would have to be carried forward. In other words, a C corporation can’t make the election for the research credit that the taxpayer can use to reduce current or past income tax liabilities.
The above are just the basics of the payroll tax election. Keep in mind that identifying and substantiating expenses eligible for the research credit itself is a complex area. Contact us about whether you can benefit from the payroll tax election and the research tax credit.
If your business doesn’t already have a retirement plan, now might be a good time to take the plunge. Current retirement plan rules allow for significant tax-deductible contributions.
For example, if you’re self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $61,000 for 2022. If you’re employed by your own corporation, up to 25% of your salary can be contributed to your account, with a maximum contribution of $61,000. If you’re in the 32% federal income tax bracket, making a maximum contribution could cut what you owe Uncle Sam for 2022 by a whopping $19,520 (32% times $61,000).
Other small business retirement plan options include:
Depending on your circumstances, these other types of plans may allow bigger deductible contributions.
Deadlines to establish and contribute
Thanks to a change made by the 2019 SECURE Act, tax-favored qualified employee retirement plans, except for SIMPLE-IRA plans, can now be adopted by the due date (including any extension) of the employer’s federal income tax return for the adoption year. The plan can then receive deductible employer contributions that are made by the due date (including any extension), and the employer can deduct those contributions on the return for the adoption year.
Important: The SECURE Act provision didn’t change the deadline to establish a SIMPLE-IRA plan. It remains October 1 of the year for which the plan is to take effect. Also, the SECURE Act change doesn’t override rules that require certain plan provisions to be in effect during the plan year, such as the provisions that cover employee elective deferral contributions (salary-reduction contributions) under a 401(k) plan. The plan must be in existence before such employee elective deferral contributions can be made.
For example, the deadline for the 2021 tax year for setting up a SEP-IRA for a sole proprietorship business that uses the calendar year for tax purposes is October 17, 2022, if you extend your 2021 tax return. The deadline for making the contribution for the 2021 tax year is also October 17, 2022. However, to make a SIMPLE-IRA contribution for the 2021 tax year, you must have set up the plan by October 1, 2021. So, it’s too late to set up a plan for last year.
While you can delay until next year establishing a tax-favored retirement plan for this year (except for a SIMPLE-IRA plan), why wait? Get it done this year as part of your tax planning and start saving for retirement. We can provide more information on small business retirement plan alternatives. Be aware that, if your business has employees, you may have to make contributions for them, too.
Typically, businesses want to delay recognition of taxable income into future years and accelerate deductions into the current year. But when is it prudent to do the opposite? And why would you want to?
One reason might be tax law changes that raise tax rates. There have been discussions in Washington about raising the corporate federal income tax rate from its current flat 21%. Another reason may be because you expect your noncorporate pass-through entity business to pay taxes at higher rates in the future, because the pass-through income will be taxed on your personal return. There have also been discussions in Washington about raising individual federal income tax rates.
If you believe your business income could be subject to tax rate increases, you might want to accelerate income recognition into the current tax year to benefit from the current lower tax rates. At the same time, you may want to postpone deductions into a later tax year, when rates are higher, and when the deductions will do more tax-saving good.
To accelerate income
Consider these options if you want to accelerate revenue recognition into the current tax year:
To defer deductions
Consider the following actions to postpone deductions into a higher-rate tax year, which will maximize their value:
Contact us to discuss the best tax planning actions in light of your business’s unique tax situation.
Operating as an S corporation may help reduce federal employment taxes for small businesses in the right circumstances. Although S corporations may provide tax advantages over C corporations, there are some potentially costly tax issues that you should assess before making a decision to switch.
Here’s a quick rundown of the most important issues to consider when converting from a C corporation to an S corporation:
Built-in gains tax
Although S corporations generally aren’t subject to tax, those that were formerly C corporations are taxed on built-in gains (such as appreciated property) that the C corporation has when the S election becomes effective, if those gains are recognized within 5 years after the corporation becomes an S corporation. This is generally unfavorable, although there are situations where the S election still can produce a better tax result despite the built-in gains tax.
S corporations that were formerly C corporations are subject to a special tax if their passive investment income (such as dividends, interest, rents, royalties and stock sale gains) exceeds 25% of their gross receipts, and the S corporation has accumulated earnings and profits carried over from its C corporation years. If that tax is owed for three consecutive years, the corporation’s election to be an S corporation terminates. You can avoid the tax by distributing the accumulated earnings and profits, which would be taxable to shareholders. Or you might want to avoid the tax by limiting the amount of passive income.
C corporations that use LIFO inventories have to pay tax on the benefits they derived by using LIFO if they convert to S corporations. The tax can be spread over four years. This cost must be weighed against the potential tax gains from converting to S status.
If your C corporation has unused net operating losses, the losses can't be used to offset its income as an S corporation and can’t be passed through to shareholders. If the losses can’t be carried back to an earlier C corporation year, it will be necessary to weigh the cost of giving up the losses against the tax savings expected to be generated by the switch to S status.
There are other factors to consider in switching from C to S status. Shareholder-employees of S corporations can’t get the full range of tax-free fringe benefits that are available with a C corporation. And there may be complications for shareholders who have outstanding loans from their qualified plans. All of these factors have to be considered to understand the full effect of converting from C to S status.
There are strategies for eliminating or minimizing some of these tax problems and for avoiding unnecessary pitfalls related to them. But a lot depends upon your company’s particular circumstances. Contact us to discuss the effect of these and other potential problems, along with possible strategies for dealing with them.
Adding a new partner in a partnership has several financial and legal implications. Let’s say you and your partners are planning to admit a new partner. The new partner will acquire a one-third interest in the partnership by making a cash contribution to it. Let’s further assume that your bases in your partnership interests are sufficient so that the decrease in your portions of the partnership’s liabilities because of the new partner’s entry won’t reduce your bases to zero.
Not as simple as it seems
Although the entry of a new partner appears to be a simple matter, it’s necessary to plan the new person’s entry properly in order to avoid various tax problems. Here are two issues to consider:
First, if there’s a change in the partners’ interests in unrealized receivables and substantially appreciated inventory items, the change is treated as a sale of those items, with the result that the current partners will recognize gain. For this purpose, unrealized receivables include not only accounts receivable, but also depreciation recapture and certain other ordinary income items. In order to avoid gain recognition on those items, it’s necessary that they be allocated to the current partners even after the entry of the new partner.
Second, the tax code requires that the “built-in gain or loss” on assets that were held by the partnership before the new partner was admitted be allocated to the current partners and not to the entering partner. Generally speaking, “built-in gain or loss” is the difference between the fair market value and basis of the partnership property at the time the new partner is admitted.
The most important effect of these rules is that the new partner must be allocated a portion of the depreciation equal to his share of the depreciable property based on current fair market value. This will reduce the amount of depreciation that can be taken by the current partners. The other effect is that the built-in gain or loss on the partnership assets must be allocated to the current partners when partnership assets are sold. The rules that apply here are complex and the partnership may have to adopt special accounting procedures to cope with the relevant requirements.
Keep track of your basis
When adding a partner or making other changes, a partner’s basis in his or her interest can undergo frequent adjustment. It’s imperative to keep proper track of your basis because it can have an impact in several areas: gain or loss on the sale of your interest, how partnership distributions to you are taxed and the maximum amount of partnership loss you can deduct.
Contact us if you’d like help in dealing with these issues or any other issues that may arise in connection with your partnership.
Once a relatively obscure concept, “income in respect of a decedent” (IRD) may create a surprising tax bill for those who inherit certain types of property, such as IRAs or other retirement plans. Fortunately, there may be ways to minimize or even eliminate the IRD tax bite.
For the most part, property you inherit isn’t included in your income for tax purposes. Items that are IRD, however, do have to be included in your income, although you may also be entitled to an IRD deduction on account of them.
What’s IRD? It is income that the decedent (the person from whom you inherit the property) would have taken into income on his or her final income tax return except that death interceded. One common IRD item is the decedent’s last paycheck, received after death. It would have normally been included in the decedent’s income on the final income tax return. However, since the decedent’s tax year closed as of the date of death, it wasn’t included. As an item of IRD, it’s taxed as income to whomever does receive it (the estate or another individual). Not just the final paycheck, but any compensation-related benefits paid after death, such as accrued vacation pay or voluntary employer benefit payments, will be IRD to the recipient.
Other common IRD items include pension benefits and amounts in a decedent’s individual retirement accounts (IRAs) at death as well as a decedent’s share of partnership income up to the date of death. If you receive these IRD items, they’re included in your income.
The IRD deduction
Although IRD must be included in the income of the recipient, a deduction may come along with it. The deduction is allowed (as an itemized deduction) to lessen the “double tax” impact that’s caused by having the IRD items subject to the decedent’s estate tax as well as the recipient’s income tax.
To calculate the IRD deduction, the decedent’s executor may have to be contacted for information. The deduction is determined as follows:
In the following example, the top estate tax rate of 40% is used. Example: At Tom’s death, $50,000 of IRD items were included in his gross estate, $10,000 of which were paid to Alex. There were also $3,000 of deductions in respect of a decedent, for a net value of $47,000. Had the estate been $47,000 less, the estate tax bill would have been $18,800 less. Alex will include in income the $10,000 of IRD received. If Alex itemizes deductions, Alex may also deduct $3,760, which is 20% (10,000/50,000) of $18,800.
We can help
If you inherit property that could be considered IRD, consult with us for assistance in managing the tax consequences.
In some cases, homeowners decide to move to new residences, but keep their present homes and rent them out. If you’re thinking of doing this, you’re probably aware of the financial risks and rewards. However, you also should know that renting out your home carries potential tax benefits and pitfalls.
You’re generally treated as a regular real estate landlord once you begin renting your home. That means you must report rental income on your tax return, but also are entitled to offsetting landlord deductions for the money you spend on utilities, operating expenses, incidental repairs and maintenance (for example, fixing a leak in the roof). Additionally, you can claim depreciation deductions for the home. You can fully offset rental income with otherwise allowable landlord deductions.
Passive activity rules
However, under the passive activity loss (PAL) rules, you may not be able to currently claim the rent-related deductions that exceed your rental income unless an exception applies. Under the most widely applicable exception, the PAL rules won’t affect your converted property for a tax year in which your adjusted gross income doesn’t exceed $100,000, you actively participate in running the home-rental business, and your losses from all rental real estate activities in which you actively participate don’t exceed $25,000.
You should also be aware that potential tax pitfalls may arise from renting your residence. Unless your rentals are strictly temporary and are made necessary by adverse market conditions, you could forfeit an important tax break for home sellers if you finally sell the home at a profit. In general, you can escape tax on up to $250,000 ($500,000 for married couples filing jointly) of gain on the sale of your principal home. However, this tax-free treatment is conditioned on your having used the residence as your principal residence for at least two of the five years preceding the sale. So renting your home out for an extended time could jeopardize a big tax break.
Even if you don’t rent out your home so long as to jeopardize your principal residence exclusion, the tax break you would have gotten on the sale (the $250,000/$500,000 exclusion) won’t apply to the extent of any depreciation allowable with respect to the rental or business use of the home for periods after May 6, 1997, or to any gain allocable to a period of nonqualified use (any period during which the property isn’t used as the principal residence of the taxpayer or the taxpayer’s spouse or former spouse) after December 31, 2008. A maximum tax rate of 25% will apply to this gain (attributable to depreciation deductions).
Selling at a loss
Some homeowners who bought at the height of a market may ultimately sell at a loss someday. In such situations, the loss is available for tax purposes only if the owner can establish that the home was in fact converted permanently into income-producing property. Here, a longer lease period helps an owner. However, if you’re in this situation, be aware that you may not wind up with much of a loss for tax purposes. That’s because basis (the cost for tax purposes) is equal to the lesser of actual cost or the property’s fair market value when it’s converted to rental property. So if a home was bought for $300,000, converted to a rental when it’s worth $250,000, and ultimately sold for $225,000, the loss would be only $25,000.
The question of whether to turn a principal residence into rental property isn’t easy. Contact us to review your situation and help you make a decision.
Many tax limits that affect businesses are annually indexed for inflation, and a number of them have increased for 2022. Here’s a rundown of those that may be important to you and your business.
Social Security tax
The amount of an employee’s earnings that is subject to Social Security tax is capped for 2022 at $147,000 (up from $142,800 in 2021).
In 2022 and 2021, the deduction for eligible business-related food and beverage expenses provided by a restaurant is 100% (up from 50% in 2020).
Other employee benefits
These are only some of the tax limits that may affect your business and additional rules may apply. Contact us if you have questions.
Do you want to sell commercial or investment real estate that has appreciated significantly? One way to defer a tax bill on the gain is with a Section 1031 “like-kind” exchange where you exchange the property rather than sell it. With real estate prices up in some markets (and higher resulting tax bills), the like-kind exchange strategy may be attractive.
A like-kind exchange is any exchange of real property held for investment or for productive use in your trade or business (relinquished property) for like-kind investment, trade or business real property (replacement property).
For these purposes, like-kind is broadly defined, and most real property is considered to be like-kind with other real property. However, neither the relinquished property nor the replacement property can be real property held primarily for sale.
Under the Tax Cuts and Jobs Act, tax-deferred Section 1031 treatment is no longer allowed for exchanges of personal property — such as equipment and certain personal property building components — that are completed after December 31, 2017.
If you’re unsure if the property involved in your exchange is eligible for like-kind treatment, please contact us to discuss the matter.
Assuming the exchange qualifies, here’s how the tax rules work. If it’s a straight asset-for-asset exchange, you won’t have to recognize any gain from the exchange. You’ll take the same “basis” (your cost for tax purposes) in the replacement property that you had in the relinquished property. Even if you don’t have to recognize any gain on the exchange, you still must report it on Form 8824, “Like-Kind Exchanges.”
Frequently, however, the properties aren’t equal in value, so some cash or other property is tossed into the deal. This cash or other property is known as “boot.” If boot is involved, you’ll have to recognize your gain, but only up to the amount of boot you receive in the exchange. In these situations, the basis you get in the like-kind replacement property you receive is equal to the basis you had in the relinquished property you gave up reduced by the amount of boot you received but increased by the amount of any gain recognized.
An example to illustrate
Let’s say you exchange land (business property) with a basis of $100,000 for a building (business property) valued at $120,000 plus $15,000 in cash. Your realized gain on the exchange is $35,000: You received $135,000 in value for an asset with a basis of $100,000. However, since it’s a like-kind exchange, you only have to recognize $15,000 of your gain. That’s the amount of cash (boot) you received. Your basis in your new building (the replacement property) will be $100,000: your original basis in the relinquished property you gave up ($100,000) plus the $15,000 gain recognized, minus the $15,000 boot received.
Note that no matter how much boot is received, you’ll never recognize more than your actual (“realized”) gain on the exchange.
If the property you’re exchanging is subject to debt from which you’re being relieved, the amount of the debt is treated as boot. The theory is that if someone takes over your debt, it’s equivalent to the person giving you cash. Of course, if the replacement property is also subject to debt, then you’re only treated as receiving boot to the extent of your “net debt relief” (the amount by which the debt you become free of exceeds the debt you pick up).
Great tax-deferral vehicle
Like-kind exchanges can be a great tax-deferred way to dispose of investment, trade or business real property. Contact us if you have questions or would like to discuss the strategy further.
Traditional IRAs and Roth IRAs have been around for decades and the rules surrounding them have changed many times. What hasn’t changed is that they can help you save for retirement on a tax-favored basis. Here’s an overview.
You can make an annual deductible contribution to a traditional IRA if:
For example, in 2022, if you’re a joint return filer covered by an employer plan, your deductible IRA contribution phases out over $109,000 to $129,000 of MAGI ($68,000 to $78,000 for singles).
Deductible IRA contributions reduce your current tax bill, and earnings are tax-deferred. However, withdrawals are taxed in full (and subject to a 10% penalty if taken before age 59½, unless one of several exceptions apply). You must begin making minimum withdrawals by April 1 of the year following the year you turn age 72.
You can make an annual nondeductible IRA contribution without regard to employer plan coverage and your MAGI. The earnings in a nondeductible IRA are tax-deferred but taxed when distributed (and subject to a 10% penalty if taken early, unless an exception applies).
You must begin making minimum withdrawals by April 1 of the year after the year you reach age 72. Nondeductible contributions aren’t taxed when withdrawn. If you’ve made deductible and nondeductible IRA contributions, a portion of each distribution is treated as coming from nontaxable IRA contributions (and the rest is taxed).
The maximum annual IRA contribution (deductible or nondeductible, or a combination) is $6,000 for 2022 and 2021 ($7,000 if age 50 or over). Additionally, your contribution can’t exceed the amount of your compensation includible in income for that year. There’s no age limit for making contributions, as long as you have compensation income (before 2021, traditional IRA contributions weren’t allowed after age 70½).
You can make an annual contribution to a Roth IRA if your income doesn’t exceed certain levels based on filing status. For example, in 2022, if you’re a joint return filer, the maximum annual Roth IRA contribution phases out between $204,000 and $214,000 of MAGI ($129,000 to $144,000 for singles). Annual Roth contributions can be made up to the amount allowed as a contribution to a traditional IRA, reduced by the amount you contribute for the year to non-Roth IRAs, but not reduced by contributions to a SEP or SIMPLE plan.
Roth IRA contributions aren’t deductible. However, earnings are tax-deferred and (unlike a traditional IRA) withdrawals are tax-free if paid out:
You can make Roth IRA contributions even after reaching age 72 (if you have compensation income), and you don’t have to take required minimum distributions from a Roth. You can “roll over” (or convert) a traditional IRA to a Roth regardless of your income. The amount taken out of the traditional IRA and rolled into the Roth is treated for tax purposes as a regular withdrawal (but not subject to the 10% early withdrawal penalty).
Contact us for more information about how you may be able to benefit from IRAs.
The IRS announced it is opening the 2021 individual income tax return filing season on January 24. (Business returns are already being accepted.) Even if you typically don’t file until much closer to the April deadline (or you file for an extension until October), consider filing earlier this year. Why? You can potentially protect yourself from tax identity theft — and there may be other benefits, too.
How tax identity theft occurs
In a tax identity theft scheme, a thief uses another individual’s personal information to file a bogus tax return early in the filing season and claim a fraudulent refund.
The actual taxpayer discovers the fraud when he or she files a return and is told by the IRS that it is being rejected because one with the same Social Security number has already been filed for the tax year. While the taxpayer should ultimately be able to prove that his or her return is the legitimate one, tax identity theft can be a hassle to straighten out and significantly delay a refund.
Filing early may be your best defense: If you file first, it will be the tax return filed by a potential thief that will be rejected — not yours.
Note: You can still get your individual tax return prepared by us before January 24 if you have all the required documents. But processing of the return will begin after IRS systems open on that date.
Your W-2s and 1099s
To file your tax return, you need all of your W-2s and 1099s. January 31 is the deadline for employers to issue 2021 W-2 forms to employees and, generally, for businesses to issue Form 1099s to recipients for any 2021 interest, dividend or reportable miscellaneous income payments (including those made to independent contractors).
If you haven’t received a W-2 or 1099 by February 1, first contact the entity that should have issued it. If that doesn’t work, you can contact the IRS for help.
Other benefits of filing early
In addition to protecting yourself from tax identity theft, another advantage of early filing is that, if you’re getting a refund, you’ll get it sooner. The IRS expects most refunds to be issued within 21 days. However, the IRS has been experiencing delays during the pandemic in processing some returns. Keep in mind that the time to receive a refund is typically shorter if you file electronically and receive a refund by direct deposit into a bank account.
Direct deposit also avoids the possibility that a refund check could be lost, stolen, returned to the IRS as undeliverable or caught in mail delays.
If you were eligible for an Economic Impact Payment (EIP) or advance Child Tax Credit (CTC) payments, and you didn’t receive them or you didn’t receive the full amount due, filing early will help you to receive the money sooner. In 2021, the third round of EIPs were paid by the federal government to eligible individuals to help mitigate the financial effects of COVID-19. Advance CTC payments were made monthly in 2021 to eligible families from July through December. EIP and CTC payments due that weren’t made to eligible taxpayers can be claimed on your 2021 return.
We can help
Contact us If you have questions or would like an appointment to prepare your tax return. We can help you ensure you file an accurate return that takes advantage of all of the breaks available to you.Help safeguard your personal information by filing your 2021 tax return early
While Congress didn’t pass the Build Back Better Act in 2021, there are still tax changes that may affect your tax situation for this year. That’s because some tax figures are adjusted annually for inflation.
If you’re like most people, you’re probably more concerned about your 2021 tax bill right now than you are about your 2022 tax situation. That’s understandable because your 2021 individual tax return is generally due to be filed by April 18 (unless you file an extension).
However, it’s a good idea to acquaint yourself with tax amounts that may have changed for 2022. Below are some Q&As about tax amounts for this year.
I have a 401(k) plan through my job. How much can I contribute to it?
For 2022, you can contribute up to $20,500 (up from $19,500 in 2021) to a 401(k) or 403(b) plan. You can make an additional $6,500 catch-up contribution if you’re age 50 or older.
How much can I contribute to an IRA for 2022?
If you’re eligible, you can contribute $6,000 a year to a traditional or Roth IRA, or up to 100% of your earned income. If you’re 50 or older, you can make another $1,000 “catch-up” contribution. (These amounts were the same for 2021.)
I sometimes hire a babysitter and a cleaning person. Do I have to withhold and pay FICA tax on the amounts I pay them?
In 2022, the threshold when a domestic employer must withhold and pay FICA for babysitters, house cleaners, etc., is $2,400 (up from $2,300 in 2021).
How much do I have to earn in 2022 before I can stop paying Social Security on my salary?
The Social Security tax wage base is $147,000 for this year (up from $142,800 in 2021). That means that you don’t owe Social Security tax on amounts earned above that. (You must pay Medicare tax on all amounts that you earn.)
I didn’t qualify to itemize deductions on my last tax return. Will I qualify for 2022?
A 2017 tax law eliminated the tax benefit of itemizing deductions for many people by increasing the standard deduction and reducing or eliminating various deductions. For 2022, the standard deduction amount is $25,900 for married couples filing jointly (up from $25,100). For single filers, the amount is $12,950 (up from $12,550) and for heads of households, it’s $19,400 (up from $18,800). If your itemized deductions (such as mortgage interest) are less than the applicable standard deduction amount, you won’t itemize.
If I don’t itemize, can I claim charitable deductions on my 2022 return?
Generally, taxpayers who claim the standard deduction on their federal tax returns can’t deduct charitable donations. But thanks to two COVID-19-relief laws, non-itemizers could claim a limited charitable contribution deduction for the past two years (for 2021, this deduction is $300 for single taxpayers and $600 for married couples filing jointly). Unfortunately, unless Congress acts to extend this tax break, it has expired for 2022.
How much can I give to one person without triggering a gift tax return in 2022?
The annual gift exclusion for 2022 is $16,000 (up from $15,000 in 2021). This amount is only adjusted in $1,000 increments, so it typically only increases every few years.
More to your tax picture
These are only some of the tax amounts that may apply to you. Contact us for more information about your tax situation, or if you have questions.
Now that you've finished your accounting for 2021, it's time to look at the big picture. The end of one year and the beginning of another is always an optimal time to look back on the preceding 12 calendar months and ask a deceptively simple question: How’d we do?
Large companies tend to have thoroughly documented strategic plans in place, some stretching years into the future, that include various metrics for measuring whether they’ve achieved the growth intended. For them, reviewing a calendar year’s success in terms of strategic planning is relatively easy. They mostly just crunch the numbers.
For small to midsize businesses, the strategic planning process may be a little more informal and less precise. Yet even if your strategic plan isn’t a detailed document replete with spreadsheets and pie charts, you can still review actual performance against it and use this assessment to look ahead to 2022.
Areas that inform
Generally, there are three areas of most businesses that inform the success of a strategic plan. They are:
HR. Your people are your most valuable asset. So, how does your employee turnover rate for 2021 compare with previous years? High employee turnover could be a sign of underlying problems, such as poor training, lax management or low employee morale.
Much has been written this year about “the Great Resignation,” the trend of employees leaving their jobs for various reasons. How has it affected your company? Has it stymied your efforts to meet strategic goals? You may need to make hiring and retention efforts a focal point of your 2022 strategic plan.
Sales and marketing. Did you meet your monthly goals for new sales, in terms of both revenue and number of new customers? Did you generate an adequate return on investment (ROI) for your marketing dollars?
If you can’t clearly answer the latter question, enhance your tracking of existing marketing efforts so you can better gauge ROI going forward. And set reasonable but growth-oriented sales goals for 2022 that will make or keep your business a competitive force to be reckoned with.
Production. If you manufacture products, what was your unit reject rate over the past year? Or, if yours is a service business, how satisfied were your customers with the level of service provided?
Again, if you’re not sure, you may need to establish or enhance your methods of tracking product quality or measuring customer satisfaction to meet this year’s strategic goals. Many companies now use customer satisfaction scores or a customer satisfaction index to establish objectives and benchmark their success.
Flexibility and the right adjustments
By now, you should probably have at least the framework of a 2022 strategic plan in place. However, if you’re not that far along, don’t worry. Strategic plans are best when they’re flexible and open to adjustment as economic conditions and buying trends change.
This is particularly true when the year ahead looks as uncertain as this one, given the continuing impact of the pandemic. We can help you review your 2021 financials and use the right metrics to develop a cohesive, realistic strategic plan for the next 12 months.
Now that 2022 is up and running, business owners can expect to face a few challenges and tough choices as the year rolls along. No matter how busy things get, don’t forget about an easily accessible and highly informative resource that’s probably just a few clicks away: your financial statements.
Assuming you follow U.S. Generally Accepted Accounting Principles (GAAP) or similar reporting standards, your financial statements will comprise three major components: an income statement, a balance sheet and a statement of cash flows. Each one contains different, but equally important, information about your company’s financial performance. Together, they can help you and your leadership team make optimal business decisions.
Revenue and expenses
The first component of your financial statements is the income statement. It shows revenue and expenses over a given accounting period. A commonly used term when discussing income statements is “net income.” This is the income remaining after you’ve paid all expenses, including taxes.
It’s also important to check out “gross profit.” This is the income earned after subtracting the cost of goods sold from revenue. Cost of goods sold includes the cost of direct labor and materials, as well as any manufacturing overhead costs required to make a product.
The income statement also lists sales, general and administrative (SG&A) expenses. They reflect functions, such as marketing and payroll, that support a company’s production of products or services. Often, SG&A costs are relatively fixed, no matter how well your business is doing. Calculate the ratio of SG&A costs to revenue: If the percentage increases over time, business may be slowing down.
Assets, liabilities and net worth
The second component is the balance sheet. It tallies your assets, liabilities and net worth to create a snapshot of the company’s financial health on the financial statement date. Assets are customarily listed in order of liquidity. Current assets (such as accounts receivable) are expected to be converted into cash within a year. Long-term assets (such as plant and equipment) will be used to generate revenue beyond the next 12 months.
Similarly, liabilities are listed in order of maturity. Current liabilities (such as accounts payable) come due within a year. Long-term liabilities are payment obligations that extend beyond the current year.
True to its name, the balance sheet must balance — that is, assets must equal liabilities plus net worth. So, net worth is the extent to which assets exceed liabilities. It may signal financial distress if your net worth is negative.
Other red flags include current assets that grow faster than sales and a deteriorating ratio of current assets to current liabilities. These trends could indicate that management is managing working capital less efficiently than in previous periods.
Inflows and outflows of cash
The statement of cash flows shows all the cash flowing in and out of your business during the accounting period.
Cash inflows typically come from selling products or services, borrowing and selling stock. Outflows generally result from paying expenses, investing in capital equipment and repaying debt. The statement of cash flows is organized into three sections, cash flows from activities related to:
Ideally, a company will generate enough cash from operations to cover its expenses. If not, it might need to borrow money or sell stock to survive.
The good and the bad
Sometimes business owners get into the habit of thinking of their financial statements as a regularly occurring formality performed to satisfy outside parties such as investors and lenders. On the contrary, your financial statements contain a wealth of data that can allow you to calculate ratios and identify trends — both good and bad — affecting the business. For help generating accurate financial statements, as well as analyzing the information therein, please contact us.
Year-end is a good time to plan to save taxes by carefully structuring your capital gains and losses.
Consider some possibilities if you have losses on certain investments to date. For example, suppose you lost money this year on some stock and have other stock that has appreciated. Consider selling appreciated assets before December 31 (if you think their value has peaked) and offsetting gains with losses.
Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains. You may use up to $3,000 ($1,500 for married filing separately) of total capital losses in excess of total capital gains as a deduction against ordinary income in computing your adjusted gross income (AGI).
Individuals are subject to federal tax at a rate as high as 37% on short-term capital gains and ordinary income. But long-term capital gains on most investments receive favorable treatment. They’re taxed at rates ranging from zero to 20% depending on your taxable income (inclusive of the gains). High-income taxpayers pay an additional 3.8% net investment income tax on their net gain and certain other investment income.
This means you should try to avoid having long-term capital losses offset long-term capital gains since those losses will be more valuable if they’re used to offset short-term capital gains or up to $3,000 per year of ordinary income. This requires making sure that the long-term capital losses aren’t taken in the same year as the long-term capital gains.
However, this isn’t just a tax issue. Investment factors must also be considered. You don’t want to defer recognizing gain until next year if there’s too much risk that the investment’s value will decline before it can be sold. Similarly, you wouldn’t want to risk increasing a loss on investments you expect to decline in value by deferring a sale until the following year.
To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, take steps to prevent those losses from offsetting those gains.
If you’ve yet to realize net capital losses for 2021 but expect to realize net capital losses next year well in excess of the $3,000 ceiling, consider accelerating some excess losses into this year. The losses can offset current gains and up to $3,000 of any excess loss will become deductible against ordinary income this year.
For the reasons outlined above, paper losses or gains on stocks may be worth recognizing this year. But suppose the stock is also an investment worth holding for the long term. You can’t sell stock to establish a tax loss and buy it back the next day. The “wash sale” rule precludes recognition of a loss where substantially identical securities are bought and sold within a 61-day period (30 days before or 30 days after the date of sale).
However, you may be able to realize a tax loss by:
Careful handling of capital gains and losses can save tax. Contact us if you have questions about these strategies.
The Social Security Administration recently announced that the wage base for computing Social Security tax will increase to $147,000 for 2022 (up from $142,800 for 2021). Wages and self-employment income above this threshold aren’t subject to Social Security tax.
The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees and self-employed workers — one for Old Age, Survivors and Disability Insurance, which is commonly known as the Social Security tax, and the other for Hospital Insurance, which is commonly known as the Medicare tax.
There’s a maximum amount of compensation subject to the Social Security tax, but no maximum for Medicare tax. For 2022, the FICA tax rate for employers is 7.65% — 6.2% for Social Security and 1.45% for Medicare (the same as in 2021).
For 2022, an employee will pay:
For 2022, the self-employment tax imposed on self-employed people is:
More than one employer
What happens if an employee works for your business and has a second job? That employee would have taxes withheld from two different employers. Can the employee ask you to stop withholding Social Security tax once he or she reaches the wage base threshold? Unfortunately, no. Each employer must withhold Social Security taxes from the individual’s wages, even if the combined withholding exceeds the maximum amount that can be imposed for the year. Fortunately, the employee will get a credit on his or her tax return for any excess withheld.
We can help
Contact us if you have questions about payroll tax filing or payments. We can help ensure you stay in compliance.
With the increasing cost of employee health care benefits, your business may be interested in providing some of these benefits through an employer-sponsored Health Savings Account (HSA). For eligible individuals, an HSA offers a tax-advantaged way to set aside funds (or have their employers do so) to meet future medical needs. Here are the important tax benefits:
To be eligible for an HSA, an individual must be covered by a “high deductible health plan.” For 2021, a “high deductible health plan” is one with an annual deductible of at least $1,400 for self-only coverage, or at least $2,800 for family coverage. (These amounts will remain the same for 2022.) For self-only coverage, the 2021 limit on deductible contributions is $3,600 (increasing to $3,650 for 2022). For family coverage, the 2021 limit on deductible contributions is $7,200 (increasing to $7,300 for 2022). Additionally, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits for 2021 cannot exceed $7,000 for self-only coverage or $14,000 for family coverage (increasing to $7,050 and $14,100, respectively, for 2022).
An individual (and the individual’s covered spouse, as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional “catch-up” contributions for 2021 and 2022 of up to $1,000.
Contributions from an employer
If an employer contributes to the HSA of an eligible individual, the employer’s contribution is treated as employer-provided coverage for medical expenses under an accident or health plan. It’s also excludable from an employee’s gross income up to the deduction limitation. Funds can be built up for years because there’s no “use-it-or-lose-it” provision. An employer that decides to make contributions on its employees’ behalf must generally make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer doesn’t make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.
HSA distributions can be made to pay for qualified medical expenses, which generally means expenses that would qualify for the medical expense itemized deduction. Among these expenses are doctors’ visits, prescriptions, chiropractic care and premiums for long-term care insurance.
If funds are withdrawn from the HSA for other reasons, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it’s made after reaching age 65, or in the event of death or disability.
HSAs offer a flexible option for providing health care coverage and they may be an attractive benefit for your business. But the rules are somewhat complex. Contact us if you’d like to discuss offering HSAs to your employees.
The use of a company vehicle is a valuable fringe benefit for owners and employees of small businesses. This perk results in tax deductions for the employer as well as tax breaks for the owners and employees using the cars. (And of course, they get the nontax benefit of getting a company car.) Plus, current tax law and IRS rules make the benefit even better than it was in the past.
The rules in action
Let’s say you’re the owner-employee of a corporation that’s going to provide you with a company car. You need the car to visit customers, meet with vendors and check on suppliers. You expect to drive the car 8,500 miles a year for business. You also expect to use the car for about 7,000 miles of personal driving, including commuting, running errands and weekend trips. Therefore, your usage of the vehicle will be approximately 55% for business and 45% for personal purposes. You want a nice car to reflect positively on your business, so the corporation buys a new $55,000 luxury sedan.
Your cost for personal use of the vehicle is equal to the tax you pay on the fringe benefit value of your 45% personal mileage. By contrast, if you bought the car yourself to be able to drive the personal miles, you’d be out-of-pocket for the entire purchase cost of the car.
Your personal use will be treated as fringe benefit income. For tax purposes, your corporation will treat the car much the same way it would any other business asset, subject to depreciation deduction restrictions if the auto is purchased. Out-of-pocket expenses related to the car (including insurance, gas, oil and maintenance) are deductible, including the portion that relates to your personal use. If the corporation finances the car, the interest it pays on the loan would be deductible as a business expense (unless the business is subject to the business interest expense deduction limitation under the tax code).
In contrast, if you bought the auto yourself, you wouldn’t be entitled to any deductions. Your outlays for the business-related portion of your driving would be unreimbursed employee business expenses that are nondeductible from 2018 to 2025 due to the suspension of miscellaneous itemized deductions under the Tax Cuts and Jobs Act. And if you financed the car yourself, the interest payments would be nondeductible.
And finally, the purchase of the car by your corporation will have no effect on your credit rating.
Providing an auto for an owner’s or key employee’s business and personal use comes with complications and paperwork. Personal use will have to be tracked and valued under the fringe benefit tax rules and treated as income. This article only explains the basics.
Despite the necessary valuation and paperwork, a company-provided car is still a valuable fringe benefit for business owners and key employees. It can provide them with the use of a vehicle at a low tax cost while generating tax deductions for their businesses. We can help you stay in compliance with the rules and explain more about this prized perk.
Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2022. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
January 17 (The usual deadline of January 15 is a Saturday)
After two years of no increases, the optional standard mileage rate used to calculate the deductible cost of operating an automobile for business will be going up in 2022 by 2.5 cents per mile. The IRS recently announced that the cents-per-mile rate for the business use of a car, van, pickup or panel truck will be 58.5 cents (up from 56 cents for 2021).
The increased tax deduction partly reflects the price of gasoline. On December 21, 2021, the national average price of a gallon of regular gas was $3.29, compared with $2.22 a year earlier, according to AAA Gas Prices.
Don’t want to keep track of actual expenses?
Businesses can generally deduct the actual expenses attributable to business use of vehicles. This includes gas, oil, tires, insurance, repairs, licenses and vehicle registration fees. In addition, you can claim a depreciation allowance for the vehicle. However, in many cases, certain limits apply to depreciation write-offs on vehicles that don’t apply to other types of business assets.
The cents-per-mile rate is beneficial if you don’t want to keep track of actual vehicle-related expenses. With this method, you don’t have to account for all your actual expenses. However, you still must record certain information, such as the mileage for each business trip, the date and the destination.
Using the cents-per-mile rate is also popular with businesses that reimburse employees for business use of their personal vehicles. These reimbursements can help attract and retain employees who drive their personal vehicles a great deal for business purposes. Why? Under current law, employees can’t deduct unreimbursed employee business expenses, such as business mileage, on their own income tax returns.
If you do use the cents-per-mile rate, keep in mind that you must comply with various rules. If you don’t comply, the reimbursements could be considered taxable wages to the employees.
How is the rate calculated?
The business cents-per-mile rate is adjusted annually. It’s based on an annual study commissioned by the IRS about the fixed and variable costs of operating a vehicle, such as gas, maintenance, repair and depreciation. Occasionally, if there’s a substantial change in average gas prices, the IRS will change the cents-per-mile rate midyear.
When can the cents-per-mile method not be used?
There are some cases when you can’t use the cents-per-mile rate. It partly depends on how you’ve claimed deductions for the same vehicle in the past. In other situations, it depends on if the vehicle is new to your business this year or whether you want to take advantage of certain first-year depreciation tax breaks on it.
As you can see, there are many factors to consider in deciding whether to use the standard mileage rate to deduct vehicle expenses. We can help if you have questions about tracking and claiming such expenses in 2022 — or claiming 2021 expenses on your 2021 income tax return.
The Infrastructure Investment and Jobs Act (IIJA) was signed into law on November 15, 2021. It includes new information reporting requirements that will generally apply to digital asset transactions starting in 2023. Cryptocurrency exchanges will be required to perform intermediary Form 1099 reporting for cryptocurrency transactions.
Existing reporting rules
If you have a stock brokerage account, whenever you sell stock or other securities, you receive a Form 1099-B after the end of the year. Your broker uses the form to report transaction details such as sale proceeds, relevant dates, your tax basis and the character of gains or losses. In addition, if you transfer stock from one broker to another broker, the old broker must furnish a statement with relevant information, such as tax basis, to the new broker.
Digital asset broker reporting
The IIJA expands the definition of brokers who must furnish Forms 1099-B to include businesses that are responsible for regularly providing any service accomplishing transfers of digital assets on behalf of another person (“crypto exchanges”). Thus, any platform on which you can buy and sell cryptocurrency will be required to report digital asset transactions to you and the IRS after the end of each year.
Sometimes you may have a transfer transaction that isn’t a sale or exchange. For example, if you transfer cryptocurrency from your wallet at one crypto exchange to your wallet at another crypto exchange, the transaction isn’t a sale or exchange. For that transfer, as with stock, the old crypto exchange will be required to furnish relevant digital asset information to the new crypto exchange. Additionally, if the transfer is to an account maintained by a party that isn’t a crypto exchange (or broker), the IIJA requires the old crypto exchange to file a return with the IRS. It’s anticipated that such a return will include generally the same information that’s furnished in a broker-to-broker transfer.
Digital asset definition
For the reporting requirements, a “digital asset” is any digital representation of value that’s recorded on a cryptographically secured distributed ledger or similar technology. (The IRS can modify this definition.) As it stands, the definition will capture most cryptocurrencies as well as potentially include some non-fungible tokens (NFTs) that are using blockchain technology for one-of-a-kind assets like digital artwork.
Cash transaction reporting
You may know that when a business receives $10,000 or more in cash in a transaction, it is required to report the transaction, including the identity of the person from whom the cash was received, to the IRS on Form 8300. The IIJA will require businesses to treat digital assets like cash for purposes of this requirement.
When reporting begins
These reporting rules will apply to information reporting that’s due after December 31, 2023. For Form 1099-B reporting, this means that applicable transactions occurring after January 1, 2023, will be reported. Whether the IRS will refine the form for digital assets, or come up with a new form, is not known yet. Form 8300 reporting of cash transactions will presumably follow the same effective dates.
If you use a crypto exchange, and it hasn’t already collected a Form W-9 from you seeking your taxpayer identification number, expect it to do so. The transactions subject to the reporting will include not only selling cryptocurrencies for fiat currencies (like U.S. dollars), but also exchanging cryptocurrencies for other cryptocurrencies. And keep in mind that a reporting intermediary doesn’t always have accurate information, especially with a new type of reporting. Contact us with any questions.
In Notice 2021-61, the IRS recently announced 2022 cost-of-living adjustments to dollar limits and thresholds for qualified retirement plans. Here are some highlights:
Elective deferrals. The annual limit on elective deferrals (employee contributions) will increase from $19,500 to $20,500 for 401(k), 403(b) and 457 plans, as well as for Salary Reduction Simplified Employee Pensions (SARSEPs). The annual limit will rise to $14,000, up from $13,500, for Savings Incentive Match Plans for Employees (SIMPLEs) and SIMPLE IRAs.
Catch-up contributions. The annual limit on catch-up contributions for individuals age 50 and over remains at $6,500 for 401(k), 403(b) and 457 plans, as well as for SARSEPs. It also stays at $3,000 for SIMPLEs and SIMPLE IRAs.
Annual additions. The limit on annual additions — that is, employer contributions plus employee contributions — to 401(k)s and other defined contribution plans will increase from $58,000 to $61,000.
Compensation. The annual limit on compensation that can be taken into account for contributions and deductions will increase from $290,000 to $305,000 for 401(k)s and other qualified plans. This includes Simplified Employee Pensions (SEPs) and SARSEPs.
Highly compensated employees (HCEs). The threshold for determining who is an HCE will increase from $130,000 to $135,000.
Key employees. The threshold for determining whether an officer is a “key employee” under the top-heavy rules, as well as the cafeteria plan nondiscrimination rules, will increase from $185,000 to $200,000.
Participation in a SEP or SARSEP. The threshold for determining participation in either type of plan will remain $650.
Business owners, along with their HR and benefits staff or providers, should carefully note when the new limits and thresholds apply. Sometimes the answer isn’t obvious. For example, the 2022 compensation threshold used to identify HCEs will be generally used by 401(k) plans for 2023 nondiscrimination testing, not 2022.
Review your employee communications, plan procedures and administrative forms, updating them as necessary to reflect these changes. Whether your company offers a 401(k) or another type of defined contribution plan, we can provide further information on the applicable tax rules.
Among the biggest long-term concerns of many business owners is succession planning — how to smoothly and safely transfer ownership and control of the company to the next generation.
From a tax perspective, the optimal time to start this process is long before the owner is ready to give up control. A family limited partnership (FLP) can help you enjoy the tax benefits of gradually transferring ownership while you continue to run the business.
How it works
To establish an FLP, you transfer your ownership interests to a partnership in exchange for both general and limited partnership interests. You then transfer limited partnership interests to your children or other beneficiaries.
You retain the general partnership interest, which may be as little as 1% of the assets. However, as general partner, you still run day-to-day operations and make business decisions.
As you transfer the FLP interests, their value is removed from your taxable estate. What’s more, the future business income and asset appreciation associated with those interests move to the next generation.
Because your children hold limited partnership interests, they have no control over the FLP, and thus no control over the business. They also can’t sell their interests without your consent or force the FLP’s liquidation.
The lack of control and lack of an outside market for the FLP interests generally mean the interests can be valued at a discount — so greater portions of the business can be transferred before triggering gift tax. For example, let’s say the discount is 25%. That means, in 2022, you could gift an FLP interest equal to as much as $21,333 (on a controlling basis) tax-free because the discounted value wouldn’t exceed the $16,000 annual gift tax exclusion.
There also may be income tax benefits. The FLP’s income will flow through to the partners for income tax purposes. Your children may be in a lower tax bracket, potentially reducing the amount of income tax paid overall by the family.
Perhaps the biggest downside is that the IRS tends to scrutinize how FLPs are structured. If it determines that discounts are excessive or that your FLP has no valid business purpose beyond minimizing taxes, it could assess additional taxes, interest and penalties.
The IRS also pays close attention to how FLPs are administered. Lack of attention to partnership formalities, for instance, can indicate that an FLP was set up solely as a tax-avoidance strategy.
Not for everyone
An FLP can be an effective succession and estate planning tool but, as noted, it’s far from risk free. We can help you determine whether one is right for you and advise you on other ways to develop a sound succession plan.
If your business is depreciating over a 30-year period the entire cost of constructing the building that houses your operation, you should consider a cost segregation study. It might allow you to accelerate depreciation deductions on certain items, thereby reducing taxes and boosting cash flow. And under current law, the potential benefits of a cost segregation study are now even greater than they were a few years ago due to enhancements to certain depreciation-related tax breaks.
Fundamentals of depreciation
Generally, business buildings have a 39-year depreciation period (27.5 years for residential rental properties). Usually, you depreciate a building’s structural components, including walls, windows, HVAC systems, elevators, plumbing and wiring, along with the building. Personal property — such as equipment, machinery, furniture and fixtures — is eligible for accelerated depreciation, usually over five or seven years. And land improvements, such as fences, outdoor lighting and parking lots, are depreciable over 15 years.
Often, businesses allocate all or most of their buildings’ acquisition or construction costs to real property, overlooking opportunities to allocate costs to shorter-lived personal property or land improvements. In some cases — computers or furniture, for example — the distinction between real and personal property is obvious. But the line between the two is frequently less clear. Items that appear to be “part of a building” may in fact be personal property, like removable wall and floor coverings, removable partitions, awnings and canopies, window treatments, signs and decorative lighting.
In addition, certain items that otherwise would be treated as real property may qualify as personal property if they serve more of a business function than a structural purpose. This includes reinforced flooring to support heavy manufacturing equipment, electrical or plumbing installations required to operate specialized equipment, or dedicated cooling systems for data processing rooms.
Classify property into the appropriate asset classes
A cost segregation study combines accounting and engineering techniques to identify building costs that are properly allocable to tangible personal property rather than real property. Although the relative costs and benefits of a cost segregation study depend on your particular facts and circumstances, it can be a valuable investment.
The Tax Cuts and Jobs Act (TCJA) enhances certain depreciation-related tax breaks, which may also enhance the benefits of a cost segregation study. Among other things, the act permanently increased limits on Section 179 expensing, which allows you to immediately deduct the entire cost of qualifying equipment or other fixed assets up to specified thresholds.
The TCJA also expanded 15-year-property treatment to apply to qualified improvement property. Previously this break was limited to qualified leasehold improvement, retail improvement and restaurant property. And it temporarily increased first-year bonus depreciation to 100% (from 50%).
The savings can be substantial
Fortunately, it isn’t too late to get the benefit of speedier depreciation for items that were incorrectly assumed to be part of your building for depreciation purposes. You don’t have to amend your past returns (or meet a deadline for claiming tax refunds) to claim the depreciation that you could have already claimed. Instead, you can claim that depreciation by following procedures, in connection with the next tax return that you file, that will result in “automatic” IRS consent to a change in your accounting for depreciation.
Cost segregation studies can yield substantial benefits, but they’re not right for every business. We can judge whether a study will result in overall tax savings greater than the costs of the study itself. Contact us to find out whether this would be worthwhile for you.
Are employees at your business traveling again after months of virtual meetings? In Notice 2021-52, the IRS announced the fiscal 2022 “per diem” rates that became effective October 1, 2021. Taxpayers can use these rates to substantiate the amount of expenses for lodging, meals and incidental expenses when traveling away from home. (Taxpayers in the transportation industry can use a special transportation industry rate.)
A simplified alternative to tracking actual business travel expenses is to use the high-low per diem method. This method provides fixed travel per diems. The amounts are based on rates set by the IRS that vary from locality to locality.
Under the high-low method, the IRS establishes an annual flat rate for certain areas with higher costs of living. All locations within the continental United States that aren’t listed as “high-cost” are automatically considered “low-cost.” The high-low method may be used in lieu of the specific per diem rates for business destinations. Examples of high-cost areas include Boston, San Francisco and Seattle.
Under some circumstances — for example, if an employer provides lodging or pays the hotel directly — employees may receive a per diem reimbursement only for their meals and incidental expenses. There’s also a $5 incidental-expenses-only rate for employees who don’t pay or incur meal expenses for a calendar day (or partial day) of travel.
If your company uses per diem rates, employees don’t have to meet the usual recordkeeping rules required by the IRS. Receipts of expenses generally aren’t required under the per diem method. But employees still must substantiate the time, place and business purpose of the travel. Per diem reimbursements generally aren’t subject to income or payroll tax withholding or reported on an employee’s Form W-2.
The FY2022 rates
For travel after September 30, 2021, the per diem rate for all high-cost areas within the continental United States is $296. This consists of $222 for lodging and $74 for meals and incidental expenses. For all other areas within the continental United States, the per diem rate is $202 for travel after September 30, 2021 ($138 for lodging and $64 for meals and incidental expenses). Compared to the FY2021 per diems, both the high and low-cost area per diems increased $4.
Important: This method is subject to various rules and restrictions. For example, companies that use the high-low method for an employee must continue using it for all reimbursement of business travel expenses within the continental United States during the calendar year. However, the company may use any permissible method to reimburse that employee for any travel outside the continental United States.
For travel during the last three months of a calendar year, employers must continue to use the same method (per diem or high-low method) for an employee as they used during the first nine months of the calendar year. Also, note that per diem rates can’t be paid to individuals who own 10% or more of the business.
If your employees are traveling, it may be a good time to review the rates and consider switching to the high-low method. It can reduce the time and frustration associated with traditional travel reimbursement. Contact us for more information.
Here are some of the key tax-related deadlines affecting businesses and other employers during the fourth quarter of 2021. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
Note: Certain tax-filing and tax-payment deadlines may be postponed for taxpayers who reside in or have a business in federally declared disaster areas.
Monday, November 1
Wednesday, November 10
Wednesday, December 15
Contact us if you’d like more information about the filing requirements and to ensure you’re meeting all applicable deadlines.
Low interest rates and other factors have caused global merger and acquisition (M&A) activity to reach new highs in 2021, according to Refinitiv, a provider of financial data. It reports that 2021 is set to be the biggest in M&A history, with the United States accounting for $2.14 trillion worth of transactions already this year. If you’re considering buying or selling a business — or you’re in the process of an M&A transaction — it’s important that both parties report it to the IRS and state agencies in the same way. Otherwise, you may increase your chances of being audited.
If a sale involves business assets (as opposed to stock or ownership interests), the buyer and the seller must generally report to the IRS the purchase price allocations that both use. This is done by attaching IRS Form 8594, “Asset Acquisition Statement,” to each of their respective federal income tax returns for the tax year that includes the transaction.
Here’s what must be reported
If you buy business assets in an M&A transaction, you must allocate the total purchase price to the specific assets that are acquired. The amount allocated to each asset then becomes its initial tax basis. For depreciable and amortizable assets, the initial tax basis of each asset determines the depreciation and amortization deductions for that asset after the acquisition. Depreciable and amortizable assets include:
In addition to reporting the items above, you must also disclose on Form 8594 whether the parties entered into a noncompete agreement, management contract or similar agreement, as well as the monetary consideration paid under it.
What the IRS might examine
The IRS may inspect the forms that are filed to see if the buyer and the seller use different allocations. If the tax agency finds that different allocations are used, auditors may dig deeper and the examination could expand beyond the transaction. So, it’s best to ensure that both parties use the same allocations. Consider including this requirement in your asset purchase agreement at the time of the sale.
The tax implications of buying or selling a business are complex. Price allocations are important because they affect future tax benefits. Both the buyer and the seller need to report them to the IRS in an identical way to avoid unwanted attention. To lock in the best results after an acquisition, consult with us before finalizing any transaction.
If you use an automobile in your trade or business, you may wonder how depreciation tax deductions are determined. The rules are complicated, and special limitations that apply to vehicles classified as passenger autos (which include many pickups and SUVs) can result in it taking longer than expected to fully depreciate a vehicle.
Cents-per-mile vs. actual expenses
First, note that separate depreciation calculations for a passenger auto only come into play if you choose to use the actual expense method to calculate deductions. If, instead, you use the standard mileage rate (56 cents per business mile driven for 2021), a depreciation allowance is built into the rate.
If you use the actual expense method to determine your allowable deductions for a passenger auto, you must make a separate depreciation calculation for each year until the vehicle is fully depreciated. According to the general rule, you calculate depreciation over a six-year span as follows: Year 1, 20% of the cost; Year 2, 32%; Year 3, 19.2%; Years 4 and 5, 11.52%; and Year 6, 5.76%. If a vehicle is used 50% or less for business purposes, you must use the straight-line method to calculate depreciation deductions instead of the percentages listed above.
For a passenger auto that costs more than the applicable amount for the year the vehicle is placed in service, you’re limited to specified annual depreciation ceilings. These are indexed for inflation and may change annually.
Heavy SUVs, pickups, and vans
Much more favorable depreciation rules apply to heavy SUVs, pickups, and vans used over 50% for business, because they’re treated as transportation equipment for depreciation purposes. This means a vehicle with a gross vehicle weight rating (GVWR) above 6,000 pounds. Quite a few SUVs and pickups pass this test. You can usually find the GVWR on a label on the inside edge of the driver-side door.
After-tax cost is what counts
What’s the impact of these depreciation limits on your business vehicle decisions? They change the after-tax cost of passenger autos used for business. That is, the true cost of a business asset is reduced by the tax savings from related depreciation deductions. To the extent depreciation deductions are reduced, and thereby deferred to future years, the value of the related tax savings is also reduced due to time-value-of-money considerations, and the true cost of the asset is therefore that much higher.
The rules are different if you lease an expensive passenger auto used for business. Contact us if you have questions or want more information.
Thinking about starting your own business? Often, this can have special tax perks over being an employee of somebody else. Being a business owner can allow you to put added money away for retirement. You also get special tax breaks on depreciating some types of property, and are subject to something called QBI.
1. Claim bonus depreciation or a Section 179 deduction for asset additions
Under current law, 100% first-year bonus depreciation is available for qualified new and used property that’s acquired and placed in service in calendar year 2021. That means your business might be able to write off the entire cost of some or all asset additions on this year’s return. Consider making acquisitions between now and December 31.
Note: It doesn’t always make sense to claim a 100% bonus depreciation deduction in the first year that qualifying property is placed in service. For example, if you think that tax rates will increase in the future — either due to tax law changes or a change in your income — it might be better to forgo bonus depreciation and instead depreciate your 2021 asset acquisitions over time.
There’s also a Section 179 deduction for eligible asset purchases. The maximum Section 179 deduction is $1.05 million for qualifying property placed in service in 2021. Recent tax laws have enhanced Section 179 and bonus depreciation but most businesses benefit more by claiming bonus depreciation. We can explain the details of these tax breaks and which is right for your business. You don’t have to decide until you file your tax return.
2. Claim bonus depreciation for a heavy vehicle
The 100% first-year bonus depreciation provision can have a sizable, beneficial impact on first-year depreciation deductions for new and used heavy SUVs, pickups and vans used over 50% for business. For federal tax purposes, heavy vehicles are treated as transportation equipment so they qualify for 100% bonus depreciation.
This option is available only when the manufacturer’s gross vehicle weight rating (GVWR) is above 6,000 pounds. You can verify a vehicle’s GVWR by looking at the manufacturer’s label, usually found on the inside edge of the driver’s side door.
Buying an eligible vehicle and placing it in service before the end of the year can deliver a big write-off on this year’s return. Before signing a sales contract, we can help evaluate what’s right for your business.
3. Maximize the QBI deduction for pass-through businesses
A valuable deduction is the one based on qualified business income (QBI) from pass-through entities. For tax years through 2025, the deduction can be up to 20% of a pass-through entity owner’s QBI. This deduction is subject to restrictions that can apply at higher income levels and based on the owner’s taxable income.
For QBI deduction purposes, pass-through entities are defined as sole proprietorships, single-member LLCs that are treated as sole proprietorships for tax purposes, partnerships, LLCs that are treated as partnerships for tax purposes and S corporations. For these taxpayers, the deduction can also be claimed for up to 20% of income from qualified real estate investment trust dividends and 20% of qualified income from publicly traded partnerships.
Because of various limitations on the QBI deduction, tax planning moves can unexpectedly increase or decrease it. For example, strategies that reduce this year’s taxable income can have the negative side-effect of reducing your QBI deduction.
These are only a few of the tax breaks your small business may be able to claim. Contact us to help evaluate your planning options and optimize your tax results.
A business may be able to claim a federal income tax deduction for a theft loss. But does embezzlement count as theft? In most cases it does but you’ll have to substantiate the loss. A recent U.S. Tax Court decision illustrates how that’s sometimes difficult to do.
Basic rules for theft losses
The tax code allows a deduction for losses sustained during the taxable year and not compensated by insurance or other means. The term “theft” is broadly defined to include larceny, embezzlement and robbery. In general, a loss is regarded as arising from theft only if there’s a criminal element to the appropriation of a taxpayer’s property.
In order to claim a theft loss deduction, a taxpayer must prove:
Facts of the recent court case
Years ago, the taxpayer cofounded an S corporation with another shareholder. At the time of the alleged embezzlement, the other original shareholder was no longer a shareholder, and she wasn’t supposed to be compensated by the business. However, according to court records, she continued to manage the S corporation’s books and records.
The taxpayer suffered an illness that prevented him from working for most of the year in question. During this time, the former shareholder paid herself $166,494. Later, the taxpayer filed a civil suit in a California court alleging that the woman had misappropriated funds from the business.
On an amended tax return, the corporation reported a $166,494 theft loss due to the embezzlement. The IRS denied the deduction. After looking at the embezzlement definition under California state law, the Tax Court agreed with the IRS.
The Tax Court stated that the taxpayer didn’t offer evidence that the former shareholder “acted with the intent to defraud,” and the taxpayer didn’t show that the corporation “experienced a theft meeting the elements of embezzlement under California law.”
The IRS and the court also denied the taxpayer’s alternate argument that the corporation should be allowed to claim a compensation deduction for the amount of money the former shareholder paid herself. The court stated that the taxpayer didn’t provide evidence that the woman was entitled to be paid compensation from the corporation and therefore, the corporation wasn’t entitled to a compensation deduction. (TC Memo 2021-66)
How to proceed if you’re victimized
If your business is victimized by theft, embezzlement or internal fraud, you may be able to claim a tax deduction for the loss. Keep in mind that a deductible loss can only be claimed for the year in which the loss is discovered, and that you must meet other tax-law requirements. Keep records to substantiate the claimed theft loss, including when you discovered the loss. If you receive an insurance payment or other reimbursement for the loss, that amount must be subtracted when computing the deductible loss for tax purposes. Contact us with any questions you may have about theft and casualty loss deductions.
In order to prepare for a business audit, an IRS examiner generally does research about the specific industry and issues on the taxpayer’s return. Examiners may use IRS “Audit Techniques Guides (ATGs).” A little-known secret is that these guides are available to the public on the IRS website. In other words, your business can use the same guides to gain insight into what the IRS is looking for in terms of compliance with tax laws and regulations.
Many ATGs target specific industries or businesses, such as construction, aerospace, art galleries, architecture and veterinary medicine. Others address issues that frequently arise in audits, such as executive compensation, passive activity losses and capitalization of tangible property.
IRS auditors need to examine different types of businesses, as well as individual taxpayers and tax-exempt organizations. Each type of return might have unique industry issues, business practices and terminology. Before meeting with taxpayers and their advisors, auditors do their homework to understand various industries or issues, the accounting methods commonly used, how income is received, and areas where taxpayers might not be in compliance.
By using a specific ATG, an auditor may be able to reconcile discrepancies when reported income or expenses aren’t consistent with what’s normal for the industry or to identify anomalies within the geographic area in which the business is located.
Updates and revisions
Some guides were written several years ago and others are relatively new. There is not a guide for every industry. Here are some of the guide titles that have been revised or added this year:
Although ATGs were created to help IRS examiners uncover common methods of hiding income and inflating deductions, they also can help businesses ensure they aren’t engaging in practices that could raise audit red flags. For a complete list of ATGs, visit the IRS website here: http://bit.ly/2rh7umD
If you’re a business owner and you’re getting a divorce, tax issues can complicate matters. Your business ownership interest is one of your biggest personal assets and in many cases, your marital property will include all or part of it.
Tax-free property transfers
You can generally divide most assets, including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).
Let’s say that under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding periods for the home and the stock would carry over to the person who receives them.
Tax-free transfers can occur before a divorce or at the time it becomes final. Tax-free treatment also applies to post-divorce transfers as long as they’re made “incident to divorce.” This means transfers that occur within:
More tax issues
Later on, there will be tax implications for assets received tax-free in a divorce settlement. The ex-spouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies).
What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.
Note that the person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement.
In addition, the beneficial tax-free transfer rule is now extended to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in a divorce, these types of ordinary-income assets can also be transferred tax-free. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.
Plan ahead to avoid surprises
Like many major life events, divorce can have major tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher. We can help you minimize the adverse tax consequences of settling your divorce.
What if you decide to, or are asked to, guarantee a loan to your corporation? Before agreeing to act as a guarantor, endorser or indemnitor of a debt obligation of your closely held corporation, be aware of the possible tax consequences. If your corporation defaults on the loan and you’re required to pay principal or interest under the guarantee agreement, you don’t want to be blindsided.
Business vs. nonbusiness
If you’re compelled to make good on the obligation, the payment of principal or interest in discharge of the obligation generally results in a bad debt deduction. This may be either a business or a nonbusiness bad debt deduction. If it’s a business bad debt, it’s deductible against ordinary income. A business bad debt can be either totally or partly worthless. If it’s a nonbusiness bad debt, it’s deductible as a short-term capital loss, which is subject to certain limitations on deductions of capital losses. A nonbusiness bad debt is deductible only if it’s totally worthless.
In order to be treated as a business bad debt, the guarantee must be closely related to your trade or business. If the reason for guaranteeing the corporation loan is to protect your job, the guarantee is considered closely related to your trade or business as an employee. But employment must be the dominant motive. If your annual salary exceeds your investment in the corporation, this tends to show that the dominant motive for the guarantee was to protect your job. On the other hand, if your investment in the corporation substantially exceeds your annual salary, that’s evidence that the guarantee was primarily to protect your investment rather than your job.
Except in the case of job guarantees, it may be difficult to show the guarantee was closely related to your trade or business. You’d have to show that the guarantee was related to your business as a promoter, or that the guarantee was related to some other trade or business separately carried on by you.
If the reason for guaranteeing your corporation’s loan isn’t closely related to your trade or business and you’re required to pay off the loan, you can take a nonbusiness bad debt deduction if you show that your reason for the guarantee was to protect your investment, or you entered the guarantee transaction with a profit motive.
In addition to satisfying the above requirements, a business or nonbusiness bad debt is deductible only if:
Any payment you make on a loan you guaranteed is deductible as a bad debt in the year you make it, unless the agreement (or local law) provides for a right of subrogation against the corporation. If you have this right, or some other right to demand payment from the corporation, you can’t take a bad debt deduction until the rights become partly or totally worthless.
These are only a few of the possible tax consequences of guaranteeing a loan to your closely held corporation. Contact us to learn all the implications in your situation.
A few years ago, IRS Revenue Procedure 2018-15 changed the rules regarding not-for-profit restructuring. If you’ve participated in a restructuring in the past, you’ll be relieved to know that in many cases it’s now easier. Even so, if recent challenges have led your organization to consider restructuring, it’s important to work with a professional advisor, such as a CPA.
That was then
Under previous IRS rules, tax-exempt organizations were required to file a new exemption application when they made certain changes to their structure. Filing this application created a new legal entity.
To apply for new exempt status, nonprofits had to file a final Form 990 under their initial Employer Identification Number (EIN), obtain a new EIN and apply for exemption for the new entity. In addition to being a time-consuming and often expensive process, the new nonprofit risked failing to receive its tax-exempt status. The process also required changing the EIN on all bank and investment accounts.
This is now
Now in many situations restructuring nonprofits are required only to report significant organizational changes on their Forms 990. To be eligible, the restructuring must satisfy certain conditions. Your organization must be:
And your reorganization must do one of the following: change from an unincorporated association to a corporation; reincorporate a corporation under the laws of another state after dissolving in the original state; file articles of domestication to transfer a corporation to a new state without dissolving in the original state; or merge a corporation with or into another corporation.
The “surviving” organization must carry out the same exempt purpose that the original organization did. For a 501(c)(3) organization, the new articles of incorporation must continue to satisfy the IRS’s organizational test that requires your nonprofit’s organizing documents to limit its purposes and use of its assets to exempt purposes.
Note that there are additional limitations. For example, the new rules don’t apply if your surviving organization is a “disregarded entity,” limited liability company (LLC), partnership or foreign business entity. Also, surviving organizations still have reporting obligations — for instance, to report the restructuring on any required Form 990 for the applicable tax year. And, these rules apply only to federal income tax exemptions. Your state’s laws could require you to file a new exemption application.
For more information and guidance, contact us.
Since the beginning of the pandemic, financial markets have been riding a roller coaster. This volatility is a good reminder that if your nonprofit has an endowment, it could benefit from management by a professional investment advisor. Here’s how to find a qualified advisor.
Nonprofit experience required
Finding the right investment advisor for your organization starts with identifying a pool of qualified candidates with proven track records. Ask for referrals from local private foundations (possibly ones that have funded you in the past) or other area nonprofits. Also, members of your board may know investment advisors they can recommend. Qualified candidates should have experience working with nonprofit endowments.
Request detailed proposals from candidates on how they’d manage your investments — as well as the fee structure for their services. Generally, investment advisors charge clients based on one (or a combination) of three structures:
After reviewing the candidates’ proposals and checking their references, allow search committee members to talk to other nonprofit leaders to gauge their satisfaction level with your short list. Then select two or three people to interview.
Grow without incurring excessive risk
Members of your board’s investment or finance committee should interview candidates. They should look for someone who closely follows market movements and trends and is capable of creating and managing a balanced portfolio that can grow without incurring excessive risk. Understanding the candidates’ investment processes, along with their long-term results, is essential.
Other desirable qualities include experience assisting investment committees in drafting and changing investment policies and an ability to clearly explain the processes behind their investment decisions. Committee members might ask candidates, based on what they know of your organization, what changes to your endowment’s current investment strategy they might propose.
Good candidates should express empathy toward the kinds of problems your organization faces and suggest investment solutions specific to your nonprofit. And they should have the time to properly manage your investments. Ask how many hours per month they anticipate spending on your account and whether they’d be able to attend off-hour meetings, if necessary.
Finally, consider how much you trust the candidate. Don’t engage an investment advisor for your nonprofit unless you’d wholeheartedly trust the person to handle your own money.
If you’re not sure where to look for a qualified investment advisor, contact us for referrals. Also contact us if you don’t yet have an endowment but would like to establish one.
If you’re fortunate enough to own a vacation home, you may want to rent it out for part of the year. What are the tax consequences?
The tax treatment can be complex. It depends on how many days it’s rented and your level of personal use. Personal use includes vacation use by you, your relatives (even if you charge them market rent) and use by nonrelatives if a market rent isn’t charged.
Less than 15 days
If you rent the property out for less than 15 days during the year, it’s not treated as “rental property” at all. In the right circumstances, this can produce revenue and significant tax benefits. Any rent you receive isn’t included in your income for tax purposes. On the other hand, you can only deduct property taxes and mortgage interest — no other operating costs or depreciation. (Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.)
If you rent the property out for more than 14 days, you must include the rent received in income. However, you can deduct part of your operating expenses and depreciation, subject to certain rules. First, you must allocate your expenses between the personal use days and the rental days. For example, if the house is rented for 90 days and used personally for 30 days, 75% of the use is rental (90 out of 120 total use days). You’d allocate 75% of your costs such as maintenance, utilities and insurance to rental. You’d also allocate 75% of your depreciation allowance, interest and taxes for the property to rental. The personal use portion of taxes is separately deductible. The personal use part of interest on a second home is also deductible (if eligible) where the personal use exceeds the greater of 14 days or 10% of the rental days. However, depreciation on the personal use portion isn’t allowed.
Claiming a loss
If the rental income exceeds these allocable deductions, you report the rent and deductions to determine the amount of rental income to add to your other income. If the expenses exceed the income, you may be able to claim a rental loss. This depends on how many days you use the house for personal purposes.
Here’s the test: if you use it personally for more than the greater of a) 14 days, or b) 10% of the rental days, you’re using it “too much” and can’t claim your loss. In this case, you can still use your deductions to wipe out rental income, but you can’t create a loss. Deductions you can’t use are carried forward and may be usable in future years. If you’re limited to using deductions only up to the rental income amount, you must use the deductions allocated to the rental portion in this order: 1) interest and taxes, 2) operating costs and 3) depreciation.
If you “pass” the personal use test, you must still allocate your expenses between the personal and rental portions. In this case, however, if your rental deductions exceed rental income, you can claim the loss. (The loss is “passive,” however, and may be limited under passive loss rules.)
These are only the basic rules. There may be other rules if you’re considered a small landlord or real estate professional. Contact us if you have questions. We can help plan your vacation home use to achieve optimal tax results.
If you own a valuable piece of art, or other property, you may wonder how much of a tax deduction you could get by donating it to charity.
The answer to that question can be complex because several different tax rules may come into play with such contributions. A charitable contribution of a work of art is subject to reduction if the charity’s use of the work of art is unrelated to the purpose or function that’s the basis for its qualification as a tax-exempt organization. The reduction equals the amount of capital gain you’d have realized had you sold the property instead of giving it to charity.
For example, let’s say you bought a painting years ago for $10,000 that’s now worth $20,000. You contribute it to a hospital. Your deduction is limited to $10,000 because the hospital’s use of the painting is unrelated to its charitable function, and you’d have a $10,000 long-term capital gain if you sold it. What if you donate the painting to an art museum? In that case, your deduction is $20,000.
One or more substantiation rules may apply when donating art. First, if you claim a deduction of less than $250, you must get and keep a receipt from the organization and keep written records for each item contributed.
If you claim a deduction of $250 to $500, you must get and keep an acknowledgment of your contribution from the charity. It must state whether the organization gave you any goods or services in return for your contribution and include a description and good faith estimate of the value of any goods or services given.
If you claim a deduction in excess of $500, but not over $5,000, in addition to getting an acknowledgment, you must maintain written records that include information about how and when you obtained the property and its cost basis. You must also complete an IRS form and attach it to your tax return.
If the claimed value of the property exceeds $5,000, in addition to an acknowledgment, you must also have a qualified appraisal of the property. This is an appraisal that was done by a qualified appraiser no more than 60 days before the contribution date and meets numerous other requirements. You include information about these donations on an IRS form filed with your tax return.
If your total deduction for art is $20,000 or more, you must attach a copy of the signed appraisal. If an item is valued at $20,000 or more, the IRS may request a photo. If an art item has been appraised at $50,000 or more, you can ask the IRS to issue a “Statement of Value” that can be used to substantiate the value.
In addition, your deduction may be limited to 20%, 30%, 50%, or 60% of your contribution base, which usually is your adjusted gross income. The percentage varies depending on the year the contribution is made, the type of organization, and whether the deduction of the artwork had to be reduced because of the unrelated use rule explained above. The amount not deductible on account of a ceiling may be deductible in a later year under carryover rules.
Other rules may apply
Donors sometimes make gifts of partial interests in a work of art. Special requirements apply to these donations. If you’d like to discuss any of these rules, please contact us.
Studies have found that more people are engaging in online gambling and sports betting since the pandemic began. And there are still more traditional ways to gamble and play the lottery. If you’re lucky enough to win, be aware that tax consequences go along with your good fortune.
Review the tax rules
Whether you win online, at a casino, a bingo hall, a fantasy sports event or elsewhere, you must report 100% of your winnings as taxable income. They’re reported on the “Other income” line of your 1040 tax return. To measure your winnings on a particular wager, use the net gain. For example, if a $30 bet at the racetrack turns into a $110 win, you’ve won $80, not $110.
You must separately keep track of losses. They’re deductible, but only as itemized deductions. Therefore, if you don’t itemize and take the standard deduction, you can’t deduct gambling losses. In addition, gambling losses are only deductible up to the amount of gambling winnings. Therefore, you can use losses to “wipe out” gambling income but you can’t show a gambling tax loss.
Maintain good records of your losses during the year. Keep a diary in which you indicate the date, place, amount and type of loss, as well as the names of anyone who was with you. Save all documentation, such as checks or credit slips.
Hitting a lottery jackpot
The odds of winning the lottery are slim. But if you don’t follow the tax rules after winning, the chances of hearing from the IRS are much higher.
Lottery winnings are taxable. This is the case for cash prizes and for the fair market value of any noncash prizes, such as a car or vacation. Depending on your other income and the amount of your winnings, your federal tax rate may be as high as 37%. You may also be subject to state income tax.
You report lottery winnings as income in the year, or years, you actually receive them. In the case of noncash prizes, this would be the year the prize is received. With cash, if you take the winnings in annual installments, you only report each year’s installment as income for that year.
If you win more than $5,000 in the lottery or certain types of gambling, 24% must be withheld for federal tax purposes. You’ll receive a Form W-2G from the payer showing the amount paid to you and the federal tax withheld. (The payer also sends this information to the IRS.) If state tax withholding is withheld, that amount may also be shown on Form W-2G.
Since the federal tax rate can currently be up to 37%, which is well above the 24% withheld, the withholding may not be enough to cover your federal tax bill. Therefore, you may have to make estimated tax payments — and you may be assessed a penalty if you fail to do so. In addition, you may be required to make state and local estimated tax payments.
Talk with us
If you’re fortunate enough to win a sizable amount of money, there are other issues to consider, including estate planning. This article only covers the basic tax rules. Different rules apply to people who qualify as professional gamblers. Contact us with questions. We can help you minimize taxes and stay in compliance with all requirements.
Given the escalating cost of health care, there may be a more cost-effective way to pay for it. For eligible individuals, a Health Savings Account (HSA) offers a tax-favorable way to set aside funds (or have an employer do so) to meet future medical needs. Here are the main tax benefits:
To be eligible for an HSA, you must be covered by a “high deductible health plan.” For 2021, a high deductible health plan is one with an annual deductible of at least $1,400 for self-only coverage, or at least $2,800 for family coverage. For self-only coverage, the 2021 limit on deductible contributions is $3,600. For family coverage, the 2021 limit on deductible contributions is $7,200. Additionally, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits can’t exceed $7,000 for self-only coverage or $14,000 for family coverage.
An individual (and the individual’s covered spouse) who has reached age 55 before the close of the year (and is an eligible HSA contributor) may make additional “catch-up” contributions for 2021 of up to $1,000.
HSAs may be established by, or on behalf of, any eligible individual.
You can deduct contributions to an HSA for the year up to the total of your monthly limitations for the months you were eligible. For 2021, the monthly limitation on deductible contributions for a person with self-only coverage is 1/12 of $3,600. For an individual with family coverage, the monthly limitation on deductible contributions is 1/12 of $7,200. Thus, deductible contributions aren’t limited by the amount of the annual deductible under the high deductible health plan.
Also, taxpayers who are eligible individuals during the last month of the tax year are treated as having been eligible individuals for the entire year for purposes of computing the annual HSA contribution.
However, if an individual is enrolled in Medicare, he or she is no longer eligible under the HSA rules and contributions to an HSA can no longer be made.
On a once-only basis, taxpayers can withdraw funds from an IRA, and transfer them tax-free to an HSA. The amount transferred can be up to the maximum deductible HSA contribution for the type of coverage (individual or family) in effect at the transfer time. The amount transferred is excluded from gross income and isn’t subject to the 10% early withdrawal penalty.
HSA Distributions to cover an eligible individual’s qualified medical expenses, or those of his spouse or dependents, aren’t taxed. Qualified medical expenses for these purposes generally mean those that would qualify for the medical expense itemized deduction. If funds are withdrawn from the HSA for other reasons, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it’s made after reaching age 65 or in the event of death or disability.
As you can see, HSAs offer a very flexible option for providing health care coverage, but the rules are somewhat complex. Contact us if you have questions.
Many homeowners across the country have seen their home values increase recently. According to the National Association of Realtors, the median price of homes sold in July of 2021 rose 17.8% over July of 2020. The median home price was $411,200 in the Northeast, $275,300 in the Midwest, $305,200 in the South and $508,300 in the West.
Be aware of the tax implications if you’re selling your home or you sold one in 2021. You may owe capital gains tax and net investment income tax (NIIT).
If you’re selling your principal residence, and meet certain requirements, you can exclude from tax up to $250,000 ($500,000 for joint filers) of gain.
To qualify for the exclusion, you must meet these tests:
In addition, you can’t use the exclusion more than once every two years.
Gain above the exclusion amount
What if you have more than $250,000/$500,000 of profit? Any gain that doesn’t qualify for the exclusion generally will be taxed at your long-term capital gains rate, provided you owned the home for at least a year. If you didn’t, the gain will be considered short term and subject to your ordinary-income rate, which could be more than double your long-term rate.
If you’re selling a second home (such as a vacation home), it isn’t eligible for the gain exclusion. But if it qualifies as a rental property, it can be considered a business asset, and you may be able to defer tax on any gains through an installment sale or a Section 1031 like-kind exchange. In addition, you may be able to deduct a loss.
How does the 3.8% NIIT apply to home sales? If you sell your main home, and you qualify to exclude up to $250,000/$500,000 of gain, the excluded gain isn’t subject to the NIIT.
However, gain that exceeds the exclusion limit is subject to the tax if your adjusted gross income is over a certain amount. Gain from the sale of a vacation home or other second residence, which doesn’t qualify for the exclusion, is also subject to the NIIT.
The NIIT applies only if your modified adjusted gross income (MAGI) exceeds: $250,000 for married taxpayers filing jointly and surviving spouses; $125,000 for married taxpayers filing separately; and $200,000 for unmarried taxpayers and heads of household.
Two other tax considerations
As you can see, depending on your home sale profit and your income, some or all of the gain may be tax free. But for higher-income people with pricey homes, there may be a tax bill. We can help you plan ahead to minimize taxes and answer any questions you have about home sales.
As we approach the holidays and the end of the year, many people may want to make gifts of cash or stock to their loved ones. By properly using the annual exclusion, gifts to family members and loved ones can reduce the size of your taxable estate, within generous limits, without triggering any estate or gift tax. The exclusion amount for 2021 is $15,000.
The exclusion covers gifts you make to each recipient each year. Therefore, a taxpayer with three children can transfer $45,000 to the children every year free of federal gift taxes. If the only gifts made during a year are excluded in this fashion, there’s no need to file a federal gift tax return. If annual gifts exceed $15,000, the exclusion covers the first $15,000 per recipient, and only the excess is taxable. In addition, even taxable gifts may result in no gift tax liability thanks to the unified credit (discussed below).
Note: This discussion isn’t relevant to gifts made to a spouse because these gifts are free of gift tax under separate marital deduction rules.
Gift-splitting by married taxpayers
If you’re married, a gift made during a year can be treated as split between you and your spouse, even if the cash or gift property is actually given by only one of you. Thus, by gift-splitting, up to $30,000 a year can be transferred to each recipient by a married couple because of their two annual exclusions. For example, a married couple with three married children can transfer a total of $180,000 each year to their children and to the children’s spouses ($30,000 for each of six recipients).
If gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return (or returns) that the spouses file. The IRS prefers that both spouses indicate their consent on each return filed. Because more than $15,000 is being transferred by a spouse, a gift tax return (or returns) will have to be filed, even if the $30,000 exclusion covers total gifts. We can prepare a gift tax return (or returns) for you, if more than $15,000 is being given to a single individual in any year.)
“Unified” credit for taxable gifts
Even gifts that aren’t covered by the exclusion, and that are thus taxable, may not result in a tax liability. This is because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $11.7 million for 2021. However, to the extent you use this credit against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death.
Be aware that gifts made directly to a financial institution to pay for tuition or to a health care provider to pay for medical expenses on behalf of someone else do not count towards the exclusion. For example, you can pay $20,000 to your grandson’s college for his tuition this year, plus still give him up to $15,000 as a gift.
Annual gifts help reduce the taxable value of your estate. There have been proposals in Washington to reduce the estate and gift tax exemption amount, as well as make other changes to the estate tax laws. Making large tax-free gifts may be one way to recognize and address this potential threat. It could help insulate you against any later reduction in the unified federal estate and gift tax exemption.
In recent weeks, some Americans have been victimized by hurricanes, severe storms, flooding, wildfires and other disasters. No matter where you live, unexpected disasters may cause damage to your home or personal property. Before the Tax Cuts and Jobs Act (TCJA), eligible casualty loss victims could claim a deduction on their tax returns. But there are now restrictions that make these deductions harder to take.
What’s considered a casualty for tax purposes? It’s a sudden, unexpected or unusual event, such as a hurricane, tornado, flood, earthquake, fire, act of vandalism or a terrorist attack.
More difficult to qualify
For losses incurred through 2025, the TCJA generally eliminates deductions for personal casualty losses, except for losses due to federally declared disasters. For example, during the summer of 2021, there have been presidential declarations of major disasters in parts of Tennessee, New York state, Florida and California after severe storms, flooding and wildfires. So victims in affected areas would be eligible for casualty loss deductions.
Note: There’s an exception to the general rule of allowing casualty loss deductions only in federally declared disaster areas. If you have personal casualty gains because your insurance proceeds exceed the tax basis of the damaged or destroyed property, you can deduct personal casualty losses that aren’t due to a federally declared disaster up to the amount of your personal casualty gains.
Special election to claim a refund
If your casualty loss is due to a federally declared disaster, a special election allows you to deduct the loss on your tax return for the preceding year and claim a refund. If you’ve already filed your return for the preceding year, you can file an amended return to make the election and claim the deduction in the earlier year. This can potentially help you get extra cash when you need it.
This election must be made by no later than six months after the due date (without considering extensions) for filing your tax return for the year in which the disaster occurs. However, the election itself must be made on an original or amended return for the preceding year.
How to calculate the deduction
You must take the following three steps to calculate the casualty loss deduction for personal-use property in an area declared a federal disaster:
Important: Another factor that now makes it harder to claim a casualty loss than it used to be years ago is that you must itemize deductions to claim one. Through 2025, fewer people will itemize, because the TCJA significantly increased the standard deduction amounts. For 2021, they’re $12,550 for single filers, $18,800 for heads of households, and $25,100 for married joint-filing couples.
So even if you qualify for a casualty deduction, you might not get any tax benefit, because you don’t have enough itemized deductions.
These are the rules for personal property. Keep in mind that the rules for business or income-producing property are different. (It’s easier to get a deduction for business property casualty losses.) If you are a victim of a disaster, we can help you understand the complex rules.
Employer-provided life insurance is a coveted fringe benefit. However, if group term life insurance is part of your benefit package, and the coverage is higher than $50,000, there may be undesirable income tax implications.
Tax on income you don’t receive
The first $50,000 of group term life insurance coverage that your employer provides is excluded from taxable income and doesn’t add anything to your income tax bill. But the employer-paid cost of group term coverage in excess of $50,000 is taxable income to you. It’s included in the taxable wages reported on your Form W-2 — even though you never actually receive it. In other words, it’s “phantom income.”
What’s worse, the cost of group term insurance must be determined under a table prepared by the IRS even if the employer’s actual cost is less than the cost figured under the table. With these determinations, the amount of taxable phantom income attributed to an older employee is often higher than the premium the employee would pay for comparable coverage under an individual term policy. This tax trap gets worse as an employee gets older and as the amount of his or her compensation increases.
Your W-2 has answers
What should you do if you think the tax cost of employer-provided group term life insurance is higher than you’d like? First, you should establish if this is actually the case. If a specific dollar amount appears in Box 12 of your Form W-2 (with code “C”), that dollar amount represents your employer’s cost of providing you with group term life insurance coverage in excess of $50,000, less any amount you paid for the coverage. You’re responsible for federal, state and local taxes on the amount that appears in Box 12 and for the associated Social Security and Medicare taxes as well.
But keep in mind that the amount in Box 12 is already included as part of your total “Wages, tips and other compensation” in Box 1 of the W-2, and it’s the Box 1 amount that’s reported on your tax return
If you decide that the tax cost is too high for the benefit you’re getting in return, find out whether your employer has a “carve-out” plan (a plan that carves out selected employees from group term coverage) or, if not, whether it would be willing to create one. There are different types of carve-out plans that employers can offer to their employees.
For example, the employer can continue to provide $50,000 of group term insurance (since there’s no tax cost for the first $50,000 of coverage). Then, the employer can either provide the employee with an individual policy for the balance of the coverage, or give the employee the amount the employer would have spent for the excess coverage as a cash bonus that the employee can use to pay the premiums on an individual policy.
Contact us if you have questions about group term coverage or whether it’s adding to your tax bill.
There may be a tax-advantaged way for people to save for the needs of family members with disabilities — without having them lose eligibility for government benefits to which they’re entitled. It can be done though an Achieving a Better Life Experience (ABLE) account, which is a tax-free account that can be used for disability-related expenses.
Who is eligible?
ABLE accounts can be created by eligible individuals to support themselves, by family members to support their dependents, or by guardians for the benefit of the individuals for whom they’re responsible. Anyone can contribute to an ABLE account. While contributions aren’t tax-deductible, the funds in the account are invested and grow free of tax.
Eligible individuals must be blind or disabled — and must have become so before turning age 26. They also must be entitled to benefits under the Supplemental Security Income (SSI) or Social Security Disability Insurance (SSDI) programs. Alternatively, an individual can become eligible if a disability certificate is filed with the IRS for him or her.
Distributions from an ABLE account are tax-free if used to pay for expenses that maintain or improve the beneficiary’s health, independence or quality of life. These expenses include education, housing, transportation, employment support, health and wellness costs, assistive technology, personal support services, and other IRS-approved expenses.
If distributions are used for nonqualified expenses, the portion of the distribution that represents earnings on the account is subject to income tax — plus a 10% penalty.
Here are some other key factors:
States establish programs
There are many choices. ABLE accounts are established under state programs. An account may be opened under any state’s program (if the state allows out-of-state participants). The funds in an account can be invested in a variety of options and the account’s investment directions can be changed up to twice a year. Contact us if you’d like more details about setting up or maintaining an ABLE account.
Are you age 65 and older and have basic Medicare insurance? You may need to pay additional premiums to get the level of coverage you want. The premiums can be expensive, especially if you’re married and both you and your spouse are paying them. But there may be a bright side: You may qualify for a tax break for paying the premiums.
Medicare premiums are medical expenses
You can combine premiums for Medicare health insurance with other qualifying medical expenses for purposes of claiming an itemized deduction for medical expenses on your tax return. This includes amounts for “Medigap” insurance and Medicare Advantage plans. Some people buy Medigap policies because Medicare Parts A and B don’t cover all their health care expenses. Coverage gaps include co-payments, coinsurance, deductibles and other costs. Medigap is private supplemental insurance that’s intended to cover some or all gaps.
Itemizing versus the standard deduction
Qualifying for a medical expense deduction is hard for many people for a couple of reasons. For 2021, you can deduct medical expenses only if you itemize deductions and only to the extent that total qualifying expenses exceeded 7.5% of AGI.
The Tax Cuts and Jobs Act nearly doubled the standard deduction amounts for 2018 through 2025. As a result, fewer individuals are claiming itemized deductions. For 2021, the standard deduction amounts are $12,550 for single filers, $25,100 for married couples filing jointly and $18,800 for heads of household. (For 2020, these amounts were $12,400, $24,800 and $18,650, respectively.)
However, if you have significant medical expenses, including Medicare health insurance premiums, you may itemize and collect some tax savings.
Note: Self-employed people and shareholder-employees of S corporations can generally claim an above-the-line deduction for their health insurance premiums, including Medicare premiums. So, they don’t need to itemize to get the tax savings from their premiums.
Medical expense deduction basics
In addition to Medicare premiums, you can deduct various medical expenses, including those for dental treatment, ambulance services, dentures, eyeglasses and contacts, hospital services, lab tests, qualified long-term care services, prescription medicines and others.
There are also many items that Medicare doesn’t cover that can be deducted for tax purposes, if you qualify. In addition, you can deduct transportation expenses to get to medical appointments. If you go by car, you can deduct a flat 16-cents-per-mile rate for 2021 (down from 17 cents for 2020), or you can keep track of your actual out-of-pocket expenses for gas, oil and repairs.
Claim all eligible deductions
Contact us if you have additional questions about claiming medical expense deductions on your tax return.
If your business receives large amounts of cash or cash equivalents, you may be required to report these transactions to the IRS.
What are the requirements?
Each person who, in the course of operating a trade or business, receives more than $10,000 in cash in one transaction (or two or more related transactions), must file Form 8300. What is considered a “related transaction?” Any transactions conducted in a 24-hour period. Transactions can also be considered related even if they occur over a period of more than 24 hours if the recipient knows, or has reason to know, that each transaction is one of a series of connected transactions.
To complete a Form 8300, you’ll need personal information about the person making the cash payment, including a Social Security or taxpayer identification number.
Why does the government require reporting?
Although many cash transactions are legitimate, the IRS explains that “information reported on (Form 8300) can help stop those who evade taxes, profit from the drug trade, engage in terrorist financing and conduct other criminal activities. The government can often trace money from these illegal activities through the payments reported on Form 8300 and other cash reporting forms.”
You should keep a copy of each Form 8300 for five years from the date you file it, according to the IRS.
What’s considered “cash” and “cash equivalents?”
For Form 8300 reporting purposes, cash includes U.S. currency and coins, as well as foreign money. It also includes cash equivalents such as cashier’s checks (sometimes called bank checks), bank drafts, traveler’s checks and money orders.
Money orders and cashier’s checks under $10,000, when used in combination with other forms of cash for a single transaction that exceeds $10,000, are defined as cash for Form 8300 reporting purposes.
Note: Under a separate reporting requirement, banks and other financial institutions report cash purchases of cashier’s checks, treasurer’s checks and/or bank checks, bank drafts, traveler’s checks and money orders with a face value of more than $10,000 by filing currency transaction reports.
Can the forms be filed electronically?
Businesses required to file reports of large cash transactions on Form 8300 should know that in addition to filing on paper, e-filing is an option. The form is due 15 days after a transaction and there’s no charge for the e-file option. Businesses that file electronically get an automatic acknowledgment of receipt when they file.
The IRS also reminds businesses that they can “batch file” their reports, which is especially helpful to those required to file many forms.
How can we set up an electronic account?
To file Form 8300 electronically, a business must set up an account with FinCEN’s Bank Secrecy Act E-Filing System. For more information, visit: https://bit.ly/3fMMLAu Interested businesses can also call the BSA E-Filing Help Desk at 866-346-9478 (Monday through Friday from 8 am to 6 pm EST). Contact us with any questions or for assistance.
Perhaps you operate your small business as a sole proprietorship and want to form a limited liability company (LLC) to protect your assets. Or maybe you are launching a new business and want to know your options for setting it up. Here are the basics of operating as an LLC and why it might be appropriate for your business.
An LLC is somewhat of a hybrid entity because it can be structured to resemble a corporation for owner liability purposes and a partnership for federal tax purposes. This duality may provide the owners with the best of both worlds.
Personal asset protection
Like the shareholders of a corporation, the owners of an LLC (called “members” rather than shareholders or partners) generally aren’t liable for the debts of the business except to the extent of their investment. Thus, the owners can operate the business with the security of knowing that their personal assets are protected from the entity’s creditors. This protection is far greater than that afforded by partnerships. In a partnership, the general partners are personally liable for the debts of the business. Even limited partners, if they actively participate in managing the business, can have personal liability.
The owners of an LLC can elect under the “check-the-box” rules to have the entity treated as a partnership for federal tax purposes. This can provide a number of important benefits to the owners. For example, partnership earnings aren’t subject to an entity-level tax. Instead, they “flow through” to the owners, in proportion to the owners’ respective interests in profits, and are reported on the owners’ individual returns and are taxed only once.
To the extent the income passed through to you is qualified business income, you’ll be eligible to take the Code Section 199A pass-through deduction, subject to various limitations. In addition, since you’re actively managing the business, you can deduct on your individual tax return your ratable shares of any losses the business generates. This, in effect, allows you to shelter other income that you and your spouse may have.
An LLC that’s taxable as a partnership can provide special allocations of tax benefits to specific partners. This can be an important reason for using an LLC over an S corporation (a form of business that provides tax treatment that’s similar to a partnership). Another reason for using an LLC over an S corporation is that LLCs aren’t subject to the restrictions the federal tax code imposes on S corporations regarding the number of owners and the types of ownership interests that may be issued.
Review your situation
In summary, an LLC can give you corporate-like protection from creditors while providing the benefits of taxation as a partnership. For these reasons, you should consider operating your business as an LLC. Contact us to discuss in more detail how an LLC might benefit you and the other owners.
Do you play a major role in a closely held corporation and sometimes spend money on corporate expenses personally? These costs may wind up being nondeductible both by an officer and the corporation unless proper steps are taken. This issue is more likely to arise in connection with a financially troubled corporation.
Deductible vs. nondeductible expenses
In general, you can’t deduct an expense you incur on behalf of your corporation, even if it’s a legitimate “trade or business” expense and even if the corporation is financially troubled. This is because a taxpayer can only deduct expenses that are his own. And since your corporation’s legal existence as a separate entity must be respected, the corporation’s costs aren’t yours and thus can’t be deducted even if you pay them.
What’s more, the corporation won’t generally be able to deduct them either because it didn’t pay them itself. Accordingly, be advised that it shouldn’t be a practice of your corporation’s officers or major shareholders to cover corporate costs.
When expenses may be deductible
On the other hand, if a corporate executive incurs costs that relate to an essential part of his or her duties as an executive, they may be deductible as ordinary and necessary expenses related to his or her “trade or business” of being an executive. If you wish to set up an arrangement providing for payments to you and safeguarding their deductibility, a provision should be included in your employment contract with the corporation stating the types of expenses which are part of your duties and authorizing you to incur them. For example, you may be authorized to attend out-of-town business conferences on the corporation’s behalf at your personal expense.
Alternatively, to avoid the complete loss of any deductions by both yourself and the corporation, an arrangement should be in place under which the corporation reimburses you for the expenses you incur. Turn the receipts over to the corporation and use an expense reimbursement claim form or system. This will at least allow the corporation to deduct the amount of the reimbursement.
Contact us if you’d like assistance or would like to discuss these issues further.
Despite the COVID-19 pandemic, government officials are seeing a large increase in the number of new businesses being launched. From June 2020 through June 2021, the U.S. Census Bureau reports that business applications are up 18.6%. The Bureau measures this by the number of businesses applying for an Employer Identification Number.
Entrepreneurs often don’t know that many of the expenses incurred by start-ups can’t be currently deducted. You should be aware that the way you handle some of your initial expenses can make a large difference in your federal tax bill.
How to treat expenses for tax purposes
If you’re starting or planning to launch a new business, keep these three rules in mind:
In general, start-up expenses are those you make to:
To qualify for the election, an expense also must be one that would be deductible if it were incurred after a business began. One example is money you spend analyzing potential markets for a new product or service.
To be eligible as an “organization expense,” an expense must be related to establishing a corporation or partnership. Some examples of organization expenses are legal and accounting fees for services related to organizing a new business and filing fees paid to the state of incorporation.
If you have start-up expenses that you’d like to deduct this year, you need to decide whether to take the election described above. Recordkeeping is critical. Contact us about your start-up plans. We can help with the tax and other aspects of your new business.
No not-for-profit looks forward to annual audits. But regular maintenance and preparation specific to an impending audit can make the process less disruptive. We recommend taking the following steps.
1. Reconcile routinely
You shouldn’t wait until audit time to reconcile accounts — for example, cash, receivables, pledges, payables, accruals and revenues. Reconcile general ledger account balances to supporting schedules (bank reconciliation, receivables and payable aging) monthly or at least quarterly. And don’t forget to reconcile database information provided and maintained by nonaccounting departments, such as contributions, events revenue, registration revenue and sponsorships.
2. Prepare supporting documentation
Collect all supporting documentation before your audit and, if anything is missing, alert auditors immediately. It might be necessary to request duplicate invoices from vendors or ask donors for copies of letters describing restrictions on contributions.
3. Assemble the PBC list items
As part of their planning process, auditors typically compile a Provided by Client (PBC) list of materials they expect you to produce. The list includes a timeline indicating when the auditors need each type of material. Submit everything on the list according to the timeline. If you don’t, you could push back the audit itself and miss your board deadline for completion. Also, to ensure accuracy, perform a self-review of all information before you send it.
4. Be ready to explain variances
Before the auditors arrive, identify major fluctuations in your account balances compared to the previous year. Your auditors will inquire into significant variances in revenues and expenses. Make sure you’re ready to explain them — as well as budget variances — promptly and clearly.
5. Review earlier audits
Audits from previous years provide useful guidance. Check prior years’ audit entries and confirm that you didn’t make the same errors this year. Also confirm that you posted all of the audit entries from the last audit. If you didn’t, your financial statements might be distorted.
Don’t think of audits as a once-a-year obligation. Keep in touch with auditors throughout the year. For example, if you land a new grant or contract and aren’t certain how to properly record it, don’t hesitate to ask your auditors.
If you have a parent entering a nursing home, you may not be thinking about taxes. But there are a number of possible tax implications. Here are five.
1. Long-term medical care
The costs of qualified long-term care, including nursing home care, are deductible as medical expenses to the extent they, along with other medical expenses, exceed 7.5% of adjusted gross income (AGI).
Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating and rehabilitative services, and maintenance or personal-care services required by a chronically ill individual that is provided under care administered by a licensed healthcare practitioner.
To qualify as chronically ill, a physician or other licensed healthcare practitioner must certify an individual as unable to perform at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for at least 90 days due to a loss of functional capacity or severe cognitive impairment.
2. Long-term care insurance
Premiums paid for a qualified long-term care insurance contract are deductible as medical expenses (subject to limitations explained below) to the extent they, along with other medical expenses, exceed the percentage-of-AGI threshold. A qualified long-term care insurance contract covers only qualified long-term care services, doesn’t pay costs covered by Medicare, is guaranteed renewable and doesn’t have a cash surrender value.
Qualified long-term care premiums are includible as medical expenses up to certain amounts. For individuals over 60 but not over 70 years old, the 2021 limit on deductible long-term care insurance premiums is $4,520, and for those over 70, the 2021 limit is $5,640.
3. Nursing home payments
Amounts paid to a nursing home are deductible as a medical expense if a person is staying at the facility principally for medical, rather than custodial care. If a person isn’t in the nursing home principally to receive medical care, only the portion of the fee that’s allocable to actual medical care qualifies as a deductible expense. But if the individual is chronically ill, all qualified long-term care services, including maintenance or personal care services, are deductible.
If your parent qualifies as your dependent, you can include any medical expenses you incur for your parent along with your own when determining your medical deduction.
4. Head-of-household filing status
If you aren’t married and you meet certain dependency tests for your parent, you may qualify for head-of-household filing status, which has a higher standard deduction and lower tax rates than single filing status. You may be eligible to file as head of household even if the parent for whom you claim an exemption doesn’t live with you.
5. The sale of your parent’s home.
If your parent sells his or her home, up to $250,000 of the gain from the sale may be tax-free. In order to qualify for the $250,000 exclusion, the seller must generally have owned the home for at least two years out of the five years before the sale, and used the home as a principal residence for at least two years out of the five years before the sale. However, there’s an exception to the two-out-of-five-year use test if the seller becomes physically or mentally unable to care for him or herself during the five-year period.
These are only some of the tax issues you may deal with when your parent moves into a nursing home. Contact us if you need more information or assistance.
More than 43 million student borrowers are in debt with an average of $39,351 each, according to the research group EducationData.org. If you have student loan debt, you may wonder if you can deduct the interest you pay. The answer is yes, subject to certain limits. However, the deduction is phased out if your adjusted gross income exceeds certain levels — and they aren’t as high as the income levels for many other deductions.
Basics of the deduction
The maximum amount of student loan interest you can deduct each year is $2,500. The interest must be for a “qualified education loan,” which means a debt incurred to pay tuition, room and board, and related expenses to attend a post-high school educational institution, including certain vocational schools. Post-graduate programs may also qualify. For example, an internship or residency program leading to a degree or certificate awarded by an institution of higher education, hospital, or health care facility offering post-graduate training can qualify.
It doesn’t matter when the loan was taken out or whether interest payments made in earlier years on the loan were deductible or not.
For 2021, the deduction is phased out for single taxpayers with AGI between $70,000 and $85,000 ($140,000 and $170,000 for married couples filing jointly). The deduction is unavailable for single taxpayers with AGI of more than $85,000 ($170,000 or married couples filing jointly).
Married taxpayers must file jointly to claim this deduction.
The deduction is taken “above the line.” In other words, it’s subtracted from gross income to determine AGI. Thus, it’s available even to taxpayers who don’t itemize deductions.
No deduction is allowed to a taxpayer who can be claimed as a dependent on another tax return. For example, let’s say a parent is paying for the college education of a child whom the parent is claiming as a dependent. In this case, the interest deduction is only available for interest the parent pays on a qualifying loan, not for any of the interest the child may pay on a loan the student may have taken out. The child will be able to deduct interest that is paid in later years when he or she is no longer a dependent.
The interest must be on funds borrowed to cover qualified education costs of the taxpayer or his spouse or dependent. The student must be a degree candidate carrying at least half the normal full-time workload. Also, the education expenses must be paid or incurred within a reasonable time before or after the loan is taken out.
Taxpayers must keep records to verify qualifying expenditures. Documenting a tuition expense isn’t likely to pose a problem. However, care should be taken to document other qualifying education-related expenses including books, equipment, fees, and transportation.
Documenting room and board expenses should be straightforward for students living and dining on campus. Student who live off campus should maintain records of room and board expenses, especially when there are complicating factors such as roommates.
Contact us if you’d like help in determining whether you qualify for this deduction or if you have questions about it.
If you’re planning your estate, or you’ve recently inherited assets, you may be unsure of the “cost” (or “basis”) for tax purposes.
The current rules
Under the current fair market value basis rules (also known as the “step-up and step-down” rules), an heir receives a basis in inherited property equal to its date-of-death value. So, for example, if your grandmother bought stock in 1935 for $500 and it’s worth $1 million at her death, the basis is stepped up to $1 million in the hands of your grandmother’s heirs — and all of that gain escapes federal income tax.
The fair market value basis rules apply to inherited property that’s includible in the deceased’s gross estate, and those rules also apply to property inherited from foreign persons who aren’t subject to U.S. estate tax. It doesn’t matter if a federal estate tax return is filed. The rules apply to the inherited portion of property owned by the inheriting taxpayer jointly with the deceased, but not the portion of jointly held property that the inheriting taxpayer owned before his or her inheritance. The fair market value basis rules also don’t apply to reinvestments of estate assets by fiduciaries.
Gifting before death
It’s crucial to understand the current fair market value basis rules so that you don’t pay more tax than you’re legally required to.
For example, in the above example, if your grandmother decides to make a gift of the stock during her lifetime (rather than passing it on when she dies), the “step-up” in basis (from $500 to $1 million) would be lost. Property that has gone up in value acquired by gift is subject to the “carryover” basis rules. That means the person receiving the gift takes the same basis the donor had in it ($500 in this example), plus a portion of any gift tax the donor pays on the gift.
A “step-down” occurs if someone dies owning property that has declined in value. In that case, the basis is lowered to the date-of-death value. Proper planning calls for seeking to avoid this loss of basis. Giving the property away before death won’t preserve the basis. That’s because when property that has gone down in value is the subject of a gift, the person receiving the gift must take the date of gift value as his basis (for purposes of determining his or her loss on a later sale). Therefore, a good strategy for property that has declined in value is for the owner to sell it before death so he or she can enjoy the tax benefits of the loss.
Change on the horizon?
Be aware that President Biden has proposed ending the ability to step-up the basis for gains in excess of $1 million. There would be exemptions for family-owned businesses and farms. Of course, any proposal must be approved by Congress in order to be enacted.
These are the basic rules. Other rules and limits may apply. For example, in some cases, a deceased person’s executor may be able to make an alternate valuation election. Contact us for tax assistance when estate planning or after receiving an inheritance. We’ll keep you up to date on any tax law changes.
There’s a harsh tax penalty that you could be at risk for paying personally if you own or manage a business with employees. It’s called the “Trust Fund Recovery Penalty” and it applies to the Social Security and income taxes required to be withheld by a business from its employees’ wages.
Because taxes are considered property of the government, the employer holds them in “trust” on the government’s behalf until they’re paid over. The penalty is also sometimes called the “100% penalty” because the person liable and responsible for the taxes will be penalized 100% of the taxes due. Accordingly, the amounts IRS seeks when the penalty is applied are usually substantial, and IRS is aggressive in enforcing the penalty.
The Trust Fund Recovery Penalty is among the more dangerous tax penalties because it applies to a broad range of actions and to a wide range of people involved in a business.
Here are some answers to questions about the penalty so you can safely avoid it.
What actions are penalized? The Trust Fund Recovery Penalty applies to any willful failure to collect, or truthfully account for, and pay over Social Security and income taxes required to be withheld from employees’ wages.
Who is at risk? The penalty can be imposed on anyone “responsible” for collection and payment of the tax. This has been broadly defined to include a corporation’s officers, directors and shareholders under a duty to collect and pay the tax as well as a partnership’s partners, or any employee of the business with such a duty. Even voluntary board members of tax-exempt organizations, who are generally exempt from responsibility, can be subject to this penalty under some circumstances. In some cases, responsibility has even been extended to family members close to the business, and to attorneys and accountants.
According to the IRS, responsibility is a matter of status, duty and authority. Anyone with the power to see that the taxes are (or aren’t) paid may be responsible. There’s often more than one responsible person in a business, but each is at risk for the entire penalty. You may not be directly involved with the payroll tax withholding process in your business. But if you learn of a failure to pay over withheld taxes and have the power to pay them but instead make payments to creditors and others, you become a responsible person.
Although a taxpayer held liable can sue other responsible people for contribution, this action must be taken entirely on his or her own after the penalty is paid. It isn’t part of the IRS collection process.
What’s considered “willful?” For actions to be willful, they don’t have to include an overt intent to evade taxes. Simply bending to business pressures and paying bills or obtaining supplies instead of paying over withheld taxes that are due the government is willful behavior. And just because you delegate responsibilities to someone else doesn’t necessarily mean you’re off the hook. Your failure to take care of the job yourself can be treated as the willful element.
Never borrow from taxes
Under no circumstances should you fail to withhold taxes or “borrow” from withheld amounts. All funds withheld should be paid over to the government on time. Contact us with any questions about making tax payments.
Are you eligible to take the deduction for qualified business income (QBI)? Here are 10 facts about this valuable tax break, referred to as the pass-through deduction, QBI deduction or Section 199A deduction.
As you can see, this substantial deduction is complex, especially if your taxable income exceeds the thresholds discussed above. Other rules apply. Contact us if you have questions about your situation.
The Employee Retention Tax Credit (ERTC) is a valuable tax break that was extended and modified by the American Rescue Plan Act (ARPA), enacted in March of 2021. Here’s a rundown of the rules.
Back in March of 2020, Congress originally enacted the ERTC in the CARES Act to encourage employers to hire and retain employees during the pandemic. At that time, the ERTC applied to wages paid after March 12, 2020, and before January 1, 2021. However, Congress later modified and extended the ERTC to apply to wages paid before July 1, 2021.
The ARPA again extended and modified the ERTC to apply to wages paid after June 30, 2021, and before January 1, 2022. Thus, an eligible employer can claim the refundable ERTC against “applicable employment taxes” equal to 70% of the qualified wages it pays to employees in the third and fourth quarters of 2021. Except as discussed below, qualified wages are generally limited to $10,000 per employee per 2021 calendar quarter. Thus, the maximum ERTC amount available is generally $7,000 per employee per calendar quarter or $28,000 per employee in 2021.
For purposes of the ERTC, a qualified employer is eligible if it experiences a significant decline in gross receipts or a full or partial suspension of business due to a government order. Employers with up to 500 full-time employees can claim the credit without regard to whether the employees for whom the credit is claimed actually perform services. But, except as explained below, employers with more than 500 full-time employees can only claim the ERTC with respect to employees that don’t perform services.
Employers who got a Payroll Protection Program loan in 2020 can still claim the ERTC. But the same wages can’t be used both for seeking loan forgiveness or satisfying conditions of other COVID relief programs (such as the Restaurant Revitalization Fund program) in calculating the ERTC.
Beginning in the third quarter of 2021, the following modifications apply to the ERTC:
Contact us if you have any questions related to your business claiming the ERTC.
As we continue to come out of the COVID-19 pandemic, you may be traveling again for business. Under tax law, there are a number of rules for deducting the cost of your out-of-town business travel within the United States. These rules apply if the business conducted out of town reasonably requires an overnight stay.
Note that under the Tax Cuts and Jobs Act, employees can’t deduct their unreimbursed travel expenses through 2025 on their own tax returns. That’s because unreimbursed employee business expenses are “miscellaneous itemized deductions” that aren’t deductible through 2025.
However, self-employed individuals can continue to deduct business expenses, including away-from-home travel expenses.
Here are some of the rules that come into play.
Transportation and meals
The actual costs of travel (for example, plane fare and cabs to the airport) are deductible for out-of-town business trips. You’re also allowed to deduct the cost of meals and lodging. Your meals are deductible even if they’re not connected to a business conversation or other business function. The Consolidated Appropriations Act includes a provision that removes the 50% limit on deducting eligible business meals for 2021 and 2022. The law allows a 100% deduction for food and beverages provided by a restaurant. Takeout and delivery meals provided by a restaurant are also fully deductible.
Keep in mind that no deduction is allowed for meal or lodging expenses that are “lavish or extravagant,” a term that’s been interpreted to mean “unreasonable.”
Personal entertainment costs on the trip aren’t deductible, but business-related costs such as those for dry cleaning, phone calls and computer rentals can be written off.
Combining business and pleasure
Some allocations may be required if the trip is a combined business/pleasure trip, for example, if you fly to a location for five days of business meetings and stay on for an additional period of vacation. Only the cost of meals, lodging, etc., incurred for the business days are deductible — not those incurred for the personal vacation days.
On the other hand, with respect to the cost of the travel itself (plane fare, etc.), if the trip is “primarily” business, the travel cost can be deducted in its entirety and no allocation is required. Conversely, if the trip is primarily personal, none of the travel costs are deductible. An important factor in determining if the trip is primarily business or personal is the amount of time spent on each (although this isn'’t the sole factor).
If the trip doesn’t involve the actual conduct of business but is for the purpose of attending a convention, seminar, etc., the IRS may check the nature of the meetings carefully to make sure they aren’t vacations in disguise. Retain all material helpful in establishing the business or professional nature of this travel.
The rules for deducting the costs of a spouse who accompanies you on a business trip are very restrictive. No deduction is allowed unless the spouse is an employee of you or your company, and the spouse’s travel is also for a business purpose.
Finally, note that personal expenses you incur at home as a result of taking the trip aren’t deductible. For example, the cost of boarding a pet while you’re away isn’t deductible. Contact us if you have questions about your small business deductions.
Here are some of the key tax-related deadlines affecting businesses and other employers during the third quarter of 2021. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
Monday, August 2
Tuesday, August 10
Wednesday, September 15
If you’re claiming deductions for business meals or auto expenses, expect the IRS to closely review them. In some cases, taxpayers have incomplete documentation or try to create records months (or years) later. In doing so, they fail to meet the strict substantiation requirements set forth under tax law. Tax auditors are adept at rooting out inconsistencies, omissions and errors in taxpayers’ records, as illustrated by one recent U.S. Tax Court case.
Facts of the case
In the case, the taxpayer ran a notary and paralegal business. She deducted business meals and vehicle expenses that she allegedly incurred in connection with her business.
The deductions were denied by the IRS and the court. Tax law “establishes higher substantiation requirements” for these and certain other expenses, the court noted. No deduction is generally allowed “unless the taxpayer substantiates the amount, time and place, business purpose, and business relationship to the taxpayer of the person receiving the benefit” for each expense with adequate records or sufficient evidence.
The taxpayer in this case didn’t provide adequate records or other sufficient evidence to prove the business purpose of her meal expenses. She gave vague testimony that she deducted expenses for meals where she “talked strategies” with people who “wanted her to do some work.” The court found this was insufficient to show the connection between the meals and her business.
When it came to the taxpayer’s vehicle expense deductions, she failed to offer credible evidence showing where she drove her vehicle, the purpose of each trip and her business relationship to the places visited. She also conceded that she used her car for both business and personal activities. (TC Memo 2021-50)
Best practices for business expenses
This case is an example of why it’s critical to maintain meticulous records to support business expenses for meals and vehicle deductions. Here’s a list of “DOs and DON'Ts” to help meet the strict IRS and tax law substantiation requirements for these items:
DO keep detailed, accurate records. For each expense, record the amount, the time and place, the business purpose, and the business relationship of any person to whom you provided a meal. If you have employees who you reimburse for meals and auto expenses, make sure they’re complying with all the rules.
DON’T reconstruct expense logs at year end or wait until you receive a notice from the IRS. Take a moment to record the details in a log or diary or on a receipt at the time of the event or soon after. Require employees to submit monthly expense reports.
DO respect the fine line between personal and business expenses. Be careful about combining business and pleasure. Your business checking account shouldn’t be used for personal expenses.
DON’T be surprised if the IRS asks you to prove your deductions. Meal and auto expenses are a magnet for attention. Be prepared for a challenge.
With organization and guidance from us, your tax records can stand up to scrutiny from the IRS. There may be ways to substantiate your deductions that you haven’t thought of, and there may be a way to estimate certain deductions (“the Cohan rule”), if your records are lost due to a fire, theft, flood or other disaster.
If you’re a business owner and you hire your children this summer, you can obtain tax breaks and other nontax benefits. The kids can gain on-the-job experience, spend time with you, save for college and learn how to manage money. And you may be able to:
A legitimate job
If you hire your child, you get a business tax deduction for employee wage expenses. In turn, the deduction reduces your federal income tax bill, your self-employment tax bill (if applicable), and your state income tax bill (if applicable). However, in order for your business to deduct the wages as a business expense, the work performed by the child must be legitimate and the child’s salary must be reasonable.
For example, let’s say you operate as a sole proprietor and you’re in the 37% tax bracket. You hire your 16-year-old daughter to help with office work on a full-time basis during the summer and part-time into the fall. Your daughter earns $10,000 during 2021 and doesn’t have any other earnings.
You save $3,700 (37% of $10,000) in income taxes at no tax cost to your daughter, who can use her 2021 $12,550 standard deduction to completely shelter her earnings.
Your family’s taxes are cut even if your daughter’s earnings exceed her standard deduction. Why? The unsheltered earnings will be taxed to the daughter beginning at a rate of 10%, instead of being taxed at your higher rate.
How payroll taxes might be saved
If your business isn’t incorporated, your child’s wages are exempt from Social Security, Medicare and FUTA taxes if certain conditions are met. Your child must be under age 18 for this to apply (or under age 21 in the case of the FUTA tax exemption). Contact us for how this works.
Be aware that there’s no FICA or FUTA exemption for employing a child if your business is incorporated or a partnership that includes nonparent partners. And payments for the services of your child are subject to income tax withholding, regardless of age, no matter what type of entity you operate.
Begin saving for retirement
Your business also may be able to provide your child with retirement benefits, depending on the type of plan you have and how it defines qualifying employees. And because your child has earnings from his or her job, he can contribute to a traditional IRA or Roth IRA and begin to build a nest egg. For the 2021 tax year, a working child can contribute the lesser of his or her earned income, or $6,000, to an IRA or a Roth.
Keep accurate records
As you can see, hiring your child can be a tax-smart idea. Be sure to keep the same records as you would for other employees to substantiate the hours worked and duties performed (such as timesheets and job descriptions). Issue your child a Form W-2. Contact us if you have questions about how these rules apply to your situation.
The IRS recently released guidance providing the 2022 inflation-adjusted amounts for Health Savings Accounts (HSAs).
Fundamentals of HSAs
An HSA is a trust created or organized exclusively for the purpose of paying the “qualified medical expenses” of an “account beneficiary.” An HSA can only be established for the benefit of an “eligible individual” who is covered under a “high deductible health plan.” In addition, a participant can’t be enrolled in Medicare or have other health coverage (exceptions include dental, vision, long-term care, accident and specific disease insurance).
A high deductible health plan (HDHP) is generally a plan with an annual deductible that isn’t less than $1,000 for self-only coverage and $2,000 for family coverage. In addition, the sum of the annual deductible and other annual out-of-pocket expenses required to be paid under the plan for covered benefits (but not for premiums) can’t exceed $5,000 for self-only coverage, and $10,000 for family coverage.
Within specified dollar limits, an above-the-line tax deduction is allowed for an individual’s contribution to an HSA. This annual contribution limitation and the annual deductible and out-of-pocket expenses under the tax code are adjusted annually for inflation.
Inflation adjustments for next year
In Revenue Procedure 2021-25, the IRS released the 2022 inflation-adjusted figures for contributions to HSAs, which are as follows:
Annual contribution limitation. For calendar year 2022, the annual contribution limitation for an individual with self-only coverage under a HDHP will be $3,650. For an individual with family coverage, the amount will be $7,300. This is up from $3,600 and $7,200, respectively, for 2021.
High deductible health plan defined. For calendar year 2022, an HDHP will be a health plan with an annual deductible that isn’t less than $1,400 for self-only coverage or $2,800 for family coverage (these amounts are unchanged from 2021). In addition, annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) won’t be able to exceed $7,050 for self-only coverage or $14,100 for family coverage (up from $7,000 and $14,000, respectively, for 2021).
There are a variety of benefits to HSAs. Contributions to the accounts are made on a pre-tax basis. The money can accumulate tax free year after year and be can be withdrawn tax free to pay for a variety of medical expenses such as doctor visits, prescriptions, chiropractic care and premiums for long-term care insurance. In addition, an HSA is “portable.” It stays with an account holder if he or she changes employers or leaves the workforce. If you have questions about HSAs at your business, contact your employee benefits and tax advisors.
Your not-for-profit may prefer to avoid activities that subject it to unrelated business income tax (UBIT). But if you accept advertising or sponsorships that aren’t substantially related to your tax-exempt purpose, you may unwittingly expose your organization to UBIT liability. The rules governing these types of support are complicated, so it’s important to have a basic understanding of what is and what isn’t potentially taxable.
Qualified sponsorship dollars: Not taxable
Sponsorship dollars generally aren’t taxed. Qualified sponsorship payments are made by a person (a sponsor) engaged in a trade or business with no arrangement to receive — or expectation of receiving — any substantial benefit from the nonprofit in return for the payment. The IRS allows exempt organizations to use information that’s an established part of a sponsor’s identity, such as logos, slogans, locations, phone numbers and URLs.
There are some exceptions. For example, if the payment amount is contingent upon the level of attendance at an event, broadcast ratings or other factors indicating the quantity of public exposure received, the IRS doesn’t consider it a sponsorship and the payment would likely trigger UBIT.
Providing facilities, services or other privileges to a sponsor — such as complimentary tickets or admission to golf tournaments — doesn’t automatically disallow a payment from being a qualified sponsorship payment. Generally, if the privileges provided aren’t what the IRS considers a “substantial benefit” or if providing them is a related business activity, the payments won’t be subject to UBIT. But when services or privileges provided by an exempt organization to a sponsor are deemed to be substantial, part or all of the sponsorship payment may be taxable.
Advertising payments: Taxable
Payment for advertising a sponsor’s products or services is considered unrelated business income, so it’s subject to UBIT. According to the IRS, advertising includes endorsements, inducements to buy, sell or use products, and messages containing qualitative or comparative language, price information or other indications of value.
Some activities often are misclassified as advertising. Using logos or slogans that are an established part of a sponsor’s identity is not, by itself, advertising. And if your nonprofit distributes or displays a sponsor’s product at an event, whether for free or remuneration, it’s considered use or acknowledgment, not advertising.
Distinctions between taxable advertising and nontaxable sponsorships can be nuanced. So before you seek new income sources, contact us for help determining whether they may subject your nonprofit to UBIT.
Do you have significant investment-related expenses, including the cost of subscriptions to financial services, home office expenses and clerical costs? Under current tax law, these expenses aren’t deductible through 2025 if they’re considered investment expenses for the production of income. But they’re deductible if they’re considered trade or business expenses.
For years before 2018, production-of-income expenses were deductible, but they were included in miscellaneous itemized deductions, which were subject to a 2%-of-adjusted-gross-income floor. (These rules are scheduled to return after 2025.) If you do a significant amount of trading, you should know which category your investment expenses fall into, because qualifying for trade or business expense treatment is more advantageous now.
In order to deduct your investment-related expenses as business expenses, you must be engaged in a trade or business. The U.S. Supreme Court held many years ago that an individual taxpayer isn’t engaged in a trade or business merely because the individual manages his or her own securities investments — regardless of the amount or the extent of the work required.
A trader vs. an investor
However, if you can show that your investment activities rise to the level of carrying on a trade or business, you may be considered a trader, who is engaged in a trade or business, rather than an investor, who isn’t. As a trader, you’re entitled to deduct your investment-related expenses as business expenses. A trader is also entitled to deduct home office expenses if the home office is used exclusively on a regular basis as the trader’s principal place of business. An investor, on the other hand, isn’t entitled to home office deductions since the investment activities aren’t a trade or business.
Since the Supreme Court decision, there has been extensive litigation on the issue of whether a taxpayer is a trader or investor. The U.S. Tax Court has developed a two-part test that must be satisfied in order for a taxpayer to be a trader. Under this test, a taxpayer’s investment activities are considered a trade or business only where both of the following are true:
Profit in the short term
So, the fact that a taxpayer’s investment activities are regular, extensive and continuous isn’t in itself sufficient for determining that a taxpayer is a trader. In order to be considered a trader, you must show that you buy and sell securities with reasonable frequency in an effort to profit on a short-term basis. In one case, a taxpayer who made more than 1,000 trades a year with trading activities averaging about $16 million annually was held to be an investor rather than a trader because the holding periods for stocks sold averaged about one year.
Contact us if you have questions or would like to figure out whether you’re an investor or a trader for tax purposes.
The IRS just released its audit statistics for the 2020 fiscal year and fewer taxpayers had their returns examined as compared with prior years. But even though a small percentage of returns are being chosen for audit these days, that will be little consolation if yours is one of them.
Overall, just 0.5% of individual tax returns were audited in 2020. However, as in the past, those with higher incomes were audited at higher rates. For example, in 2020, 2.2% of taxpayers with adjusted gross incomes (AGIs) of between $1 million and $5 million were audited. Among the richest taxpayers, those with AGIs of $10 million and more, 7% of returns were audited in 2020.
These are among the lowest percentages of audits conducted in recent years. However, the Biden administration has announced it would like to raise revenue by increasing tax compliance and enforcement. In other words, audits may be on the rise in coming years.
Prepare in advance
Even though fewer audits were performed in 2020, the IRS will still examine thousands of returns this year. With proper planning, you may fare well even if you’re one of the unlucky ones.
The easiest way to survive an IRS examination is to prepare in advance. On a regular basis, you should systematically maintain documentation — invoices, bills, canceled checks, receipts, or other proof — for all items reported on your tax returns.
It’s possible you didn’t do anything wrong. Just because a return is selected for audit doesn’t mean that an error was made. Some returns are randomly selected based on statistical formulas. For example, IRS computers compare income and deductions on returns with what other taxpayers report. If an individual deducts a charitable contribution that’s significantly higher than what others with similar incomes report, the IRS may want to know why.
Returns can also be selected if they involve issues or transactions with other taxpayers who were previously selected for audit, such as business partners or investors.
The government generally has three years within which to conduct an audit, and often the exam won’t begin until a year or more after you file your return.
Complex vs. simple returns
The scope of an audit depends on the tax return’s complexity. A return reflecting business or real estate income and expenses will obviously take longer to examine than a return with only salary income.
An audit may be conducted by mail or through an in-person interview and review of records. The interview may be conducted at an IRS office or may be a “field audit” at the taxpayer’s home, business, or accountant’s office.
Important: Even if you're chosen for audit, an IRS examination may be nothing to lose sleep over. In many cases, the IRS asks for proof of certain items and routinely “closes” the audit after the documentation is presented.
Don’t go it alone
It’s advisable to have a tax professional represent you at an audit. A tax pro knows the issues that the IRS is likely to scrutinize and can prepare accordingly. In addition, a professional knows that in many instances IRS auditors will take a position (for example, to disallow certain deductions) even though courts and other guidance have expressed contrary opinions on the issues. Because pros can point to the proper authority, the IRS may be forced to concede on certain issues.
If you receive an IRS audit letter or simply want to improve your recordkeeping, we’re here to help. Contact us to discuss this or any other aspect of your taxes.
Married couples may not be able to save as much as they need for retirement when one spouse doesn’t work outside the home — perhaps so that spouse can take care of children or elderly parents. In general, an IRA contribution is allowed only if a taxpayer earns compensation. However, there’s an exception involving a “spousal” IRA. It allows contributions to be made for nonworking spouses.
For 2021, the amount that an eligible married couple can contribute to an IRA for a nonworking spouse is $6,000, which is the same limit that applies for the working spouse.
As you may know, IRAs offer two types of advantages for taxpayers who make contributions to them.
As long as the couple together has at least $12,000 of earned income, $6,000 can be contributed to an IRA for each, for a total of $12,000. (The contributions for both spouses can be made to either a regular IRA or a Roth IRA, or split between them, as long as the combined contributions don’t exceed the $12,000 limit.)
Boost contributions if 50 or older
In addition, individuals who are age 50 or older can make “catch-up” contributions to an IRA or Roth IRA in the amount of $1,000. Therefore, for 2021, for a taxpayer and his or her spouse, both of whom will have reached age 50 by the end of the year, the combined limit of the deductible contributions to an IRA for each spouse is $7,000, for a combined deductible limit of $14,000.
There’s one catch, however. If, in 2021, the working spouse is an active participant in either of several types of retirement plans, a deductible contribution of up to $6,000 (or $7,000 for a spouse who will be 50 by the end of the year) can be made to the IRA of the nonparticipant spouse only if the couple’s AGI doesn’t exceed $125,000. This limit is phased out for AGI between $198,000 and $208,000.
Contact us if you’d like more information about IRAs or you’d like to discuss retirement planning.
If you’re a parent with a college-bound child, you may be concerned about being able to fund future tuition and other higher education costs. You want to take maximum advantage of tax benefits to minimize your expenses. Here are some possible options.
Series EE U.S. savings bonds offer two tax-saving opportunities for eligible families when used to finance college:
To qualify for the tax exemption for college use, you must purchase the bonds in your name (not the child’s) or jointly with your spouse. The proceeds must be used for tuition, fees and certain other expenses — not room and board. If only part of the proceeds is used for qualified expenses, only that part of the interest is exempt.
The exemption is phased out if your adjusted gross income (AGI) exceeds certain amounts.
A qualified tuition program (also known as a 529 plan) allows you to buy tuition credits for a child or make contributions to an account set up to meet a child’s future higher education expenses. Qualified tuition programs are established by state governments or private education institutions.
Contributions aren’t deductible. The contributions are treated as taxable gifts to the child, but they’re eligible for the annual gift tax exclusion ($15,000 for 2021). A donor who contributes more than the annual exclusion limit for the year can elect to treat the gift as if it were spread out over a five-year period.
The earnings on the contributions accumulate tax-free until college costs are paid from the funds. Distributions from 529 plans are tax-free to the extent the funds are used to pay “qualified higher education expenses.” Distributions of earnings that aren’t used for qualified expenses will be subject to income tax plus a 10% penalty tax.
Coverdell education savings accounts (ESAs)
You can establish a Coverdell ESA and make contributions of up to $2,000 annually for each child under age 18.
The right to make contributions begins to phase out once your AGI is over a certain amount. If the income limitation is a problem, a child can contribute to his or her own account.
Although the contributions aren’t deductible, income in the account isn’t taxed, and distributions are tax-free if used on qualified education expenses. If the child doesn’t attend college, the money must be withdrawn when he or she turns 30, and any earnings will be subject to tax and penalty. But unused funds can be transferred tax-free to a Coverdell ESA of another member of the child’s family who hasn’t reached age 30. (Some ESA requirements don’t apply to individuals with special needs.)
These are just some of the tax-favored ways to build up a college fund for your children. Once your child is in college, you may qualify for tax breaks such as the American Opportunity Tax Credit or the Lifetime Learning Credit. Contact us if you’d like to discuss any of the options.
If you’re getting ready to retire, you’ll soon experience changes in your lifestyle and income sources that may have numerous tax implications.
Here’s a brief rundown of four tax and financial issues you may deal with when you retire:
Taking required minimum distributions. This is the minimum amount you must withdraw from your retirement accounts. You generally must start taking withdrawals from your IRA, SEP, SIMPLE and other retirement plan accounts when you reach age 72 (70½ before January 1, 2020). Roth IRAs don’t require withdrawals until after the death of the owner.
You can withdraw more than the minimum required amount. Your withdrawals will be included in your taxable income except for any part that was taxed before or that can be received tax-free (such as qualified distributions from Roth accounts).
Selling your principal residence. Many retirees want to downsize to smaller homes. If you’re one of them and you have a gain from the sale of your principal residence, you may be able to exclude up to $250,000 of that gain from your income. If you file a joint return, you may be able to exclude up to $500,000.
To claim the exclusion, you must meet certain requirements. During a five-year period ending on the date of the sale, you must have owned the home and lived in it as your main home for at least two years.
If you’re thinking of selling your home, make sure you’ve identified all items that should be included in its basis , which can save you tax.
Engaging in new work activities. After retirement, many people continue to work as consultants or start new businesses. Here are some tax-related questions to ask:
Taking Social Security benefits. If you continue to work, it may have an impact on your Social Security benefits. If you retire before reaching full Social Security retirement age (65 years of age for people born before 1938, rising to 67 years of age for people born after 1959) and the sum of your wages plus self-employment income is over the Social Security annual exempt amount ($18,960 for 2021), you must give back $1 of Social Security benefits for each $2 of excess earnings.
If you reach full retirement age this year, your benefits will be reduced $1 for every $3 you earn over a different annual limit ($50,520 in 2021) until the month you reach full retirement age. Then, your earnings will no longer affect the amount of your monthly benefits, no matter how much you earn.
Speaking of Social Security, you may have to pay federal (and possibly state) tax on your benefits. Depending on how much income you have from other sources, you may have to report up to 85% of your benefits as income on your tax return and pay the resulting federal income tax.
As you can see, tax planning is still important after you retire. We can help maximize the tax breaks you’re entitled to so you can keep more of your hard-earned money.
High-income taxpayers face a 3.8% net investment income tax (NIIT) that’s imposed in addition to regular income tax. Fortunately, there are some steps you may be able to take to reduce its impact.
The NIIT applies to you only if modified adjusted gross income (MAGI) exceeds:
The amount subject to the tax is the lesser of your net investment income or the amount by which your MAGI exceeds the threshold ($250,000, $200,000, or $125,000) that applies to you.
Net investment income includes interest, dividend, annuity, royalty, and rental income, unless those items were derived in the ordinary course of an active trade or business. In addition, other gross income from a trade or business that’s a passive activity is subject to the NIIT, as is income from a business trading in financial instruments or commodities.
There are many types of income that are exempt from the NIIT. For example, tax-exempt interest and the excluded gain from the sale of your main home aren’t subject to the tax. Distributions from qualified retirement plans aren’t subject to the NIIT. Wages and self-employment income also aren’t subject to the NIIT, though they may be subject to a different Medicare surtax.
It’s important to remember the NIIT applies only if you have net investment income and your MAGI exceeds the applicable thresholds above. But by following strategies, you may be able to minimize net investment income.
If your income is high enough to trigger the NIIT, shifting some income investments to tax-exempt bonds could result in less exposure to the tax. Tax-exempt bonds lower your MAGI and avoid the NIIT.
Dividend-paying stocks are taxed more heavily as a result of the NIIT. The maximum income tax rate on qualified dividends is 20%, but the rate becomes 23.8% with the NIIT.
As a result, you may want to consider rebalancing your investment portfolio to emphasize growth stocks over dividend-paying stocks. While the capital gain from these investments will be included in net investment income, there are two potential benefits: 1) the tax will be deferred because the capital gain won’t be subject to the NIIT until the stock is sold and 2) capital gains can be offset by capital losses, which isn’t the case with dividends.
Because distributions from qualified retirement plans are exempt from the NIIT, upper-income taxpayers with some control over their situations (such as small business owners) might want to make greater use of qualified plans.
These are only a couple of strategies you may be able to employ. You also may be able to make moves related to charitable donations, passive activities and rental income that may allow you to minimize the NIIT. If you’re subject to the tax, you should include it in your tax planning. Consult with us for tax-planning strategies.
Eligible parents will soon begin receiving payments from the federal government. The IRS announced that the 2021 advance child tax credit (CTC) payments, which were created in the American Rescue Plan Act (ARPA), will begin being made on July 15, 2021.
How have child tax credits changed?
The ARPA temporarily expanded and made CTCs refundable for 2021. The law increased the maximum CTC — for 2021 only — to $3,600 for each qualifying child under age 6 and to $3,000 per child for children ages 6 to 17, provided their parents’ income is below a certain threshold.
Advance payments will receive up to $300 monthly for each child under 6, and up to $250 monthly for each child 6 and older. The increased credit amount will be reduced or phased out, for households with modified adjusted gross income above the following thresholds:
Under prior law, the maximum annual CTC for 2018 through 2025 was $2,000 per qualifying child but the income thresholds were higher and some of the qualification rules were different.
Important: If your income is too high to receive the increased advance CTC payments, you may still qualify to claim the $2,000 CTC on your tax return for 2021.
What is a qualifying child?
For 2021, a “qualifying child” with respect to a taxpayer is defined as one who is under age 18 and who the taxpayer can claim as a dependent. That means a child related to the taxpayer who, generally, lived with the taxpayer for at least six months during the year. The child also must be a U.S. citizen or national or a U.S. resident.
How and when will advance payments be sent out?
Under the ARPA, the IRS is required to establish a program to make periodic advance payments which in total equal 50% of IRS’s estimate of the eligible taxpayer’s 2021 CTCs, during the period July 2021 through December 2021. The payments will begin on July 15, 2021. After that, they’ll be made on the 15th of each month unless the 15th falls on a weekend or holiday. Parents will receive the monthly payments through direct deposit, paper check or debit card.
Who will benefit from these payments and do they have to do anything to receive them?
According to the IRS, about 39 million households covering 88% of children in the U.S. “are slated to begin receiving monthly payments without any further action required.” Contact us if you have questions about the child tax credit.
As mitigation measures related to COVID-19 ease, it will be interesting to see which practices and regulatory changes taken in response to the pandemic remain in place long-term. One of them might be relief from a sometimes-inconvenient requirement related to the administration of 401(k) plans.
A virtual solution
In IRS Notice 2021-40, the IRS recently announced a 12-month extension of its temporary relief from the requirement that certain signatures be witnessed “in the physical presence” of a 401(k) plan representative or notary public.
The original relief, which appeared in IRS Notice 2020-42, was provided primarily to facilitate plan loans and distributions under the CARES Act. However, the relief could be used during 2020 for any signature that, under regulations, had to be witnessed in the physical presence of a plan representative or notary public. This included required spousal consents. The relief was subsequently extended through June 30, 2021, under IRS Notice 2021-03.
Under the notices, signatures witnessed remotely by a plan representative satisfy the physical presence requirement if the electronic system uses live audio-video technology and meets four requirements established under the original relief:
Signatures witnessed by a notary public satisfy the physical presence requirement if the electronic system for remote notarization uses live audio-video technology and is consistent with state-law requirements for a notary public.
As mentioned, IRS Notice 2021-40 further extends the relief — subject to the same conditions — through June 30, 2022. The notice also requests comments regarding whether permanent modifications should be made to the physical presence requirement. Comments are specifically requested regarding:
Comments should be submitted by September 30, 2021.
Going forward, the need for a signature may often relate to spousal consents. If your business recently established a 401(k), the plan may be designed to limit or even eliminate the need for spousal consents.
However, plans that offer annuity forms of distribution are still subject to the spousal consent rules. And other 401(k) plans must require spousal consent if a married participant wants to name a nonspouse as primary beneficiary. Feel free to contact our firm for more information on the latest IRS guidance addressing employee benefits.
Most of us are taught from a young age never to assume anything. Why? Well, because when you assume, you make an … you probably know how the rest of the expression goes.
A dangerous assumption that many business owners make is that, if their companies are profitable, their cash flow must also be strong. But this isn’t always the case. Taking a closer look at the accounting involved can provide an explanation.
Investing in the business
What are profits, really? In accounting terms, they’re closely related to taxable income. Reported at the bottom of your company’s income statement, profits are essentially the result of revenue less the cost of goods sold and other operating expenses incurred in the accounting period.
Generally Accepted Accounting Principles (GAAP) require companies to “match” costs and expenses to the period in which revenue is recognized. Under accrual-basis accounting, it doesn’t necessarily matter when you receive payments from customers or when you pay expenses.
For example, inventory sitting in a warehouse or retail store can’t be deducted — even though it may have been long paid for (or financed). The expense hits your income statement only when an item is sold or used. Your inventory account contains many cash outflows that are waiting to be expensed.
Other working capital accounts — such as accounts receivable, accrued expenses and trade payables — also represent a difference between the timing of cash flows. As your business grows and strives to increase future sales, you invest more in working capital, which temporarily depletes cash.
However, the reverse also may be true. That is, a mature business may be a “cash cow” that generates ample dollars, despite reporting lackluster profits.
Accounting for expenses
The difference between profits and cash flow doesn’t begin and end with working capital. Your income statement also includes depreciation and amortization, which are noncash expenses. And it excludes changes in fixed assets, bank financing and owners’ capital accounts, which affect cash on hand.
Suppose your company uses tax depreciation schedules for book purposes. Let say, in 2020, you bought new equipment to take advantage of the expanded Section 179 and bonus depreciation allowances. Then you deducted the purchase price of these items from profits in 2020. However, because these purchases were financed with debt, the actual cash outflows from the investments in 2020 were minimal.
In 2021, your business will make loan payments that will reduce the amount of cash in your checking account. But your profits will be hit with only the interest expense (not the amount of principal that’s being repaid). Plus, there will be no “basis” left in the 2020 purchases to depreciate in 2021. These circumstances will artificially boost profits in 2021, without a proportionate increase in cash.
Keeping your eye on the ball
It’s dangerous to assume that, just because you’re turning a profit, your cash position is strong. Cash flow warrants careful monitoring. Our firm can help you generate accurate financial statements and glean the most important insights from them.
For many business owners, putting together a succession plan may seem like an overwhelming task. It might even seem unnecessary for those who are relatively young and have no intention of giving up ownership anytime soon.
But if the past year or so have taught us anything, it’s that anything can happen. Owners who’ve built up considerable “sweat equity” in their companies shouldn’t risk liquidation or seeing the business end up in someone else’s hands only because there’s no succession plan in place.
Variations on a theme
To help you get your arms around the concept of succession planning, you can look at it from three different perspectives:
1. The long view. If you have many years to work with, use this gift of time to identify one or more talented individuals who share your values and have the aptitude to successfully run the company. This is especially important for keeping a family-owned business in the family.
As soon as you’ve identified a successor, and he or she is ready, you can begin mentoring the incoming leader to competently run the company and preserve your legacy. Meanwhile, you can carefully identify how to best fund your retirement and structure your estate plan.
2. An imminent horizon. Many business owners wake up one day and realize that they’re almost ready to retire, or move on to another professional endeavor, but they’ve spent little or no time putting together a succession plan. In such a case, you may still be able to choose and train a successor. However, you’ll likely also want to explore alternatives such as selling the company to a competitor or other buyer. Sometimes even liquidation is the optimal move financially.
In any case, the objective here is less about maintaining the strategic direction of the company and more about ensuring you receive an equitable payout for your ownership share. If you’re a co-owner, a buy-sell agreement is highly advisable. It’s also critical to set a firm departure date and work with a qualified team of advisors.
3. A sudden emergency. The COVID-19 pandemic has brought renewed attention to emergency succession planning. True to its name, this approach emphasizes enabling the business to maintain operations immediately after an unforeseen event causes the owner’s death or disability.
If your company doesn’t yet have an emergency succession plan, you should probably create one before you move on to a longer-term plan. Name someone who can take on a credible leadership role if you become seriously ill or injured. Formulate a plan for communicating and delegating duties during a crisis. Make sure everyone knows about the emergency succession plan and how it will affect day-to-day operations, if executed.
Create the future
As with any important task, the more time you give yourself to create a succession plan, the fewer mistakes or oversights you’re likely to make. Our firm can help you create or refine a plan that suits your financial needs, personal wishes and vision for the future of your company.
If your business is organized as a sole proprietorship or as a wholly owned limited liability company (LLC), you’re subject to both income tax and self-employment tax. There may be a way to cut your tax bill by conducting business as an S corporation.
Fundamentals of self-employment tax
The self-employment tax is imposed on 92.35% of self-employment income at a 12.4% rate for Social Security up to a certain maximum ($142,800 for 2021) and at a 2.9% rate for Medicare. No maximum tax limit applies to the Medicare tax. An additional 0.9% Medicare tax is imposed on income exceeding $250,000 for married couples ($125,000 for married persons filing separately) and $200,000 in all other cases.
What if you conduct your business as a partnership in which you’re a general partner? In that case, in addition to income tax, you’re subject to the self-employment tax on your distributive share of the partnership’s income. On the other hand, if you conduct your business as an S corporation, you’ll be subject to income tax, but not self-employment tax, on your share of the S corporation’s income.
An S corporation isn’t subject to tax at the corporate level. Instead, the corporation’s items of income, gain, loss and deduction are passed through to the shareholders. However, the income passed through to the shareholder isn’t treated as self-employment income. Thus, by using an S corporation, you may be able to avoid self-employment income tax.
Keep your salary “reasonable”
Be aware that the IRS requires that the S corporation pay you reasonable compensation for your services to the business. The compensation is treated as wages subject to employment tax (split evenly between the corporation and the employee), which is equivalent to the self-employment tax. If the S corporation doesn’t pay you reasonable compensation for your services, the IRS may treat a portion of the S corporation’s distributions to you as wages and impose Social Security taxes on the amount it considers wages.
There’s no simple formula regarding what’s considered reasonable compensation. Presumably, reasonable compensation is the amount that unrelated employers would pay for comparable services under similar circumstances. There are many factors that should be taken into account in making this determination.
Converting from a C corporation
There may be complications if you convert a C corporation to an S corporation. A “built-in gains tax” may apply when you dispose of appreciated assets held by the C corporation at the time of the conversion. However, there may be ways to minimize its impact.
Many factors to consider
Contact us if you’d like to discuss the factors involved in conducting your business as an S corporation, and how much the business should pay you as compensation.
Many businesses use independent contractors to help keep their costs down. If you’re among them, make sure that these workers are properly classified for federal tax purposes. If the IRS reclassifies them as employees, it can be a costly error.
It can be complex to determine whether a worker is an independent contractor or an employee for federal income and employment tax purposes. If a worker is an employee, your company must withhold federal income and payroll taxes, pay the employer’s share of FICA taxes on the wages, plus FUTA tax. A business may also provide the worker with fringe benefits if it makes them available to other employees. In addition, there may be state tax obligations.
On the other hand, if a worker is an independent contractor, these obligations don’t apply. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if it’s $600 or more).
What are the factors the IRS considers?
Who is an “employee?” Unfortunately, there’s no uniform definition of the term.
The IRS and courts have generally ruled that individuals are employees if the organization they work for has the right to control and direct them in the jobs they’re performing. Otherwise, the individuals are generally independent contractors. But other factors are also taken into account including who provides tools and who pays expenses.
Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Section 530. This protection generally applies only if an employer meets certain requirements. For example, the employer must file all federal returns consistent with its treatment of a worker as a contractor and it must treat all similarly situated workers as contractors.
Note: Section 530 doesn’t apply to certain types of workers.
Should you ask the IRS to decide?
Be aware that you can ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, be aware that the IRS has a history of classifying workers as employees rather than independent contractors.
Businesses should consult with us before filing Form SS-8 because it may alert the IRS that your business has worker classification issues — and it may unintentionally trigger an employment tax audit.
It may be better to properly treat a worker as an independent contractor so that the relationship complies with the tax rules.
Workers who want an official determination of their status can also file Form SS-8. Disgruntled independent contractors may do so because they feel entitled to employee benefits and want to eliminate self-employment tax liabilities.
If a worker files Form SS-8, the IRS will notify the business with a letter. It identifies the worker and includes a blank Form SS-8. The business is asked to complete and return the form to the IRS, which will render a classification decision.
These are the basic tax rules. In addition, the U.S. Labor Department has recently withdrawn a non-tax rule introduced under the Trump administration that would make it easier for businesses to classify workers as independent contractors. Contact us if you’d like to discuss how to classify workers at your business. We can help make sure that your workers are properly classified.
Many businesses provide education fringe benefits so their employees can improve their skills and gain additional knowledge. An employee can receive, on a tax-free basis, up to $5,250 each year from his or her employer for educational assistance under a “qualified educational assistance program.”
For this purpose, “education” means any form of instruction or training that improves or develops an individual’s capabilities. It doesn’t matter if it’s job-related or part of a degree program. This includes employer-provided education assistance for graduate-level courses, including those normally taken by an individual pursuing a program leading to a business, medical, law or other advanced academic or professional degree.
The educational assistance must be provided under a separate written plan that’s publicized to your employees, and must meet a number of conditions, including nondiscrimination requirements. In other words, it can’t discriminate in favor of highly compensated employees. In addition, not more than 5% of the amounts paid or incurred by the employer for educational assistance during the year may be provided for individuals who (including their spouses or dependents) who own 5% or more of the business.
No deduction or credit can be taken by the employee for any amount excluded from the employee’s income as an education assistance benefit.
If you pay more than $5,250 for educational benefits for an employee during the year, he or she must generally pay tax on the amount over $5,250. Your business should include the amount in income in the employee’s wages. However, in addition to, or instead of applying, the $5,250 exclusion, an employer can satisfy an employee’s educational expenses, on a nontaxable basis, if the educational assistance is job-related. To qualify as job-related, the educational assistance must:
“Job-related” employer educational assistance isn’t subject to a dollar limit. To be job-related, the education can’t qualify the employee to meet the minimum educational requirements for qualification in his or her employment or other trade or business.
Educational assistance meeting the above “job-related” rules is excludable from an employee’s income as a working condition fringe benefit.
In addition to education assistance, some employers offer student loan repayment assistance as a recruitment and retention tool. Recent COVID-19 relief laws may provide your employees with tax-free benefits. Contact us to learn more about setting up an education assistance or student loan repayment plan at your business.
Are you wondering whether alternative energy technologies can help you manage energy costs in your business? If so, there’s a valuable federal income tax benefit (the business energy credit) that applies to the acquisition of many types of alternative energy property.
The credit is intended primarily for business users of alternative energy (other energy tax breaks apply if you use alternative energy in your home or produce energy for sale).
The business energy credit equals 30% of the basis of the following:
The credit equals 10% of the basis of the following:
Pluses and minuses
However, there are several restrictions. For example, the credit isn’t available for property acquired with certain non-recourse financing. Additionally, if the credit is allowable for property, the “basis” is reduced by 50% of the allowable credit.
On the other hand, a favorable aspect is that, for the same property, the credit can sometimes be used in combination with other benefits — for example, federal income tax expensing, state tax credits or utility rebates.
There are business considerations unrelated to the tax and non-tax benefits that may influence your decision to use alternative energy. And even if you choose to use it, you might do so without owning the equipment, which would mean forgoing the business energy credit.
As you can see, there are many issues to consider. We can help you address these alternative energy considerations.
Owners of incorporated businesses know that there’s a tax advantage to taking money out of a C corporation as compensation rather than as dividends. The reason: A corporation can deduct the salaries and bonuses that it pays executives, but not dividend payments. Thus, if funds are paid as dividends, they’re taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is only taxed once — to the employee who receives it.
However, there are limits to how much money you can take out of the corporation this way. Under tax law, compensation can be deducted only to the extent that it’s reasonable. Any unreasonable portion isn’t deductible and, if paid to a shareholder, may be taxed as if it were a dividend. Keep in mind that the IRS is generally more interested in unreasonable compensation payments made to someone “related” to a corporation, such as a shareholder-employee or a member of a shareholder’s family.
Determining reasonable compensation
There’s no easy way to determine what’s reasonable. In an audit, the IRS examines the amount that similar companies would pay for comparable services under similar circumstances. Factors that are taken into account include the employee’s duties and the amount of time spent on those duties, as well as the employee’s skills, expertise and compensation history. Other factors that may be reviewed are the complexities of the business and its gross and net income.
There are some steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation. For example, you can:
You can avoid problems and challenges by planning ahead. If you have questions or concerns about your situation, contact us.
Are you thinking about setting up a retirement plan for yourself and your employees, but you’re worried about the financial commitment and administrative burdens involved in providing a traditional pension plan? Two options to consider are a “simplified employee pension” (SEP) or a “savings incentive match plan for employees” (SIMPLE).
SEPs are intended as an alternative to “qualified” retirement plans, particularly for small businesses. The relative ease of administration and the discretion that you, as the employer, are permitted in deciding whether or not to make annual contributions, are features that are appealing.
If you don’t already have a qualified retirement plan, you can set up a SEP simply by using the IRS model SEP, Form 5305-SEP. By adopting and implementing this model SEP, which doesn’t have to be filed with the IRS, you’ll have satisfied the SEP requirements. This means that as the employer, you’ll get a current income tax deduction for contributions you make on behalf of your employees. Your employees won’t be taxed when the contributions are made but will be taxed later when distributions are made, usually at retirement. Depending on your needs, an individually-designed SEP — instead of the model SEP — may be appropriate for you.
When you set up a SEP for yourself and your employees, you’ll make deductible contributions to each employee’s IRA, called a SEP-IRA, which must be IRS-approved. The maximum amount of deductible contributions that you can make to an employee’s SEP-IRA, and that he or she can exclude from income, is the lesser of: 25% of compensation and $58,000 for 2021. The deduction for your contributions to employees’ SEP-IRAs isn’t limited by the deduction ceiling applicable to an individual’s own contribution to a regular IRA. Your employees control their individual IRAs and IRA investments, the earnings on which are tax-free.
There are other requirements you’ll have to meet to be eligible to set up a SEP. Essentially, all regular employees must elect to participate in the program, and contributions can’t discriminate in favor of the highly compensated employees. But these requirements are minor compared to the bookkeeping and other administrative burdens connected with traditional qualified pension and profit-sharing plans.
The detailed records that traditional plans must maintain to comply with the complex nondiscrimination regulations aren’t required for SEPs. And employers aren’t required to file annual reports with IRS, which, for a pension plan, could require the services of an actuary. The required recordkeeping can be done by a trustee of the SEP-IRAs — usually a bank or mutual fund.
Another option for a business with 100 or fewer employees is a “savings incentive match plan for employees” (SIMPLE). Under these plans, a “SIMPLE IRA” is established for each eligible employee, with the employer making matching contributions based on contributions elected by participating employees under a qualified salary reduction arrangement. The SIMPLE plan is also subject to much less stringent requirements than traditional qualified retirement plans. Or, an employer can adopt a “simple” 401(k) plan, with similar features to a SIMPLE plan, and automatic passage of the otherwise complex nondiscrimination test for 401(k) plans.
For 2021, SIMPLE deferrals are up to $13,500 plus an additional $3,000 catch-up contributions for employees age 50 and older.
Contact us for more information or to discuss any other aspect of your retirement planning.
As the COVID-19 pandemic finally seems to be fading in the United States, your not-for-profit organization may be making plans for its post-pandemic future. Is a merger with another nonprofit part of these plans?
A merger can provide your organization with greater stability and resilience so that you can survive any new challenges that comes your way. But a merger isn’t always the best solution if, for example, you’re looking for a financial rescue. Here’s a rundown of good — and bad — reasons to join forces.
Successful mergers are based on a foundation of solid motivations. You might decide to merge to establish the stability that will make it easier to pursue your mission. Such a union could lead to a stronger organization that’s better able to survive difficult times. You also might want to merge to reduce the competition for funding, which could intensify as cash-strapped state governments cut back on their nonprofit grants and contracts in the wake of the pandemic.
A merger can help nonprofits achieve economies of scale that will make the merged organization more efficient, too. This might come, for example, from combining infrastructures — everything from staffing and board leadership to administration, information systems, human resources and accounting. A merger could also give you access to a wider network, as well as more perspectives and experiences to base decisions on. And it might enable you to provide more programming or add physical locations.
For all of the worthwhile reasons to consider a merger, it’s important to remember that mergers do sometimes fail. One common reason is that the merger itself, as well as the new organization, can cost much more than expected. In the short term, for example, you’ll need to finance transactional and integration costs.
Arrangements intended to rescue a failing organization are another red flag. In this scenario, you usually see a larger, more stable nonprofit swoop in to save a smaller counterpart that, despite its weaknesses, has something to offer. But a merger isn’t likely to solve problems such as poor leadership or business practices. The better approach in such a situation is for the larger nonprofit to acquire assets, or viable pieces, of the smaller organization.
If you do decide to proceed with a merger, be careful about choosing a partner. It should share a similar mission, values and work culture. That doesn’t mean you have to offer duplicative services, but they should at least complement each other.
Contact us for more information about the benefits and risks of a merger. We can review your financial situation and help determine whether your plans make sense or whether there are better alternatives.
If your not-for-profit organization accepts contributions of nonfinancial assets, such as land, services and supplies, you should know about Financial Accounting Standards Board (FASB) rules approved last year. Accounting Standards Update (ASU), Not-for-Profit Entities (Topic 958): Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets is intended to increase transparency around gifts in kind.
The updated rules were generated in response to concerns about U.S. wholesale market prices being used to determine the value of donated pharmaceuticals that can’t legally be sold in the United States. A donor, for example, could contribute such drugs for use only outside the country.
Stakeholders worried that the values will be inflated, which could increase an organization’s revenue and program expenses. The nonprofit might, therefore, appear larger and more efficient than a smaller organization or one with lower values for its gifts-in-kind donations.
New procedures and disclosures
The most dramatic change from previous gifts-in-kind rules is that donations should be reported by type of asset (for example, building, food or pharmaceuticals), rather than reported in aggregate. The rules also require you to report gifts-in-kind donations as a separate line item in the statement of activities.
Further, you must disclose:
This last disclosure is necessary if donor restrictions prohibit your nonprofit from selling or using the donation in the principal or most advantageous market. The principal market has the highest volume of activity for the donated asset. The most advantageous market generally maximizes the amount that would be received if the donation were sold.
Compliance required soon
If you aren’t already following the rules, prepare to comply with them. They take effect for annual reporting periods starting after June 15, 2021, and interim periods within fiscal years starting after June 15, 2022. Contact us if you have questions or need help.
If your not-for-profit periodically prepares internal financial statements for your board, you may have noticed that your auditors propose adjustments to these interim statements at year end. Why do auditors do this? Generally, it reflects differences due to cash basis vs. accrual basis financial statements. But you can help minimize the need for such adjustments. Here’s how.
Cash basis accounting
Under cash basis accounting, income is recognized when you receive payments and expenses are recognized when you pay them. The cash “ins” and “outs” are totaled (generally by accounting software) to produce the internal financial statements and trial balance you use to prepare periodic statements. Cash basis financial statements are useful because they’re quick and easy to prepare and they can alert you to any immediate cash flow problems.
The simplicity of this accounting method comes at a price, however: Accounts receivable (income you’re owed but haven’t yet received, such as pledges) and accounts payable and accrued expenses (expenses you’ve incurred but haven’t yet paid) don’t exist.
Accrual basis accounting
With accrual accounting, accounts receivable, accounts payable and other accrued expenses are recognized when they occur, allowing your financial statements to be a truer picture of your organization at any point in time. If a donor pledges money to you, you recognize it now when it’s pledged rather than waiting until you receive the money — which could be next month or next year.
Generally Accepted Accounting Principles (GAAP) require the use of accrual accounting and recognition of contributions as income when promised. Often, year-end audited financial statements are prepared on a GAAP basis.
Internal and year end statements also may differ because your auditors proposed adjusting certain entries for reasonable estimates. This could include a reserve for accounts receivable that may be ultimately uncollectible. Another common estimate is for litigation settlement. Your organization may be the party or counterparty to a lawsuit for which there’s a reasonable estimate of the amount to be received or paid.
We can help you reduce disparities between monthly or quarterly statements and those prepared at year end by maximizing your accounting software’s capabilities. Also, we can work with you to improve the accuracy of estimates. Contact us.
Not-for-profit organizations are different from for-profit businesses in many vital ways. One of the most crucial differences is that under Section 501(c)(3), Sec. 501(c)(7) and other provisions, nonprofits are tax-exempt. But your tax-exempt status is fragile. If you don’t follow the rules laid out in IRS Publication 557, Tax-Exempt Status for Your Organization, the IRS could revoke it. Be particularly alert to the following common stumbling blocks.
Lobbying and campaign activities
There are many categories of tax exemption — each with its own rules. But certain hot-button issues apply to most tax-exempt entities — such as lobbying and campaign activities. Having a Sec. 501(c)(3) status limits the amount of lobbying a charitable organization can undertake. This doesn’t mean lobbying is totally prohibited. But according to the IRS, your organization shouldn’t devote “a substantial part of its activities” trying to influence legislation.
For nonprofits that are exempt under other categories of Sec. 501(c), there are fewer restrictions on lobbying activities. Lobbying activities these groups undertake must relate to the accomplishment of the group’s purpose. For instance, an association of teachers can lobby for education reform without risking its tax exemption.
The IRS considers lobbying to be different from campaign activities, which are completely off limits to Sec. 501(c)(3) organizations. This means they can’t participate or intervene in any political campaign for or against a candidate for public office. If you’re not a 501(c)(3) organization, campaign restrictions vary.
Excess profit and unrelated revenue
The cardinal rule about excess profits is that a nonprofit can’t be operated to benefit private interests. If your fundraising is successful and you have extra income, you must put it back into the organization through additional services or by creating a reserve or an endowment. You can’t use extra income to reward an individual or a person’s related entities.
If you’re generating income through a trade or business you conduct regularly and it’s outside the scope of your mission, you may be subject to unrelated business income tax (UBIT). Examples include a college that rents performance halls to noncollege members of its community or a charity that sells advertising in its newsletter. Almost all nonprofits are subject to this provision of the tax code, and, if you ignore it, you could risk your exempt status. That said, losing an exempt status from unrelated business income is rare.
Notice from the IRS
The best way to preserve your organization’s exempt status is to refrain from risky activities. But if you receive notice from the IRS of a violation, please contact us. We can help you respond and get your nonprofit back on track.
Many not-for-profits are just starting to emerge from one of the most challenging environments in recent memory due to the COVID-19 pandemic. Even if your organization is in good shape, don’t get too comfortable. Financial obstacles can appear at any time and you need to be vigilant about acting on certain warning signs. Consider the following.
Once your board has signed off on a budget, you should carefully monitor it for unexplained variances. Although some variances are to be expected, staff should be able to provide reasonable explanations — such as funding changes or macroeconomic factors — for significant discrepancies. Where necessary, work to mitigate negative variances by, for example, cutting expenses.
Also make sure you don’t:
Such moves might mark the beginning of a financially unsustainable cycle.
If your financial statements are untimely and inconsistent or aren’t prepared using U.S. Generally Accepted Accounting Principles (GAAP), you could be heading for trouble. Poor financial statements can lead to poor decision-making and undermine your nonprofit’s reputation. They also can make it difficult to obtain funding or financing.
Insist on professionally prepared statements as well as annual audits. Members of your organization’s audit committee should communicate directly with auditors before and during the process, and all board members should have the opportunity to review and question the audit report.
Let’s say you’ve noticed a decline in donations. Then you start hearing from long-standing supporters that they’re losing confidence in your organization’s finances or leadership. Investigate immediately.
Ask supporters what they’re seeing or hearing that prompts their concerns. Also note when development staff hits up major donors outside of the usual fundraising cycle. These contacts could mean your nonprofit is scrambling for cash.
Even the most experienced and knowledgeable nonprofit executive director shouldn’t have absolute power. Your board needs to step in if an executive tries to ignore expense limits and breaks other rules of good fiscal management. The board also should question an executive who attempts to choose a new auditor or makes strategic decisions without the board’s input.
Don’t ignore the signs
If one of these danger signs appears, it’s important to act swiftly. Financial problems don’t disappear on their own. Contact us for help evaluating the situation and for advice on how to get your organization back on track.
Events of the past year put a dent in many not-for-profit’s reserves. Perhaps you tapped this stash to buy personal protective equipment or to pay staffers’ salaries when your budget no longer proved adequate. As the pandemic wanes and economic conditions improve, you’ll need to start thinking about rebuilding your operating reserves.
Back on steady ground
Assembling an adequate operating reserve takes time and should be regarded as a continuous project. Obviously, it’s nearly impossible to contribute to reserves when you’re under financial stress. But once you feel your nonprofit is on steadier ground, your board of directors needs to determine what amount to target and how your organization will reach that target. It’s also a good time to review circumstances under which reserves can be drawn down.
Reserve funds can come from unrestricted contributions, investment income and planned surpluses. Many boards designate a portion of their organizations’ unrestricted net assets as an operating reserve. On the other hand, funds that shouldn’t be considered part of an operating reserve include endowments and temporarily restricted funds. Net assets tied up in illiquid fixed assets used in operations, such as your buildings and equipment, generally don’t qualify either.
Protection and flexibility
Determining how much should be in your operating reserve depends on your organization and its operations. Generally, if you depend heavily on only a few funders or government grants, your nonprofit probably will benefit from a larger reserve. Likewise, if personnel costs are high, your organization could use a healthy reserve cushion.
Three months of reserves is typically considered a minimum accumulation. Six months of reserves provides greater security. A three-to-six-month reserve should enable your organization to continue its operations for a relatively brief transition in operations or funding. Or, in the worst-case scenario, it would allow for an orderly winding up of affairs.
An operating reserve of more than six months provides greater protection if, for example, something similar to the COVID-19 lockdown occurs again. And a bigger reserve can give you financial flexibility. For example, you might have the funds to pursue a new program initiative that’s not fully funded, or to leverage debt funding for needed facilities or equipment.
Note that it’s generally not a good idea to put aside more than 12 months of expenses. Increasingly, donors want to see the nonprofits they support put funds to work, not hoard them. Contact us for more information about operating reserves and setting policies that are appropriate for your organization.
Even after your 2020 tax return has been successfully filed with the IRS, you may still have some questions about the return. Here are brief answers to three questions that we’re frequently asked at this time of year.
Are you wondering when you will receive your refund?
The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Get Your Refund Status.” You’ll need your Social Security number, filing status and the exact refund amount.
Which tax records can you throw away now?
At a minimum, keep tax records related to your return for as long as the IRS can audit your return or assess additional taxes. In general, the statute of limitations is three years after you file your return. So you can generally get rid of most records related to tax returns for 2017 and earlier years. (If you filed an extension for your 2017 return, hold on to your records until at least three years from when you filed the extended return.)
However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.
You should hang on to certain tax-related records longer. For example, keep the actual tax returns indefinitely, so you can prove to the IRS that you filed legitimate returns. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)
When it comes to retirement accounts, keep records associated with them until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset, plus at least three years after you sell it and report the sale on your tax return. (You can keep these records for six years if you want to be extra safe.)
If you overlooked claiming a tax break, can you still collect a refund for it?
In general, you can file an amended tax return and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later.
However, there are a few opportunities when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.
Year-round tax help
Contact us if you have questions about retaining tax records, receiving your refund or filing an amended return. We’re not just here at tax filing time. We’re available all year long.
Before the COVID-19 pandemic hit, the number of people engaged in the “gig” or sharing economy had been growing, according to several reports. And reductions in working hours during the pandemic have caused even more people to turn to gig work to make up lost income. There are tax consequences for the people who perform these jobs, which include providing car rides, delivering food, walking dogs and providing other services.
Bottom line: If you receive income from freelancing or from one of the online platforms offering goods and services, it’s generally taxable. That’s true even if the income comes from a side job and even if you don’t receive an income statement reporting the amount of money you made.
Basics for gig workers
The IRS considers gig workers as those who are independent contractors and conduct their jobs through online platforms. Examples include Uber, Lyft, Airbnb and DoorDash.
Unlike traditional employees, independent contractors don’t receive benefits associated with employment or employer-sponsored health insurance. They also aren’t covered by the minimum wage or other protections of federal laws and they aren’t part of states’ unemployment insurance systems. In addition, they’re on their own when it comes to retirement savings and taxes.
Pay taxes throughout the year
If you’re part of the gig or sharing economy, here are some tax considerations.
It’s important to keep good records tracking income and expenses in case you are audited by the IRS or state tax authorities. Contact us if you have questions about your tax obligations as a gig worker or the deductions you can claim. You don’t want to get an unwanted surprise when you file your tax return.
The May 17 deadline for filing your 2020 individual tax return is coming up soon. It’s important to file and pay your tax return on time to avoid penalties imposed by the IRS. Here are the basic rules.
Failure to pay
Separate penalties apply for failing to pay and failing to file. The failure-to-pay penalty is 1/2% for each month (or partial month) the payment is late. For example, if payment is due May 17 and is made June 22, the penalty is 1% (1/2% times 2 months or partial months). The maximum penalty is 25%.
The failure-to-pay penalty is based on the amount shown as due on the return (less credits for amounts paid through withholding or estimated payments), even if the actual tax bill turns out to be higher. On the other hand, if the actual tax bill turns out to be lower, the penalty is based on the lower amount.
For example, if your payment is two months late and your return shows that you owe $5,000, the penalty is 1%, which equals $50. If you’re audited and your tax bill increases by another $1,000, the failure-to-pay penalty isn’t increased because it’s based on the amount shown on the return as due.
Failure to file
The failure-to-file penalty runs at a more severe rate of 5% per month (or partial month) of lateness to a maximum of 25%. If you obtain an extension to file (until October 15), you’re not filing late unless you miss the extended due date. However, a filing extension doesn’t apply to your responsibility for payment.
If the 1/2% failure-to-pay penalty and the failure-to-file penalty both apply, the failure-to-file penalty drops to 4.5% per month (or part) so the total combined penalty is 5%. The maximum combined penalty for the first five months is 25%. After that, the failure-to-pay penalty can continue at 1/2% per month for 45 more months (an additional 22.5%). Thus, the combined penalties could reach 47.5% over time.
The failure-to-file penalty is also more severe because it’s based on the amount required to be shown on the return, and not just the amount shown as due. (Credit is given for amounts paid via withholding or estimated payments. So if no amount is owed, there’s no penalty for late filing.) For example, if a return is filed three months late showing $5,000 owed (after payment credits), the combined penalties would be 15%, which equals $750. If the actual tax liability is later determined to be an additional $1,000, the failure to file penalty (4.5% × 3 = 13.5%) would also apply for an additional $135 in penalties.
A minimum failure to file penalty will also apply if you file your return more than 60 days late. This minimum penalty is the lesser of $210 or the tax amount required to be shown on the return.
Both penalties may be excused by IRS if lateness is due to “reasonable cause.” Typical qualifying excuses include death or serious illness in the immediate family and postal irregularities.
As you can see, filing and paying late can get expensive. Furthermore, in particularly abusive situations involving a fraudulent failure to file, the late filing penalty can reach 15% per month, with a 75% maximum. Contact us if you have questions or need an appointment to prepare your return.
In recent months, there have been a number of tax changes that may affect your individual tax bill. Many of these changes were enacted to help mitigate the financial damage caused by COVID-19.
Here are two changes that may result in tax savings for you on your 2020 or 2021 tax returns. The 2020 return is due on May 17, 2021 (because the IRS extended many due dates from the usual April 15 this year). If you can’t file by that date, you can request an extra five months to file your 2020 tax return by October 15, 2021. Your 2021 return will be due in April of 2022.
1. Some unemployment compensation from last year is tax free.
Many people lost their jobs last year due to pandemic shutdowns. Generally, unemployment compensation is included in gross income for federal tax purposes. But thanks to the American Rescue Plan Act (ARPA), enacted on March 11, 2021, up to $10,200 of unemployment compensation can be excluded from federal gross income on 2020 federal returns for taxpayers with an adjusted gross income (AGI) under $150,000. In the case of a joint return, the first $10,200 per spouse isn’t included in gross income. That means if both spouses lost their jobs and collected unemployment last year, they’re eligible for up to a $20,400 exclusion.
However, keep in mind that some states tax unemployment compensation that is exempt from federal income tax under the ARPA.
The IRS has announced that taxpayers who already filed their 2020 individual tax returns without taking advantage of the 2020 unemployment benefit exclusion, don’t need to file an amended return to take advantage of it. Any resulting overpayment of tax will be either refunded or applied to other outstanding taxes owed.
The IRS will take steps in the spring and summer to make the appropriate change to the returns, which may result in a refund. The first refunds are expected to be made in May and will continue into the summer.
2. More taxpayers may qualify for a tax credit for buying health insurance.
The premium tax credit (PTC) is a refundable credit that assists individuals and families in paying for health insurance obtained through a Marketplace established under the Affordable Care Act. The ARPA made several significant enhancements to this credit.
For example, under pre-ARPA law, individuals with household income above 400% of the federal poverty line (FPL) weren’t eligible for the PTC. But under the new law, for 2021 and 2022, the premium tax credit is available to taxpayers with household incomes that exceed 400% of the FPL. This change increases the number of people who are eligible for the credit.
Let’s say a 45-year-old unmarried man has income of $58,000 (450% of FPL) in 2021. He wouldn’t have been eligible for the PTC before ARPA was enacted. But under the ARPA, he’s eligible for a premium tax credit of about $1,250.
Other favorable changes were also made to the premium tax credit.
Many more changes
The 2020 unemployment benefit exclusion and the enhanced premium tax credit are just two of the many recent tax changes that may be beneficial to you. Contact us if you have questions about your situation.
The housing market in many parts of the country is strong this spring. If you’re buying or selling a home, you should know how to determine your “basis.”
How it works
You can claim an itemized deduction on your tax return for real estate taxes and home mortgage interest. Most other home ownership costs can’t be deducted currently. However, these costs may increase your home’s “basis” (your cost for tax purposes). And a higher basis can save taxes when you sell.
The law allows an exclusion from income for all or part of the gain realized on the sale of your home. The general exclusion limit is $250,000 ($500,000 for married taxpayers). You may feel the exclusion amount makes keeping track of the basis relatively unimportant. Many homes today sell for less than $500,000. However, that reasoning doesn’t take into account what may happen in the future. If history is any indication, a home that’s owned for 20 or 30 years appreciates greatly. Thus, you want your basis to be as high as possible in order to avoid or reduce the tax that may result when you eventually sell.
To prove the amount of your basis, keep accurate records of your purchase price, closing costs, and other expenses that increase your basis. Save receipts and other records for improvements and additions you make to the home. When you eventually sell, your basis will establish the amount of your gain. Keep the supporting documentation for at least three years after you file your return for the sale year.
Start with the purchase price
The main element in your home’s basis is the purchase price. This includes your down payment and any debt, such as a mortgage. It also includes certain settlement or closing costs. If you had your house built on land you own, your basis is the cost of the land plus certain costs to complete the house.
You add to the cost of your home expenses that you paid in connection with the purchase, including attorney’s fees, abstract fees, owner’s title insurance, recording fees and transfer taxes. The basis of your home is affected by expenses after a casualty to restore damaged property and depreciation if you used your home for business or rental purposes,
Over time, you may make additions and improvements to your home. Add the cost of these improvements to your basis. Improvements that add to your home’s basis include:
Home expenses that don’t add much to the value or the property’s life are considered repairs, not improvements. Therefore, you can’t add them to the property’s basis. Repairs include painting, fixing gutters, repairing leaks and replacing broken windows. However, an entire job is considered an improvement if items that would otherwise be considered repairs are done as part of extensive remodeling.
The cost of appliances purchased for your home generally don’t add to your basis unless they are considered attached to the house. Thus, the cost of a built-in oven or range would increase basis. But an appliance that can be easily removed wouldn’t.
Plan for best results
Other rules and requirements may apply. We can help you plan for the best tax results involving your home’s basis.
The COVID-19 pandemic has affected various industries in very different ways. Widespread lockdowns and discouraged movement have led to increased profitability for some manufacturers and many big-box retailers. The restaurant industry, however, has had a much harder go of it — especially smaller, privately owned businesses in economically challenged areas.
In response, the Small Business Administration (SBA) has launched the Restaurant Revitalization Fund (RRF). It was established under the American Rescue Plan Act (ARPA) signed into law in March. The RRF went live for applications on May 3, and the SBA is strongly urging interested, eligible businesses to apply as soon as possible.
Funds are available for restaurants, of course, but also many other similar types of businesses. Food stands, trucks and carts can apply, as well as bars, saloons, lounges and taverns. Catering companies may also file an RRF application.
In addition, the program is available to snack and nonalcoholic beverage bars, as well as “licensed facilities or premises of a beverage alcohol producer where the public may taste, sample, or purchase products,” according to the SBA.
For some restaurant-like businesses, on-site sales to the public must comprise at least 33% of gross receipts. These include bakeries; inns; wineries and distilleries; breweries and/or microbreweries; and brewpubs, tasting rooms and taprooms.
How much funding is available?
Under the ARPA, the RRF received a total of $28.6 billion in direct relief funds for restaurants and other similar establishments that have suffered economic hardship and substantial operational losses because of the COVID-19 pandemic.
The dollar amount an eligible business can receive under the RRF will equal its decrease in gross revenues during 2020 compared to gross revenues in 2019 — less the amount of any Paycheck Protection Program (PPP) loans received. Other amounts must be excluded from 2020 gross receipts as well, including:
Overall, the RFF may provide a qualifying establishment with funding equal to its pandemic-related revenue loss up to $10 million per business and not more than $5 million per physical location. Recipients must use funds for allowable expenses by March 11, 2023.
What will we need to apply?
A timely, properly completed application is critical to acquiring this funding. An applicant business must submit documentation of its 2020 and 2019 gross receipts, as well as at least one of the following:
Warning: Internally prepared financials could significantly delay SBA review of your application.
You’ll also need to disclose the amount of any PPP loans you’ve received. However, the SBA’s online application system should provide this information automatically.
Get started now
To get started, register for an account at restaurants.sba.gov. The SBA advises applicants to first download a sample version of the application here. Our firm can help you identify necessary documentation and navigate the process.
The premium tax credit (PTC) is a refundable credit that helps individuals and families pay for insurance obtained from a Health Insurance Marketplace (commonly known as an “Exchange”). A provision of the Affordable Care Act (ACA) created the credit.
The American Rescue Plan Act (ARPA), signed into law in March 2021, made several significant enhancements to the PTC. Although these changes expand access to the credit for individuals and families, they could increase the risk of some businesses incurring an ACA penalty.
More eligible people
Under pre-ARPA law, individuals with household income above 400% of the federal poverty line (FPL) were ineligible for the PTC. Under ARPA, for 2021 and 2022, the PTC is available to taxpayers with household incomes that exceed 400% of the FPL. This change will increase the number of PTC-eligible people.
For example, a 45-year-old single person earning $58,000 in 2021 (450% of FPL) would have been ineligible for the PTC under pre-ARPA law. Under ARPA, that individual is eligible for a PTC of about $1,250.
Lower income cap
The PTC is calculated on a sliding scale based on household income, expressed as a percentage of the FPL. The amount of the credit is limited to the excess of the premiums for the applicable benchmark plan over the taxpayer’s required share of those premiums. The required share comes from a table divided into income tiers.
Because the required share is less under the new tables for 2021 and 2022 than it otherwise would have been, the PTC will be greater. Under pre-ARPA law, a taxpayer might have had to spend as much as 9.83% of household income in 2021 on health insurance premiums. Under ARPA, that amount is capped at 8.5% for 2021 and 2022.
More penalty exposure
As mentioned, the expanded PTC will help individuals and families obtain coverage through a Health Insurance Marketplace. However, because applicable large employers (ALEs) potentially face shared responsibility penalties if full-time employees receive PTCs, expanded eligibility could increase penalty exposure for ALEs that don’t offer affordable, minimum-value coverage to all full-time employees as mandated under the ACA.
An employer’s size, for ACA purposes, is determined in any given year by its number of employees in the previous year. Generally, if your company had 50 or more full-time or full-time equivalent employees on average during the previous year, you’ll be considered an ALE for the current calendar year. A full-time employee is someone employed on average at least 30 hours of service per week.
Assess your risk
If your business is an ALE, be sure you’re aware of this development when designing or revising your employer-provided health care benefits. Should you decide to add staff this year, keep an eye on the tipping point of when you could become an ALE. Our firm can further explain the ARPA’s premium tax credit provisions and help you determine whether you qualify as an ALE — or may soon will.
Many businesses have retained employees during the COVID-19 pandemic and enjoyed tax relief with the help of the employee retention credit (ERC). The recent signing of the American Rescue Plan Act (ARPA) brings good news: the ERC has been extended yet again.
The original credit
As originally introduced under last year’s CARES Act, the ERC was a refundable tax credit against certain employment taxes equal to 50% of qualified wages, up to $10,000, that an eligible employer paid to employees after March 12, 2020, and before January 1, 2021. An employer could qualify for the ERC if, in 2020, there was a:
The definition of “qualified wages” depends on staff size. If an employer averaged more than 100 full-time employees during 2019, qualified wages are generally those paid to employees who aren’t providing services because operations were suspended or due to the decline in gross receipts. Qualified wages may include certain health care costs and are capped at $10,000 per employee. These employers could count wages only up to the amount that the employee would’ve been paid for working an equivalent duration during the 30 days immediately preceding the period of economic hardship.
If an employer averaged 100 or fewer full-time employees during 2019, qualified wages are those wages, also including health care costs and capped at $10,000 per employee, paid to any employee during the period operations were suspended or the period of the decline in gross receipts — regardless of whether employees are providing services.
Expansion and extensions
Under the Consolidated Appropriations Act (CAA), signed into law at the end of 2020, the ERC was extended through June 30, 2021. The CAA also expanded the ERC rate of credit from 50% to 70% of qualified wages. The law further expanded eligibility by:
Most recently, the ARPA further extended the ERC from June 30, 2021, until December 31, 2021. The 70% of qualified wages is also extended for this period, as is the allowance for up to $10,000 in qualified wages for any calendar quarter. This means an employer could potentially have up to $40,000 in qualified wages per employee through 2021.
We can help you determine whether your business qualifies for the ERC and, if so, how much the credit may reduce your tax bill.
As a business owner, you should be aware that you can save family income and payroll taxes by putting your child on the payroll.
Here are some considerations.
Shifting business earnings
You can turn some of your high-taxed income into tax-free or low-taxed income by shifting some business earnings to a child as wages for services performed. In order for your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child’s salary must be reasonable.
For example, suppose you’re a sole proprietor in the 37% tax bracket. You hire your 16-year-old son to help with office work full-time in the summer and part-time in the fall. He earns $10,000 during the year (and doesn’t have other earnings). You can save $3,700 (37% of $10,000) in income taxes at no tax cost to your son, who can use his $12,550 standard deduction for 2021 to shelter his earnings.
Family taxes are cut even if your son’s earnings exceed his standard deduction. That’s because the unsheltered earnings will be taxed to him beginning at a 10% rate, instead of being taxed at your higher rate.
Income tax withholding
Your business likely will have to withhold federal income taxes on your child’s wages. Usually, an employee can claim exempt status if he or she had no federal income tax liability for last year and expects to have none this year.
However, exemption from withholding can’t be claimed if: 1) the employee’s income exceeds $1,100 for 2021 (and includes more than $350 of unearned income), and 2) the employee can be claimed as a dependent on someone else’s return.
Keep in mind that your child probably will get a refund for part or all of the withheld tax when filing a return for the year.
Social Security tax savings
If your business isn’t incorporated, you can also save some Social Security tax by shifting some of your earnings to your child. That’s because services performed by a child under age 18 while employed by a parent isn’t considered employment for FICA tax purposes.
A similar but more liberal exemption applies for FUTA (unemployment) tax, which exempts earnings paid to a child under age 21 employed by a parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting only of his or her parents.
Note: There’s no FICA or FUTA exemption for employing a child if your business is incorporated or is a partnership that includes non-parent partners. However, there’s no extra cost to your business if you’re paying a child for work you’d pay someone else to do.
Your business also may be able to provide your child with retirement savings, depending on your plan and how it defines qualifying employees. For example, if you have a SEP plan, a contribution can be made for the child up to 25% of his or her earnings (not to exceed $58,000 for 2021).
Contact us if you have any questions about these rules in your situation. Keep in mind that some of the rules about employing children may change from year to year and may require your income-shifting strategies to change too.
President Biden signed the $1.9 trillion American Rescue Plan Act (ARPA) on March 11. While the new law is best known for the provisions providing relief to individuals, there are also several tax breaks and financial benefits for businesses.
Here are some of the tax highlights of the ARPA.
The Employee Retention Credit (ERC). This valuable tax credit is extended from June 30 until December 31, 2021. The ARPA continues the ERC rate of credit at 70% for this extended period of time. It also continues to allow for up to $10,000 in qualified wages for any calendar quarter. Taking into account the Consolidated Appropriations Act extension and the ARPA extension, this means an employer can potentially have up to $40,000 in qualified wages per employee through 2021.
Employer-Provided Dependent Care Assistance. In general, an eligible employee’s gross income doesn’t include amounts paid or incurred by an employer for dependent care assistance provided to the employee under a qualified dependent care assistance program (DCAP).
Previously, the amount that could be excluded from an employee’s gross income under a DCAP during a tax year wasn’t more than $5,000 ($2,500 for married individuals filing separately), subject to certain limitations. However, any contribution made by an employer to a DCAP can’t exceed the employee’s earned income or, if married, the lesser of employee’s or spouse’s earned income.
Under the ARPA, for 2021 only, the exclusion for employer-provided dependent care assistance is increased from $5,000 to $10,500 (from $2,500 to $5,250 for married individuals filing separately).
This provision is effective for tax years beginning after December 31, 2020.
Paid Sick and Family Leave Credits. Changes under the ARPA apply to amounts paid with respect to calendar quarters beginning after March 31, 2021. Among other changes, the law extends the paid sick time and paid family leave credits under the Families First Coronavirus Response Act from March 31, 2021, through September 30, 2021. It also provides that paid sick and paid family leave credits may each be increased by the employer’s share of Social Security tax (6.2%) and employer’s share of Medicare tax (1.45%) on qualified leave wages.
Grants to restaurants. Under the ARPA, eligible restaurants, food trucks, and similar businesses that provide food and drinks may receive restaurant revitalization grants from the Small Business Administration. For tax purposes, amounts received as restaurant revitalization grants aren’t included in the gross income of the person who receives the money.
These are only some of the provisions in the ARPA. There are many others that may be beneficial to your business. Contact us for more information about your situation.
No one needs to tell nonprofit organizations how tough the past year has been. According to the John Hopkins Center for Civil Society Studies, 7.7% of not-for-profit workers — nearly one million people — lost their jobs between February 2020 and January 2021. An even higher percentage of arts and education organizations lost jobs last year. Although the nonprofit sector received higher-than-usual donations in 2020, many nonprofits that sought COVID-19-related loans were shut out.
So the new American Rescue Plan Act’s (ARPA’s) provisions for nonprofits are welcome. Let’s take a look at some key elements.
Employer tax credits
As with 2020’s CARES Act, the ARPA helps nonprofit employers keep employees on their payrolls. The Employee Retention Tax Credit has been extended through December 31, 2021, for eligible employers that continue to pay worker wages during COVID-19-related closures or experience reduced revenue.
Tax credits for nonprofits granting paid sick and family leave to staffers are also extended — to September 30, 2021. The ARPA increases the amount of wages employers can claim from $10,000 to $12,000 per employee. Employers may now include time employees use to obtain vaccinations (and any time needed to recover from vaccination side effects) as paid leave.
To help self-insuring nonprofits, the ARPA extends federal coverage of the unemployment costs of reimbursing nonprofits. The current reimbursement rate of 50% continues to March 31, 2001. On April 1, it increases to 75% and remains at that rate until September 6. The ARPA also continues coverage for self-employed nonprofit workers and staff of religious and smaller nonprofits.
Expanded loan and grant access
The ARPA allocates a new $7.5 billion to the Paycheck Protection Program (PPP) and expands eligibility to some nonprofits with more than 500 employees that operate in more than one location. Currently, eligible nonprofits have until March 31, 2021, to apply for PPP loans. Because this gives employers little time to assess their needs and apply for a loan, many nonprofit advocates are calling for an extension beyond March 31. Congress is discussing a standalone bill that would extend the deadline.
Performing arts organizations can apply for PPP loans, but they may also want to consider requesting a grant from the new Shuttered Venue Operators Grants (SVOG) program. The Small Business Administration is expected to start accepting applications for this program in April. Note that PPP funds can reduce the size of SVOG grants.
In addition, ARPA state and local funding is expected to benefit charities. For example, if your organization lost a government grant due to COVID-19-related declines in revenue, you may be able to obtain new funding.
It’s possible that Congress will extend the PPP deadline (and other ARPA dates). However, if your organization intends to apply, start the process immediately. Contact us for help and for additional information about ARPA provisions.
When you file your tax return, you must check one of the following filing statuses: Single, married filing jointly, married filing separately, head of household or qualifying widow(er). Who qualifies to file a return as a head of household, which is more favorable than single?
To qualify, you must maintain a household, which for more than half the year, is the principal home of a “qualifying child” or other relative of yours whom you can claim as a dependent (unless you only qualify due to the multiple support rules).
A qualifying child?
A child is considered qualifying if he or she:
If a child’s parents are divorced, the child will qualify if he meets these tests for the custodial parent — even if that parent released his or her right to a dependency exemption for the child to the noncustodial parent.
A person isn’t a “qualifying child” if he or she is married and can’t be claimed by you as a dependent because he or she filed jointly or isn’t a U.S. citizen or resident. Special “tie-breaking” rules apply if the individual can be a qualifying child of (and is claimed as such by) more than one taxpayer.
Maintaining a household
You’re considered to “maintain a household” if you live in the home for the tax year and pay over half the cost of running it. In measuring the cost, include house-related expenses incurred for the mutual benefit of household members, including property taxes, mortgage interest, rent, utilities, insurance on the property, repairs and upkeep, and food consumed in the home. Don’t include items such as medical care, clothing, education, life insurance or transportation.
Special rule for parents
Under a special rule, you can qualify as head of household if you maintain a home for a parent of yours even if you don’t live with the parent. To qualify under this rule, you must be able to claim the parent as your dependent.
You must be unmarried to claim head of household status. If you’re unmarried because you’re widowed, you can use the married filing jointly rates as a “surviving spouse” for two years after the year of your spouse’s death if your dependent child, stepchild, adopted child, or foster child lives with you and you “maintain” the household. The joint rates are more favorable than the head of household rates.
If you’re married, you must file either as married filing jointly or separately, not as head of household. However, if you’ve lived apart from your spouse for the last six months of the year and your dependent child, stepchild, adopted child, or foster child lives with you and you “maintain” the household, you’re treated as unmarried. If this is the case, you can qualify as head of household.
We can answer questions if you’d like to discuss a particular situation or would like additional information about whether someone qualifies as your dependent.
If you have a life insurance policy, you may want to ensure that the benefits your family will receive after your death won’t be included in your estate. That way, the benefits won’t be subject to federal estate tax.
Current exemption amounts
For 2021, the federal estate and gift tax exemption is $11.7 million ($23.4 million for married couples). That’s generous by historical standards but in 2026, the exemption is set to fall to about $6 million ($12 million for married couples) after inflation adjustments — unless Congress changes the law.
In or out of your estate
Under the estate tax rules, insurance on your life will be included in your taxable estate if:
It’s easy to avoid the first situation by making sure your estate isn’t designated as the policy beneficiary.
The second rule is more complicated. Just having someone else possess legal title to the policy won’t prevent the proceeds from being included in your estate if you keep “incidents of ownership.” Rights that, if held by you, will cause the proceeds to be taxed in your estate include:
Be aware that merely having any of the above powers will cause the proceeds to be taxed in your estate even if you never exercise them.
Buy-sell agreements and trusts
Life insurance obtained to fund a buy-sell agreement for a business interest under a “cross-purchase” arrangement won’t be taxed in your estate (unless the estate is the beneficiary).
An irrevocable life insurance trust (ILIT) is another effective vehicle that can be set up to keep life insurance proceeds from being taxed in the insured’s estate. Typically, the policy is transferred to the trust along with assets that can be used to pay future premiums. Alternatively, the trust buys the insurance with funds contributed by the insured. As long as the trust agreement doesn’t give the insured the ownership rights described above, the proceeds won’t be included in the insured’s estate.
The three-year rule
If you’re considering setting up a life insurance trust with a policy you own currently or simply assigning away your ownership rights in such a policy, consult with us to ensure you achieve your goals. Unless you live for at least three years after these steps are taken, the proceeds will be taxed in your estate. (For policies in which you never held incidents of ownership, the three-year rule doesn’t apply.)
Contact us if you have questions or would like assistance with estate planning and taxation.
The new American Rescue Plan Act (ARPA) provides eligible families with an enhanced child and dependent care credit for 2021. This is the credit available for expenses a taxpayer pays for the care of qualifying children under the age of 13 so that the taxpayer can be gainfully employed.
Note that a credit reduces your tax bill dollar for dollar.
For care to qualify for the credit, the expenses must be “employment-related.” In other words, they must enable you and your spouse to work. In addition, they must be for the care of your child, stepchild, foster child, brother, sister or step-sibling (or a descendant of any of these), who’s under 13, lives in your home for over half the year, and doesn’t provide over half of his or her own support for the year. The expenses can also be for the care of your spouse or dependent who’s handicapped and lives with you for over half the year.
The typical expenses that qualify for the credit are payments to a day care center, nanny or nursery school. Sleep-away camp doesn’t qualify. The cost of kindergarten or higher grades doesn’t qualify because it’s an education expense. However, the cost of before and after school programs may qualify.
To claim the credit, married couples must file a joint return. You must also provide the caregiver’s name, address and Social Security number (or tax ID number for a day care center or nursery school). You also must include on the return the Social Security number(s) of the children receiving the care.
The 2021 credit is refundable as long as either you or your spouse has a principal residence in the U.S. for more than half of the tax year.
What are the limits?
When calculating the credit, several limits apply. First, qualifying expenses are limited to the income you or your spouse earn from work, self-employment, or certain disability and retirement benefits — using the figure for whichever of you earns less. Under this limitation, if one of you has no earned income, you aren’t entitled to any credit. However, in some cases, if one spouse has no actual earned income and that spouse is a full-time student or disabled, the spouse is considered to have monthly income of $250 (for one qualifying individual) or $500 (for two or more qualifying individuals).
For 2021, the first $8,000 of care expenses generally qualifies for the credit if you have one qualifying individual, or $16,000 if you have two or more. (These amounts have increased significantly from $3,000 and $6,000, respectively.) However, if your employer has a dependent care assistance program under which you receive benefits excluded from gross income, the qualifying expense limits ($8,000 or $16,000) are reduced by the excludable amounts you receive.
How much is the credit worth?
If your AGI is $125,000 or less, the maximum credit amount is $4,000 for taxpayers with one qualifying individual and $8,000 for taxpayers with two or more qualifying individuals. The credit phases out under a complicated formula. For taxpayers with an AGI greater than $440,000, it’s phased out completely.
These are the essential elements of the enhanced child and dependent care credit in 2021 under the new law. Contact us if you have questions.
The American Rescue Plan Act, signed into law on March 11, provides a variety of tax and financial relief to help mitigate the effects of the COVID-19 pandemic. Among the many initiatives are direct payments that will be made to eligible individuals. And parents under certain income thresholds will also receive additional payments in the coming months through a greatly revised Child Tax Credit.
Here are some answers to questions about these payments.
What are the two types of payments?
Under the new law, eligible individuals will receive advance direct payments of a tax credit. The law calls these payments “recovery rebates.” The law also includes advance Child Tax Credit payments to eligible parents later this year.
How much are the recovery rebates?
An eligible individual is allowed a 2021 income tax credit, which will generally be paid in advance through direct bank deposit or a paper check. The full amount is $1,400 ($2,800 for eligible married joint filers) plus $1,400 for each dependent.
Who is eligible?
There are several requirements but the most important is income on your most recently filed tax return. Full payments are available to those with adjusted gross incomes (AGIs) of less than $75,000 ($150,000 for married joint filers and $112,500 for heads of households). Your AGI can be found on page 1 of Form 1040.
The credit phases out and is no longer available to taxpayers with AGIs of more than $80,000 ($160,000 for married joint filers and $120,000 for heads of households).
Who isn’t eligible?
Among those who aren’t eligible are nonresident aliens, individuals who are the dependents of other taxpayers, estates and trusts.
How has the Child Tax Credit changed?
Before the new law, the Child Tax Credit was $2,000 per “qualifying child.” Under the new law, the credit is increased to $3,000 per child ($3,600 for children under age 6 as of the end of the year). But the increased 2021 credit amounts are phased out at modified AGIs of over $75,000 for singles ($150,000 for joint filers and $112,500 for heads of households).
A qualifying child before the new law was defined as an under-age-17 child, whom the taxpayer could claim as a dependent. The $2,000 Child Tax Credit was phased out for taxpayers with modified AGIs of over $400,000 for joint filers, and $200,000 for other filers.
Under the new law, for 2021, the definition of a qualifying child for purposes of the Child Tax Credit includes one who hasn’t turned 18 by the end of this year. So 17-year-olds qualify for the credit for 2021 only.
How are parents going to receive direct payments of the Child Tax Credit this year?
Unlike in the past, you don’t have to wait to file your tax return to fully benefit from the credit. The new law directs the IRS to establish a program to make monthly advance payments equal to 50% of eligible taxpayers’ 2021 Child Tax Credits. These payments will be made from July through December 2021.
What if my income is above the amounts listed above?
Taxpayers who aren’t eligible to claim an increased Child Tax Credit, because their incomes are too high, may be able to claim a regular credit of up to $2,000 on their 2021 tax returns, subject to the existing phaseout rules.
There are other rules and requirements involving these payments. This article only describes the basics. Stay tuned for additional details about other tax breaks in the new law.
The term and concept known as “blockchain” is hardly new. This technology surfaced more than a decade ago. Bitcoin, the relatively well-known form of cryptocurrency, has gotten much more attention than blockchain itself, which is the platform on which Bitcoin is exchanged.
One might be tempted to think that, having spent so many years in the shadows, blockchain has missed its opportunity to become widely accepted by businesses. Yet its promise persists, and you’d be well-advised to keep an eye on when blockchain might begin to make further inroads into your industry — if it hasn’t already.
A shared ledger
In simple terms, blockchain is a distributed, shared ledger that’s continuously copied and synchronized to thousands of computers. These so-called “nodes” are part of a public or private network.
The ledger isn’t housed on a central server or controlled by any one party. Rather, transactions are added to the ledger only when they’re verified through established consensus protocols. Third-party verification makes blockchain highly resistant to errors, tampering or fraud. The technology uses encryption and digital signatures to ensure participants’ identities aren’t disclosed without permission.
Blockchain’s ability to produce indelible, validated records establishes trust without the need for intermediaries to settle or authenticate transactions. So, the technology lends itself to a wide variety of uses.
Perhaps the most talked-about functionality of blockchain is smart contracts. These allow parties to create and execute contracts directly using blockchain, with less involvement by lawyers or other intermediaries.
For example, under a simple lease agreement, a business might lease office space through blockchain, paying the deposit and rent in Bitcoin or another cryptocurrency. The system automatically generates a receipt, which is held in a virtual contract between the parties. It’s impossible for either party to tamper with the lease document without the other party being alerted.
The landlord provides the lessee with a digital entry key, and the funds are released to the landlord. If the landlord fails to provide the key by the specified date, the system automatically processes a refund.
Business owners may also encounter blockchain when looking to exercise, secure or defend their legal rights. In litigation, demonstrating that “service of process” has been completed or attempted can be a challenge. Some companies are using blockchain to address this issue.
Process servers in the field use an app to post metadata — such as GPS coordinates, timestamps and device data — to a blockchain, which generates a unique identification code. Lawyers, courts and other interested parties can use the blockchain ID to access service of process data and confirm that information in physical affidavits or other records hasn’t been altered.
Blockchain continues to beckon forward-thinking business owners with its ability to provide highly efficient and secure transactions — particularly for companies that do business internationally. We can assist you in identifying whether this or other technologies may enable you to better manage your company’s finances.
The American Rescue Plan Act (ARPA), signed into law in early March, aims at offering widespread financial relief to individuals and employers adversely affected by the COVID-19 pandemic. The law specifically targets small businesses in many of its provisions.
If you own a small company, you may want to explore funding via the Small Business Administration’s (SBA’s) Economic Injury Disaster Loan (EIDL) program. And if you happen to own a restaurant or similar enterprise, the ARPA offers a special type of grant just for you.
Under the ARPA, eligible small businesses may receive targeted EIDL advances from the SBA. Amounts received as targeted EIDL advances are excluded from the gross income of the person who receives the funds. The law stipulates that no deduction or basis increase will be denied, and no tax attribute will be reduced, because of the ARPA’s gross income exclusion.
In the case of a partnership or S corporation that receives a targeted EIDL advance, any amount of the advance excluded from income under the ARPA will be treated as tax-exempt income for federal tax purposes. Because targeted EIDL advances are treated as such, they’ll be allocated to the partners or shareholders — increasing their bases in their partnership interests.
The IRS is expected to prescribe rules for determining a partner’s distributive share of EIDL advances for federal tax purposes. S corporation shareholders will receive allocations of tax-exempt income from targeted EIDL advances in proportion to their ownership interests in the company under the single-class-of-stock rule.
Restaurant revitalization grants
Under the ARPA, eligible restaurants, food trucks and similar businesses may receive restaurant revitalization grants from the SBA. As is the case for EIDL loans:
In the case of a partnership or S corporation that receives a restaurant revitalization grant, any amount of the grant excluded from income under the ARPA will be treated as tax-exempt income for federal tax purposes. Because restaurant revitalization grants are treated as tax-exempt income, they’ll be allocated to partners or shareholders and increase their bases in their partnership interests.
Just like EIDL advances, the IRS is expected to prescribe rules for determining a partner’s distributive share of the grant for federal tax purposes. And S corporation shareholders will receive allocations of tax-exempt income from restaurant revitalization grants in proportion to their ownership interests in the company under the single-class-of-stock rule.
Help with the process
The provisions related to EIDL advances and restaurant revitalization grants are effective as of the ARPA’s date of enactment: March 11, 2021. Contact us for help determining whether your small business or restaurant may qualify for financial relief under the ARPA and, if so, for assistance with the application process.
During the COVID-19 pandemic, many employees and their families have lost group health plan coverage because of layoffs or reduced hours. If your business has had to take such steps, and it’s required to offer continuing health care coverage under the Consolidated Omnibus Budget Reconciliation Act (COBRA), the recently passed American Rescue Plan Act (ARPA) includes some critical provisions that you should be aware of.
Under the ARPA, assistance-eligible individuals (AEIs) may receive a 100% subsidy for COBRA premiums during the period beginning April 1, 2021, and ending on September 30, 2021.
An AEI is a COBRA qualified beneficiary — in other words, an employee, former employee, covered spouse or covered dependent — who’s eligible for and elects COBRA coverage because of a qualifying event of involuntary termination of employment or reduction of hours. For purposes of the law, the subsidy is available for AEIs for the period beginning April 1, 2021, and ending September 30, 2021.
Extended election period
Individuals without a COBRA election in effect on April 1, 2021, but who would be an AEI if they did, are eligible for the subsidy. Those who elected but discontinued COBRA coverage before April 1, 2021, are also eligible if they’d otherwise be an AEI and are still within their maximum period of coverage.
Individuals meeting these criteria may make a COBRA election during the period beginning on April 1, 2021, and ending 60 days after they’re provided required notification of the extended election period. Coverage elected during the extended period will commence with the first period of coverage beginning on or after April 1, 2021, and may not extend beyond the AEI’s original maximum period of coverage.
Duration of coverage
As explained, the subsidy is available for any period of coverage in effect between April 1, 2021, and September 30, 2021. However, eligibility may end earlier if the qualified beneficiary’s maximum period of coverage ends before September 30, 2021. Eligibility may also end if the qualified beneficiary becomes eligible for coverage under Medicare or another group health plan other than coverage consisting of only excepted benefits or coverage under a Health Flexible Spending Arrangement or Qualified Small Employer Health Reimbursement Arrangement.
The ARPA’s COBRA provisions go beyond the subsidy. For example, they stipulate that group health plan sponsors may voluntarily allow AEIs to elect to enroll in different coverage under certain circumstances. In addition, group health plans must issue notices to AEIs regarding the:
The U.S. Department of Labor is expected to issue model notices addressing all three points.
The COVID-19 crisis has emphasized the importance of health care coverage. Our firm can further explain the ARPA’s COBRA provisions and help you manage the financial risks of offering health care benefits to your employees.
Many organizations get stuck in procedural ruts because it’s easier in the short term to continue doing things the way they’ve always been done. But it generally pays to regularly review your not-for-profit’s accounting function for inefficiencies and oversight gaps. You might plan to conduct a review once a year or perform an assessment whenever significant changes, such as staff turnover or the introduction of new software, warrants one.
Room for improvement
Be sure to consider the following items in your review:
Cutoff policies. Your nonprofit should set and adhere to monthly invoicing and expense recording cutoffs. For example, require all invoices to be submitted to your accounting department by the end of each month. Too many adjustments — or waiting for staffers or departments to turn in invoices and expense reports — waste time and can delay financial statement production.
Account reconciliation. You may be able to save considerable time at the end of the year by reconciling your bank accounts shortly after the end of each month. It’s easier to correct errors when you catch them early. Also, reconcile accounts payable and accounts receivable data to your statements of financial position.
Processing in batches. Don’t enter only one invoice or cut only one check at a time. Set aside a block of time to do the job when you have multiple items to process. Some organizations process payments only once or twice a month. Make the schedule available to everyone and fewer “emergency” checks and deposits are likely to surface.
Increased oversight. Make sure that the individual or group that’s responsible for financial oversight — for example, your CFO, treasurer or finance committee — reviews monthly bank statements, financial statements and accounting entries for obvious errors or unexpected amounts.
Software use. Many organizations underuse the accounting software package they’ve purchased because they haven’t learned its full functionality. If needed, hire a trainer to review the software’s basic functions with staff and teach time-saving shortcuts. Make sure you install updates as they become available and know when it’s time to buy new packages — for example, when your software is no longer “supported” because the vendor has gone out of business.
Accounting systems can become inefficient over time if they aren’t monitored. So look for labor-intensive steps that could be automated or procedures that don’t add value and might be eliminated. Often, for example, steps are duplicated by two different employees or the process is slowed down by “handing off” part of a project. That said, it’s essential to maintain the segregation of accounting duties to prevent fraud.
Contact us for more information or if you need help streamlining your accounting function.
While many businesses have been forced to close due to the COVID-19 pandemic, some entrepreneurs have started new small businesses. Many of these people start out operating as sole proprietors. Here are some tax rules and considerations involved in operating with that entity.
The pass-through deduction
To the extent your business generates qualified business income (QBI), you’re eligible to claim the pass-through or QBI deduction, subject to limitations. For tax years through 2025, the deduction can be up to 20% of a pass-through entity owner’s QBI. You can take the deduction even if you don’t itemize deductions on your tax return and instead claim the standard deduction.
As a sole proprietor, you’ll file Schedule C with your Form 1040. Your business expenses are deductible against gross income. If you have losses, they’ll generally be deductible against your other income, subject to special rules related to hobby losses, passive activity losses and losses in activities in which you weren’t “at risk.”
If you hire employees, you need to get a taxpayer identification number and withhold and pay employment taxes.
For 2021, you pay Social Security on your net self-employment earnings up to $142,800, and Medicare tax on all earnings. An additional 0.9% Medicare tax is imposed on self-employment income in excess of $250,000 on joint returns; $125,000 for married taxpayers filing separate returns; and $200,000 in all other cases. Self-employment tax is imposed in addition to income tax, but you can deduct half of your self-employment tax as an adjustment to income.
Quarterly estimated payments
As a sole proprietor, you generally have to make estimated tax payments. For 2021, these are due on April 15, June 15, September 15 and January 17, 2022.
Home office deductions
If you work from a home office, perform management or administrative tasks there, or store product samples or inventory at home, you may be entitled to deduct an allocable portion of some costs of maintaining your home.
Health insurance expenses
You can deduct 100% of your health insurance costs as a business expense. This means your deduction for medical care insurance won’t be subject to the rule that limits medical expense deductions.
Retain complete records of your income and expenses so you can claim all the tax breaks to which you’re entitled. Certain expenses, such as automobile, travel, meals, and office-at-home expenses, require special attention because they’re subject to special recordkeeping rules or deductibility limits.
Saving for retirement
Consider establishing a qualified retirement plan. The advantage is that amounts contributed to the plan are deductible at the time of the contribution and aren’t taken into income until they’re withdrawn. A SEP plan requires less paperwork than many qualified plans. A SIMPLE plan is also available to sole proprietors and offers tax advantages with fewer restrictions and administrative requirements. If you don’t establish a retirement plan, you may still be able to contribute to an IRA.
We can help
Contact us if you want additional information about the tax aspects of your new business, or if you have questions about reporting or recordkeeping requirements
Are you a business owner thinking about hiring? Be aware that a recent law extended a credit for hiring individuals from one or more targeted groups. Employers can qualify for a tax credit known as the Work Opportunity Tax Credit (WOTC) that’s worth as much as $2,400 for each eligible employee ($4,800, $5,600 and $9,600 for certain veterans and $9,000 for “long-term family assistance recipients”). The credit is generally limited to eligible employees who began work for the employer before January 1, 2026.
Generally, an employer is eligible for the credit only for qualified wages paid to members of a targeted group. These groups are:
You must meet certain requirements
There are a number of requirements to qualify for the credit. For example, for each employee, there’s also a minimum requirement that the employee must have completed at least 120 hours of service for the employer. Also, the credit isn’t available for certain employees who are related to or who previously worked for the employer.
There are different rules and credit amounts for certain employees. The maximum credit available for the first-year wages is $2,400 for each employee, $4,000 for long-term family assistance recipients, and $4,800, $5,600 or $9,600 for certain veterans. Additionally, for long-term family assistance recipients, there’s a 50% credit for up to $10,000 of second-year wages, resulting in a total maximum credit, over two years, of $9,000.
For summer youth employees, the wages must be paid for services performed during any 90-day period between May 1 and September 15. The maximum WOTC credit available for summer youth employees is $1,200 per employee.
A valuable credit
There are additional rules and requirements. In some cases, employers may elect not to claim the WOTC. And in limited circumstances, the rules may prohibit the credit or require an allocation of it. However, for most employers hiring from targeted groups, the credit can be valuable. Contact us with questions or for more information about your situation.
Merger and acquisition activity in many industries slowed during 2020 due to COVID-19. But analysts expect it to improve in 2021 as the country comes out of the pandemic. If you are considering buying or selling another business, it’s important to understand the tax implications.
Two ways to arrange a deal
Under current tax law, a transaction can basically be structured in two ways:
1. Stock (or ownership interest). A buyer can directly purchase a seller’s ownership interest if the target business is operated as a C or S corporation, a partnership, or a limited liability company (LLC) that’s treated as a partnership for tax purposes.
The current 21% corporate federal income tax rate makes buying the stock of a C corporation somewhat more attractive. Reasons: The corporation will pay less tax and generate more after-tax income. Plus, any built-in gains from appreciated corporate assets will be taxed at a lower rate when they’re eventually sold.
The current law’s reduced individual federal tax rates have also made ownership interests in S corporations, partnerships and LLCs more attractive. Reason: The passed-through income from these entities also is taxed at lower rates on a buyer’s personal tax return. However, current individual rate cuts are scheduled to expire at the end of 2025, and, depending on actions taken in Washington, they could be eliminated earlier.
Keep in mind that President Biden has proposed increasing the tax rate on corporations to 28%. He has also proposed increasing the top individual income tax rate from 37% to 39.6%. With Democrats in control of the White House and Congress, business and individual tax changes are likely in the next year or two.
2. Assets. A buyer can also purchase the assets of a business. This may happen if a buyer only wants specific assets or product lines. And it’s the only option if the target business is a sole proprietorship or a single-member LLC that’s treated as a sole proprietorship for tax purposes.
Preferences of buyers
For several reasons, buyers usually prefer to buy assets rather than ownership interests. In general, a buyer’s primary goal is to generate enough cash flow from an acquired business to pay any acquisition debt and provide an acceptable return on the investment. Therefore, buyers are concerned about limiting exposure to undisclosed and unknown liabilities and minimizing taxes after a transaction closes.
A buyer can step up (increase) the tax basis of purchased assets to reflect the purchase price. Stepped-up basis lowers taxable gains when certain assets, such as receivables and inventory, are sold or converted into cash. It also increases depreciation and amortization deductions for qualifying assets.
Preferences of sellers
In general, sellers prefer stock sales for tax and nontax reasons. One of their objectives is to minimize the tax bill from a sale. That can usually be achieved by selling their ownership interests in a business (corporate stock or partnership or LLC interests) as opposed to selling assets
With a sale of stock or other ownership interest, liabilities generally transfer to the buyer and any gain on sale is generally treated as lower-taxed long-term capital gain (assuming the ownership interest has been held for more than one year).
Obtain professional advice
Be aware that other issues, such as employee benefits, can also cause tax issues in M&A transactions. Buying or selling a business may be the largest transaction you’ll ever make, so it’s important to seek professional assistance. After a transaction is complete, it may be too late to get the best tax results. Contact us about how to proceed.
A number of tax-related limits that affect businesses are annually indexed for inflation, and many have increased for 2021. Some stayed the same due to low inflation. And the deduction for business meals has doubled for this year after a new law was enacted at the end of 2020. Here’s a rundown of those that may be important to you and your business.
Social Security tax
The amount of employees’ earnings that are subject to Social Security tax is capped for 2021 at $142,800 (up from $137,700 for 2020).
Deduction for eligible business-related food and beverage expenses provided by a restaurant: 100% (up from 50%)
Other employee benefits
These are only some of the tax limits that may affect your business and additional rules may apply. If you have questions, please contact us.
April 15 is not only the deadline for filing your 2020 tax return, it’s also the deadline for the first quarterly estimated tax payment for 2021, if you’re required to make one.
You may have to make estimated tax payments if you receive interest, dividends, alimony, self-employment income, capital gains, prize money or other income. If you don’t pay enough tax during the year through withholding and estimated payments, you may be liable for a tax penalty on top of the tax that’s ultimately due.
Four due dates
Individuals must pay 25% of their “required annual payment” by April 15, June 15, September 15, and January 15 of the following year, to avoid an underpayment penalty. If one of those dates falls on a weekend or holiday, the payment is due on the next business day.
The required annual payment for most individuals is the lower of 90% of the tax shown on the current year’s return or 100% of the tax shown on the return for the previous year. However, if the adjusted gross income on your previous year’s return was more than $150,000 (more than $75,000 if you’re married filing separately), you must pay the lower of 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year.
Most people who receive the bulk of their income in the form of wages satisfy these payment requirements through the tax withheld by their employers from their paychecks. Those who make estimated tax payments generally do so in four installments. After determining the required annual payment, they divide that number by four and make four equal payments by the due dates.
The annualized method
But you may be able to use the annualized income method to make smaller payments. This method is useful to people whose income flow isn’t uniform over the year, perhaps because they’re involved in a seasonal business.
If you fail to make the required payments, you may be subject to a penalty. However, the underpayment penalty doesn’t apply to you:
In addition, the IRS may waive the penalty if the failure was due to casualty, disaster, or other unusual circumstances and it would be inequitable to impose it. The penalty may also be waived for reasonable cause during the first two years after you retire (after reaching age 62) or become disabled.
Stay on track
Contact us if you have questions about how to calculate estimated tax payments. We can help you stay on track so you aren’t liable for underpayment penalties.
If you’re approaching retirement, you probably want to ensure the money you’ve saved in retirement plans lasts as long as possible. If so, be aware that a law was recently enacted that makes significant changes to retirement accounts. The SECURE Act, which was signed into law in late 2019, made a number of changes of interest to those nearing retirement.
You can keep making traditional IRA contributions if you’re still working
Before 2020, traditional IRA contributions weren’t allowed once you reached age 70½. But now, an individual of any age can make contributions to a traditional IRA, as long as he or she has compensation, which generally means earned income from wages or self-employment. So if you work part time after retiring, or do some work as an independent contractor, you may be able to continue saving in your IRA if you’re otherwise eligible.
The required minimum distribution (RMD) age was raised from 70½ to 72.
Before 2020, retirement plan participants and IRA owners were generally required to begin taking RMDs from their plans by April 1 of the year following the year they reached age 70½. The age 70½ requirement was first applied in the early 1960s and, until recently, hadn’t been adjusted to account for increased life expectancies.
For distributions required to be made after December 31, 2019, for individuals who attain age 70½ after that date, the age at which individuals must begin taking distributions from their retirement plans or IRAs is increased from 70½ to 72.
“Stretch IRAs” have been partially eliminated
If a plan participant or IRA owner died before 2020, their beneficiaries (spouses and non-spouses) were generally allowed to stretch out the tax-deferral advantages of the plan or IRA by taking distributions over the life or life expectancy of the beneficiaries. This was sometimes called a “stretch IRA.”
However, for deaths of plan participants or IRA owners beginning in 2020 (later for some participants in collectively bargained plans and governmental plans), distributions to most non-spouse beneficiaries are generally required to be distributed within 10 years following a plan participant’s or IRA owner’s death. Therefore, the “stretch” strategy is no longer allowed for those beneficiaries.
There are some exceptions to the 10-year rule. For example, it’s still allowed for: the surviving spouse of a plan participant or IRA owner; a child of a plan participant or IRA owner who hasn’t reached the age of majority; a chronically ill individual; and any other individual who isn’t more than 10 years younger than a plan participant or IRA owner. Those beneficiaries who qualify under this exception may generally still take their distributions over their life expectancies.
More changes may be ahead
These are only some of the changes included in the SECURE Act. In addition, there’s bipartisan support in Congress to make even more changes to promote retirement saving. Last year, a law dubbed the SECURE Act 2.0 was introduced in the U.S. House of Representatives. At this time, it’s unclear if or when it could be enacted. We’ll let you know about any new opportunities. In the meantime, if you have questions about your situation, don’t hesitate to contact us.
If you’re getting ready to file your 2020 tax return, and your tax bill is higher than you’d like, there might still be an opportunity to lower it. If you qualify, you can make a deductible contribution to a traditional IRA right up until the April 15, 2021 filing date and benefit from the tax savings on your 2020 return.
Who is eligible?
You can make a deductible contribution to a traditional IRA if:
For 2020, if you’re a joint tax return filer and you are covered by an employer plan, your deductible IRA contribution phases out over $104,000 to $124,000 of modified AGI. If you’re single or a head of household, the phaseout range is $65,000 to $75,000 for 2020. For married filing separately, the phaseout range is $0 to $10,000. For 2020, if you’re not an active participant in an employer-sponsored retirement plan, but your spouse is, your deductible IRA contribution phases out with modified AGI of between $196,000 and $206,000.
Deductible IRA contributions reduce your current tax bill, and earnings within the IRA are tax deferred. However, every dollar you take out is taxed in full (and subject to a 10% penalty before age 59 1/2, unless one of several exceptions apply).
IRAs often are referred to as “traditional IRAs” to differentiate them from Roth IRAs. You also have until April 15 to make a Roth IRA contribution. But while contributions to a traditional IRA are deductible, contributions to a Roth IRA aren’t. However, withdrawals from a Roth IRA are tax-free as long as the account has been open at least five years and you’re age 59 1/2 or older. (There are also income limits to contribute to a Roth IRA.)
Here are two other IRA strategies that may help you save tax.
1. Turn a nondeductible Roth IRA contribution into a deductible IRA contribution. Did you make a Roth IRA contribution in 2020? That may help you in the future when you take tax-free payouts from the account. However, the contribution isn’t deductible. If you realize you need the deduction that a traditional IRA contribution provides, you can change your mind and turn a Roth IRA contribution into a traditional IRA contribution via the “recharacterization” mechanism. The traditional IRA deduction is then yours if you meet the requirements described above.
2. Make a deductible IRA contribution, even if you don’t work. In general, you can’t make a deductible traditional IRA contribution unless you have wages or other earned income. However, an exception applies if your spouse is the breadwinner and you are a homemaker. In this case, you may be able to take advantage of a spousal IRA.
What’s the contribution limit?
For 2020 if you’re eligible, you can make a deductible traditional IRA contribution of up to $6,000 ($7,000 if you’re 50 or over).
In addition, small business owners can set up and contribute to a Simplified Employee Pension (SEP) plan up until the due date for their returns, including extensions. For 2020, the maximum contribution you can make to a SEP is $57,000.
If you want more information about IRAs or SEPs, contact us or ask about it when we’re preparing your return. We can help you save the maximum tax-advantaged amount for retirement.
If you’re like many Americans, letters from your favorite charities may be appearing in your mailbox acknowledging your 2020 donations. But what happens if you haven’t received such a letter — can you still claim a deduction for the gift on your 2020 income tax return? It depends.
What is required
To support a charitable deduction, you need to comply with IRS substantiation requirements. This generally includes obtaining a contemporaneous written acknowledgment from the charity stating the amount of the donation, whether you received any goods or services in consideration for the donation and the value of any such goods or services.
“Contemporaneous” means the earlier of:
So if you made a donation in 2020 but haven’t yet received substantiation from the charity, it’s not too late — as long as you haven’t filed your 2020 return. Contact the charity and request a written acknowledgment.
Keep in mind that, if you made a cash gift of under $250 with a check or credit card, generally a canceled check, bank statement or credit card statement is sufficient. However, if you received something in return for the donation, you generally must reduce your deduction by its value — and the charity is required to provide you a written acknowledgment as described earlier.
New deduction for non-itemizers
In general, taxpayers who don’t itemize their deductions (and instead claim the standard deduction) can’t claim a charitable deduction. Under the CARES Act, individuals who don’t itemize deductions can claim a federal income tax write-off for up to $300 of cash contributions to IRS-approved charities for the 2020 tax year. The same $300 limit applies to both unmarried taxpayers and married joint-filing couples.
Even better, this tax break was extended to cover $300 of cash contributions made in 2021 under the Consolidated Appropriations Act. The new law doubles the deduction limit to $600 for married joint-filing couples for cash contributions made in 2021.
2020 and 2021 deductions
Additional substantiation requirements apply to some types of donations. We can help you determine whether you have sufficient substantiation for the donations you hope to deduct on your 2020 income tax return — and guide you on the substantiation you’ll need for gifts you’re planning this year to ensure you can enjoy the desired deductions on your 2021 return.
Many people are more concerned about their 2020 tax bills right now than they are about their 2021 tax situations. That’s understandable because your 2020 individual tax return is due to be filed in less than three months (unless you file an extension).
However, it’s a good idea to acquaint yourself with tax amounts that may have changed for 2021. Below are some Q&As about tax amounts for this year.
Be aware that not all tax figures are adjusted annually for inflation and even if they are, they may be unchanged or change only slightly due to low inflation. In addition, some amounts only change with new legislation.
How much can I contribute to an IRA for 2021?
If you’re eligible, you can contribute $6,000 a year to a traditional or Roth IRA, up to 100% of your earned income. If you’re 50 or older, you can make another $1,000 “catch up” contribution. (These amounts were the same for 2020.)
I have a 401(k) plan through my job. How much can I contribute to it?
For 2021, you can contribute up to $19,500 (unchanged from 2020) to a 401(k) or 403(b) plan. You can make an additional $6,500 catch-up contribution if you’re age 50 or older.
I sometimes hire a babysitter and a cleaning person. Do I have to withhold and pay FICA tax on the amounts I pay them?
In 2021, the threshold when a domestic employer must withhold and pay FICA for babysitters, house cleaners, etc., is $2,300 (up from $2,200 in 2020).
How much do I have to earn in 2021 before I can stop paying Social Security on my salary?
The Social Security tax wage base is $142,800 for this year (up from $137,700 last year). That means that you don’t owe Social Security tax on amounts earned above that. (You must pay Medicare tax on all amounts that you earn.)
I didn’t qualify to itemize deductions on my last tax return. Will I qualify for 2021?
A 2017 tax law eliminated the tax benefit of itemizing deductions for many people by increasing the standard deduction and reducing or eliminating various deductions. For 2021, the standard deduction amount is $25,100 for married couples filing jointly (up from $24,800). For single filers, the amount is $12,550 (up from $12,400) and for heads of households, it’s $18,800 (up from $18,650). If the amount of your itemized deductions (such as mortgage interest) are less than the applicable standard deduction amount, you won’t itemize for 2021.
If I don’t itemize, can I claim charitable deductions on my 2021 return?
Generally, taxpayers who claim the standard deduction on their federal tax returns can’t deduct charitable donations. But thanks to the CARES Act that was enacted last year, single and married joint filing taxpayers can deduct up to $300 in donations to qualified charities on their 2020 federal returns, even if they claim the standard deduction. The Consolidated Appropriations Act extended this tax break into 2021 and increased the amount that married couples filing jointly can claim to $600.
How much can I give to one person without triggering a gift tax return in 2021?
The annual gift exclusion for 2021 is $15,000 (unchanged from 2020). This amount is only adjusted in $1,000 increments, so it typically only increases every few years.
Your tax situation
These are only some of the tax amounts that may apply to you. Contact us for more information about your tax situation, or if you have questions
If your business sponsors a 401(k) plan, you might someday consider adding designated Roth contributions. Here are some factors to explore when deciding whether such a feature would make sense for your company and its employees.
Roth contributions differ from other elective deferrals in two key tax respects. First, they’re irrevocably designated to be made on an after-tax basis, rather than pretax. Second, if all applicable requirements are met and the distribution constitutes a “qualified distribution,” the earnings won’t be subject to federal income tax when distributed.
To be qualified, a distribution generally must occur after a five-year waiting period, as well as after the participant reaches age 59½, becomes disabled or dies. Because of the different tax treatment, plans must maintain separate accounts for designated Roth contributions.
Pluses and minuses
The Roth option gives participants an opportunity to hedge against the possibility that their income tax rates will be higher in retirement. However, if tax rates fall or participants are in lower tax brackets during retirement, Roth contributions may provide less after-tax retirement income than comparable pretax contributions. The result could also be worse than that of ordinary elective deferrals if Roth amounts aren’t held long enough to make distributions tax-free.
Nonetheless, if your business employs a substantial number of relatively highly paid employees, a Roth 401(k) component may be well-appreciated. This is because participants can make much larger designated Roth 401(k) contributions than they can for a Roth IRA — in 2020 and 2021, $19,500 for designated Roth 401(k) versus $6,000 for Roth IRA.
Catch-up contributions for individuals 50 or older are also considerably higher for designated Roth 401(k) contributions — in 2020 and 2021, $6,500 for designated Roth 401(k)s versus $1,000 for Roth IRAs. And higher-paid participants who are ineligible to make Roth IRA contributions because of the income cap on eligibility could make designated Roth contributions to your plan.
Yet participants will need to know what they’re getting into. They’ll have to consider:
For plan sponsors, the separate accounting required for Roth contributions may raise plan costs and increase the risk of error. (One common mistake: treating elected contributions as pretax when the participant elected Roth contributions, or vice versa.)
And because Roth contributions are treated as elective deferrals for other purposes — including nondiscrimination requirements, vesting rules and distribution restrictions — plan administration and communication will be more complex.
Not for everyone
Before adding Roth contributions to your 401(k), be sure participants are adequately engaged and savvy, and will derive enough benefit, to make it worth the risks and burdens. We can assist you in deciding whether this would be an appropriate move for your business.
When the Small Business Administration (SBA) launched the Paycheck Protection Program (PPP) last year, the program’s stated objective was “to provide a direct incentive for small businesses to keep their workers on the payroll.” However, according to federal officials, the recently issued second round of funding has distributed only a small percentage of the $15 billion set aside for small businesses and low- to moderate-income “first-draw” borrowers.
In late February, the SBA, in cooperation with the Biden Administration, announced adjustments to the PPP aimed at “increasing access and much-needed aid to Main Street businesses that anchor our neighborhoods and help families build wealth,” according to SBA Senior Advisor Michael Roth.
5 primary objectives
The adjustments address five primary objectives:
1. Move the smallest businesses to the front of the line. The SBA has established a two-week exclusive application period for businesses and nonprofits with fewer than 20 employees. It began on February 24. The agency has reassured larger eligible companies that they’ll still have time to apply for and receive support before the program is set to expire on March 31.
2. Change the math. The loan calculation formula has been revised to focus on gross profits rather than net profits. The previous formula inadvertently excluded many sole proprietors, independent contractors and self-employed individuals.
3. Eliminate the non-fraud felony exclusion. Under the original PPP rules, a business was disqualified from funding if it was at least 20% owned by someone with either 1) an arrest or conviction for a felony related to financial assistance fraud in the previous five years, or 2) any other felony in the previous year. The new rules eliminate the one-year lookback for any kind of felony unless the applicant or owner is incarcerated at the time of application.
4. Eventually remove the student loan exclusion. Current rules prohibit PPP loans to any business that’s at least 20% owned by an individual who’s delinquent or has defaulted on a federal debt, which includes federal student loans, within the previous seven years. The SBA intends to collaborate with the U.S. Departments of Treasury and Education to remove the student loan delinquency restriction to broaden PPP access.
5. Clarify loan eligibility for noncitizen small business. The CARES Act stipulates that any lawful U.S. resident can apply for a PPP loan. However, holders of Individual Taxpayer Identification Numbers (ITINs), such as Green Card holders and those in the United States on a visa, have been unable to consistently access the program. The SBA has committed to issuing new guidance to address this issue, which, in part, will state that otherwise eligible applicants can’t be denied PPP loans solely because they use ITINs when paying their taxes.
The PPP could evolve further as the year goes along, potentially as an indirect result of the COVID-19 relief bill currently making its way through Congress. Our firm can keep you updated on all aspects of the program, including the tax impact of loan proceeds.
This year, the optional standard mileage rate used to calculate the deductible costs of operating an automobile for business decreased by one-and-one-half cents, to 56 cents per mile. As a result, you might claim a lower deduction for vehicle-related expenses for 2021 than you could for 2020 or 2019. This is the second year in a row that the cents-per-mile rate has decreased.
Deducting actual expenses vs. cents-per-mile
In general, businesses can deduct the actual expenses attributable to business use of vehicles. This includes gas, oil, tires, insurance, repairs, licenses and vehicle registration fees. In addition, you can claim a depreciation allowance for the vehicle. However, in many cases, certain limits apply to depreciation write-offs on vehicles that don’t apply to other types of business assets.
The cents-per-mile rate is useful if you don’t want to keep track of actual vehicle-related expenses. With this method, you don’t have to account for all your actual expenses. However, you still must record certain information, such as the mileage for each business trip, the date and the destination.
Using the cents-per-mile rate is also popular with businesses that reimburse employees for business use of their personal vehicles. These reimbursements can help attract and retain employees who drive their personal vehicles extensively for business purposes. Why? Under current law, employees can no longer deduct unreimbursed employee business expenses, such as business mileage, on their own income tax returns.
If you do use the cents-per-mile rate, be aware that you must comply with various rules. If you don’t comply, the reimbursements could be considered taxable wages to the employees.
The 2021 rate
Beginning on January 1, 2021, the standard mileage rate for the business use of a car (van, pickup or panel truck) is 56 cents per mile. It was 57.5 cents for 2020 and 58 cents for 2019.
The business cents-per-mile rate is adjusted annually. It’s based on an annual study commissioned by the IRS about the fixed and variable costs of operating a vehicle, such as gas, maintenance, repair and depreciation. The rate partly reflects the current price of gas, which is down from a year ago. According to AAA Gas Prices, the average nationwide price of a gallon of unleaded regular gas was $2.42 recently, compared with $2.49 a year ago. Occasionally, if there’s a substantial change in average gas prices, the IRS will change the cents-per-mile rate midyear.
When this method can’t be used
There are some situations when you can’t use the cents-per-mile rate. In some cases, it partly depends on how you’ve claimed deductions for the same vehicle in the past. In other cases, it depends on if the vehicle is new to your business this year or whether you want to take advantage of certain first-year depreciation tax breaks on it.
As you can see, there are many factors to consider in deciding whether to use the mileage rate to deduct vehicle expenses. We can help if you have questions about tracking and claiming such expenses in 2021 — or claiming them on your 2020 income tax return.
If your not-for-profit has lost financial support during the pandemic, you may be looking for ways to raise new revenue. But if your proposed solution is a side business, be careful. Even when business ventures are related to a nonprofit’s exempt purpose, they can run afoul of the commerciality doctrine — and jeopardize an organization’s tax status.
Countering an unfair tax advantage
The commerciality doctrine was created along with the operational test to address concerns over nonprofits competing at an unfair tax advantage with for-profit businesses. In general, the operational test requires that a nonprofit be both organized and operating exclusively to accomplish its exempt purpose. The test also requires that no more than an “insubstantial part” of an organization’s activities further a nonexempt purpose. This means that your organization can operate a business as a substantial part of its activities as long as the business furthers your exempt purpose.
Here’s the catch: Under the commerciality doctrine, courts have ruled that the otherwise exempt activities of some organizations are substantially the same as those of commercial entities. Courts and the IRS consider several factors when evaluating commerciality. No single factor is decisive, but asking the following questions about your nonprofit and its business activities can help you evaluate risk:
Also consider the extent to which your organization relies on charitable donations. They should be a significant percentage of total support.
There’s another risk for nonprofits operating a business. You could pass muster under the commerciality doctrine but end up liable for unrelated business income tax (UBIT).
Revenue that a nonprofit generates from a regularly conducted trade or business that isn’t substantially related to furthering the organization’s tax-exempt purpose may be subject to UBIT. Much depends on how significant the business activities are to your organization as a whole. There are also several exceptions, so be sure to check with us.
If you’re thinking about launching a new business venture to raise revenue, talk to us first. We can review your proposed idea and help you reduce the risk that the commerciality doctrine or UBIT will trip it up.
Although electric vehicles (or EVs) are a small percentage of the cars on the road today, they’re increasing in popularity all the time. And if you buy one, you may be eligible for a federal tax break.
The tax code provides a credit to purchasers of qualifying plug-in electric drive motor vehicles including passenger vehicles and light trucks. The credit is equal to $2,500 plus an additional amount, based on battery capacity, that can’t exceed $5,000. Therefore, the maximum credit allowed for a qualifying EV is $7,500.
The EV definition
For purposes of the tax credit, a qualifying vehicle is defined as one with four wheels that’s propelled to a significant extent by an electric motor, which draws electricity from a battery. The battery must have a capacity of not less than four kilowatt hours and be capable of being recharged from an external source of electricity.
The credit may not be available because of a per-manufacturer cumulative sales limitation. Specifically, it phases out over six quarters beginning when a manufacturer has sold at least 200,000 qualifying vehicles for use in the United States (determined on a cumulative basis for sales after December 31, 2009). For example, Tesla and General Motors vehicles are no longer eligible for the tax credit.
The IRS provides a list of qualifying vehicles on its website and it recently added a number of models that are eligible. You can access the list here: https://bit.ly/2Yrhg5Z.
Here are some additional points about the plug-in electric vehicle tax credit:
There’s a separate 10% federal income tax credit for the purchase of qualifying electric two-wheeled vehicles manufactured primarily for use on public thoroughfares and capable of at least 45 miles per hour (in other words, electric-powered motorcycles). It can be worth up to $2,500. This electric motorcycle credit was recently extended to cover qualifying 2021 purchases.
These are only the basic rules. There may be additional incentives provided by your state. Contact us if you’d like to receive more information about the federal plug-in electric vehicle tax break.
Many business owners generate financial statements, at least in part, because lenders and other stakeholders demand it. You’re likely also aware of how insightful properly prepared financial statements can be — especially when they follow Generally Accepted Accounting Principles.
But how can you best extract these useful insights? One way is to view your financial statements through a wide variety of “lenses” provided by key performance indicators (KPIs). These are calculations or formulas into which you can plug numbers from your financial statements and get results that enable you to make better business decisions.
Learn about liquidity
If you’ve been in business for any amount of time, you know how important it is to be “liquid.” Companies must have sufficient current assets to meet their current obligations. Cash is obviously the most liquid asset, followed by marketable securities, receivables and inventory.
Working capital — the difference between current assets and current liabilities — is a quick and relatively simple KPI for measuring liquidity. Other KPIs that assess liquidity include working capital as a percentage of total assets and the current ratio (current assets divided by current liabilities). A more rigorous benchmark is the acid (or quick) test, which excludes inventory and prepaid assets from the equation.
Accentuate asset awareness
Businesses are more than just cash; your assets matter too. Turnover ratios, a form of KPI, show how efficiently companies manage their assets. Total asset turnover (sales divided by total assets) estimates how many dollars in revenue a company generates for every dollar invested in assets. In general, the more dollars earned, the more efficiently assets are used.
Turnover ratios also can be measured for each specific category of assets. For example, you can calculate receivables turnover ratios in terms of days. The collection period equals average receivables divided by annual sales multiplied by 365 days. A collection period of 45 days indicates that the company takes an average of one and one-half months to collect invoices.
Liquidity and asset management are critical, but the bottom line is the bottom line. When it comes to measuring profitability, public companies tend to focus on earnings per share. But private businesses typically look at profit margin (net income divided by revenue) and gross margin (gross profits divided by revenue).
For meaningful comparisons, you’ll need to adjust for nonrecurring items, discretionary spending and related-party transactions. When comparing your business to other companies with different tax strategies, capital structures or depreciation methods, it may be useful to compare earnings before interest, taxes, depreciation and amortization (EBITDA).
As your business grows, your financial statements may contain so much information that it’s hard to know what to focus on. Well-chosen and accurately calculated KPIs can reveal important trends and developments. Contact us with any questions you might have about generating sound financial statements and getting the most out of them.
If you have a traditional IRA or tax-deferred retirement plan account, you probably know that you must take required minimum distributions (RMDs) when you reach a certain age — or you’ll be penalized. The CARES Act, which passed last March, allowed people to skip taking these withdrawals in 2020 but now that we’re in 2021, RMDs must be taken again.
Once you attain age 72 (or age 70½ before 2020), you must begin taking RMDs from your traditional IRAs and certain retirement accounts, including 401(k) plans. In general, RMDs are calculated using life expectancy tables published by the IRS. If you don’t withdraw the minimum amount each year, you may have to pay a 50% penalty tax on what you should have taken out — but didn’t. (Roth IRAs don’t require withdrawals until after the death of the owner.)
You can always take out more than the required amount. In planning for distributions, your income needs must be weighed against the desirable goal of keeping the tax shelter of the IRA going for as long as possible for both yourself and your beneficiaries.
In order to provide tax relief due to COVID-19, the CARES Act suspended RMDs for calendar year 2020 — but only for that one year. That meant that taxpayers could put off RMDs, not have to pay tax on them and allow their retirement accounts to keep growing tax deferred.
Begin taking RMDs again
Many people hoped that the RMD suspension would be extended into 2021. However, the Consolidated Appropriations Act, which was enacted on December 27, 2020, to provide more COVID-19 relief, didn’t extend the RMD relief. That means if you’re required to take RMDs, you need to take them this year or face a penalty.
Note: The IRS may waive part or all of the penalty if you can prove that you didn’t take RMDs due to reasonable error and you’re taking steps to remedy the shortfall. In these cases, the IRS reviews the information a taxpayer provides and decides whether to grant a request for a waiver.
Keep more of your money
Feel free to contact us if have questions about calculating RMDs or avoiding the penalty for not taking them. We can help make sure you keep more of your money.
Most not-for-profit organizations collect vast volumes of data. But according to a study conducted by EveryAction and Nonprofit Hub, only 40% of nonprofits regularly use that data to drive decisions. The majority of organizations that don’t analyze and apply data say they lack the time or staff to dedicate to it. But because it helps prevent bad decisions that must later be revisited and revised, data analytics can actually save nonprofits time and effort.
Finding the data
Data analytics is the science of collecting and analyzing sets of data to develop useful insights, connections and patterns that can lead to more informed decision making. It produces such metrics as program efficacy, outcomes vs. efforts, and membership renewal that can reflect past and current performance and, in turn, predict and guide future performance.
The data usually comes from two sources, internal and external data. Internal data includes your organization’s databases of detailed information on donors, beneficiaries or members. External data can be obtained from government databases, social media and other organizations, both non- and for-profit.
Facilitating discussions and plans
Data analytics can help your organization validate trends, uncover root causes and improve transparency. For example, analysis of certain fundraising data makes it easier to target those individuals most likely to contribute to your nonprofit.
It typically facilitates fact-based discussions and planning, which is helpful when considering new initiatives or cost-cutting measures that stir political or emotional waters. The ability to predict outcomes can support sensitive programming decisions by considering data on a wide range of factors — such as at-risk populations, funding restrictions and grantmaker priorities.
Getting your money’s worth
Some basic analytics tools are free, such as those offered by Google Analytics. But for more sophisticated and powerful functions, you may need to spend a little money.
Your organization’s informational needs should dictate the data analytics package you buy. Thousands of potential performance metrics can be produced, but not all of them will be useful. So identify those metrics that matter most to stakeholders and that truly drive decisions. Also ensure that the technology solution you choose complies with any applicable privacy and security regulations, as well as your organization’s ethical standards.
Obtaining professional help
If you don’t already have experienced staff, you may need to hire someone to conduct data analytics and convert the results into actionable intelligence. Contact us for more information and for resource suggestions.
There’s a new IRS form for business taxpayers that pay or receive certain types of nonemployee compensation and it must be furnished to most recipients by February 1, 2021. After sending the forms to recipients, taxpayers must file the forms with the IRS by March 1 (March 31 if filing electronically).
The requirement begins with forms for tax year 2020. Payers must complete Form 1099-NEC, “Nonemployee Compensation,” to report any payment of $600 or more to a recipient. February 1 is also the deadline for furnishing Form 1099-MISC, “Miscellaneous Income,” to report certain other payments to recipients.
If your business is using Form 1099-MISC to report amounts in box 8, “substitute payments in lieu of dividends or interest,” or box 10, “gross proceeds paid to an attorney,” there’s an exception to the regular due date. Those forms are due to recipients by February 16, 2021.
Before the 2020 tax year, Form 1099-MISC was filed to report payments totaling at least $600 in a calendar year for services performed in a trade or business by someone who isn’t treated as an employee (in other words, an independent contractor). These payments are referred to as nonemployee compensation (NEC) and the payment amount was reported in box 7.
Form 1099-NEC was introduced to alleviate the confusion caused by separate deadlines for Form 1099-MISC that reported NEC in box 7 and all other Form 1099-MISC for paper filers and electronic filers.
Payers of nonemployee compensation now use Form 1099-NEC to report those payments.
Generally, payers must file Form 1099-NEC by January 31. But for 2020 tax returns, the due date is February 1, 2021, because January 31, 2021, is on a Sunday. There’s no automatic 30-day extension to file Form 1099-NEC. However, an extension to file may be available under certain hardship conditions.
When to file 1099-NEC
If the following four conditions are met, you must generally report payments as nonemployee compensation:
We can help
If you have questions about filing Form 1099-NEC, Form 1099-MISC or any tax forms, contact us. We can assist you in staying in compliance with all rules.
The Small Business Administration (SBA) announced that the Paycheck Protection Program (PPP) reopened the week of January 11. If you’re fortunate to get a PPP loan to help during the COVID-19 crisis (or you received one last year), you may wonder about the tax consequences.
Background on the loans
In March of 2020, the CARES Act became law. It authorized the SBA to make loans to qualified businesses under certain circumstances. The law established the PPP, which provided up to 24 weeks of cash-flow assistance through 100% federally guaranteed loans to eligible recipients. Taxpayers could apply to have the loans forgiven to the extent their proceeds were used to maintain payroll during the COVID-19 pandemic and to cover certain other expenses.
At the end of 2020, the Consolidated Appropriations Act (CAA) was enacted to provide additional relief related to COVID-19. This law includes funding for more PPP loans, including a “second draw” for businesses that received a loan last year. It also allows businesses to claim a tax deduction for the ordinary and necessary expenses paid from the proceeds of PPP loans.
Second draw loans
The CAA permits certain smaller businesses who received a PPP loan and experienced a 25% reduction in gross receipts to take a PPP second draw loan of up to $2 million.
To qualify for a second draw loan, a taxpayer must have taken out an original PPP Loan. In addition, prior PPP borrowers must now meet the following conditions to be eligible:
To be eligible for full PPP loan forgiveness, a business must generally spend at least 60% of the loan proceeds on qualifying payroll costs (including certain health care plan costs) and the remaining 40% on other qualifying expenses. These include mortgage interest, rent, utilities, eligible operations expenditures, supplier costs, worker personal protective equipment and other eligible expenses to help comply with COVID-19 health and safety guidelines or equivalent state and local guidelines.
Eligible entities include for-profit businesses, certain non-profit organizations, housing cooperatives, veterans’ organizations, tribal businesses, self-employed individuals, sole proprietors, independent contractors and small agricultural co-operatives.
Deductibility of expenses paid by PPP loans
The CARES Act didn’t address whether expenses paid with the proceeds of PPP loans could be deducted on tax returns. Last year, the IRS took the position that these expenses weren’t deductible. However, the CAA provides that expenses paid from the proceeds of PPP loans are deductible.
Cancellation of debt income
Generally, when a lender reduces or cancels debt, it results in cancellation of debt (COD) income to the debtor. However, the forgiveness of PPP debt is excluded from gross income. Your tax attributes (net operating losses, credits, capital and passive activity loss carryovers, and basis) wouldn’t generally be reduced on account of this exclusion.
This only covers the basics of applying for PPP loans, as well as the tax implications. Contact us if you have questions or if you need assistance in the PPP loan application or forgiveness process.
COVID-19 has shut down many businesses, causing widespread furloughs and layoffs. Fortunately, employers that keep workers on their payrolls are eligible for a refundable Employee Retention Tax Credit (ERTC), which was extended and enhanced in the latest law.
Background on the credit
The CARES Act, enacted in March of 2020, created the ERTC. The credit:
The Consolidated Appropriations Act, enacted December 27, 2020, extends and greatly enhances the ERTC. Under the CARES Act rules, the credit only covered wages paid between March 13, 2020, and December 31, 2020. The new law now extends the covered wage period to include the first two calendar quarters of 2021, ending on June 30, 2021.
In addition, for the first two quarters of 2021 ending on June 30, the new law increases the overall covered wage ceiling to 70% of qualified wages paid during the applicable quarter (versus 50% under the CARES Act). And it increases the per-employee covered wage ceiling to $10,000 of qualified wages paid during the applicable quarter (versus a $10,000 annual ceiling under the original rules).
Interaction with the PPP
In a change retroactive to March 12, 2020, the new law also stipulates that the employee retention credit can be claimed for qualified wages paid with proceeds from Paycheck Protection Program (PPP) loans that aren’t forgiven.
What’s more, the new law liberalizes an eligibility rule. Specifically, it expands eligibility for the credit by reducing the required year-over-year gross receipts decline from 50% to 20% and provides a safe harbor allowing employers to use prior quarter gross receipts to determine eligibility.
We can help
These are just some of the changes made to the ERTC, which rewards employers that can afford to keep workers on the payroll during the COVID-19 crisis. Contact us for more information about this tax saving opportunity.
The COVID-19 relief bill, signed into law on December 27, 2020, provides a further response from the federal government to the pandemic. It also contains numerous tax breaks for businesses. Here are some highlights of the Consolidated Appropriations Act of 2021 (CAA), which also includes other laws within it.
Business meal deduction increased
The new law includes a provision that removes the 50% limit on deducting business meals provided by restaurants and makes those meals fully deductible.
As background, ordinary and necessary food and beverage expenses that are incurred while operating your business are generally deductible. However, for 2020 and earlier years, the deduction is limited to 50% of the allowable expenses.
The new legislation adds an exception to the 50% limit for expenses of food or beverages provided by a restaurant. This rule applies to expenses paid or incurred in calendar years 2021 and 2022.
The use of the word “by” (rather than “in”) a restaurant clarifies that the new tax break isn’t limited to meals eaten on a restaurant’s premises. Takeout and delivery meals from a restaurant are also 100% deductible.
Note: Other than lifting the 50% limit for restaurant meals, the legislation doesn’t change the rules for business meal deductions. All the other existing requirements continue to apply when you dine with current or prospective customers, clients, suppliers, employees, partners and professional advisors with whom you deal with (or could engage with) in your business.
Therefore, to be deductible:
If food or beverages are provided at an entertainment activity (such as a sporting event or theater performance), either they must be purchased separately from the entertainment or their cost must be stated on a separate bill, invoice or receipt. This is required because the entertainment, unlike the food and beverages, is nondeductible.
The new law authorizes more money towards the Paycheck Protection Program (PPP) and extends it to March 31, 2021. There are a couple of tax implications for employers that received PPP loans:
These are just a couple of the provisions in the new law that are favorable to businesses. The CAA also provides extensions and modifications to earlier payroll tax relief, allows changes to employee benefit plans, includes disaster relief and much more. Contact us if you have questions about your situation.
The IRS announced it is opening the 2020 individual income tax return filing season on February 12. (This is later than in past years because of a new law that was enacted late in December.) Even if you typically don’t file until much closer to the April 15 deadline (or you file for an extension), consider filing earlier this year. Why? You can potentially protect yourself from tax identity theft — and there may be other benefits, too.
How is a person’s tax identity stolen?
In a tax identity theft scheme, a thief uses another individual’s personal information to file a fraudulent tax return early in the filing season and claim a bogus refund.
The real taxpayer discovers the fraud when he or she files a return and is told by the IRS that the return is being rejected because one with the same Social Security number has already been filed for the tax year. While the taxpayer should ultimately be able to prove that his or her return is the legitimate one, tax identity theft can be a hassle to straighten out and significantly delay a refund.
Filing early may be your best defense: If you file first, it will be the tax return filed by a potential thief that will be rejected — not yours.
Note: You can get your individual tax return prepared by us before February 12 if you have all the required documents. It’s just that processing of the return will begin after IRS systems open on that date.
When will you receive your W-2s and 1099s?
To file your tax return, you need all of your W-2s and 1099s. January 31 is the deadline for employers to issue 2020 Form W-2 to employees and, generally, for businesses to issue Form 1099s to recipients of any 2020 interest, dividend or reportable miscellaneous income payments (including those made to independent contractors).
If you haven’t received a W-2 or 1099 by February 1, first contact the entity that should have issued it. If that doesn’t work, you can contact the IRS for help.
How else can you benefit by filing early?
In addition to protecting yourself from tax identity theft, another benefit of early filing is that, if you’re getting a refund, you’ll get it faster. The IRS expects most refunds to be issued within 21 days. The time is typically shorter if you file electronically and receive a refund by direct deposit into a bank account.
Direct deposit also avoids the possibility that a refund check could be lost, stolen, returned to the IRS as undeliverable or caught in mail delays.
If you haven’t received an Economic Impact Payment (EIP), or you didn’t receive the full amount due, filing early will help you to receive the amount sooner. EIPs have been paid by the federal government to eligible individuals to help mitigate the financial effects of COVID-19. Amounts due that weren’t sent to eligible taxpayers can be claimed on your 2020 return.
Do you need help?
If you have questions or would like an appointment to prepare your return, please contact us. We can help you ensure you file an accurate return that takes advantage of all of the breaks available to you.
Attending college is one of the biggest investments that parents and students ever make. If you or your child (or grandchild) attends (or plans to attend) an institution of higher learning, you may be eligible for tax breaks to help foot the bill.
The Consolidated Appropriations Act, which was enacted recently, made some changes to the tax breaks. Here’s a rundown of what has changed.
Deductions vs. credits
Before the new law, there were tax breaks available for qualified education expenses including the Tuition and Fees Deduction, the Lifetime Learning Credit and the American Opportunity Tax Credit.
Tax credits are generally better than tax deductions. The difference? A tax deduction reduces your taxable income while a tax credit reduces the amount of taxes you owe on a dollar-for-dollar basis.
First, let’s look at the deduction
For 2020, the Tuition and Fees Deduction could be up to $4,000 at lower income levels or up to $2,000 at middle income levels. If your 2020 modified adjusted gross income (MAGI) allows you to be eligible, you can claim the deduction whether you itemize or not. Here are the income thresholds:
As you’ll see below, the Tuition and Fees Deduction is not available after the 2020 tax year.
Two credits aligned
Before the new law, an unfavorable income phase-out rule applied to the Lifetime Learning Credit, which can be worth up to $2,000 per tax return annually. For 2021 and beyond, the new law aligns the phase-out rule for the Lifetime Learning Credit with the more favorable phase-out rule for the American Opportunity Tax Credit, which can be worth up to $2,500 per student each year. The CAA also repeals the Tuition and Fees Deduction for 2021 and later years. Basically, the law trades the old-law write-off for the more favorable new-law Lifetime Learning Credit phase-out rule.
Under the CAA, both the Lifetime Learning Credit and the American Opportunity Tax Credit are phased out for 2021 and beyond between a MAGI of $80,001 and $90,000 for unmarried individuals ($160,001 and $180,000 for married couples filing jointly). Before the new law, the Lifetime Learning Credit was phased out for 2020 between a MAGI of $59,001 and $69,000 for unmarried individuals ($118,001 and $138,000 married couples filing jointly).
Best for you
Talk with us about which of the two remaining education tax credits is the most beneficial in your situation. Each of them has its own requirements. There are also other education tax opportunities you may be able to take advantage of, including a Section 529 tuition plan and a Coverdell Education Savings Account.
The new COVID-19 relief law that was signed on December 27, 2020, contains a multitude of provisions that may affect you. Here are some of the highlights of the Consolidated Appropriations Act, which also contains two other laws: the COVID-related Tax Relief Act (COVIDTRA) and the Taxpayer Certainty and Disaster Tax Relief Act (TCDTR).
The law provides for direct payments (which it calls recovery rebates) of $600 per eligible individual ($1,200 for a married couple filing a joint tax return), plus $600 per qualifying child. The U.S. Treasury Department has already started making these payments via direct bank deposits or checks in the mail and will continue to do so in the coming weeks.
The credit payment amount is phased out at a rate of $5 per $100 of additional income starting at $150,000 of modified adjusted gross income for marrieds filing jointly and surviving spouses, $112,500 for heads of household, and $75,000 for single taxpayers.
Medical expense tax deduction
The law makes permanent the 7.5%-of-adjusted-gross-income threshold on medical expense deductions, which was scheduled to increase to 10% of adjusted gross income in 2021. The lower threshold will make it easier to qualify for the medical expense deduction.
Charitable deduction for non-itemizers
For 2020, individuals who don’t itemize their deductions can take up to a $300 deduction per tax return for cash contributions to qualified charitable organizations. The new law extends this $300 deduction through 2021 for individuals and increases it to $600 for married couples filing jointly. Taxpayers who overstate their contributions when claiming this deduction are subject to a 50% penalty (previously it was 20%).
Allowance of charitable contributions
In response to the pandemic, the limit on cash charitable contributions by an individual in 2020 was increased to 100% of the individual’s adjusted gross income (AGI). (The usual limit is 60% of adjusted gross income.) The new law extends this rule through 2021.
Energy tax credit
A credit of up to $500 is available for purchases of qualifying energy improvements made to a taxpayer’s main home. However, the $500 maximum allowance must be reduced by any credits claimed in earlier years. The law extends this credit, which was due to expire at the end of 2020, through 2021.
Other energy-efficient provisions
There are a few other energy-related provisions in the new law. For example, the tax credit for a qualified fuel cell motor vehicle and the two-wheeled plug-in electric vehicle were scheduled to expire in 2020 but have been extended through the end of 2021.
There’s also a valuable tax credit for qualifying solar energy equipment expenditures for your home. For equipment placed in service in 2020, the credit rate is 26%. The rate was scheduled to drop to 22% for equipment placed in service in 2021 before being eliminated for 2022 and beyond.
Under the new law, the 26% credit rate is extended to cover equipment placed in service in 2021 and 2022 and the law also extends the 22% rate to cover equipment placed in service in 2023. For 2024 and beyond, the credit is scheduled to vanish.
Maximize tax breaks
These are only a few tax breaks contained in the massive new law. We’ll make sure that you claim all the tax breaks you’re entitled to when we prepare your tax return.
Congress recently passed, and President Trump signed, a new law providing additional relief for businesses and individuals during the COVID-19 pandemic. One item of interest for small business owners in the Consolidated Appropriations Act (CAA) is the opportunity to take out a second loan under the Paycheck Protection Program (PPP).
The CAA permits certain smaller businesses who received a PPP loan to take out a “PPP Second Draw Loan” of up to $2 million. To qualify, you must:
Eligible entities include for-profit businesses (including those owned by sole proprietors), certain nonprofit organizations, housing cooperatives, veterans’ organizations, tribal businesses, self-employed individuals, independent contractors and small agricultural co-operatives.
Here are some additional points to consider:
Loan terms. Borrowers may receive a PPP Second Draw Loan of up to 2.5 times the average monthly payroll costs in the year preceding the loan or the calendar year. However, borrowers in the hospitality or food services industries may receive PPP Second Draw Loans of up to 3.5 times average monthly payroll costs. Only a single PPP Second Draw Loan is permitted to an eligible entity.
Gross receipts and simplified certification of revenue test. PPP Second Draw Loans of no more than $150,000 may submit a certification, on or before the date the loan forgiveness application is submitted, attesting that the eligible entity meets the applicable revenue loss requirement. Nonprofits and veterans’ organizations may use gross receipts to calculate their revenue loss standard.
Loan forgiveness. Like the first PPP loan, a PPP Second Draw Loan may be forgiven for payroll costs of up to 60% (with some exceptions) and nonpayroll costs such as rent, mortgage interest and utilities of 40%. Forgiveness of the loans isn’t included in income as cancellation of indebtedness income.
Application of exemption based on employee availability. The CAA extends current safe harbors on restoring full-time employees and salaries and wages. Specifically, it applies the rule of reducing loan forgiveness for a borrower reducing the number of employees retained and reducing employees’ salaries in excess of 25%.
Deductibility of expenses paid by PPP loans. The CARES Act didn’t address whether expenses paid with the proceeds of PPP loans could be deducted. The IRS eventually took the position that these expenses were nondeductible. The CAA, however, provides that expenses paid both from the proceeds of loans under the original PPP and PPP Second Draw Loans are deductible.
Contact us with any questions you might have about PPP loans, including applying for a Second Draw Loan or availing yourself of forgiveness.
The best choice of entity can affect your business in several ways, including the amount of your tax bill. In some cases, businesses decide to switch from one entity type to another. Although S corporations can provide substantial tax benefits over C corporations in some circumstances, there are potentially costly tax issues that you should assess before making the decision to convert from a C corporation to an S corporation.
Here are four issues to consider:
1. LIFO inventories. C corporations that use last-in, first-out (LIFO) inventories must pay tax on the benefits they derived by using LIFO if they convert to S corporations. The tax can be spread over four years. This cost must be weighed against the potential tax gains from converting to S status.
2. Built-in gains tax. Although S corporations generally aren’t subject to tax, those that were formerly C corporations are taxed on built-in gains (such as appreciated property) that the C corporation has when the S election becomes effective, if those gains are recognized within five years after the conversion. This is generally unfavorable, although there are situations where the S election still can produce a better tax result despite the built-in gains tax.
3. Passive income. S corporations that were formerly C corporations are subject to a special tax. It kicks in if their passive investment income (including dividends, interest, rents, royalties, and stock sale gains) exceeds 25% of their gross receipts, and the S corporation has accumulated earnings and profits carried over from its C corporation years. If that tax is owed for three consecutive years, the corporation’s election to be an S corporation terminates. You can avoid the tax by distributing the accumulated earnings and profits, which would be taxable to shareholders. Or you might want to avoid the tax by limiting the amount of passive income.
4. Unused losses. If your C corporation has unused net operating losses, they can’t be used to offset its income as an S corporation and can’t be passed through to shareholders. If the losses can’t be carried back to an earlier C corporation year, it will be necessary to weigh the cost of giving up the losses against the tax savings expected to be generated by the switch to S status.
When a business switches from C to S status, these are only some of the factors to consider. For example, shareholder-employees of S corporations can’t get all of the tax-free fringe benefits that are available with a C corporation. And there may be issues for shareholders who have outstanding loans from their qualified plans. These factors have to be taken into account in order to understand the implications of converting from C to S status.
If you’re interested in an entity conversion, contact us. We can explain what your options are, how they’ll affect your tax bill and some possible strategies you can use to minimize taxes.
Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2021. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
February 1 (The usual deadline of January 31 is a Sunday)
March 1 (The usual deadline of February 28 is a Sunday)
Are you considering replacing a car that you’re using in your business? There are several tax implications to keep in mind.
A cap on deductions
Cars are subject to more restrictive tax depreciation rules than those that apply to other depreciable assets. Under so-called “luxury auto” rules, depreciation deductions are artificially “capped.” So is the alternative Section 179 deduction that you can claim if you elect to expense (write-off in the year placed in service) all or part of the cost of a business car under the tax provision that for some assets allows expensing instead of depreciation. For example, for most cars that are subject to the caps and that are first placed in service in calendar year 2020 (including smaller trucks or vans built on a truck chassis that are treated as cars), the maximum depreciation and/or expensing deductions are:
The effect is generally to extend the number of years it takes to fully depreciate the vehicle.
The heavy SUV strategy
Because of the restrictions for cars, you might be better off from a tax standpoint if you replace your business car with a heavy sport utility vehicle (SUV), pickup or van. That’s because the caps on annual depreciation and expensing deductions for passenger automobiles don’t apply to trucks or vans (and that includes SUVs). What type of SUVs qualify? Those that are rated at more than 6,000 pounds gross (loaded) vehicle weight.
This means that in most cases you’ll be able to write off the entire cost of a new heavy SUV used entirely for business purposes as 100% bonus depreciation in the year you place it into service. And even if you elect out of bonus depreciation for the heavy SUV (which generally would apply to the entire depreciation class the SUV belongs in), you can elect to expense under Section 179 (subject to an aggregate dollar limit for all expensed assets), the cost of an SUV up to an inflation-adjusted limit ($25,900 for an SUV placed in service in tax years beginning in 2020). You’d then depreciate the remainder of the cost under the usual rules without regard to the annual caps.
The tax benefits described above are all subject to adjustment for non-business use. Also, if business use of an SUV doesn’t exceed 50% of total use, the SUV won’t be eligible for the expensing election, and would have to be depreciated on a straight-line method over a six-tax-year period.
Contact us if you’d like more information about tax breaks when you buy a heavy SUV for business.
When it comes to taxes, December 31 is more than just New Year’s Eve. That date will affect the filing status box that will be checked on your 2020 tax return. When filing a return, you do so with one of five tax filing statuses. In part, they depend on whether you’re married or unmarried on December 31.
More than one filing status may apply, and you can use the one that saves the most tax. It’s also possible that your status could change during the year.
Here are the filing statuses and who can claim them:
How to qualify as “head of household”
In general, head of household status is more favorable than filing as a single taxpayer. To qualify, you must “maintain a household” that, for more than half the year, is the principal home of a “qualifying child” or other relative that you can claim as your dependent.
A “qualifying child” is defined as one who:
If a child’s parents are divorced, different rules may apply. Also, a child isn’t eligible to be a “qualifying child” if he or she is married and files a joint tax return or isn’t a U.S. citizen or resident.
There are other head of household requirements. You’re considered to maintain a household if you live in it for the tax year and pay more than half the cost. This includes property taxes, mortgage interest, rent, utilities, property insurance, repairs, upkeep, and food consumed in the home. Don’t include medical care, clothing, education, life insurance or transportation.
Under a special rule, you can qualify as head of household if you maintain a home for a parent even if you don’t live with him or her. To qualify, you must claim the parent as your dependent.
Determining marital status
You must generally be unmarried to claim head of household status. If you’re married, you must generally file as either married filing jointly or married filing separately — not as head of household. However, if you’ve lived apart from your spouse for the last six months of the year, a qualifying child lives with you and you “maintain” the household, you’re treated as unmarried. In this case, you may qualify as head of household.
Contact us if you have questions about your filing status. Or ask us when we prepare your return.
You may be able to deduct some of your medical expenses, including prescription drugs, on your federal tax return. However, the rules make it hard for many people to qualify. But with proper planning, you may be able to time discretionary medical expenses to your advantage for tax purposes.
Itemizers must meet a threshold
For 2020, the medical expense deduction can only be claimed to the extent your unreimbursed costs exceed 7.5% of your adjusted gross income (AGI). This threshold amount is scheduled to increase to 10% of AGI for 2021. You also must itemize deductions on your return in order to claim a deduction.
If your total itemized deductions for 2020 will exceed your standard deduction, moving or “bunching” nonurgent medical procedures and other controllable expenses into 2020 may allow you to exceed the 7.5% floor and benefit from the medical expense deduction. Controllable expenses include refilling prescription drugs, buying eyeglasses and contact lenses, going to the dentist and getting elective surgery.
In addition to hospital and doctor expenses, here are some items to take into account when determining your allowable costs:
Costs for dependents
You can deduct the medical costs that you pay for dependents, such as your children. Additionally, you may be able to deduct medical costs you pay for other individuals, such as an elderly parent. Contact us if you have questions about medical expense deductions.
If you’re self-employed and don’t have withholding from paychecks, you probably have to make estimated tax payments. These payments must be sent to the IRS on a quarterly basis. The fourth 2020 estimated tax payment deadline for individuals is Friday, January 15, 2021. Even if you do have some withholding from paychecks or payments you receive, you may still have to make estimated payments if you receive other types of income such as Social Security, prizes, rent, interest, and dividends.
You must make sufficient federal income tax payments long before the April filing deadline through withholding, estimated tax payments, or a combination of the two. If you fail to make the required payments, you may be subject to an underpayment penalty, as well as interest.
In general, you must make estimated tax payments for 2020 if both of these statements apply:
If you’re a sole proprietor, partner or S corporation shareholder, you generally have to make estimated tax payments if you expect to owe $1,000 or more in tax when you file your return.
Quarterly due dates
Estimated tax payments are spread out through the year. The due dates are April 15, June 15, September 15 and January 15 of the following year. However, if the date falls on a weekend or holiday, the deadline is the next business day.
Estimated tax is calculated by factoring in expected gross income, taxable income, deductions and credits for the year. The easiest way to pay estimated tax is electronically through the Electronic Federal Tax Payment System. You can also pay estimated tax by check or money order using the Estimated Tax Payment Voucher or by credit or debit card.
Most individuals make estimated tax payments in four installments. In other words, you can determine the required annual payment, divide the number by four and make four equal payments by the due dates. But you may be able to make smaller payments under an “annualized income method.” This can be useful to people whose income isn’t uniform over the year, perhaps because of a seasonal business. You may also want to use the annualized income method if a large portion of your income comes from capital gains on the sale of securities that you sell at various times during the year.
Determining the correct amount
Contact us if you think you may be eligible to determine your estimated tax payments under the annualized income method, or you have any other questions about how the estimated tax rules apply to you.
It’s been estimated that there are roughly 5 million family-owned businesses in the United States. Annually, these companies make substantial contributions to both employment figures and the gross domestic product. If you own a family business, one important issue to address is how to best weave together your succession plan with your estate plan.
Rise to the challenge
Transferring ownership of a family business is often difficult because of the distinction between ownership and management succession. From an estate planning perspective, transferring assets to the younger generation as early as possible allows you to remove future appreciation from your estate, minimizing any estate taxes. However, you may not be ready to hand over control of your business or you may feel that your children aren’t yet ready to run the company.
There are various ways to address this quandary. You could set up a family limited partnership, transfer nonvoting stock to heirs or establish an employee stock ownership plan.
Another reason to separate ownership and management succession is to deal with family members who aren’t involved in the business. Providing such heirs with nonvoting stock or other equity interests that don’t confer control can be an effective way to share the wealth with them while allowing those who work in the business to take over management.
Consider an installment sale
An additional challenge to family businesses is that older and younger generations may have conflicting financial needs. Fortunately, strategies are available to generate cash flow for the owner while minimizing the burden on the next generation.
For example, consider an installment sale. These transactions provide liquidity for the owner while improving the chances that the younger generation’s purchase can be funded by cash flows from the business. Plus, so long as the price and terms are comparable to arm’s-length transactions between unrelated parties, the sale shouldn’t trigger gift or estate taxes.
Explore trust types
Or, you might want to create a trust. By transferring business interests to a grantor retained annuity trust (GRAT), for instance, the owner obtains a variety of gift and estate tax benefits (provided he or she survives the trust term) while enjoying a fixed income stream for a period of years. At the end of the term, the business is transferred to the owner’s children or other beneficiaries. GRATs are typically designed to be gift-tax-free.
There are other options as well, such as an installment sale to an intentionally defective grantor trust (IDGT). Essentially a properly structured IDGT allows an owner to sell the business on a tax-advantaged basis while enjoying an income stream and retaining control during the trust term. Once the installment payments are complete, the business passes to the owner’s beneficiaries free of gift taxes.
Protect your legacy
Family-owned businesses play an important role in the U.S. economy. We can help you integrate your succession plan with your estate plan to protect both the company itself and your financial legacy.
Hinkle Richter & Rhine, LLP is proud to be an environmentally certified sustainable company.
What does this mean? It means that when we say “Guiding Clients Down the Right Path”, we walk the talk.
The Edenark Group ISO 14001 environmental sustainability certification program is the world’s premier sustainability standard, used by organizations around the world, that care about all current, and future, stakeholders.
The program helps the organization define how it interacts internally, externally, and with the environment. It incorporates energy/waste/water/materials management and reduction, employee health and performance enhancement, community involvement, procurement and suppliers, compliance and regulations, emergency/security, and stakeholder engagement. Benefits include creating a culture of continual improvement, stakeholder engagement, lower costs, higher revenues and profits, improved employee performance, and, most importantly,...... doing something good for current and future generations.
“When you have served a community for forty years, you have deep roots and a perspective that only comes from experience. We want our organization to be the best it can be; and we care about our team, our clients, the community, and future generations,” said Darryl Hinkle, Managing Partner of Hinkle, Richter & Rhine. “As accountants and business advisors, we are always looking for ways to improve an organization, be it ours or our clients’. This program is designed to accomplish our financial goals of lower costs, higher revenues and profits, and improved team health and performance. But, we look beyond that and see this program being consistent with how we choose to lead by example; and how we wish to be viewed, in our community, by our clients and by our peers,” added Hinkle.
“When an organization pursues, and attains, the Edenark Group ISO 14001 sustainability certification, they are not just doing it to see their costs go down and revenues and profits go up. They are setting a higher bar for their organization and sending a signal to all those around them,” says David Goodman, CEO of Edenark Group. “They are not just changing out a few light bulbs and calling it a day. They are agreeing to adhere to the world’s Gold standard for sustainability certification and are joining an elite fraternity of over 300,000 organizations, in over 150 countries, that have committed to continually improving in every way, for the benefit of all of us today, and all of us tomorrow.”
S corporations can provide tax advantages over C corporations in the right circumstances. This is true if you expect that the business will incur losses in its early years because shareholders in a C corporation generally get no tax benefit from such losses. Conversely, as an S corporation shareholder, you can deduct your percentage share of these losses on your personal tax return to the extent of your basis in the stock and any loans you personally make to the entity.
Losses that can’t be deducted because they exceed your basis are carried forward and can be deducted by you when there’s sufficient basis.
Therefore, your ability to use losses that pass through from an S corporation depends on your basis in the corporation’s stock and debt. And, basis is important for other purposes such as determining the amount of gain or loss you recognize if you sell the stock. Your basis in the corporation is adjusted to reflect various events such as distributions from the corporation, contributions you make to the corporation and the corporation’s income or loss.
Adjustments to basis
However, you may not be aware that several elections are available to an S corporation or its shareholders that can affect the basis adjustments caused by distributions and other events. Here is some information about four elections:
Contact us if you would like to go over how these elections, as well as other S corporation planning strategies, can help maximize the tax benefits of operating as an S corporation.
Small business owners are well aware of the increasing cost of employee health care benefits. As a result, your business may be interested in providing some of these benefits through an employer-sponsored Health Savings Account (HSA). Or perhaps you already have an HSA. It’s a good time to review how these accounts work since the IRS recently announced the relevant inflation-adjusted amounts for 2021.
The basics of HSAs
For eligible individuals, HSAs offer a tax-advantaged way to set aside funds (or have their employers do so) to meet future medical needs. Here are the key tax benefits:
Key 2020 and 2021 amounts
To be eligible for an HSA, an individual must be covered by a “high deductible health plan.” For 2020, a “high deductible health plan” is one with an annual deductible of at least $1,400 for self-only coverage, or at least $2,800 for family coverage. For 2021, these amounts are staying the same.
For self-only coverage, the 2020 limit on deductible contributions is $3,550. For family coverage, the 2020 limit on deductible contributions is $7,100. For 2021, these amounts are increasing to $3,600 and $7,200, respectively. Additionally, for 2020, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits cannot exceed $6,900 for self-only coverage or $13,800 for family coverage. For 2021, these amounts are increasing to $7,000 and $14,000.
An individual (and the individual’s covered spouse, as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional “catch-up” contributions for 2020 and 2021 of up to $1,000.
Contributing on an employee’s behalf
If an employer contributes to the HSA of an eligible individual, the employer’s contribution is treated as employer-provided coverage for medical expenses under an accident or health plan and is excludable from an employee’s gross income up to the deduction limitation. There’s no “use-it-or-lose-it” provision, so funds can be built up for years. An employer that decides to make contributions on its employees’ behalf must generally make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer doesn’t make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.
Paying for eligible expenses
HSA distributions can be made to pay for qualified medical expenses. This generally means those expenses that would qualify for the medical expense itemized deduction. They include expenses such as doctors’ visits, prescriptions, chiropractic care and premiums for long-term care insurance.
If funds are withdrawn from the HSA for any other reason, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it’s made after reaching age 65, or in the event of death or disability.
As you can see, HSAs offer a flexible option for providing health care coverage, but the rules are somewhat complex. Contact us with questions or if you’d like to discuss offering this benefit to your employees.
Contributing to a tax-advantaged retirement plan can help you reduce taxes and save for retirement. If your employer offers a 401(k) or Roth 401(k) plan, contributing to it is a smart way to build a substantial sum of money.
If you’re not already contributing the maximum allowed, consider increasing your contribution rate. Because of tax-deferred compounding (tax-free in the case of Roth accounts), boosting contributions can have a major impact on the size of your nest egg at retirement.
With a 401(k), an employee makes an election to have a certain amount of pay deferred and contributed by an employer on his or her behalf to the plan. The contribution limit for 2020 is $19,500. Employees age 50 or older by year end are also permitted to make additional “catch-up” contributions of $6,500, for a total limit of $26,000 in 2020.
The IRS recently announced that the 401(k) contribution limits for 2021 will remain the same as for 2020.
If you contribute to a traditional 401(k)
A traditional 401(k) offers many benefits, including:
If you already have a 401(k) plan, take a look at your contributions. Try to increase your contribution rate to get as close to the $19,500 limit (with an extra $6,500 if you’re age 50 or older) as you can afford. Keep in mind that your paycheck will be reduced by less than the dollar amount of the contribution, because the contributions are pretax — so, income tax isn’t withheld.
If you contribute to a Roth 401(k)
Employers may also include a Roth option in their 401(k) plans. If your employer offers this, you can designate some or all of your contributions as Roth contributions. While such contributions don’t reduce your current MAGI, qualified distributions will be tax-free.
Roth 401(k) contributions may be especially beneficial for higher-income earners, because they don’t have the option to contribute to a Roth IRA. Your ability to make a Roth IRA contribution for 2021 will be reduced if your adjusted gross income (AGI) in 2021 exceeds:
Your ability to contribute to a Roth IRA in 2021 will be eliminated entirely if you’re a married joint filer and your 2021 AGI equals or exceeds $208,000 (up from $206,000 for 2020). The 2021 cutoff for single filers is $140,000 or more (up from $139,000 for 2020).
The best mix
Contact us if you have questions about how much to contribute or the best mix between traditional and Roth 401(k) contributions. We can discuss the tax and retirement-saving strategies in your situation.
Although planning is needed to help build the biggest possible nest egg in your traditional IRA (including a SEP-IRA and SIMPLE-IRA), it’s even more critical that you plan for withdrawals from these tax-deferred retirement vehicles. There are three areas where knowing the fine points of the IRA distribution rules can make a big difference in how much you and your family will keep after taxes:
Early distributions. What if you need to take money out of a traditional IRA before age 59½? For example, you may need money to pay your child’s education expenses, make a down payment on a new home or meet necessary living expenses if you retire early. In these cases, any distribution to you will be fully taxable (unless nondeductible contributions were made, in which case part of each payout will be tax-free). In addition, distributions before age 59½ may also be subject to a 10% penalty tax. However, there are several ways that the penalty tax (but not the regular income tax) can be avoided, including a method that’s tailor-made for individuals who retire early and need to draw cash from their traditional IRAs to supplement other income.
Naming beneficiaries. The decision concerning who you want to designate as the beneficiary of your traditional IRA is critically important. This decision affects the minimum amounts you must generally withdraw from the IRA when you reach age 72, who will get what remains in the account at your death, and how that IRA balance can be paid out. What’s more, a periodic review of the individual(s) you’ve named as IRA beneficiaries is vital. This helps assure that your overall estate planning objectives will be achieved in light of changes in the performance of your IRAs, as well as in your personal, financial and family situation.
Required minimum distributions (RMDs). Once you attain age 72, distributions from your traditional IRAs must begin. If you don’t withdraw the minimum amount each year, you may have to pay a 50% penalty tax on what should have been paid out — but wasn’t. However, for 2020, the CARES Act suspended the RMD rules — including those for inherited accounts — so you don’t have to take distributions this year if you don’t want to. Beginning in 2021, the RMD rules will kick back in unless Congress takes further action. In planning for required distributions, your income needs must be weighed against the desirable goal of keeping the tax shelter of the IRA going for as long as possible for both yourself and your beneficiaries.
Traditional versus Roth
It may seem easier to put money into a traditional IRA than to take it out. This is one area where guidance is essential, and we can assist you and your family. Contact us to conduct a review of your traditional IRAs and to analyze other aspects of your retirement planning. We can also discuss whether you can benefit from a Roth IRA, which operate under a different set of rules than traditional IRAs.
If you own a business, you may wonder if you’re eligible to take the qualified business income (QBI) deduction. Sometimes this is referred to as the pass-through deduction or the Section 199A deduction.
The QBI deduction:
Taxpayers other than corporations may be entitled to a deduction of up to 20% of their QBI. For 2020, if taxable income exceeds $163,300 for single taxpayers, or $326,600 for a married couple filing jointly, the QBI deduction may be limited based on different scenarios. These include whether the taxpayer is engaged in a service-type of trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business.
The limitations are phased in. For example, the phase-in for 2020 applies to single filers with taxable income between $163,300 and $213,300 and joint filers with taxable income between $326,600 and $426,600.
For tax years beginning in 2021, the inflation-adjusted threshold amounts will be $164,900 for single taxpayers, and $329,800 for married couples filing jointly.
Year-end planning tip
Some taxpayers may be able to achieve significant savings with respect to this deduction, by deferring income or accelerating deductions at year end so that they come under the dollar thresholds (or be subject to a smaller phaseout of the deduction) for 2020. Depending on your business model, you also may be able to increase the deduction by increasing W-2 wages before year end. The rules are quite complex, so contact us with questions and consult with us before taking steps.
Many employees take advantage of the opportunity to save taxes by placing funds in their employer’s health or dependent care flexible spending arrangements (FSAs). As the end of 2020 nears, here are some rules and reminders to keep in mind.
A pre-tax contribution of $2,750 to a health FSA is permitted in both 2020 and 2021. You save taxes because you use pre-tax dollars to pay for medical expenses that might not be deductible. For example, they wouldn’t be deductible if you don’t itemize deductions on your tax return. Even if you do itemize, medical expenses must exceed a certain percentage of your adjusted gross income in order to be deductible. Additionally, the amounts that you contribute to a health FSA aren’t subject to FICA taxes.
Your plan should have a listing of qualifying items and any documentation from a medical provider that may be needed to get a reimbursement for these items.
To avoid any forfeiture of your health FSA funds because of the “use-it-or-lose-it” rule, you must incur qualifying medical expenditures by the last day of the plan year (Dec. 31 for a calendar year plan), unless the plan allows an optional grace period. A grace period can’t extend beyond the 15th day of the third month following the close of the plan year (March 15 for a calendar year plan).
An additional exception to the use-it-or lose-it rule permits health FSAs to allow a carryover of a participant’s unused health FSA funds of up to $550. Amounts carried forward under this rule are added to the up-to-$2,750 amount that you elect to contribute to the health FSA for 2021. An employer may allow a carryover or a grace period for an FSA, but not both features.
Examining your year-to-date expenditures now will also help you to determine how much to set aside for next year. Don’t forget to reflect any changed circumstances in making your calculation.
Dependent care FSAs
Some employers also allow employees to set aside funds on a pre-tax basis in dependent care FSAs. A $5,000 maximum annual contribution is permitted ($2,500 for a married couple filing separately).
These FSAs are for a dependent-qualifying child under age 13, or a dependent or spouse who is physically or mentally incapable of self-care and who has the same principal place of abode as the taxpayer for more than half of the tax year.
Like health FSAs, dependent care FSAs are subject to a use-it-or-lose-it rule, but only the grace period relief applies, not the up-to-$550 forfeiture exception. Thus, now is a good time to review expenditures to date and to project amounts to be set aside for next year.
Note: Because of COVID-19, the IRS has temporarily allowed employees to take certain actions in 2020 related to their health care and dependent care FSAs. For example, employees may be permitted to make prospective mid-year elections and changes. Ask your HR department if your plan allows these actions if you believe they would be beneficial in your situation. Other rules and exceptions may apply.
Contact us if you’d like to discuss FSAs in greater detail.
As we approach the end of the year, it’s a good time to think about whether your business needs to buy business equipment and other depreciable property. If so, you may benefit from the Section 179 depreciation tax deduction for business property. The election provides a tax windfall to businesses, enabling them to claim immediate deductions for qualified assets, instead of taking depreciation deductions over time.
Even better, the Sec. 179 deduction isn’t the only avenue for immediate tax write-offs for qualified assets. Under the 100% bonus depreciation tax break, the entire cost of eligible assets placed in service in 2020 can be written off this year.
But to benefit for this tax year, you need to buy and place qualifying assets in service by December 31.
The Sec. 179 deduction applies to tangible personal property such as machinery and equipment purchased for use in a trade or business, and, if the taxpayer elects, qualified real property. It’s generally available on a tax year basis and is subject to a dollar limit.
The annual deduction limit is $1.04 million for tax years beginning in 2020, subject to a phaseout rule. Under the rule, the deduction is phased out (reduced) if more than a specified amount of qualifying property is placed in service during the tax year. The amount is $2.59 million for tax years beginning in 2020. (Note: Different rules apply to heavy SUVs.)
There’s also a taxable income limit. If your taxable business income is less than the dollar limit for that year, the amount for which you can make the election is limited to that taxable income. However, any amount you can’t immediately deduct is carried forward and can be deducted in later years (to the extent permitted by the applicable dollar limit, the phaseout rule, and the taxable income limit).
In addition to significantly increasing the Sec. 179 deduction, the TCJA also expanded the definition of qualifying assets to include depreciable tangible personal property used mainly in the furnishing of lodging, such as furniture and appliances.
The TCJA also expanded the definition of qualified real property to include qualified improvement property and some improvements to nonresidential real property, such as roofs; heating, ventilation and air-conditioning equipment; fire protection and alarm systems; and security systems.
What about bonus depreciation?
With bonus depreciation, businesses are allowed to deduct 100% of the cost of certain assets in the first year, rather than capitalize them on their balance sheets and gradually depreciate them. (Before the Tax Cuts and Jobs Act, you could deduct only 50% of the cost of qualified new property.)
This tax break applies to qualifying assets placed in service between September 28, 2017, and December 31, 2022 (by December 31, 2023, for certain assets with longer production periods and for aircraft). After that, the bonus depreciation percentage is reduced by 20% per year, until it’s fully phased out after 2026 (or after 2027 for certain assets described above).
Bonus depreciation is allowed for both new and used qualifying assets, which include most categories of tangible depreciable assets other than real estate.
Important: When both 100% first-year bonus depreciation and the Sec. 179 deduction are available for the same asset, it’s generally more advantageous to claim 100% bonus depreciation, because there are no limitations on it.
These favorable depreciation deductions may deliver tax-saving benefits to your business on your 2020 return. Contact us if you have questions, or you want more information about how your business can maximize the deductions.
Unfortunately, the COVID-19 pandemic has forced many businesses to shut down. If this is your situation, we’re here to assist you in any way we can, including taking care of the various tax obligations that must be met.
Of course, a business must file a final income tax return and some other related forms for the year it closes. The type of return to be filed depends on the type of business you have. Here’s a rundown of the basic requirements.
Sole Proprietorships. You’ll need to file the usual Schedule C, “Profit or Loss from Business,” with your individual return for the year you close the business. You may also need to report self-employment tax.
Partnerships. A partnership must file Form 1065, “U.S. Return of Partnership Income,” for the year it closes. You also must report capital gains and losses on Schedule D. Indicate that this is the final return and do the same on Schedules K-1, “Partner’s Share of Income, Deductions, Credits, Etc.”
All Corporations. Form 966, “Corporate Dissolution or Liquidation,” must be filed if you adopt a resolution or plan to dissolve a corporation or liquidate any of its stock.
C Corporations. File Form 1120, “U.S. Corporate Income Tax Return,” for the year you close. Report capital gains and losses on Schedule D. Indicate this is the final return.
S Corporations. File Form 1120-S, “U.S. Income Tax Return for an S Corporation” for the year of closing. Report capital gains and losses on Schedule D. The “final return” box must be checked on Schedule K-1.
All Businesses. Other forms may need to be filed to report sales of business property and asset acquisitions if you sell your business.
Employees and contract workers
If you have employees, you must pay them final wages and compensation owed, make final federal tax deposits and report employment taxes. Failure to withhold or deposit employee income, Social Security and Medicare taxes can result in full personal liability for what’s known as the Trust Fund Recovery Penalty.
If you’ve paid any contractors at least $600 during the calendar year in which you close your business, you must report those payments on Form 1099-NEC, “Nonemployee Compensation.”
Other tax issues
If your business has a retirement plan for employees, you’ll want to terminate the plan and distribute benefits to participants. There are detailed notice, funding, timing and filing requirements that must be met by a terminating plan. There are also complex requirements related to flexible spending accounts, Health Savings Accounts, and other programs for your employees.
We can assist you with many other complicated tax issues related to closing your business, including Paycheck Protection Plan (PPP) loans, the COVID-19 employee retention tax credit, employment tax deferral, debt cancellation, use of net operating losses, freeing up any remaining passive activity losses, depreciation recapture, and possible bankruptcy issues.
We can advise you on the length of time you need to keep business records. You also must cancel your Employer Identification Number (EIN) and close your IRS business account.
If your business is unable to pay all the taxes it owes, we can explain the available payment options to you. Contact us to discuss these issues and get answers to any questions.
Are you thinking about selling stock shares at a loss to offset gains that you’ve realized during 2020? If so, it’s important not to run afoul of the “wash sale” rule.
IRS may disallow the loss
Under this rule, if you sell stock or securities for a loss and buy substantially identical stock or securities back within the 30-day period before or after the sale date, the loss can’t be claimed for tax purposes. The rule is designed to prevent taxpayers from using the tax benefit of a loss without parting with ownership in any significant way. Note that the rule applies to a 30-day period before or after the sale date to prevent “buying the stock back” before it’s even sold. (If you participate in any dividend reinvestment plans, it’s possible the wash sale rule may be inadvertently triggered when dividends are reinvested under the plan, if you’ve separately sold some of the same stock at a loss within the 30-day period.)
The rule even applies if you repurchase the security in a tax-advantaged retirement account, such as a traditional or Roth IRA.
Although the loss can’t be claimed on a wash sale, the disallowed amount is added to the cost of the new stock. So, the disallowed amount can be claimed when the new stock is finally disposed of in the future (other than in a wash sale).
An example to illustrate
Let’s say you bought 500 shares of ABC Inc. for $10,000 and sold them on November 5 for $3,000. On November 30, you buy 500 shares of ABC again for $3,200. Since the shares were “bought back” within 30 days of the sale, the wash sale rule applies. Therefore, you can’t claim a $7,000 loss. Your basis in the new 500 shares is $10,200: the actual cost plus the $7,000 disallowed loss.
If only a portion of the stock sold is bought back, only that portion of the loss is disallowed. So, in the above example, if you’d only bought back 300 of the 500 shares (60%), you’d be able to claim 40% of the loss on the sale ($2,800). The remaining $4,200 loss that’s disallowed under the wash sale rule would be added to your cost of the 300 shares.
If you’ve cashed in some big gains in 2020, you may be looking for unrealized losses in your portfolio so you can sell those investments before year end. By doing so, you can offset your gains with your losses and reduce your 2020 tax liability. But be careful of the wash sale rule. We can answer any questions you may have.