If you’re considering buying or selling a business — or you’re in the process of a merger or acquisition — it’s important that both parties report the transaction to the IRS 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.
When buying 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:
- Buildings and improvements,
- Furniture, fixtures and
- Intangibles (including customer lists, licenses, patents, copyrights and goodwill).
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.
The IRS may inspect the forms that are filed to see if the buyer and the seller use different allocations. If the IRS finds that different allocations are used, auditors may dig deeper and the investigation could expand beyond just the transaction. So, it’s in your best interest 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 complicated. 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 postacquisition results, consult with us before finalizing any transaction.
Small businesses may find it beneficial to barter for goods and services instead of paying cash for them. If your business engages in bartering, be aware that the fair market value of goods that you receive in bartering is taxable income. And if you exchange services with another business, the transaction results in taxable income for both parties.
Income is also realized if services are exchanged for property. For example, if a construction firm does work for a retail business in exchange for unsold inventory, it will have income equal to the fair market value of the inventory.
Many business owners join barter clubs that facilitate barter exchanges. In general, these clubs use a system of “credit units” that are awarded to members who provide goods and services. The credits can be redeemed for goods and services from other members.
Bartering is generally taxable in the year it occurs. But if you participate in a barter club, you may be taxed on the value of credit units at the time they’re added to your account, even if you don’t redeem them for actual goods and services until a later year. For example, let’s say that you earn 2,000 credit units one year, and that each unit is redeemable for $1 in goods and services. In that year, you’ll have $2,000 of income. You won’t pay additional tax if you redeem the units the next year, since you’ve already been taxed once on that income.
If you join a barter club, you’ll be asked to provide your Social Security number or employer identification number. You’ll also be asked to certify that you aren’t subject to backup withholding. Unless you make this certification, the club will withhold tax from your bartering income at a 24% rate.
By January 31 of each year, the barter club will send you a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” which shows the value of cash, property, services, and credits that you received from exchanges during the previous year. This information will also be reported to the IRS.
If you don’t contract with a barter exchange but you do trade services, you don’t file Form 1099-B. But you may have to file a form 1099-MISC.
By bartering, you can trade away excess inventory or provide services during slow times, all while hanging onto your cash. You may also find yourself bartering when a customer doesn’t have the money on hand to complete a transaction. As long as you’re aware of the federal and state tax consequences, these transactions can benefit all parties. Contact us for more information.
The Tax Cuts and Jobs Act (TCJA) has changed the landscape for business taxpayers. That’s because the law introduced a flat 21% federal income tax rate for C corporations. Under prior law, profitable C corporations paid up to 35%.
The TCJA also cut individual income tax rates, which apply to sole proprietorships and pass-through entities, including partnerships, S corporations, and LLCs (treated as partnerships for tax purposes). However, the top rate dropped from 39.6% to only 37%.
These changes have caused many business owners to ask: What’s the optimal entity choice for me?
Entity tax basics
Before the TCJA, conventional wisdom was that most small businesses should be set up as sole proprietorships or pass-through entities to avoid the double taxation of C corporations. A C corporation pays entity-level income tax and then shareholders pay tax on dividends — and on capital gains when they sell the stock. For pass-through entities, there’s no federal income tax at the entity level.
Although C corporations are still potentially subject to double taxation, their current 21% tax rate helps make up for it. This issue is further complicated, however, by another tax provision that allows noncorporate owners of pass-through entities to take a deduction equal to as much as 20% of qualified business income (QBI), subject to various limits. But, unless Congress extends it, that deduction is available only through 2025.
Many factors to consider
The best entity choice for your business depends on many factors. Keep in mind that one form of doing business might be more appropriate at one time (say, when you’re launching), while another form might be better after you’ve been operating for a few years. Here are a few examples:
- Suppose a business consistently generates losses. There’s no tax advantage to operating as a C corporation. C corporation losses can’t be deducted by their owners. A pass-through entity would generally make more sense in this scenario because losses would pass through to the owners’ personal tax returns.
- What about a profitable business that pays out all income to the owners? In this case, operating as a pass-through entity would generally be better if significant QBI deductions are available. If not, there’s probably not a clear entity-choice answer in terms of tax liability.
- Finally, what about a business that’s profitable but holds on to its profits to fund future projects? In this case, operating as a C corporation generally would be beneficial if the corporation is a qualified small business (QSB). Reason: A 100% gain exclusion may be available for QSB stock sale gains. Even if QSB status isn’t available, C corporation status is still probably preferred — unless significant QBI deductions would be available at the owner level.
As you can see, there are many issues involved and taxes are only one factor.
For example, one often-cited advantage of certain entities is that they allow a business to be treated as an entity separate from the owner. A properly structured corporation can protect you from business debts. But to ensure that the corporation is treated as a separate entity, it’s important to observe various formalities required by the state. These include filing articles of incorporation, adopting by-laws, electing a board of directors, holding organizational meetings and keeping minutes.
The best long-term choice
The TCJA has far-reaching effects on businesses. Contact us to discuss how your business should be set up to lower its tax bill over the long run. But remember that entity choice is easier when starting up a business. Converting from one type of entity to another adds complexity. We can help you examine the ins and outs of making a change.
Here are some of the key tax-related deadlines affecting businesses and other employers during the third quarter of 2019. 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.
- Report income tax withholding and FICA taxes for the second quarter of 2019 (Form 941) and pay any tax due. (See the exception below, under “August 12.”)
- File a 2018 calendar-year retirement plan report (Form 5500 or Form 5500-EZ) or request an extension.
- Report income tax withholding and FICA taxes for the second quarter of 2019 (Form 941), if you deposited on time and in full all of the associated taxes due.
- If a calendar-year C corporation, pay the third installment of 2019 estimated income taxes.
- If a calendar-year S corporation or partnership that filed an automatic six-month extension:
- File a 2018 income tax return (Form 1120S, Form 1065 or Form 1065-B) and pay any tax, interest and penalties due.
- Make contributions for 2018 to certain employer-sponsored retirement plans.
Is your business hiring this summer? If the employees come from certain “targeted groups,” you may be eligible for the Work Opportunity Tax Credit (WOTC). This includes youth whom you bring in this summer for two or three months. The maximum credit employers can claim is $2,400 to $9,600 for each eligible employee.
10 targeted groups
An employer is generally eligible for the credit only for qualified wages paid to members of 10 targeted groups:
- Qualified members of families receiving assistance under the Temporary Assistance for Needy Families program,
- Qualified veterans,
- Designated community residents who live in Empowerment Zones or rural renewal counties,
- Qualified ex-felons,
- Vocational rehabilitation referrals,
- Qualified summer youth employees,
- Qualified members of families in the Supplemental Nutrition Assistance Program,
- Qualified Supplemental Security Income recipients,
- Long-term family assistance recipients, and
- Qualified individuals who have been unemployed for 27 weeks or longer.
For each employee, there’s also a minimum requirement that the employee have completed at least 120 hours of service for the employer, and that employment begin before January 1, 2020.
Also, the credit isn’t available for certain employees who are related to the employer or work more than 50% of the time outside of a trade or business of the employer (for example, working as a house cleaner in the employer’s home). And it generally isn’t available for employees who have previously worked for the employer.
Calculate the savings
For employees other than summer youth employees, the credit amount is calculated under the following rules. The employer can take into account up to $6,000 of first-year wages per employee ($10,000 for “long-term family assistance recipients” and/or $12,000, $14,000 or $24,000 for certain veterans). If the employee completed at least 120 hours but less than 400 hours of service for the employer, the wages taken into account are multiplied by 25%. If the employee completed 400 or more hours, all of the wages taken into account are multiplied by 40%.
Therefore, the maximum credit available for the first-year wages is $2,400 ($6,000 × 40%) per employee. It is $4,000 [$10,000 × 40%] for “long-term family assistance recipients”; $4,800, $5,600 or $9,600 [$12,000, $14,000 or $24,000 × 40%] for certain veterans. In order to claim a $9,600 credit, a veteran must be certified as being entitled to compensation for a service-connected disability and be unemployed for at least six months during the one-year period ending on the hiring date.
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 [$10,000 × 40% plus $10,000 × 50%].
The “first year” described above is the year-long period which begins with the employee’s first day of work. The “second year” is the year that immediately follows.
For summer youth employees, the rules described above apply, except that you can only take into account up to $3,000 of wages, and the wages must be paid for services performed during any 90-day period between May 1 and September 15. That means that, for summer youth employees, the maximum credit available is $1,200 ($3,000 × 40%) per employee. Summer youth employees are defined as those who are at least 16 years old, but under 18 on the hiring date or May 1 (whichever is later), and reside in an Empowerment Zone, enterprise community or renewal community.
We can help
The WOTC can offset the cost of hiring qualified new employees. There are some additional rules that, in limited circumstances, prohibit the credit or require an allocation of the credit. And you must fill out and submit paperwork to the government. Contact us for assistance or more information about your situation.
If federal income tax and employment taxes (including Social Security) are withheld from employees’ paychecks and not handed over to the IRS, a harsh penalty can be imposed. To make matters worse, the penalty can be assessed personally against a “responsible individual.”
If a business makes payroll tax payments late, there are escalating penalties. And if an employer fails to make them, the IRS will crack down hard. With the “Trust Fund Recovery Penalty,” also known as the “100% Penalty,” the IRS can assess the entire unpaid amount against a responsible person who willfully fails to comply with the law.
Some business owners and executives facing a cash flow crunch may be tempted to dip into the payroll taxes withheld from employees. They may think, “I’ll send the money in later when it comes in from another source.” Bad idea!
No corporate protection
The corporate veil won’t shield corporate officers in these cases. Unlike some other liability protections that a corporation or limited liability company may have, business owners and executives can’t escape personal liability for payroll tax debts.
Once the IRS asserts the penalty, it can file a lien or take levy or seizure action against a responsible individual’s personal assets.
The penalty can be assessed against a shareholder, owner, director, officer, or employee. In some cases, it can be assessed against a third party. The IRS can also go after more than one person. To be liable, an individual or party must:
- Be responsible for collecting, accounting for, and paying over withheld federal taxes, and
- Willfully fail to pay over those taxes. That means intentionally, deliberately, voluntarily and knowingly disregarding the requirements of the law.
The easiest way out of a delinquent payroll tax mess is to avoid getting into one in the first place. If you’re involved in a small or medium-size business, make sure the federal taxes that have been withheld from employees’ paychecks are paid over to the government on time. Don’t ever allow “borrowing” from withheld amounts.
Consider hiring an outside service to handle payroll duties. A good payroll service provider relieves you of the burden of paying employees, making the deductions, taking care of the tax payments and handling recordkeeping. Contact us for more information.
Summer is just around the corner, so you might be thinking about getting some vacation time. If you’re self-employed or a business owner, you have a golden opportunity to combine a business trip with a few extra days of vacation and offset some of the cost with a tax deduction. But be careful, or you might not qualify for the write-offs you’re expecting.
Business travel expenses can potentially be deducted if the travel is within the United States and the expenses are:
“Ordinary and necessary” and
Directly related to the business.
Note: The tax rules for foreign business travel are different from those for domestic travel.
Business owners and the self-employed are generally eligible to deduct business travel expenses if they meet the tests described above. However, under the Tax Cuts and Jobs Act, employees can no longer deduct such expenses. The potential deductions discussed in this article assume that you’re a business owner or self-employed.
A business-vacation trip
Transportation costs to and from the location of your business activity may be 100% deductible if the primary reason for the trip is business rather than pleasure. But if vacation is the primary reason for your travel, generally no transportation costs are deductible. These costs include plane or train tickets, the cost of getting to and from the airport, luggage handling tips and car expenses if you drive. Costs for driving your personal car are also eligible.
The key factor in determining whether the primary reason for domestic travel is business is the number of days you spend conducting business vs. enjoying vacation days. Any day principally devoted to business activities during normal business hours counts as a business day. In addition:
Your travel days count as business days, as do weekends and holidays — if they fall between days devoted to business and it wouldn’t be practical to return home.
Standby days (days when your physical presence might be required) also count as business days, even if you aren’t ultimately called upon to work on those days.
Bottom line: If your business days exceed your personal days, you should be able to claim business was the primary reason for a domestic trip and deduct your transportation costs.
What else can you deduct?
Once at the destination, your out-of-pocket expenses for business days are fully deductible. Examples of these expenses include lodging, meals (subject to the 50% disallowance rule), seminar and convention fees, and cab fare. Expenses for personal days aren’t deductible.
Keep in mind that only expenses for yourself are deductible. You can’t deduct expenses for family members traveling with you, including your spouse — unless they’re employees of your business and traveling for a bona fide business purpose.
Keep good records
Be sure to retain proof of the business nature of your trip. You must properly substantiate all of the expenses you’re deducting. If you get audited, the IRS will want to see records during travel you claim was for business. Good records are your best defense. Additional rules and limits apply to travel expense deductions. Please contact us if you have questions.
If you’re a business owner and you hire your children (or grandchildren) this summer, you can obtain tax breaks and other nontax benefits. The kids can gain on-the-job experience, save for college and learn how to manage money. And you may be able to:
- Shift your high-taxed income into tax-free or low-taxed income,
- Realize payroll tax savings (depending on the child’s age and how your business is organized), and
- Enable retirement plan contributions for the children.
It must be a real job
When 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 a business owner operates as a sole proprietor and is in the 37% tax bracket. He hires his 16-year-old son to help with office work on a full-time basis during the summer and part-time into the fall. The son earns $10,000 during 2019 and doesn’t have any other earnings.
The business owner saves $3,700 (37% of $10,000) in income taxes at no tax cost to his son, who can use his 2019 $12,200 standard deduction to completely shelter his earnings.
The family’s taxes are cut even if the son’s earnings exceed his or her standard deduction. The reason is that the unsheltered earnings will be taxed to the son beginning at a rate of 10%, instead of being taxed at his father’s 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.
Start saving for retirement early
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. For the 2018 tax year, a working child can contribute the lesser of his or her earned income, or $6,000 to an IRA or a Roth.
Raising tax-smart children
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. If you have any questions about how these rules apply to your situation, don’t hesitate to contact us.
Roth 401(k) accounts have been around for 13 years now. Studies show that more employers are offering them each year. A recent study by the Plan Sponsor Council of America (PSCA) found that Roth 401(k)s are now available at 70% of employer plans, up from 55.6% of plans in 2016.
However, despite the prevalence of employers offering Roth 401(k)s, most employees aren’t choosing to contribute to them. The PSCA found that only 20% of participants who have access to a Roth 401(k) made contributions to one in 2017. Perhaps it’s because they don’t understand them.
If you offer a Roth 401(k) or you’re considering one, educate your employees about the accounts to boost participation.
A 401(k) with a twist
As the name implies, these plans are a hybrid — taking some characteristics from Roth IRAs and some from employer-sponsored 401(k)s.
An employer with a 401(k), 403(b) or governmental 457(b) plan can offer designated Roth 401(k) accounts.
As with traditional 401(k)s, eligible employees can elect to defer part of their salaries to Roth 401(k)s, subject to annual limits. The employer may choose to provide matching contributions. For 2019, a participating employee can contribute up to $19,000 ($25,000 if he or she is age 50 or older) to a Roth 401(k). The most you can contribute to a Roth IRA for 2019 is $6,000 ($7,000 for those age 50 or older).
Note: The ability to contribute to a Roth IRA is phased out for upper-income taxpayers, but there’s no such restriction for a Roth 401(k).
The pros and cons
Unlike with traditional 401(k)s, contributions to employees’ accounts are made with after-tax dollars, instead of pretax dollars. Therefore, employees forfeit a key 401(k) tax benefit. On the plus side, after an initial period of five years, “qualified distributions” are 100% exempt from federal income tax, just like qualified distributions from a Roth IRA. In contrast, regular 401(k) distributions are taxed at ordinary-income rates, which are currently up to 37%.
In general, qualified distributions are those:
- Made after a participant reaches age 59½, or
- Made due to death or disability.
Therefore, you can take qualified Roth 401(k) distributions in retirement after age 59½ and pay no tax, as opposed to the hefty tax bill that may be due from traditional 401(k) payouts. And unlike traditional 401(k)s, which currently require retirees to begin taking required minimum distributions after age 70½, Roth 401(k)s have no mandate to take withdrawals.
Not for everyone
A Roth 401(k) is more beneficial than a traditional 401(k) for some participants, but not all. For example, it may be valuable for employees who expect to be in higher federal and state tax brackets in retirement. Contact us if you have questions about adding a Roth 401(k) to your benefits lineup.
If you read the Internal Revenue Code (and you probably don’t want to!), you may be surprised to find that most business deductions aren’t specifically listed. It doesn’t explicitly state that you can deduct office supplies and certain other expenses.
Some expenses are detailed in the tax code, but the general rule is contained in the first sentence of Section 162, which states you can write off “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”
In general, an expense is ordinary if it’s considered common or customary in the particular trade or business. For example, insurance premiums to protect a store would be an ordinary business expense in the retail industry.
A necessary expense is defined as one that’s helpful or appropriate. For example, let’s say a car dealership purchases an automatic defibrillator. It may not be necessary for the operation of the business, but it might be helpful and appropriate if an employee or customer suffers a heart attack.
It’s possible for an ordinary expense to be unnecessary — but, in order to be deductible, an expense must be ordinary and necessary.
In addition, a deductible amount must be reasonable in relation to the benefit expected. For example, if you’re attempting to land a $3,000 deal, a $65 lunch with a potential client should be OK with the IRS. (Keep in mind that the Tax Cuts and Jobs Act eliminated most deductions for entertainment expenses but retains the 50% deduction for business meals.)
Examples of not ordinary and unnecessary
Not surprisingly, the IRS and courts don’t always agree with taxpayers about what qualifies as ordinary and necessary expenditures.
In one case, a man engaged in a business with his brother was denied deductions for his private airplane expenses. The U.S. Tax Court noted that the taxpayer had failed to prove the expenses were ordinary and necessary to the business. In addition, only one brother used the plane and the flights were to places that the taxpayer could have driven to or flown to on a commercial airline. And, in any event, the stated expenses including depreciation expenses, weren’t adequately substantiated, the court added. (TC Memo 2018-108)
In another case, the Tax Court ruled that a business owner wasn’t entitled to deduct legal and professional fees he’d incurred in divorce proceedings defending his ex-wife’s claims to his interest in, or portion of, distributions he received from his LLC. The IRS and the court ruled the divorce legal fees were nondeductible personal expenses and weren’t ordinary and necessary. (TC Memo 2018-80)
Proceed with caution
The deductibility of some expenses is clear. But for other expenses, it can get more complicated. Generally, if an expense seems like it’s not normal in your industry — or if it could be considered fun, personal or extravagant in nature — you should proceed with caution. And keep records to substantiate the expenses you’re deducting. Consult with us for guidance.
Many employers prefer to classify workers as independent contractors to lower costs, even if it means having less control over a worker’s day-to-day activities. But the government is on the lookout for businesses that classify workers as independent contractors simply to reduce taxes or avoid their employee benefit obligations.
Why it matters
When your business classifies a worker as an employee, you generally must withhold federal income tax and the employee’s share of Social Security and Medicare taxes from his or her wages. Your business must then pay the employer’s share of these taxes, pay federal unemployment tax, file federal payroll tax returns and follow other burdensome IRS and U.S. Department of Labor rules.
You may also have to pay state and local unemployment and workers’ compensation taxes and comply with more rules. Dealing with all this can cost a bundle each year.
On the other hand, with independent contractor status, you don’t have to worry about employment tax issues. You also don’t have to provide fringe benefits like health insurance, retirement plans and paid vacations. If you pay $600 or more to an independent contractor during the year, you must file a Form 1099-MISC with the IRS and send a copy to the worker to report what you paid. That’s basically the extent of your bureaucratic responsibilities.
But if you incorrectly treat a worker as an independent contractor — and the IRS decides the worker is actually an employee — your business could be assessed unpaid payroll taxes plus interest and penalties. You also could be liable for employee benefits that should have been provided but weren’t, including penalties under federal laws.
Filing an IRS form
To find out if a worker is an employee or an independent contractor, you can file optional IRS Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” Then, the IRS will let you know how to classify a worker. 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 inadvertently trigger an employment tax audit.
It can be better to simply treat independent contractors so the relationships comply with the tax rules. This generally includes not controlling how the workers perform their duties, ensuring that you’re not the workers’ only customer, providing annual Forms 1099 and, basically, not treating the workers like employees.
Workers can also ask for a determination
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 send a letter to the business. 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.
Defending your position
If your business properly handles independent contractors, don’t panic if a worker files a Form SS-8. Contact us before replying to the IRS. With a proper response, you may be able to continue to classify the worker as a contractor. We also can assist you in setting up independent contractor relationships that stand up to IRS scrutiny.
Have you recently started a new business? Or are you contemplating starting one? Launching a new venture is a hectic, exciting time. And as you know, before you even open the doors, you generally have to spend a lot of money. You may have to train workers and pay for rent, utilities, marketing and more.
Entrepreneurs are often unaware that many expenses incurred by start-ups can’t be deducted right away. You should be aware that the way you handle some of your initial expenses can make a large difference in your tax bill.
Key points on how expenses are handled
When starting or planning a new enterprise, keep these factors in mind:
- Start-up costs include those incurred or paid while creating an active trade or business — or investigating the creation or acquisition of one.
- Under the federal tax code, taxpayers can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the business begins. We don’t need to tell you that $5,000 doesn’t go far these days! And the $5,000 deduction is reduced dollar-for-dollar by the amount by which your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis.
- No deductions or amortization write-offs are allowed until the year when “active conduct” of your new business commences. That usually means the year when the enterprise has all the pieces in place to begin earning revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask questions such as: Did the taxpayer undertake the activity intending to earn a profit? Was the taxpayer regularly and actively involved? Has the activity actually begun?
Examples of expenses
Start-up expenses generally include all expenses that are incurred to:
- Investigate the creation or acquisition of a business,
- Create a business, or
- Engage in a for-profit activity in anticipation of that activity becoming an active business.
To be eligible for the election, an expense also must be one that would be deductible if it were incurred after a business began. One example would be the money you spend analyzing potential markets for a new product or service.
To qualify as an “organization expense,” the outlay must be related to the creation of a corporation or partnership. Some examples of organization expenses are legal and accounting fees for services related to organizing the new business and filing fees paid to the state of incorporation.
An important decision
Time may be of the essence if you have start-up expenses that you’d like to deduct this year. You need to decide whether to take the elections described above. Recordkeeping is important. Contact us about your business start-up plans. We can help with the tax and other aspects of your new venture.
In the course of operating your business, you probably spend time and money “wining and dining” current or potential customers, vendors and employees. What can you deduct on your tax return for these expenses? The rules changed under the Tax Cuts and Jobs Act (TCJA), but you can still claim some valuable write-offs.
No more entertainment deductions
One of the biggest changes is that you can no longer deduct most business-related entertainment expenses. Beginning in 2018, the TCJA disallows deductions for entertainment expenses, including those for sports events, theater productions, golf outings and fishing trips.
Meal deductions still allowed
You can still deduct 50% of the cost of food and beverages for meals conducted with business associates. However, you need to follow three basic rules in order to prove that your expenses are business related:
- The expenses must be “ordinary and necessary” in carrying on your business. This means your food and beverage costs are customary and appropriate. They shouldn’t be lavish or extravagant.
- The expenses must be directly related or associated with your business. This means that you expect to receive a concrete business benefit from them. The principal purpose for the meal must be business. You can’t go out with a group of friends for the evening, discuss business with one of them for a few minutes, and then write off the check.
- You must be able to substantiate the expenses. There are requirements for proving that meal and beverage expenses qualify for a deduction. You must be able to establish the amount spent, the date and place where the meals took place, the business purpose and the business relationship of the people involved.
Set up detailed recordkeeping procedures to keep track of business meal costs. That way, you can prove them and the business connection in the event of an IRS audit.
What if you spend money on food and beverages at an entertainment event? The IRS clarified in guidance (Notice 2018-76) that taxpayers can still deduct 50% of food and drink expenses incurred at entertainment events, but only if business was conducted during the event or shortly before or after. The food-and-drink expenses should also be “stated separately from the cost of the entertainment on one or more bills, invoices or receipts,” according to the guidance.
Another related tax law change involves meals provided to employees on the business premises. Before the TCJA, these meals provided to an employee for the convenience of the employer were 100% deductible by the employer. Beginning in 2018, meals provided for the convenience of an employer in an on-premises cafeteria or elsewhere on the business property are only 50% deductible. After 2025, these meals won’t be deductible at all.
As you can see, the treatment of meal and entertainment expenses became more complicated after the TCJA. Your tax advisor can keep you up to speed on the issues and suggest strategies to get the biggest tax-saving bang for your business meal bucks.
If you’re getting a divorce, you know it’s a highly stressful time. But if you’re a business owner, tax issues can complicate matters even more. Your business ownership interest is one of your biggest personal assets and your marital property will include all or part of it.
Transferring property tax-free
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).
For example, 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 the divorce or at the time it becomes final. Tax-free treatment also applies to postdivorce transfers so long as they’re made “incident to divorce.” This means transfers that occur within:
- A year after the date the marriage ends, or
- Six years after the date the marriage ends if the transfers are made pursuant to your divorce agreement.
Future tax implications
Eventually, 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 IRS now extends the beneficial tax-free transfer rule to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in 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.
Avoid adverse tax consequences
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. Your tax advisor can help you minimize the adverse tax consequences of settling your divorce under today’s laws.
Merger and acquisition activity has been brisk in recent years. If your business is considering merging with or acquiring another business, it’s important to understand how the transaction will be taxed under current law.
Stocks vs. assets
From a tax standpoint, 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 now-permanent 21% corporate federal income tax rate under the Tax Cuts and Jobs Act (TCJA) 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 TCJA’s reduced individual federal tax rates may also make ownership interests in S corporations, partnerships and LLCs more attractive. Reason: The passed-through income from these entities also will be taxed at lower rates on a buyer’s personal tax return. However, the TCJA’s individual rate cuts are scheduled to expire at the end of 2025, and, depending on future changes in Washington, they could be eliminated earlier or extended.
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.
Note: In some circumstances, a corporate stock purchase can be treated as an asset purchase by making a “Section 338 election.” Ask your tax advisor for details.
Buyer vs. seller preferences
For several reasons, buyers usually prefer to purchase assets rather than ownership interests. Generally, a buyer’s main objective 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 the deal 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.
Meanwhile, sellers generally prefer stock sales for tax and nontax reasons. One of their main 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 business 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).
Keep in mind that other issues, such as employee benefits, can also cause unexpected tax issues when merging with, or acquiring, a business.
Professional advice is critical
Buying or selling a business may be the most important transaction you make during your lifetime, so it’s important to seek professional tax advice as you negotiate. After a deal is done, it may be too late to get the best tax results.
Contact us for the best way to proceed in your situation.
Here are some of the key tax-related deadlines that apply to businesses and other employers during the second quarter of 2019. 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.
- File with the IRS if you’re an employer that will electronically file 2018 Form 1097, Form 1098, Form 1099 (other than those with an earlier deadline) and/or Form W-2G.
- If your employees receive tips and you file electronically, file Form 8027.
- If you’re an Applicable Large Employer and filing electronically, file Forms 1094-C and 1095-C with the IRS. For all other providers of minimum essential coverage filing electronically, file Forms 1094-B and 1095-B with the IRS.
- If you’re a calendar-year corporation, file a 2018 income tax return (Form 1120) or file for an automatic six-month extension (Form 7004) and pay any tax due.
- Corporations pay the first installment of 2019 estimated income taxes.
- Employers report income tax withholding and FICA taxes for the first quarter of 2019 (Form 941) and pay any tax due.
- Employers report income tax withholding and FICA taxes for the first quarter of 2019 (Form 941), if you deposited on time and fully paid all of the associated taxes due.
- Corporations pay the second installment of 2019 estimated income taxes.
The Tax Cuts and Jobs Act created a new federal tax credit for employers that provide qualified paid family and medical leave to their employees. It’s subject to numerous rules and restrictions and the credit is only available for two tax years — those beginning between January 1, 2018, and December 31, 2019. However, it may be worthwhile for some businesses.
The value of the credit
An eligible employer can claim a credit equal to 12.5% of wages paid to qualifying employees who are on family and medical leave, if the leave payments are at least 50% of the normal wages paid to them. For each 1% increase over 50%, the credit rate increases by 0.25%, up to a maximum credit rate of 25%.
An eligible employee is one who’s worked for your company for at least one year, with compensation for the preceding year not exceeding 60% of the threshold for highly compensated employees for that year. For 2019, the threshold for highly compensated employees is $125,000 (up from $120,000 for 2018). That means a qualifying employee’s 2019 compensation can’t exceed $72,000 (60% × $120,000).
Employers that claim the family and medical leave credit must reduce their deductions for wages and salaries by the amount of the credit.
For purposes of the credit, family and medical leave is defined as time off taken by a qualified employee for these reasons:
• The birth, adoption or fostering of a child (and to care for the child),
• To care for a spouse, child or parent with a serious health condition,
• If the employee has a serious health condition,
• Any qualifying need due to an employee’s spouse, child or parent being on covered active duty in the Armed Forces (or being notified of an impending call or order to covered active duty), and
• To care for a spouse, child, parent or next of kin who’s a covered veteran or member of the Armed Forces.
Employer-provided vacation, personal, medical or sick leave (other than leave defined above) isn’t eligible.
When a policy must be established
The general rule is that, to claim the credit for your company’s first tax year that begins after December 31, 2017, your written family and medical leave policy must be in place before the paid leave for which the credit will be claimed is taken.
However, under a favorable transition rule for the first tax year beginning after December 31, 2017, your company’s written leave policy (or an amendment to an existing policy) is considered to be in place as of the effective date of the policy (or amendment) rather than the later adoption date.
The new family and medical leave credit could be an attractive perk for your company’s employees. However, it can be expensive because it must be provided to all qualifying full-time employees. Consult with us if you have questions or want more information.
If you own a business and don’t have a tax-advantaged retirement plan, it’s not too late to establish one and reduce your 2018 tax bill. A Simplified Employee Pension (SEP) can still be set up for 2018, and you can make contributions to it that you can deduct on your 2018 income tax return.
A SEP can be set up as late as the due date (including extensions) of your income tax return for the tax year for which the SEP is to first apply. That means you can establish a SEP for 2018 in 2019 as long as you do it before your 2018 return filing deadline. You have until the same deadline to make 2018 contributions and still claim a potentially substantial deduction on your 2018 return.
Generally, other types of retirement plans would have to have been established by December 31, 2018, in order for 2018 contributions to be made (though many of these plans do allow 2018 contributions to be made in 2019).
With a SEP, you can decide how much to contribute each year. You aren’t obligated to make any certain minimum contributions annually.
But, if your business has employees other than you:
1. Contributions must be made for all eligible employees using the same percentage of compensation as for yourself, and
2. Employee accounts must be immediately 100% vested.
The contributions go into SEP-IRAs established for each eligible employee.
For 2018, the maximum contribution that can be made to a SEP-IRA is 25% of compensation (or 20% of self-employed income net of the self-employment tax deduction), subject to a contribution cap of $55,000. (The 2019 cap is $56,000.)
To set up a SEP, you just need to complete and sign the very simple Form 5305-SEP (“Simplified Employee Pension — Individual Retirement Accounts Contribution Agreement”). You don’t need to file Form 5305-SEP with the IRS, but you should keep it as part of your permanent tax records. A copy of Form 5305-SEP must be given to each employee covered by the SEP, along with a disclosure statement.
Although there are rules and limits that apply to SEPs beyond what we’ve discussed here, SEPs generally are much simpler to administer than other retirement plans. Contact us with any questions you have about SEPs and to discuss whether it makes sense for you to set one up for 2018 (or 2019).
Recent changes to federal tax law and accounting rules could affect whether you decide to lease or buy equipment or other fixed assets. Although there’s no universal “right” choice, many businesses that formerly leased assets are now deciding to buy them.
Pros and cons of leasing
From a cash flow perspective, leasing can be more attractive than buying. And leasing does provide some tax benefits: Lease payments generally are tax deductible as “ordinary and necessary” business expenses. (Annual deduction limits may apply.)
Leasing used to be advantageous from a financial reporting standpoint. But new accounting rules that bring leases to the lessee’s balance sheet go into effect in 2020 for calendar-year private companies. So, lease obligations will show up as liabilities, similar to purchased assets that are financed with traditional bank loans.
Leasing also has some potential drawbacks. Over the long run, leasing an asset may cost you more than buying it, and leasing doesn’t provide any buildup of equity. What’s more, you’re generally locked in for the entire lease term. So, you’re obligated to keep making lease payments even if you stop using the equipment. If the lease allows you to opt out before the term expires, you may have to pay an early-termination fee.
Pros and cons of buying
Historically, the primary advantage of buying over leasing has been that you’re free to use the assets as you see fit. But an advantage that has now come to the forefront is that Section 179 expensing and first-year bonus depreciation can provide big tax savings in the first year an asset is placed in service.
These two tax breaks were dramatically enhanced by the Tax Cuts and Jobs Act (TCJA) — enough so that you may be convinced to buy assets that your business might have leased in the past. Many businesses will be able to write off the full cost of most equipment in the year it’s purchased. Any remainder is eligible for regular depreciation deductions over IRS-prescribed schedules.
The primary downside of buying fixed assets is that you’re generally required to pay the full cost upfront or in installments, although the Sec. 179 and bonus depreciation tax benefits are still available for property that’s financed. If you finance a purchase through a bank, a down payment of at least 20% of the cost is usually required. This could tie up funds and affect your credit rating. If you decide to finance fixed asset purchases, be aware that the TCJA limits interest expense deductions (for businesses with more than $25 million in average annual gross receipts) to 30% of adjusted taxable income.
When deciding whether to lease or buy a fixed asset, there are a multitude of factors to consider, including tax implications. We can help you determine the approach that best suits your circumstances.
Shakespeare’s words don’t apply just to Julius Caesar; they also apply to calendar-year partnerships, S corporations and limited liability companies (LLCs) treated as partnerships or S corporations for tax purposes. Why? The Ides of March, more commonly known as March 15, is the federal income tax filing deadline for these “pass-through” entities.
Until the 2016 tax year, the filing deadline for partnerships was the same as that for individual taxpayers: April 15 (or shortly thereafter if April 15 fell on a weekend or holiday). One of the primary reasons for moving up the partnership filing deadline was to make it easier for owners to file their personal returns by the April filing deadline. After all, partnership (and S corporation) income passes through to the owners. The earlier date allows owners to use the information contained in the pass-through entity forms to file their personal returns.
For partnerships with fiscal year ends, tax returns are now due the 15th day of the third month after the close of the tax year. The same deadline applies to fiscal-year S corporations. Under prior law, returns for fiscal-year partnerships were due the 15th day of the fourth month after the close of the fiscal tax year.
Avoiding a tragedy
If you haven’t filed your calendar-year partnership or S corporation return yet and are worried about having sufficient time to complete it, you can avoid the tragedy of a late return by filing for an extension. Under the current law, the maximum extension for calendar-year partnerships is six months (until September 16, 2019, for 2018 returns). This is up from five months under the old law. So the extension deadline is the same — only the length of the extension has changed. The extension deadline for calendar-year S corporations also is September 16, 2019, for 2018 returns.
Whether you’ll be filing a partnership or an S corporation return, you must file for the extension by March 15 if it’s a calendar-year entity.
Extending the drama
Filing for an extension can be tax-smart if you’re missing critical documents or you face unexpected life events that prevent you from devoting sufficient time to your return right now.
But to avoid potential interest and penalties, you still must (with a few exceptions) pay any tax due by the unextended deadline. There probably won’t be any tax liability from the partnership or S corporation return. But, if filing for an extension for the entity return causes you to also have to file an extension for your personal return, it could cause you to owe interest and penalties in relation to your personal return.
We can help you file your tax returns on a timely basis or determine whether filing for an extension is appropriate. Contact us today.
If you run your business from your home or perform certain functions at home that are related to your business, you might be able to claim a home office deduction against your business income on your 2018 income tax return. Thanks to a tax law change back in 2013, there are now two methods for claiming this deduction: the actual expenses method and the simplified method.
Basics of the deduction
In general, you’ll qualify for a home office deduction if part of your home is used “regularly and exclusively” as your principal place of business.
If your home isn’t your principal place of business, you may still be able to deduct home office expenses if 1) you physically meet with patients, clients or customers on your premises, or 2) you use a storage area in your home (or a separate free-standing structure, such as a garage) exclusively and regularly for your business.
Traditionally, taxpayers have deducted actual expenses when they claim a home office deduction. Deductible home office expenses may include:
- Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,
- A proportionate share of indirect expenses, such as mortgage interest, property taxes, utilities, repairs and insurance, and
- A depreciation allowance.
But keeping track of actual expenses can be time consuming.
The simplified method
Fortunately, there’s a simplified method that’s been available since 2013: You can deduct $5 for each square foot of home office space, up to a maximum total of $1,500.
For example, if you’ve converted a 300-square-foot bedroom to an office you use exclusively and regularly for business, you can write off $1,500 under the simplified method (300 square feet x $5). However, if your business is located in a 600-square-foot finished basement, the deduction will still be only $1,500 because of the cap on the deduction under this method.
As you can see, the cap can make the simplified method less beneficial for larger home office spaces. But even for spaces of 300 square feet or less, taxpayers may qualify for a bigger deduction using the actual expense method. So, tracking your actual expenses can be worth the extra hassle.
Flexibility in filing
When claiming the home office deduction, you’re not locked into a particular method. For instance, you might choose the actual expense method on your 2018 return, use the simplified method when you file your 2019 return next year and then switch back to the actual expense method thereafter. The choice is yours.
Unsure whether you qualify for the home office deduction? Or wondering whether you should deduct actual expenses or use the simplified method? Contact us. We can help you determine what’s right for your specific situation.
Limited liability company (LLC) members commonly claim that their distributive shares of LLC income — after deducting compensation for services in the form of guaranteed payments — aren’t subject to self-employment (SE) tax. But the IRS has been cracking down on LLC members it claims have underreported SE income, with some success in court.
SE tax background
Self-employment income is subject to a 12.4% Social Security tax (up to the wage base) and a 2.9% Medicare tax. Generally, if you’re a member of a partnership — including an LLC taxed as a partnership — that conducts a trade or business, you’re considered self-employed.
General partners pay SE tax on all their business income from the partnership, whether it’s distributed or not. Limited partners, however, are subject to SE tax only on any guaranteed payments for services they provide to the partnership. The rationale is that limited partners, who have no management authority, are more akin to passive investors.
(Note, however, that “service partners” in service partnerships, such as law firms, medical practices, and architecture and engineering firms, generally may not claim limited partner status regardless of their level of participation.)
Over the years, many LLC members have taken the position that they’re equivalent to limited partners and, therefore, exempt from SE tax (except on guaranteed payments for services). But there’s a big difference between limited partners and LLC members. Both enjoy limited personal liability, but, unlike limited partners, LLC members can actively participate in management without jeopardizing their liability protection.
Arguably, LLC members who are active in management or perform substantial services related to the LLC’s business are subject to SE tax, while those who more closely resemble passive investors should be treated like limited partners. The IRS issued proposed regulations to that effect in 1997, but hasn’t finalized them — although it follows them as a matter of internal policy.
Some LLC members have argued that the IRS’s failure to finalize the regulations supports the claim that their distributive shares aren’t subject to SE tax. But the IRS routinely rejects this argument and has successfully litigated its position. The courts generally have imposed SE tax on LLC members unless, like traditional limited partners, they lack management authority and don’t provide significant services to the business.
Review your situation
The law in this area remains uncertain, particularly with regard to capital-intensive businesses. But given the IRS’s aggressiveness in collecting SE taxes from LLCs, LLC members should assess whether the IRS might claim that they’ve underpaid SE taxes.
Those who wish to avoid or reduce these taxes in the future may have some options, including converting to an S corporation or limited partnership, or restructuring their ownership interests. When evaluating these strategies, there are issues to consider beyond taxes. Contact us to discuss your specific situation.
The flat 21% federal income tax rate for C corporations under the Tax Cuts and Jobs Act (TCJA) has been great news for these entities and their owners. But some fundamental tax truths for C corporations largely remain the same:
C corporations are subject to double taxation. Double taxation occurs when corporate income is taxed once at the corporate level and again at the shareholder level as dividends are paid out. The cost of double taxation, however, is now generally less because of the 21% corporate rate.
And double taxation isn’t a problem when a C corporation needs to retain all its earnings to finance growth and capital investments. Because all the earnings stay “inside” the corporation, no dividends are paid to shareholders, and, therefore, there’s no double taxation.
Double taxation also isn’t an issue when a C corporation’s taxable income levels are low. This can often be achieved by paying reasonable salaries and bonuses to shareholder-employees and providing them with tax-favored fringe benefits (deductible by the corporation and tax-free to the recipient shareholder-employees).
C corporation status isn’t generally advisable for ventures with appreciating assets or certain depreciable assets. If assets such as real estate are eventually sold for substantial gains, it may be impossible to extract the profits from the corporation without being subject to double taxation. In contrast, if appreciating assets are held by a pass-through entity (such as an S corporation, partnership or limited liability company treated as a partnership for tax purposes), gains on such sales will be taxed only once, at the owner level.
But assets held by a C corporation don’t necessarily have to appreciate in value for double taxation to occur. Depreciation lowers the tax basis of the property, so a taxable gain results whenever the sale price exceeds the depreciated basis. In effect, appreciation can be caused by depreciation when depreciable assets hold their value.
To avoid this double-taxation issue, you might consider using a pass-through entity to lease to your C corporation appreciating assets or depreciable assets that will hold their value.
C corporation status isn’t generally advisable for ventures that will incur ongoing tax losses. When a venture is set up as a C corporation, losses aren’t passed through to the owners (the shareholders) like they would be in a pass-through entity. Instead, they create corporate net operating losses (NOLs) that can be carried over to future tax years and then used to offset any corporate taxable income.
This was already a potential downside of C corporations, because it can take many years for a start-up to be profitable. Now, under the TCJA, NOLs that arise in tax years beginning after 2017 can’t offset more than 80% of taxable income in the NOL carryover year. So it may take even longer to fully absorb tax losses.
Do you have questions about C corporation tax issues post-TCJA? Contact us.
Depreciation-related breaks on business real estate: What you need to know when you file your 2018 return
Commercial buildings and improvements generally are depreciated over 39 years, which essentially means you can deduct a portion of the cost every year over the depreciation period. (Land isn’t depreciable.) But special tax breaks that allow deductions to be taken more quickly are available for certain real estate investments.
Some of these were enhanced by the Tax Cuts and Jobs Act (TCJA) and may provide a bigger benefit when you file your 2018 tax return. But there’s one break you might not be able to enjoy due to a drafting error in the TCJA.
Section 179 expensing
This allows you to deduct (rather than depreciate over a number of years) qualified improvement property — a definition expanded by the TCJA from qualified leasehold-improvement, restaurant and retail-improvement property. The TCJA also allows Sec. 179 expensing for certain depreciable tangible personal property used predominantly to furnish lodging and for the following improvements to nonresidential real property: roofs, HVAC equipment, fire protection and alarm systems, and security systems.
Under the TCJA, for qualifying property placed in service in tax years starting in 2018, the expensing limit increases to $1 million (from $510,000 for 2017), subject to a phaseout if your qualified asset purchases for the year exceed $2.5 million (compared to $2.03 million for 2017). These amounts will be adjusted annually for inflation, and for 2019 they’re $1.02 million and $2.55 million, respectively.
This break allows a shortened recovery period of 15 years for qualified improvement property. Before the TCJA, the break was available only for qualified leasehold-improvement, restaurant and retail-improvement property.
This additional first-year depreciation allowance is available for qualified assets, which before the TCJA included qualified improvement property. But due to a drafting error in the new law, qualified improvement property will be eligible for bonus depreciation only if a technical correction is issued.
When available, bonus depreciation is increased to 100% (up from 50%) for qualified property placed in service after Sept. 27, 2017, but before Jan. 1, 2023. For 2023 through 2026, bonus depreciation is scheduled to be gradually reduced. Warning: Under the TCJA, real estate businesses that elect to deduct 100% of their business interest will be ineligible for bonus depreciation starting in 2018.
Can you benefit?
Although the enhanced depreciation-related breaks may offer substantial savings on your 2018 tax bill, it’s possible they won’t prove beneficial over the long term. Taking these deductions now means forgoing deductions that could otherwise be taken later, over a period of years under normal depreciation schedules. In some situations — such as if in the future your business could be in a higher tax bracket or tax rates go up — the normal depreciation deductions could be more valuable long-term.
For more information on these breaks or advice on whether you should take advantage of them, please contact us.
A variety of tax-related limits affecting businesses are annually indexed for inflation, and many have gone up for 2019. Here’s a look at some that may affect you and your business.
- Section 179 expensing:
- Limit: $1.02 million (up from $1 million)
- Phaseout: $2.55 million (up from $2.5 million)
- Income-based phase-ins for certain limits on the Sec. 199A qualified business income deduction:
- Married filing jointly: $321,400-$421,400 (up from $315,000-$415,000)
- Married filing separately: $160,725-$210,725 (up from $157,500-$207,500)
- Other filers: $160,700-$210,700 (up from $157,500-$207,500)
- Employee contributions to 401(k) plans: $19,000 (up from $18,500)
- Catch-up contributions to 401(k) plans: $6,000 (no change)
- Employee contributions to SIMPLEs: $13,000 (up from $12,500)
- Catch-up contributions to SIMPLEs: $3,000 (no change)
- Combined employer/employee contributions to defined contribution plans (not including catch-ups): $56,000 (up from $55,000)
- Maximum compensation used to determine contributions: $280,000 (up from $275,000)
- Annual benefit for defined benefit plans: $225,000 (up from $220,000)
- Compensation defining “highly compensated employee”: $125,000 (up from $120,000)
- Compensation defining “key employee”: $180,000 (up from $175,000)
Other employee benefits
- Qualified transportation fringe-benefits employee income exclusion: $265 per month (up from $260)
- Health Savings Account contributions:
- Individual coverage: $3,500 (up from $3,450)
- Family coverage: $7,000 (up from $6,900)
- Catch-up contribution: $1,000 (no change)
- Flexible Spending Account contributions:
- Health care: $2,700 (up from $2,650)
- Dependent care: $5,000 (no change)
Additional rules apply to these limits, and they are only some of the limits that may affect your business. Please contact us for more information.
This year, the optional standard mileage rate used to calculate the deductible costs of operating an automobile for business increased by 3.5 cents, to the highest level since 2008. As a result, you might be able to claim a larger deduction for vehicle-related expense for 2019 than you can for 2018.
Actual costs vs. mileage rate
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 depreciation write-offs on vehicles are subject to certain limits that don’t apply to other types of business assets.
The mileage rate comes into play when taxpayers don’t want to keep track of actual vehicle-related expenses. With this approach, you don’t have to account for all your actual expenses, although you still must record certain information, such as the mileage for each business trip, the date and the destination.
The mileage rate approach also is popular with businesses that reimburse employees for business use of their personal automobiles. Such reimbursements can help attract and retain employees who’re expected to drive their personal vehicle extensively for business purposes. Why? Under the Tax Cuts and Jobs Act, employees can no longer deduct unreimbursed employee business expenses, such as business mileage, on their individual income tax returns.
But be aware that you must comply with various rules. If you don’t, you risk having the reimbursements considered taxable wages to the employees.
The 2019 rate
Beginning on January 1, 2019, the standard mileage rate for the business use of a car (van, pickup or panel truck) is 58 cents per mile. For 2018, the rate was 54.5 cents per mile.
The business cents-per-mile rate is adjusted annually. It is 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 is a substantial change in average gas prices, the IRS will change the mileage rate midyear.
There are certain situations where you can’t use the cents-per-mile rate. It depends in part on how you’ve claimed deductions for the same vehicle in the past or, if the vehicle is new to your business this year, whether you want to take advantage of certain first-year depreciation breaks on it.
As you can see, there are many variables to consider in determining whether to use the mileage rate to deduct vehicle expenses. Contact us if you have questions about tracking and claiming such expenses in 2019 — or claiming them on your 2018 income tax return.
There aren’t too many things businesses can do after a year ends to reduce tax liability for that year. However, you might be able to pay employee bonuses for 2018 in 2019 and still deduct them on your 2018 tax return. In certain circumstances, businesses can deduct bonuses employees have earned during a tax year if the bonuses are paid within 2½ months after the end of that year (by March 15 for a calendar-year company).
First, only accrual-basis taxpayers can take advantage of the 2½ month rule. Cash-basis taxpayers must deduct bonuses in the year they’re paid, regardless of when they’re earned.
Second, even for accrual-basis taxpayers, the 2½ month rule isn’t automatic. The bonuses can be deducted on the tax return for the year they’re earned only if the business’s bonus liability was fixed by the end of the year.
Passing the test
For accrual-basis taxpayers, a liability (such as a bonus) is deductible when it is incurred. To determine this, the IRS applies the “all-events test.” Under this test, a liability is incurred when:
- All events have occurred that establish the taxpayer’s liability,
- The amount of the liability can be determined with reasonable accuracy, and
- Economic performance has occurred.
Generally, the last requirement isn’t an issue; it’s satisfied when an employee performs the services required to earn a bonus. But the first two requirements can delay your tax deduction until the year of payment, depending on how your bonus plan is designed.
For example, many bonus plans require an employee to still be an employee on the payment date to receive the bonus. Even when the amount of each employee’s bonus is fixed at the end of the tax year, if employees who leave the company before the payment date forfeit their bonuses, the all-events test isn’t satisfied until the payment date. Why? The business’s liability for bonuses isn’t fixed until then.
Diving into a bonus pool
Fortunately, it’s possible to accelerate deductions with a carefully designed bonus pool arrangement. According to the IRS, employers may deduct bonuses in the year they’re earned — even if there’s a risk of forfeiture — as long as any forfeited bonuses are reallocated among the remaining employees in the bonus pool rather than retained by the employer.
Under such a plan, an employer satisfies the all-events test because the aggregate bonus amount is fixed at the end of the year. It doesn’t matter that amounts allocated to specific employees aren’t determined until the payment date.
When you can deduct bonuses
So does your current bonus plan allow you to take 2018 deductions for bonuses paid in early 2019? If you’re not sure, contact us. We can review your situation and determine when you can deduct your bonus payments.
If you’re an accrual taxpayer but don’t qualify to accelerate your bonus deductions this time, we can help you design a bonus plan for 2019 that will allow you to accelerate deductions when you file your 2019 return next year.
The dawning of 2019 means the 2018 income tax filing season will soon be upon us. After year end, it’s generally too late to take action to reduce 2018 taxes. Business owners may, therefore, want to shift their focus to assessing whether they’ll likely owe taxes or get a refund when they file their returns this spring, so they can plan accordingly.
With the biggest tax law changes in decades — under the Tax Cuts and Jobs Act (TCJA) — generally going into effect beginning in 2018, most businesses and their owners will be significantly impacted. So, refreshing yourself on the major changes is a good idea.
Taxation of pass-through entities
These changes generally affect owners of S corporations, partnerships and limited liability companies (LLCs) treated as partnerships, as well as sole proprietors:
- Drops of individual income tax rates ranging from 0 to 4 percentage points (depending on the bracket) to 10%, 12%, 22%, 24%, 32%, 35% and 37%
- A new 20% qualified business income deduction for eligible owners (the Section 199A deduction)
- Changes to many other tax breaks for individuals that will impact owners’ overall tax liability
Taxation of corporations
These changes generally affect C corporations, personal service corporations (PSCs) and LLCs treated as C corporations:
- Replacement of graduated corporate rates ranging from 15% to 35% with a flat corporate rate of 21%
- Replacement of the flat PSC rate of 35% with a flat rate of 21%
- Repeal of the 20% corporate alternative minimum tax (AMT)
Tax break positives
These changes generally apply to both pass-through entities and corporations:
- Doubling of bonus depreciation to 100% and expansion of qualified assets to include used assets
- Doubling of the Section 179 expensing limit to $1 million and an increase of the expensing phaseout threshold to $2.5 million
- A new tax credit for employer-paid family and medical leave
Tax break negatives
These changes generally also apply to both pass-through entities and corporations:
- A new disallowance of deductions for net interest expense in excess of 30% of the business’s adjusted taxable income (exceptions apply)
- New limits on net operating loss (NOL) deductions
- Elimination of the Section 199 deduction (not to be confused with the new Sec.199A deduction), which was for qualified domestic production activities and commonly referred to as the “manufacturers’ deduction”
- A new rule limiting like-kind exchanges to real property that is not held primarily for sale (generally no more like-kind exchanges for personal property)
- New limitations on deductions for certain employee fringe benefits, such as entertainment and, in certain circumstances, meals and transportation
Preparing for 2018 filing
Keep in mind that additional rules and limits apply to the rates and breaks covered here. Also, these are only some of the most significant and widely applicable TCJA changes; you and your business could be affected by other changes as well. Contact us to learn precisely how you might be affected and for help preparing for your 2018 tax return filing — and beginning to plan for 2019, too.
Tax planning is a juggling act for business owners. You have to keep your eye on your company’s income and expenses and applicable tax breaks (especially if you own a pass-through entity). But you also must look out for your own financial future.
For example, you need to develop an exit strategy so that taxes don’t trip you up when you retire or leave the business for some other reason. An exit strategy is a plan for passing on responsibility for running the company, transferring ownership and extracting your money from the business.
When a business has more than one owner, a buy-sell agreement can be a powerful tool. The agreement controls what happens to the business when a specified event occurs, such as an owner’s retirement, disability or death. Among other benefits, a well-drafted agreement:
- Provides a ready market for the departing owner’s shares,
- Prescribes a method for setting a price for the shares, and
- Allows business continuity by preventing disagreements caused by new owners.
A key issue with any buy-sell agreement is providing the buyer(s) with a means of funding the purchase. Life or disability insurance often helps fulfill this need and can give rise to several tax issues and opportunities. One of the biggest advantages of life insurance as a funding method is that proceeds generally are excluded from the beneficiary’s taxable income.
Succession within the family
You can pass your business on to family members by giving them interests, selling them interests or doing some of each. Be sure to consider your income needs, the tax consequences, and how family members will feel about your choice.
Under the annual gift tax exclusion, you can gift up to $15,000 of ownership interests without using up any of your lifetime gift and estate tax exemption. Valuation discounts may further reduce the taxable value of the gift.
With the gift and estate tax exemption approximately doubled through 2025 ($11.4 million for 2019), gift and estate taxes may be less of a concern for some business owners. But others may want to make substantial transfers now to take maximum advantage of the high exemption. What’s right for you will depend on the value of your business and your timeline for transferring ownership.
If you don’t have co-owners or want to pass the business to family members, other options include a management buyout, an employee stock ownership plan (ESOP) or a sale to an outsider. Each involves a variety of tax and nontax considerations.
Please contact us to discuss your exit strategy. To be successful, your strategy will require planning well in advance of the transition.
Tax planning is a year-round activity, but there are still some year-end strategies you can use to lower your 2018 tax bill. Here are six last-minute tax moves business owners should consider:
- 1. Postpone invoices. If your business uses the cash method of accounting, and it would benefit from deferring income to next year, wait until early 2019 to send invoices. Accrual-basis businesses can defer recognition of certain advance payments for products to be delivered or services to be provided next year.
- 2. Prepay expenses. A cash-basis business may be able to reduce its 2018 taxes by prepaying certain expenses — such as lease payments, insurance premiums, utility bills, office supplies and taxes — before the end of the year. Many expenses can be deducted up to 12 months in advance.
- 3. Buy equipment. Take advantage of 100% bonus depreciation and Section 179 expensing to deduct the full cost of qualifying equipment or other fixed assets. Under the Tax Cuts and Jobs Act, bonus depreciation, like Sec. 179 expensing, is now available for both new and used assets. Keep in mind that, to deduct the expense on your 2018 return, the assets must be placed in service — not just purchased — by the end of the year.
- 4. Use credit cards. What if you’d like to prepay expenses or buy equipment before the end of the year, but you don’t have the cash? Consider using your business credit card. Generally, expenses paid by credit card are deductible when charged, even if you don’t pay the credit card bill until next year.
- 5. Contribute to retirement plans. If you’re self-employed or own a pass-through business — such as a partnership, limited liability company or S corporation — one of the best ways to reduce your 2018 tax bill is to increase deductible contributions to retirement plans. Usually, these contributions must be made by year-end. But certain plans — such as SEP IRAs — allow your business to make 2018 contributions up until its tax return due date (including extensions).
- 6. Qualify for the pass-through deduction. If your business is a sole proprietorship or pass-through entity, you may qualify for the new pass-through deduction of up to 20% of qualified business income. But if your taxable income exceeds $157,500 ($315,000 for joint filers), certain limitations kick in that can reduce or even eliminate the deduction. One way to avoid these limitations is to reduce your income below the threshold — for example, by having your business increase its retirement plan contributions.
Most of these strategies are subject to various limitations and restrictions beyond what we’ve covered here, so please consult us before you implement them. We can also offer more ideas for reducing your taxes this year and next.
As the year winds to a close, most businesses see employees taking a lot of vacation time. After all, it’s the holiday season, and workers want to enjoy it. Some businesses, however, find themselves particularly short-staffed in December because they don’t allow unused paid time off (PTO) to be rolled over to the new year, or they allow only very limited rollovers.
There are good business reasons to limit PTO rollovers. Fortunately, there’s a way to reduce the year-end PTO vortex without having to allow unlimited rollovers: a PTO contribution arrangement.
Retirement saving with a twist
A PTO contribution arrangement allows employees with unused vacation hours to elect to convert them to retirement plan contributions. If the plan has a 401(k) feature, it can treat these amounts as a pretax benefit, similar to normal employee deferrals. Alternatively, the plan can treat the amounts as employer profit sharing, converting excess PTO amounts to employer contributions.
This can be appealing to any employees who end up with a lot of PTO left at the end of the year and don’t want to lose it. But it can be especially valued by employees who are concerned about their level of retirement saving or who simply value money more than time off of work.
Good for the business
Of course the biggest benefit to your business may simply be that it’s easier to ensure you have sufficient staffing at the end of the year. But you could reap that same benefit by allowing PTO rollovers (or, if you allow some rollover, increasing the rollover limit).
A PTO contribution arrangement can be a better option than increasing the number of days employees can roll over. Why? Larger rollover limits can result in employees building up large balances that create a significant liability on your books.
Also, a PTO contribution arrangement might help you improve recruiting and retention, because of its appeal to employees who want to save more for retirement or don’t care about having a lot of PTO.
Set-up is simple
To offer a PTO contribution arrangement, simply amend your retirement plan. However, you must still follow the plan document’s eligibility, vesting, rollover, distribution and loan terms. Additional rules apply.
Have questions about PTO contribution arrangements? Contact us. We can help you assess whether such an arrangement would make sense for your business.
Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2019. 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.
- File 2018 Forms W-2, “Wage and Tax Statement,” with the Social Security Administration and provide copies to your employees.
- Provide copies of 2018 Forms 1099-MISC, “Miscellaneous Income,” to recipients of income from your business where required.
- File 2018 Forms 1099-MISC reporting nonemployee compensation payments in Box 7 with the IRS.
- File Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” for 2018. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it’s more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 11 to file the return.
- File Form 941, “Employer’s Quarterly Federal Tax Return,” to report Medicare, Social Security and income taxes withheld in the fourth quarter of 2018. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until February 11 to file the return. (Employers that have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944,“Employer’s Annual Federal Tax Return.”)
- File Form 945, “Annual Return of Withheld Federal Income Tax,” for 2018 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on accounts such as pensions, annuities and IRAs. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 11 to file the return.
- File 2018 Forms 1099-MISC with the IRS if 1) they’re not required to be filed earlier and 2) you’re filing paper copies. (Otherwise, the filing deadline is April 1.)
- If a calendar-year partnership or S corporation, file or extend your 2018 tax return and pay any tax due. If the return isn’t extended, this is also the last day to make 2018 contributions to pension and profit-sharing plans.
The holiday season is a great time for businesses to show their appreciation for employees and customers by giving them gifts or hosting holiday parties. Before you begin shopping or sending out invitations, though, it’s a good idea to find out whether the expense is tax deductible and whether it’s taxable to the recipient. Here’s a brief review of the rules.
Gifts to customers
When you make gifts to customers, the gifts are deductible up to $25 per recipient per year. For purposes of the $25 limit, you need not include “incidental” costs that don’t substantially add to the gift’s value, such as engraving, gift-wrapping, packaging or shipping. Also excluded from the $25 limit is branded marketing collateral — such as pens or stress balls imprinted with your company’s name and logo — provided they’re widely distributed and cost less than $4.
The $25 limit is for gifts to individuals. There’s no set limit on gifts to a company (a gift basket for all to share, for example) as long as they’re “reasonable.”
Gifts to employees
Generally anything of value that you transfer to an employee is included in the employee’s taxable income (and, therefore, subject to income and payroll taxes) and deductible by you. But there’s an exception for noncash gifts that constitute “de minimis fringe benefits.”
These are items so small in value and given so infrequently that it would be administratively impracticable to account for them. Common examples include holiday turkeys or hams, gift baskets, occasional sports or theater tickets (but not season tickets), and other low-cost merchandise.
De minimis fringe benefits are not included in an employee’s taxable income yet are still deductible by you. Unlike gifts to customers, there’s no specific dollar threshold for de minimis gifts. However, many businesses use an informal cutoff of $75.
Keep in mind that cash gifts — as well as cash equivalents, such as gift cards — are included in an employee’s income and subject to payroll tax withholding regardless of how small and infrequent.
The Tax Cuts and Jobs Act reduced certain deductions for business-related meals and eliminated the deduction for business entertainment altogether. There’s an exception, however, for certain recreational activities, including holiday parties.
Holiday parties are fully deductible (and excludible from recipients’ income) provided they’re primarily for the benefit of non-highly-compensated employees and their families. If customers also attend, holiday parties may be partially deductible.
Gifts that give back
If you’re thinking about giving holiday gifts to employees or customers or throwing a holiday party, contact us. With a little tax planning, you may receive a gift of your own from Uncle Sam.
Under the Tax Cuts and Jobs Act (TCJA), many more businesses are now eligible to use the cash method of accounting for federal tax purposes. The cash method offers greater tax-planning flexibility, allowing some businesses to defer taxable income. Newly eligible businesses should determine whether the cash method would be advantageous and, if so, consider switching methods.
Previously, the cash method was unavailable to certain businesses, including:
- C corporations — as well as partnerships (or limited liability companies taxed as partnerships) with C corporation partners — whose average annual gross receipts for the previous three tax years exceeded $5 million, and
- Businesses required to account for inventories, whose average annual gross receipts for the previous three tax years exceeded $1 million ($10 million for certain industries).
In addition, construction companies whose average annual gross receipts for the previous three tax years exceeded $10 million were required to use the percentage-of-completion method (PCM) to account for taxable income from long-term contracts (except for certain home construction contracts). Generally, the PCM method is less favorable, from a tax perspective, than the completed-contract method.
The TCJA raised all of these thresholds to $25 million, beginning with the 2018 tax year. In other words, if your business’s average gross receipts for the previous three tax years is $25 million or less, you generally now will be eligible for the cash method, regardless of how your business is structured, your industry or whether you have inventories. And construction firms under the threshold need not use PCM for jobs expected to be completed within two years.
You’re also eligible for streamlined inventory accounting rules. And you’re exempt from the complex uniform capitalization rules, which require certain expenses to be capitalized as inventory costs.
Should you switch?
If you’re eligible to switch to the cash method, you need to determine whether it’s the right method for you. Usually, if a business’s receivables exceed its payables, the cash method will allow more income to be deferred than will the accrual method. (Note, however, that the TCJA has a provision that limits the cash method’s advantages for businesses that prepare audited financial statements or file their financial statements with certain government entities.) It’s also important to consider the costs of switching, which may include maintaining two sets of books.
The IRS has established procedures for obtaining automatic consent to such a change, beginning with the 2018 tax year, by filing Form 3115 with your tax return. Contact us to learn more.
If most of your money is tied up in your business, retirement can be a challenge. So if you haven’t already set up a tax-advantaged retirement plan, consider doing so this year. There’s still time to set one up and make contributions that will be deductible on your 2018 tax return!
Not only are contributions tax deductible, but retirement plan funds can grow tax-deferred. If you might be subject to the 3.8% net investment income tax (NIIT), setting up and contributing to a retirement plan may be particularly beneficial because retirement plan contributions can reduce your modified adjusted gross income and thus help you reduce or avoid the NIIT.
If you have employees, they generally must be allowed to participate in the plan, provided they meet the qualification requirements. But this can help you attract and retain good employees.
And if you have 100 or fewer employees, you may be eligible for a credit for setting up a plan. The credit is for 50% of start-up costs, up to $500. Remember, credits reduce your tax liability dollar-for-dollar, unlike deductions, which only reduce the amount of income subject to tax.
3 options to consider
Many types of retirement plans are available, but here are three of the most attractive to business owners trying to build up their own retirement savings:
1. Profit-sharing plan. This is a defined contribution plan that allows discretionary employer contributions and flexibility in plan design. You can make deductible 2018 contributions as late as the due date of your 2018 tax return, including extensions — provided your plan exists on Dec. 31, 2018. For 2018, the maximum contribution is $55,000, or $61,000 if you are age 50 or older and your plan includes a 401(k) arrangement.
2. Simplified Employee Pension (SEP). This is also a defined contribution plan, and it provides benefits similar to those of a profit-sharing plan. But you can establish a SEP in 2019 and still make deductible 2018 contributions as late as the due date of your 2018 income tax return, including extensions. In addition, a SEP is easy to administer. For 2018, the maximum SEP contribution is $55,000.
3. Defined benefit plan. This plan sets a future pension benefit and then actuarially calculates the contributions needed to attain that benefit. The maximum annual benefit for 2018 is generally $220,000 or 100% of average earned income for the highest three consecutive years, if less. Because it’s actuarially driven, the contribution needed to attain the projected future annual benefit may exceed the maximum contributions allowed by other plans, depending on your age and the desired benefit.
You can make deductible 2018 defined benefit plan contributions until your tax return due date, including extensions, provided your plan exists on Dec. 31, 2018. Be aware that employer contributions generally are required.
If the benefits of setting up a retirement plan sound good, contact us. We can provide more information and help you choose the best retirement plan for your particular situation.
The Tax Cuts and Jobs Act (TCJA) has enhanced two depreciation-related breaks that are popular year-end tax planning tools for businesses. To take advantage of these breaks, you must purchase qualifying assets and place them in service by the end of the tax year. That means there’s still time to reduce your 2018 tax liability with these breaks, but you need to act soon.
Section 179 expensing
Sec. 179 expensing is valuable because it allows businesses to deduct up to 100% of the cost of qualifying assets in Year 1 instead of depreciating the cost over a number of years. Sec. 179 expensing can be used for assets such as equipment, furniture and software. Beginning in 2018, the TCJA expanded the list of qualifying assets to include qualified improvement property, certain property used primarily to furnish lodging and the following improvements to nonresidential real property: roofs, HVAC equipment, fire protection and alarm systems, and security systems.
The maximum Sec. 179 deduction for 2018 is $1 million, up from $510,000 for 2017. The deduction begins to phase out dollar-for-dollar for 2018 when total asset acquisitions for the tax year exceed $2.5 million, up from $2.03 million for 2017.
100% bonus depreciation
For qualified assets that your business places in service in 2018, the TCJA allows you to claim 100% first-year bonus depreciation -- compared to 50% in 2017. This break is available when buying computer systems, software, machinery, equipment and office furniture. The TCJA has expanded eligible assets to include used assets; previously, only new assets were eligible.
However, due to a TCJA drafting error, qualified improvement property will be eligible only if a technical correction is issued. Also be aware that, under the TCJA, certain businesses aren’t eligible for bonus depreciation in 2018, such as real estate businesses that elect to deduct 100% of their business interest and auto dealerships with floor plan financing (if the dealership has average annual gross receipts of more than $25 million for the three previous tax years).
Traditional, powerful strategy
Keep in mind that Sec. 179 expensing and bonus depreciation can also be used for business vehicles. So purchasing vehicles before year end could reduce your 2018 tax liability. But, depending on the type of vehicle, additional limits may apply.
Investing in business assets is a traditional and powerful year-end tax planning strategy, and it might make even more sense in 2018 because of the TCJA enhancements to Sec. 179 expensing and bonus depreciation. If you have questions about these breaks or other ways to maximize your depreciation deductions, please contact us.
The Tax Cuts and Jobs Act (TCJA) didn’t change the federal tax credit for “increasing research activities,” but several TCJA provisions have an indirect impact on the credit. As a result, the research credit may be available to some businesses for the first time.
Previously, corporations subject to alternative minimum tax (AMT) couldn’t offset the research credit against their AMT liability, which erased the benefits of the credit (although they could carry unused research credits forward for up to 20 years and use them in non-AMT years). By eliminating corporate AMT for tax years beginning after 2017, the TCJA removed this obstacle.
Now that the corporate AMT is gone, unused research credits from prior tax years can be offset against a corporation’s regular tax liability and may even generate a refund (subject to certain restrictions). So it’s a good idea for corporations to review their research activities in recent years and amend prior returns if necessary to ensure they claim all the research credits to which they’re entitled.
The TCJA didn’t eliminate individual AMT, but it did increase individuals’ exemption amounts and exemption phaseout thresholds. As a result, fewer owners of sole proprietorships and pass-through businesses are subject to AMT, allowing more of them to enjoy the benefits of the research credit, too.
More to consider
By reducing corporate and individual tax rates, the TCJA also will increase research credits for many businesses. Why? Because the tax code, to prevent double tax benefits, requires businesses to reduce their deductible research expenses by the amount of the credit.
To avoid this result (which increases taxable income), businesses can elect to reduce the credit by an amount calculated at the highest corporate rate that eliminates the double benefit. Because the highest corporate rate has been reduced from 35% to 21%, this amount is lower and, therefore, the research credit is higher.
Keep in mind that the TCJA didn’t affect certain research credit benefits for smaller businesses. Pass-through businesses can still claim research credits against AMT if their average gross receipts are $50 million or less. And qualifying start-ups without taxable income can still claim research credits against up to $250,000 in payroll taxes.
Do your research
If your company engages in qualified research activities, now’s a good time to revisit the credit to be sure you’re taking full advantage of its benefits.
You’ve spent years building your company and now are ready to move on to something else, whether launching a new business, taking advantage of another career opportunity or retiring. Whatever your plans, you want to get the return from your business that you’ve earned from all of the time and money you’ve put into it.
That means not only getting a good price, but also minimizing the tax hit on the proceeds. One option that can help you defer tax and perhaps even reduce it is an installment sale.
With an installment sale, you don’t receive a lump sum payment when the deal closes. Instead, you receive installment payments over a period of time, spreading the gain over a number of years.
This generally defers tax, because you pay most of the tax liability as you receive the payments. Usually tax deferral is beneficial, but it could be especially beneficial if it would allow you to stay under the thresholds for triggering the 3.8% net investment income tax (NIIT) or the 20% long-term capital gains rate.
For 2018, taxpayers with modified adjusted gross income (MAGI) over $200,000 per year ($250,000 for married filing jointly and $125,000 for married filing separately) will owe NIIT on some or all of their investment income. And the 20% long-term capital gains rate kicks in when 2018 taxable income exceeds $425,800 for singles, $452,400 for heads of households and $479,000 for joint filers (half that for separate filers).
An installment sale also might help you close a deal or get a better price for your business. For instance, an installment sale might appeal to a buyer that lacks sufficient cash to pay the price you’re looking for in a lump sum.
Or a buyer might be concerned about the ongoing success of your business without you at the helm or because of changing market or other economic factors. An installment sale that includes a contingent amount based on the business’s performance might be the solution.
An installment sale isn’t without tax risk for sellers. For example, depreciation recapture must be reported as gain in the year of sale, no matter how much cash you receive. So you could owe tax that year without receiving enough cash proceeds from the sale to pay the tax. If depreciation recapture is an issue, be sure you have cash from another source to pay the tax.
It’s also important to keep in mind that, if tax rates increase, the overall tax could end up being more. With tax rates currently quite low historically, there might be a greater chance that they could rise in the future. Weigh this risk carefully against the potential benefits of an installment sale.
Pluses and minuses
As you can see, installment sales have both pluses and minuses. To determine whether one is right for you and your business — and find out about other tax-smart options — please contact us.
As we approach the end of the year, it’s a good idea to review your business’s expenses for deductibility. At the same time, consider whether your business would benefit from accelerating certain expenses into this year.
Be sure to evaluate the impact of the Tax Cuts and Jobs Act (TCJA), which reduces or eliminates many deductions. In some cases, it may be necessary or desirable to change your expense and reimbursement policies.
What’s deductible, anyway?
There’s no master list of deductible business expenses in the Internal Revenue Code (IRC). Although some deductions are expressly authorized or excluded, most are governed by the general rule of IRC Sec. 162, which permits businesses to deduct their “ordinary and necessary” expenses.
An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your business. (It need not be indispensable.) Even if an expense is ordinary and necessary, it may not be deductible if the IRS considers it lavish or extravagant.
What did the TCJA change?
The TCJA contains many provisions that affect the deductibility of business expenses. Significant changes include these deductions:
Meals and entertainment. The act eliminates most deductions for entertainment expenses, but retains the 50% deduction for business meals. What about business meals provided in connection with nondeductible entertainment? In a recent notice, the IRS clarified that such meals continue to be 50% deductible, provided they’re purchased separately from the entertainment or their cost is separately stated on invoices or receipts.
Transportation. The act eliminates most deductions for qualified transportation fringe benefits, such as parking, vanpooling and transit passes. This change may lead some employers to discontinue these benefits, although others will continue to provide them because 1) they’re a valuable employee benefit (they’re still tax-free to employees) or 2) they’re required by local law.
Employee expenses. The act suspends employee deductions for unreimbursed job expenses — previously treated as miscellaneous itemized deductions — through 2025. Some businesses may want to implement a reimbursement plan for these expenses. So long as the plan meets IRS requirements, reimbursements are deductible by the business and tax-free to employees.
The deductibility of certain expenses, such as employee wages or office supplies, is obvious. In other cases, it may be necessary to consult IRS rulings or court cases for guidance. For assistance, please contact us.
In today’s tightening job market, to attract and retain the best employees, small businesses need to offer not only competitive pay, but also appealing fringe benefits. Benefits that are tax-free are especially attractive to employees. Let’s take a quick look at some popular options.
Businesses can provide their employees with various types of insurance on a tax-free basis. Here are some of the most common:
Health insurance. If you maintain a health care plan for employees, coverage under the plan isn’t taxable to them. Employee contributions are excluded from income if pretax coverage is elected under a cafeteria plan. Otherwise, such amounts are included in their wages, but may be deductible on a limited basis as an itemized deduction.
Disability insurance. Your premium payments aren’t included in employees’ income, nor are your contributions to a trust providing disability benefits. Employees’ premium payments (or other contributions to the plan) generally aren’t deductible by them or excludable from their income. However, they can make pretax contributions to a cafeteria plan for disability benefits, which are excludable from their income.
Long-term care insurance. Your premium payments aren’t taxable to employees. However, long-term care insurance can’t be provided through a cafeteria plan.
Life insurance. Your employees generally can exclude from gross income premiums you pay on up to $50,000 of qualified group term life insurance coverage. Premiums you pay for qualified coverage exceeding $50,000 are taxable to the extent they exceed the employee’s coverage contributions.
Other types of tax-advantaged benefits
Insurance isn’t the only type of tax-free benefit you can provide ¬― but the tax treatment of certain benefits has changed under the Tax Cuts and Jobs Act:
Dependent care assistance. You can provide employees with tax-free dependent care assistance up to $5,000 for 2018 though a dependent care Flexible Spending Account (FSA), also known as a Dependent Care Assistance Program (DCAP).
Adoption assistance. For employees who’re adopting children, you can offer an employee adoption assistance program. Employees can exclude from their taxable income up to $13,810 of adoption benefits in 2018.
Educational assistance. You can help employees on a tax-free basis through educational assistance plans (up to $5,250 per year), job-related educational assistance and qualified scholarships.
Moving expense reimbursement. Before the TCJA, if you reimbursed employees for qualifying job-related moving expenses, the reimbursement could be excluded from the employee’s income. The TCJA suspends this break for 2018 through 2025. However, such reimbursements may still be deductible by your business.
Transportation benefits. Qualified employee transportation fringe benefits, such as parking allowances, mass transit passes and van pooling, are tax-free to recipient employees. However, the TCJA suspends through 2025 the business deduction for providing such benefits. It also suspends the tax-free benefit of up to $20 a month for bicycle commuting.
Varying tax treatment
As you can see, the tax treatment of fringe benefits varies. Contact us for more information.
Businesses that acquire, construct or substantially improve a building — or did so in previous years — should consider a cost segregation study. It may allow you to accelerate depreciation deductions, thus reducing taxes and boosting cash flow. And the potential benefits are now even greater due to enhancements to certain depreciation-related breaks under the Tax Cuts and Jobs Act (TCJA).
Real property vs. tangible personal property
IRS rules generally allow you to depreciate commercial buildings over 39 years (27½ years for residential properties). Most times, you’ll depreciate a building’s structural components — such as 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 — fences, outdoor lighting and parking lots, for example — are depreciable over 15 years.
Too often, businesses allocate all or most of a building’s 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 instance — the distinction between real and personal property is obvious. But often the line between the two is 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.
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.
Depreciation break enhancements
Last year’s 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. Sec. 179 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%).
Assess the potential savings
Cost segregation studies may yield substantial benefits, but they’re not right for every business. To find out whether a study would be worthwhile for yours, contact us for help assessing the potential tax savings.
Tax identity theft may seem like a problem only for individual taxpayers. But, according to the IRS, increasingly businesses are also becoming victims. And identity thieves have become more sophisticated, knowing filing practices, the tax code and the best ways to get valuable data.
How it works
In tax identity theft, a taxpayer’s identifying information (such as Social Security number) is used to fraudulently obtain a refund or commit other crimes. Business tax identity theft occurs when a criminal uses the identifying information of a business to obtain tax benefits or to enable individual tax identity theft schemes.
For example, a thief could use an Employer Identification Number (EIN) to file a fraudulent business tax return and claim a refund. Or a fraudster may report income and withholding for fake employees on false W-2 forms. Then, he or she can file fraudulent individual tax returns for these “employees” to claim refunds.
The consequences can include significant dollar amounts, lost time sorting out the mess and damage to your reputation.
There are some red flags that indicate possible tax identity theft. For example, your business’s identity may have been compromised if:
- Your business doesn’t receive expected or routine mailings from the IRS,
- You receive an IRS notice that doesn’t relate to anything your business submitted, that’s about fictitious employees or that’s related to a defunct, closed or dormant business after all account balances have been paid,
- The IRS rejects an e-filed return or an extension-to-file request, saying it already has a return with that identification number — or the IRS accepts it as an amended return,
- You receive an IRS letter stating that more than one tax return has been filed in your business’s name, or
- You receive a notice from the IRS that you have a balance due when you haven’t yet filed a return.
Keep in mind, though, that some of these could be the result of a simple error, such as an inadvertent transposition of numbers. Nevertheless, you should contact the IRS immediately if you receive any notices or letters from the agency that you believe might indicate that someone has fraudulently used your Employer Identification Number.
Businesses should take steps such as the following to protect their own information as well as that of their employees:
- Provide training to accounting, human resources and other employees to educate them on the latest tax fraud schemes and how to spot phishing emails.
- Use secure methods to send W-2 forms to employees.
- Implement risk management strategies designed to flag suspicious communications.
Of course identity theft can go beyond tax identity theft, so be sure to have a comprehensive plan in place to protect the data of your business, your employees and your customers. If you’re concerned your business has become a victim, or you have questions about prevention, please contact us.
Does your business reimburse employees’ work-related travel expenses? If you do, you know that it can help you attract and retain employees. If you don’t, you might want to start, because changes under the Tax Cuts and Jobs Act (TCJA) make such reimbursements even more attractive to employees. Travel reimbursements also come with tax benefits, but only if you follow a method that passes muster with the IRS.
The TCJA’s impact
Before the TCJA, unreimbursed work-related travel expenses generally were deductible on an employee’s individual tax return (subject to a 50% limit for meals and entertainment) as a miscellaneous itemized deduction. However, many employees weren’t able to benefit from the deduction because either they didn’t itemize deductions or they didn’t have enough miscellaneous itemized expenses to exceed the 2% of adjusted gross income (AGI) floor that applied.
For 2018 through 2025, the TCJA suspends miscellaneous itemized deductions subject to the 2% of AGI floor. That means even employees who itemize deductions and have enough expenses that they would exceed the floor won’t be able to enjoy a tax deduction for business travel. Therefore, business travel expense reimbursements are now more important to employees.
The potential tax benefits
Your business can deduct qualifying reimbursements, and they’re excluded from the employee’s taxable income. The deduction is subject to a 50% limit for meals. But, under the TCJA, entertainment expenses are no longer deductible.
To be deductible and excludable, travel expenses must be legitimate business expenses and the reimbursements must comply with IRS rules. You can use either an accountable plan or the per diem method to ensure compliance.
Reimbursing actual expenses
An accountable plan is a formal arrangement to advance, reimburse or provide allowances for business expenses. To qualify as “accountable,” your plan must meet the following criteria:
- Payments must be for “ordinary and necessary” business expenses.
- Employees must substantiate these expenses — including amounts, times and places — ideally at least monthly.
- Employees must return any advances or allowances they can’t substantiate within a reasonable time, typically 120 days.
The IRS will treat plans that fail to meet these conditions as nonaccountable, transforming all reimbursements into wages taxable to the employee, subject to income taxes (employee) and employment taxes (employer and employee).
Keeping it simple
With the per diem method, instead of tracking actual expenses, you use IRS tables to determine reimbursements for lodging, meals and incidental expenses, or just for meals and incidental expenses, based on location. (If you don’t go with the per diem method for lodging, you’ll need receipts to substantiate those expenses.)
Be sure you don’t pay employees more than the appropriate per diem amount. The IRS imposes heavy penalties on businesses that routinely overpay per diems.
What’s right for your business?
To learn more about business travel expense deductions and reimbursements post-TCJA, contact us. We can help you determine whether you should reimburse such expenses and which reimbursement option is better for you.
Here are some of the key tax-related deadlines affecting businesses and other employers during the fourth quarter of 2018. 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.
- If a calendar-year C corporation that filed an automatic six-month extension:
- File a 2017 income tax return (Form 1120) and pay any tax, interest and penalties due.
- Make contributions for 2017 to certain employer-sponsored retirement plans.
- Report income tax withholding and FICA taxes for third quarter 2018 (Form 941) and pay any tax due. (See exception below under “November 13.”)
- Report income tax withholding and FICA taxes for third quarter 2018 (Form 941), if you deposited on time and in full all of the associated taxes due.
- If a calendar-year C corporation, pay the fourth installment of 2018 estimated income taxes.
Classifying a worker as an independent contractor frees a business from payroll tax liability and allows it to forgo providing overtime pay, unemployment compensation and other employee benefits. It also frees the business from responsibility for withholding income taxes and the worker’s share of payroll taxes.
For these reasons, the federal government views misclassifying a bona fide employee as an independent contractor unfavorably. If the IRS reclassifies a worker as an employee, your business could be hit with back taxes, interest and penalties.
When assessing worker classification, the IRS typically looks at the:
Level of behavioral control. This means the extent to which the company instructs a worker on when and where to do the work, what tools or equipment to use, whom to hire, where to purchase supplies and so on. Also, control typically involves providing training and evaluating the worker’s performance. The more control the company exercises, the more likely the worker is an employee.
Level of financial control. Independent contractors are more likely to invest in their own equipment or facilities, incur unreimbursed business expenses, and market their services to other customers. Employees are more likely to be paid by the hour or week or some other time period; independent contractors are more likely to receive a flat fee.
Relationship of the parties. Independent contractors are often engaged for a discrete project, while employees are typically hired permanently (or at least for an indefinite period). Also, workers who serve a key business function are more likely to be classified as employees.
The IRS examines a variety of factors within each category. You need to consider all of the facts and circumstances surrounding each worker relationship.
Once you’ve completed your review, there are several strategies you can use to minimize your exposure. When in doubt, reclassify questionable independent contractors as employees. This may increase your tax and benefit costs, but it will eliminate reclassification risk.
From there, modify your relationships with independent contractors to better ensure compliance. For example, you might exercise less behavioral control by reducing your level of supervision or allowing workers to set their own hours or work from home.
Also, consider using an employee-leasing company. Workers leased from these firms are employees of the leasing company, which is responsible for taxes, benefits and other employer obligations.
Handle with care
Keep in mind that taxes, interest and penalties aren’t the only possible negative consequences of a worker being reclassified as an employee. In addition, your business could be liable for employee benefits that should have been provided but weren’t. Fortunately, careful handling of contractors can help ensure that independent contractor status will pass IRS scrutiny. Contact us if you have questions about worker classification.
If your small business doesn’t offer its employees a retirement plan, you may want to consider a SIMPLE IRA. Offering a retirement plan can provide your business with valuable tax deductions and help you attract and retain employees. For a variety of reasons, a SIMPLE IRA can be a particularly appealing option for small businesses. The deadline for setting one up for this year is October 1, 2018.
SIMPLE stands for “savings incentive match plan for employees.” As the name implies, these plans are simple to set up and administer. Unlike 401(k) plans, SIMPLE IRAs don’t require annual filings or discrimination testing.
SIMPLE IRAs are available to businesses with 100 or fewer employees. Employers must contribute and employees have the option to contribute. The contributions are pretax, and accounts can grow tax-deferred like a traditional IRA or 401(k) plan, with distributions taxed when taken in retirement.
As the employer, you can choose from two contribution options:
1. Make a “nonelective” contribution equal to 2% of compensation for all eligible employees. You must make the contribution regardless of whether the employee contributes. This applies to compensation up to the annual limit of $275,000 for 2018 (annually adjusted for inflation).
2. Match employee contributions up to 3% of compensation. Here, you contribute only if the employee contributes. This isn’t subject to the annual compensation limit.
Employees are immediately 100% vested in all SIMPLE IRA contributions.
Employee contribution limits
Any employee who has compensation of at least $5,000 in any prior two years, and is reasonably expected to earn $5,000 in the current year, can elect to have a percentage of compensation put into a SIMPLE IRA.
SIMPLE IRAs offer greater income deferral opportunities than ordinary IRAs, but lower limits than 401(k)s. An employee may contribute up to $12,500 to a SIMPLE IRA in 2018. Employees age 50 or older can also make a catch-up contribution of up to $3,000. This compares to $5,500 and $1,000, respectively, for ordinary IRAs, and to $18,500 and $6,000 for 401(k)s. (Some or all of these limits may increase for 2019 under annual cost-of-living adjustments.)
You’ve got options
A SIMPLE IRA might be a good choice for your small business, but it isn’t the only option. The more-complex 401(k) plan we’ve already mentioned is one alternative. Some others are a Simplified Employee Pension (SEP) and a defined-benefit pension plan. These two plans don’t allow employee contributions and have other pluses and minuses. Contact us to learn more about a SIMPLE IRA or to hear about other retirement plan alternatives for your business.
If you gamble, be sure you understand the tax consequences. Both wins and losses can affect your income tax bill. And changes under the Tax Cuts and Jobs Act (TCJA) could also have an impact.
Wins and taxable income
You must report 100% of your gambling winnings as taxable income. The value of complimentary goodies (“comps”) provided by gambling establishments must also be included in taxable income as winnings.
Winnings are subject to your regular federal income tax rate. You might pay a lower rate on gambling winnings this year because of rate reductions under the TCJA.
Amounts you win may be reported to you on IRS Form W-2G (“Certain Gambling Winnings”). In some cases, federal income tax may be withheld, too. Anytime a Form W-2G is issued, the IRS gets a copy. So if you’ve received such a form, remember that the IRS will expect to see the winnings on your tax return.
Losses and tax deductions
You can write off gambling losses as a miscellaneous itemized deduction. While miscellaneous deductions subject to the 2% of adjusted gross income floor are not allowed for 2018 through 2025 under the TCJA, the deduction for gambling losses isn’t subject to that floor. So gambling losses are still deductible.
But the TCJA’s near doubling of the standard deduction for 2018 (to $24,000 for married couples filing jointly, $18,000 for heads of households and $12,000 for singles and separate filers) means that, even if you typically itemized deductions in the past, you may no longer benefit from itemizing. Itemizing saves tax only when total itemized deductions exceed the applicable standard deduction.
Also be aware that the deduction for gambling losses is limited to your winnings for the year, and any excess losses cannot be carried forward to future years. Also, out-of-pocket expenses for transportation, meals, lodging and so forth can’t be deducted unless you qualify as a gambling professional.
And, for 2018 through 2025, the TCJA modifies the limit on gambling losses for professional gamblers so that all deductions for expenses incurred in carrying out gambling activities, not just losses, are limited to the extent of gambling winnings.
Tracking your activities
To claim a deduction for gambling losses, you must adequately document them, including:
1. The date and type of gambling activity.
2. The name and address or location of the gambling establishment.
3. The names of other persons (if any) present with you at the gambling establishment. (Obviously, this is not possible when the gambling occurs at a public venue such as a casino, race track, or bingo parlor.)
4. The amount won or lost.
You can document income and losses from gambling on table games by recording the number of the table you played and keeping statements showing casino credit issued to you. For lotteries, you can use winning statements and unredeemed tickets as documentation.
Please contact us if you have questions or want more information about the tax treatment of gambling wins and losses.
The S corporation business structure offers many advantages, including limited liability for owners and no double taxation (at least at the federal level). But not all businesses are eligible - and, with the new 21% flat income tax rate that now applies to C corporations, S corps may not be quite as attractive as they once were.
The primary reason for electing S status is the combination of the limited liability of a corporation and the ability to pass corporate income, losses, deductions and credits through to shareholders. In other words, S corps generally avoid double taxation of corporate income — once at the corporate level and again when distributed to the shareholder. Instead, S corp tax items pass through to the shareholders’ personal returns and the shareholders pay tax at their individual income tax rates.
But now that the C corp rate is only 21% and the top rate on qualified dividends remains at 20%, while the top individual rate is 37%, double taxation might be less of a concern. On the other hand, S corp owners may be able to take advantage of the new qualified business income (QBI) deduction, which can be equal to as much as 20% of QBI.
You have to run the numbers with your tax advisor, factoring in state taxes, too, to determine which structure will be the most tax efficient for you and your business.
S eligibility requirements
If S corp status makes tax sense for your business, you need to make sure you qualify - and stay qualified. To be eligible to elect to be an S corp or to convert to S status, your business must:
- Be a domestic corporation and have only one class of stock,
- Have no more than 100 shareholders, and
- Have only “allowable” shareholders, including individuals, certain trusts and estates. Shareholders can’t include partnerships, corporations and nonresident alien shareholders.
In addition, certain businesses are ineligible, such as insurance companies.
Another important consideration when electing S status is shareholder compensation. The IRS is on the lookout for S corps that pay shareholder-employees an unreasonably low salary to avoid paying Social Security and Medicare taxes and then make distributions that aren’t subject to payroll taxes.
Compensation paid to a shareholder should be reasonable considering what a nonowner would be paid for a comparable position. If a shareholder’s compensation doesn’t reflect the fair market value of the services he or she provides, the IRS may reclassify a portion of distributions as unpaid wages. The company will then owe payroll taxes, interest and penalties on the reclassified wages.
Pros and cons
S corp status isn’t the best option for every business. To ensure that you’ve considered all the pros and cons, contact us. Assessing the tax differences can be tricky — especially with the tax law changes going into effect this year.
The Tax Cuts and Jobs Act (TCJA) liberalized the eligibility rules for using the cash method of accounting, making this method — which is simpler than the accrual method — available to more businesses. Now the IRS has provided procedures a small business taxpayer can use to obtain automatic consent to change its method of accounting under the TCJA. If you have the option to use either accounting method, it pays to consider whether switching methods would be beneficial.
Cash vs. accrual
Generally, cash-basis businesses recognize income when it’s received and deduct expenses when they’re paid. Accrual-basis businesses, on the other hand, recognize income when it’s earned and deduct expenses when they’re incurred, without regard to the timing of cash receipts or payments.
In most cases, a business is permitted to use the cash method of accounting for tax purposes unless it’s:
1. Expressly prohibited from using the cash method, or
2. Expressly required to use the accrual method.
Cash method advantages
The cash method offers several advantages, including:
Simplicity. It’s easier and cheaper to implement and maintain.
Tax-planning flexibility. It offers greater flexibility to control the timing of income and deductible expenses. For example, it allows you to defer income to next year by delaying invoices or to shift deductions into this year by accelerating the payment of expenses. An accrual-basis business doesn’t enjoy this flexibility. For example, to defer income, delaying invoices wouldn’t be enough; the business would have to put off shipping products or performing services.
Cash flow benefits. Because income is taxed in the year it’s received, the cash method does a better job of ensuring that a business has the funds it needs to pay its tax bill.
Accrual method advantages
In some cases, the accrual method may offer tax advantages. For example, accrual-basis businesses may be able to use certain tax-planning strategies that aren’t available to cash-basis businesses, such as deducting year-end bonuses that are paid within the first 2½ months of the following year and deferring income on certain advance payments.
The accrual method also does a better job of matching income and expenses, so it provides a more accurate picture of a business’s financial performance. That’s why it’s required under Generally Accepted Accounting Principles (GAAP).
If your business prepares GAAP-compliant financial statements, you can still use the cash method for tax purposes. But weigh the cost of maintaining two sets of books against the potential tax benefits.
Making a change
Keep in mind that cash and accrual are the two primary tax accounting methods, but they’re not the only ones. Some businesses may qualify for a different method, such as a hybrid of the cash and accrual methods.
If your business is eligible for more than one method, we can help you determine whether switching methods would make sense and can execute the change for you if appropriate.
One of the biggest concerns for family business owners is succession planning — transferring ownership and control of the company to the next generation. Often, the best time tax-wise to start transferring ownership is long before the owner is ready to give up control of the business. A family limited partnership (FLP) can help owners enjoy the tax benefits of gradually transferring ownership yet allow them to retain control of 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.
You retain the general partnership interest, which may be as little as 1% of the assets. But as general partner, you can 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, if the discount is 25%, in 2018 you could gift an FLP interest equal to as much as $20,000 tax-free because the discounted value wouldn’t exceed the $15,000 annual gift tax exclusion.
To transfer interests in excess of the annual exclusion, you can apply your lifetime gift tax exemption. And 2018 may be a particularly good year to do so, because the Tax Cuts and Jobs Act raised it to a record-high $11.18 million. The exemption is scheduled to be indexed for inflation through 2025 and then drop back down to an inflation-adjusted $5 million in 2026. While Congress could extend the higher exemption, using as much of it as possible now may be tax-smart.
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 scrutinizes FLPs. If it determines that discounts were excessive or that your FLP had no valid business purpose beyond minimizing taxes, it could assess additional taxes, interest and penalties.
The IRS pays close attention to how FLPs are administered. Lack of attention to partnership formalities, for example, can indicate that an FLP was set up solely as a tax-reduction strategy.
Right for you?
An FLP can be an effective succession and estate planning tool, but it isn’t risk free. Please contact us for help determining whether an FLP is right for you.
Under the Tax Cuts and Jobs Act, employees can no longer claim the home office deduction. If, however, you run a business from your home or are otherwise self-employed and use part of your home for business purposes, the home office deduction may still be available to you.
Homeowners know that they can claim itemized deductions for property tax and mortgage interest on their principal residences, subject to certain limits. Most other home-related expenses, such as utilities, insurance and repairs, aren’t deductible.
But if you use part of your home for business purposes, you may be entitled to deduct a portion of these expenses, as well as depreciation. Or you might be able to claim the simplified home office deduction of $5 per square foot, up to 300 square feet ($1,500).
Regular and exclusive use
You might qualify for the home office deduction if part of your home is used as your principal place of business “regularly and exclusively,” defined as follows:
1. Regular use. You use a specific area of your home for business on a regular basis. Incidental or occasional business use is not regular use.
2. Exclusive use. You use the specific area of your home only for business. It’s not necessary for the space to be physically partitioned off. But, you don’t meet the requirements if the area is used both for business and personal purposes, such as a home office that also serves as a guest bedroom.
Regular and exclusive business use of the space aren’t, however, the only criteria.
Principal place of business
Your home office will qualify as your principal place of business if you 1) use the space exclusively and regularly for administrative or management activities of your business, and 2) don’t have another fixed location where you conduct substantial administrative or management activities.
Examples of activities that are administrative or managerial in nature include:
- Billing customers, clients or patients,
- Keeping books and records,
- Ordering supplies,
- Setting up appointments, and
- Forwarding orders or writing reports.
Meetings or storage
If your home isn’t your principal place of business, you may still be able to deduct home office expenses if you physically meet with patients, clients or customers on your premises. The use of your home must be substantial and integral to the business conducted.
Alternatively, you may be able to claim the home office deduction if you have a storage area in your home — or in a separate free-standing structure (such as a studio, workshop, garage or barn) — that’s used exclusively and regularly for your business.
The home office deduction can provide a valuable tax-saving opportunity for business owners and other self-employed taxpayers who work from home. If you’re not sure whether you qualify or if you have other questions, please contact us.
Meal, vehicle and travel expenses are common deductions for businesses. But if you don’t properly document these expenses, you could find your deductions denied by the IRS.
A critical requirement
Subject to various rules and limits, business meal (generally 50%), vehicle and travel expenses may be deductible, whether you pay for the expenses directly or reimburse employees for them. Deductibility depends on a variety of factors, but generally the expenses must be “ordinary and necessary” and directly related to the business.
Proper documentation, however, is one of the most critical requirements. And all too often, when the IRS scrutinizes these deductions, taxpayers don’t have the necessary documentation.
What you need to do
Following some simple steps can help ensure you have documentation that will pass muster with the IRS:
Keep receipts or similar documentation. You generally must have receipts, canceled checks or bills that show amounts and dates of business expenses. If you’re deducting vehicle expenses using the standard mileage rate (54.5 cents for 2018), log business miles driven.
Track business purposes. Be sure to record the business purpose of each expense. This is especially important if on the surface an expense could appear to be a personal one. If the business purpose of an expense is clear from the surrounding circumstances, the IRS might not require a written explanation — but it’s probably better to err on the side of caution and document the business purpose anyway.
Require employees to comply. If you reimburse employees for expenses, make sure they provide you with proper documentation. Also be aware that the reimbursements will be treated as taxable compensation to the employee (and subject to income tax and FICA withholding) unless you make them via an “accountable plan.”
Don’t re-create expense logs at year end or when you receive an IRS deficiency notice. Take a moment to record the details in a log or diary at the time of the event or soon after. The IRS considers timely kept records more reliable, plus it’s easier to track expenses as you go than try to re-create a log later. For expense reimbursements, require employees to submit monthly expense reports (which is also generally a requirement for an accountable plan).
You’ve probably heard that, under the Tax Cuts and Jobs Act, entertainment expenses are no longer deductible. There’s some debate as to whether this includes business meals with actual or prospective clients. Until there’s more certainty on that issue, it’s a good idea to document these expenses. That way you’ll have what you need to deduct them if Congress or the IRS provides clarification that these expenses are indeed still deductible.
For more information about what meal, vehicle and travel expenses are and aren’t deductible — and how to properly document deductible expenses — please contact us.
The Tax Cuts and Jobs Act (TCJA) provides a valuable new tax break to noncorporate owners of pass-through entities: a deduction for a portion of qualified business income (QBI). The deduction generally applies to income from sole proprietorships, partnerships, S corporations and, typically, limited liability companies (LLCs). It can equal as much as 20% of QBI. But once taxable income exceeds $315,000 for married couples filing jointly or $157,500 for other filers, a wage limit begins to phase in.
Full vs. partial phase-in
When the wage limit is fully phased in, at $415,000 for joint filers and $207,500 for other filers, the QBI deduction generally can’t exceed the greater of the owner’s share of:
- 50% of the amount of W-2 wages paid to employees during the tax year, or
- The sum of 25% of W-2 wages plus 2.5% of the cost of qualified business property (QBP).
When the wage limit applies but isn’t yet fully phased in, the amount of the limit is reduced and the final deduction is calculated as follows:
1. The difference between taxable income and the applicable threshold is divided by $100,000 for joint filers or $50,000 for other filers.
2. The resulting percentage is multiplied by the difference between the gross deduction and the fully wage-limited deduction.
3. The result is subtracted from the gross deduction to determine the final deduction.
Let’s say Chris and Leslie have taxable income of $600,000. This includes $300,000 of QBI from Chris’s pass-through business, which pays $100,000 in wages and has $200,000 of QBP. The gross deduction would be $60,000 (20% of $300,000), but the wage limit applies in full because the married couple’s taxable income exceeds the $415,000 top of the phase-in range for joint filers. Computing the deduction is fairly straightforward in this situation.
The first option for the wage limit calculation is $50,000 (50% of $100,000). The second option is $30,000 (25% of $100,000 + 2.5% of $200,000). So the wage limit — and the deduction — is $50,000.
What if Chris and Leslie’s taxable income falls within the phase-in range? The calculation is a bit more complicated. Let’s say their taxable income is $400,000. The full wage limit is still $50,000, but only 85% of the full limit applies:
($400,000 taxable income - $315,000 threshold)/$100,000 = 85%
To calculate the amount of their deduction, the couple must first calculate 85% of the difference between the gross deduction of $60,000 and the fully wage-limited deduction of $50,000:
($60,000 - $50,000) × 85% = $8,500
That amount is subtracted from the $60,000 gross deduction for a final deduction of $51,500.
That’s not all
Be aware that another restriction may apply: For income from “specified service businesses,” the QBI deduction is reduced if an owner’s taxable income falls within the applicable income range and eliminated if income exceeds it. Please contact us to learn whether your business is a specified service business or if you have other questions about the QBI deduction.
For small businesses, managing payroll can be one of the most arduous tasks. Adding to the burden earlier this year was adjusting income tax withholding based on the new tables issued by the IRS. (Those tables account for changes under the Tax Cuts and Jobs Act.) But it’s crucial not only to withhold the appropriate taxes — including both income tax and employment taxes — but also to remit them on time to the federal government.
If you don’t, you, personally, could face harsh penalties. This is true even if your business is an entity that normally shields owners from personal liability, such as a corporation or limited liability company.
The 100% penalty
Employers must withhold federal income and employment taxes (such as Social Security) as well as applicable state and local taxes on wages paid to their employees. The federal taxes must then be remitted to the federal government according to a deposit schedule.
If a business makes payments late, there are escalating penalties. And if it fails to make them, the Trust Fund Recovery Penalty could apply. Under this penalty, also known as the 100% penalty, the IRS can assess the entire unpaid amount against a “responsible person.”
The corporate veil won’t shield corporate owners in this instance. The liability protections that owners of corporations — and limited liability companies — typically have don’t apply to payroll tax debts.
When the IRS assesses the 100% penalty, it can file a lien or take levy or seizure action against personal assets of a responsible person.
“Responsible person,” defined
The penalty can be assessed against a shareholder, owner, director, officer or employee. In some cases, it can be assessed against a third party. The IRS can also go after more than one person. To be liable, an individual or party must:
1. Be responsible for collecting, accounting for and remitting withheld federal taxes, and
2. Willfully fail to remit those taxes. That means intentionally, deliberately, voluntarily and knowingly disregarding the requirements of the law.
Prevention is the best medicine
When it comes to the 100% penalty, prevention is the best medicine. So make sure that federal taxes are being properly withheld from employees’ paychecks and are being timely remitted to the federal government. (It’s a good idea to also check state and local requirements and potential penalties.)
If you aren’t already using a payroll service, consider hiring one. A good payroll service provider relieves you of the burden of withholding the proper amounts, taking care of the tax payments and handling recordkeeping. Contact us for more information.
You’ve probably heard about the recent U.S. Supreme Court decision allowing state and local governments to impose sales taxes on more out-of-state online sales. The ruling in South Dakota v. Wayfair, Inc. is welcome news for brick-and-mortar retailers, who felt previous rulings gave an unfair advantage to their online competitors. And state and local governments are pleased to potentially be able to collect more sales tax.
But for businesses with out-of-state online sales that haven’t had to collect sales tax from out-of-state customers in the past, the decision brings many questions and concerns.
What the requirements used to be
Even before Wayfair, a state could require an out-of-state business to collect sales tax from its residents on online sales if the business had a “substantial nexus” — or connection — with the state. The nexus requirement is part of the Commerce Clause of the U.S. Constitution.
Previous Supreme Court rulings had found that a physical presence in a state (such as retail outlets, employees or property) was necessary to establish substantial nexus. As a result, some online retailers have already been collecting tax from out-of-state customers, while others have not had to.
What has changed
In Wayfair, South Dakota had enacted a law requiring out-of-state retailers that made at least 200 sales or sales totaling at least $100,000 in the state to collect and remit sales tax. The Supreme Court found that the physical presence rule is “unsound and incorrect,” and that the South Dakota tax satisfies the substantial nexus requirement.
The Court said that the physical presence rule puts businesses with a physical presence at a competitive disadvantage compared with remote sellers that needn’t charge customers for taxes.
In addition, the Court found that the physical presence rule treats sellers differently for arbitrary reasons. A business with a few items of inventory in a small warehouse in a state is subject to sales tax on all of its sales in the state, while a business with a pervasive online presence but no physical presence isn’t subject to the same tax for the sales of the same items.