We are proud to announce that we were recognized on the annual “Best in Quality” list by St. Louis Small Business Monthly for 2017! Thank you to all who nominated us and to our employees for always going above and beyond for our clients. We are beyond grateful for the support and recognition!
EDUCATE EMPLOYEES ON REQUIRED MINIMUM DISTRIBUTION RULES
The deadline for taking 2017 required minimum distributions (RMDs) is rapidly approaching: December 31, 2017. If you own a business and offer a 401(k) plan, it’s a good time to think about how you can make sure your older employees are aware of the RMD obligations, including how the rules differ for IRAs vs. 401(k) plans.
IRAs vs. 401(k)s
To avoid a huge penalty, individuals must take RMDs from their IRAs (other than Roth IRAs) on reaching age 70½. However, the first payment can be delayed until April 1 of the year following the year in which the individual turns 70½. (Beware: Different RMD rules apply to inherited IRAs.)
Distributions from 401(k)s are different; current employees don’t have to take 401(k) RMDs. Although the regulations don’t state how many hours employees need to work to postpone 401(k) RMDs, they must be doing legitimate work and receiving W-2 wages.
There’s an important exception, however: Owner-employees (if they own at least 5% of the company) must begin taking RMDs from the 401(k) beginning at 70½, regardless of work status.
If someone has multiple IRAs, it doesn’t matter which one he or she takes RMDs from so long as the total amount reflects their aggregate IRA assets. In contrast, RMDs based on 401(k) plan assets must be taken specifically from the 401(k) plan account.
Calculating RMDs
RMD amounts change each year as the retiree ages, based on the applicable IRS life expectancy table.
For example, at age 72, the “distribution period” is 25.6, meaning that the IRS life expectancy table assumes that the account holder will live about another 25½ years. Thus, someone age 72 must withdraw 1/25.6 of his or her IRA or 401(k) account. Percentage-wise, that is 3.91%.
If someone lives to age 90, the distribution period would be 11.4, resulting in an 8.77% RMD. Although the percentage amount increases over time, the IRS rules don’t force retirees to zero out their accounts. Still, if an account holder lives long enough, he or she isn’t likely to have a lot of funds remaining in the account at death.
Informed and happy
Remember, informed employees are happy employees — which can lead to more engaged, productive employees. We’d be happy to assist you in providing the most current, accurate information.
Sidebar: Other facts about RMDs
Here are some additional facts about required minimum distributions (RMDs) that you can share with employees:
Beneficiary spouses. Account holders who have a beneficiary spouse at least 10 years younger are subject to a different RMD life expectancy table that allows them to take out smaller amounts to preserve retirement assets for the younger spouse.
Tax penalty. The tax penalty for withdrawing less than the RMD amount is 50% of the portion that should have been withdrawn but wasn’t.
Form of distribution. RMDs can be taken in cash or in stock shares whose value is the same as the RMD amount. Although taking stock shares can be administratively burdensome, doing so can allow account holders to defer incurring brokerage commissions on securities they don’t want to sell. Their tax basis in the stock (for future capital gains liability calculation purposes) will reset to the value of the securities when they’re distributed.
DAPTS OFFER A HOMEGROWN APPROACH TO ASSET PROTECTION
Your assets face many potential threats to their value, such as market volatility and inflation. Another threat, especially if you’re at high risk for lawsuits, is creditors. The most effective way to protect assets from such a threat may be to transfer them to children or other family members, either outright or in trust, with no strings attached. So long as the transfer isn’t fraudulent — that is, intended to delay or defraud knowncreditors — creditors won’t be able to touch the assets.
If you wish to retain some control over your wealth, however, consider an asset protection trust. For affluent families with significant liability concerns, foreign asset protection trusts probably offer the greatest protection. But if you prefer to avoid the complexity and expense of these arrangements, look into a domestic asset protection trust (DAPT).
How does it work?
A DAPT is an irrevocable, spendthrift trust established in one of the 16 states that currently authorize this trust type (Alaska, Colorado, Delaware, Hawaii, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia and Wyoming). Unlike trusts in other jurisdictions, a DAPT offers creditor protection even if you’re a discretionary beneficiary of the trust.
You don’t necessarily have to live in one of the previously listed states. But, to set up a trust in a state where you don’t reside, you’ll typically need to move some or all of the trust assets there and engage a bank or trust company in the state to administer the trust.
DAPT protection varies from state to state, so it’s important to shop around. For example, different jurisdictions have different statute of limitations periods, which determine how long you’ll have to wait until full asset protection kicks in. (During the limitations period, creditors can challenge transfers to the trust.) Also, most of the DAPT laws contain exceptions for certain types of creditors, such as divorcing spouses, child support creditors and pre-existing tort creditors.
Usually, DAPTs are incomplete gift trusts, which give you some flexibility to change beneficiaries or otherwise control asset disposition. But it’s also possible to structure a DAPT as a completed gift trust, thereby removing the assets (and any future appreciation of those assets) from your taxable estate.
What’s the primary risk?
A DAPT’s main disadvantage is the uncertainty over whether it will withstand a court challenge. Although they’ve been around since 1997, DAPTs haven’t been widely tested in court.
Most experts agree that, if you live in one of the states with a DAPT statute, a properly designed and funded DAPT will likely be effective. But some uncertainty surrounds trusts established by nonresidents.
Is it the right move?
There are other ways to protect your assets from creditors, such as through insurance or use of various business entity structures. We can help you decide whether a DAPT is the right move.
5 COMMON MISTAKES WHEN APPLYING FOR FINANCIAL AID
Given the astronomical cost of college, even well-off parents should consider applying for financial aid. A single misstep, however, can harm your child’s eligibility. Here are five common mistakes to avoid:
The rule provides a significant planning opportunity if one spouse is substantially wealthier than the other. For example, if the child lives with the less affluent spouse for 183 days and with the other spouse for 182 days, the less affluent spouse would file the FAFSA, improving eligibility for financial aid.
These are just a few examples of financial aid pitfalls. Let us help you navigate the process and explore other ways to finance college.
ENSURING YOUR YEAR-END DONATIONS ARE TAX DEDUCTIBLE
Many people make donations at the end of the year. To be deductible on your 2017 return, a charitable donation must be made by December 31, 2017. According to the IRS, a donation generally is “made” at the time of its “unconditional delivery.” But what does this mean?
Is it the date you write a check or charge an online gift to your credit card? Or is it the date the charity actually receives the funds? In practice, the delivery date depends in part on what you donate and how you donate it. Here are a few common examples:
Checks. The date you mail it.
Credit cards. The date you make the charge.
Pay-by-phone accounts. The date the financial institution pays the amount.
Stock certificates. The date you mail the properly endorsed stock certificate to the charity.
To be deductible, a donation must be made to a “qualified charity” — one that’s eligible to receive tax-deductible contributions. The IRS’s online search tool, “Exempt Organizations (EO) Select Check,” can help you more easily find out whether an organization is eligible to receive tax-deductible charitable contributions. You can access it at https://www.irs.gov/charities-non-profits/exempt-organizations-select-check. Information about organizations eligible to receive deductible contributions is updated monthly.
Many additional rules apply to the charitable donation deduction, so please contact us if you have questions about the deductibility of a gift you’ve made or are considering making. But act soon — you don’t have much time left to make donations that will reduce your 2017 tax bill.
Important Information: The information contained in this newsletter was not intended or written to be used and cannot be used for the purpose of (1) avoiding tax-related penalties prescribed by the Internal Revenue Code or (2) promoting or marketing any tax-related matter addressed herein.
The Tax and Business Alert is designed to provide accurate information regarding the subject matter covered. However, before completing any significant transactions based on the information contained herein, please contact us for advice on how the information applies in your specific situation. Tax and Business Alert is a trademark used herein under license. © Copyright 2017.
HANDLE WITH CARE: MUTUAL FUNDS AND TAXES
Many people overlook taxes when planning their mutual fund investments. But you’ve got to handle these valuable assets with care. Here are some tips to consider.
Avoid year-end investments
Typically, mutual funds distribute accumulated dividends and capital gains toward the end of the year. But don’t fall for the common misconception that investing in a fund just before a distribution date is like getting “free money.”
True, you’ll receive a year’s worth of income right after you invest. But the value of your shares will immediately drop by the same amount, so you won’t be any better off. Plus, you’ll be liable for taxes on the distribution as if you had owned your shares all year.
You can get a general idea of when a particular fund anticipates making a distribution by checking its website periodically. Also make a note of the “record date” — investors who own fund shares on that date will participate in the distribution.
Invest in tax-efficient funds
Actively managed funds tend to be less tax efficient. They buy and sell securities more frequently, generating a greater amount of capital gain, much of it short-term gain taxable at ordinary income rates rather than the lower, long-term capital gains rates.
Consider investing in tax-efficient funds instead. For example, index funds generally have lower turnover rates. And “passively managed” funds (sometimes described as “tax managed” funds) are designed to minimize taxable distributions.
Another option is exchange-traded funds (ETFs). Unlike mutual funds, which generally redeem shares by selling securities, ETFs are often able to redeem securities “in kind” — that is, to swap them for other securities. This limits an ETF’s recognition of capital gains, making it more tax efficient.
This isn’t to say that tax-inefficient funds don’t have a place in your portfolio. In some cases, actively managed funds may offer benefits, such as above-market returns, that outweigh their tax costs.
Watch out for reinvested distributions
Many investors elect to have their distributions automatically reinvested in their funds. Be aware that those distributions are taxable regardless of whether they’re reinvested or paid out in cash.
Reinvested distributions increase your tax basis in a fund, so track your basis carefully. If you fail to account for these distributions, you’ll end up paying tax on them twice — once when they’re paid and again when you sell your shares in the fund.
Fortunately, under current rules, mutual fund companies are required to track your basis for you. But you still may need to track your basis in funds you owned before 2012 when this requirement took effect, or if you purchased units in the fund outside of the current broker holding your units.
Do your due
Tax considerations should never be the primary driver of your investment decisions. Yet it’s important to do your due diligence on the potential tax consequences of funds you’re considering — particularly for your taxable accounts.
Sidebar: Directing tax-inefficient funds into nontaxable accounts
If you invest in actively managed or other tax-inefficient funds, ideally you should put these holdings in nontaxable accounts, such as a traditional IRA or 401(k). Because earnings in these accounts are tax-deferred, distributions from funds they hold won’t have any tax consequences until you withdraw them. And if the funds are held in a Roth account, those distributions will escape taxation altogether.
BAD DEBTS AREN’T ALWAYS BAD NEWS
The IRS defines a business bad debt as “a loss from the worthlessness of a debt that was either created or acquired in a trade or business or closely related to your trade or business when it became partly to totally worthless.” Although no business owner goes out of his or her way to acquire a bad debt, they’re not always bad news.
The silver lining
Indeed, there’s a potential silver lining to bad debts. In certain situations, you can deduct uncollected debts from your business income, which may reduce your tax liability.
One requirement for a deduction generally is that the amount of the bad debt was previously included in your income. This effectively means that only businesses that use accrual-basis accounting can deduct bad debts.
Cash-basis businesses generally can’t deduct bad debts because they haven’t previously reported the debt as income. So they can’t claim a bad debt deduction simply because someone failed to pay a bill. But they may be able to claim a bad debt deduction if they’ve made a business-related loan that became uncollectible.
What may be deductible
The IRS lists the following examples of potentially deductible bad debts:
Bankruptcy is a common reason a business might determine that a debt is uncollectible and should be written off. For example, suppose a customer files for bankruptcy and states that the liquidation value of its assets is less than the amount owed to its primary lien holder. Once this customer informs you that your receivable won’t be paid, you can generally write off the amount as a bad debt.
There’s no standard test or formula for determining whether a debt is a bad debt; it depends on the specific facts and circumstances. To qualify for the deduction, you simply must show that you’ve taken reasonable steps to collect the debt and there’s little likelihood it will be paid. If you have outstanding debts that you don’t think will be paid and could be deductible on your 2017 tax return, be sure, if you haven’t already, to take steps to try to collect the debt.
Wholly vs. partially worthless debt
The IRC doesn’t define “worthlessness.” Courts, however, have defined wholly worthless debts as those lacking both current and potential value. The U.S. Tax Court says that partial worthlessness is evidenced by “some event or some change in the financial condition of the debtor . . . which adversely affects the debtor’s ability to make repayment.”
In general, you may recover a portion of a partially worthless debt in the future. You never recover any part of a wholly worthless debt.
Important topic
The right tax strategy for your company’s bad debts is an important topic to consider every year end. Our firm can help you ensure you’re taking all the bad debt deductions you’re entitled to.
PONDERING THE PURCHASE OF A LIFE INSURANCE POLICY
What, if any, role life insurance should play in your financial plan depends on a variety of factors. These include whether you’re single or married, if you have minor children or other dependents, and your net worth and estate planning goals. There’s also the tax impact to consider. Let’s look a little more closely at some of the issues behind whether you should buy a policy.
Looking at your situation
Life insurance is appealing because relatively small payments now can produce a proportionately much larger payout at death. But the fact that the return on the investment generally isn’t realized until death can also be a downside, depending on your financial situation and goals.
If you have others depending on you financially, your No. 1 priority is likely ensuring that they will continue to be provided for after you’re gone. Life insurance can be a useful tool for achieving this goal.
If you’re single and have no dependents, life insurance may be less important or even unnecessary. Perhaps you’ll want just enough coverage so that your mortgage can be paid off and your home can pass unencumbered to the designated heir(s) — or just enough to pay your funeral expenses.
Assessing your finances
Some people of high net worth may not need life insurance for any of the aforementioned purposes. Nonetheless, it might serve other purposes in their estate plans. For example, a policy can provide liquidity to pay estate taxes without having to sell assets that you want to keep in the family. Or it can be used to equalize inheritances for children who aren’t involved in a family business so that family business interests can go only to those active in the business.
While proceeds are generally income-tax-free to the beneficiary, they’ll be included in your taxable estate as long as you’re the owner. If your estate might exceed your estate tax applicable exemption amount ($5.49 million for 2017), some or all of the life insurance proceeds could be subject to estate taxes. To avoid this result, consider having someone else own the policy. This can create other tax complications, however, so it’s important to consult your tax advisor.
Figuring out your needs
For many people, life insurance is critical to creating financial security for their family or achieving other financial goals. Please contact our firm for specific insight into this important matter.
ARE FREQUENT FLYER MILES EVER TAXABLE?
If you recently redeemed frequent flyer miles to treat the family to a fun summer vacation or to take your spouse on a romantic getaway, you might assume that there are no tax implications involved. And you’re probably right — but there is a chance your miles could be taxable.
Generally, miles awarded by airlines for flying with them are considered nontaxable rebates, as are miles awarded for using a credit or debit card. The IRS even addressed the issue in Announcement 2002-18, where it said:
Consistent with prior practice, the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer’s business or official travel.
There are, however, some types of miles awards the IRS might view as taxable. Examples include miles awarded as a prize in a sweepstakes and miles awarded as a promotion.
For instance, in the 2014 case of Shankar v. Commissioner, the U.S. Tax Court sided with the IRS in finding that airline miles awarded in conjunction with opening a bank account were indeed taxable. Part of the evidence of taxability was the fact that the bank had issued Forms 1099 MISC to customers who’d redeemed rewards points to buy airline tickets.
The value of the miles for tax purposes generally is their estimated retail value. If you’re concerned you’ve received miles awards that could be taxable, please contact us.
Important Information: The information contained in this newsletter was not intended or written to be used and cannot be used for the purpose of (1) avoiding tax-related penalties prescribed by the Internal Revenue Code or (2) promoting or marketing any tax-related matter addressed herein.
The Tax and Business Alert is designed to provide accurate information regarding the subject matter covered. However, before completing any significant transactions based on the information contained herein, please contact us for advice on how the information applies in your specific situation. Tax and Business Alert is a trademark used herein under license. © Copyright 2017.
HOUSE TAX BILL RELEASED
On November 2, 2017, the House of Representatives released a draft tax reform bill titled the “Tax Cuts and Jobs Act.” The bill would reduce individual and business tax rates, would modify or eliminate a variety of itemized deductions as well as repeal the estate and alternative minimum taxes, and would change the taxation of foreign income. The Ways & Means Committee intends to formally markup the bill the week of November 6 with full House floor consideration planned before Thanksgiving. Most of the provisions would be effective starting in 2018.
Details
Under the House bill, individuals would be subject to four tax brackets at 12, 25, 35, and 39.6 percent. The 39.6 rate would apply at $1 million for married taxpayers filing jointly and $500,000 for other filers. The standard deduction would be increased, from $6,350 to $12,200 for single filers and from $12,700 to $24,400 for married taxpayers filing jointly. Personal exemptions would be repealed; however, the child tax credit would be expanded.
Itemized deductions would be changed significantly by the bill. Deductions for state and local income and sales taxes would be eliminated for individuals, and the deduction for local property taxes paid would be capped at $10,000. Mortgage interest expense deductions would be limited to acquisition indebtedness on the taxpayer’s principal residence of up to $500,000 for new mortgage indebtedness, reduced from the current limit of $1 million (existing mortgages would be grandfathered). Home equity indebtedness would no longer be deductible. Cash contributions to public charities would be limited to 60 percent of the donor’s adjusted gross income, an increase from 50 percent adjusted gross income limitation under current law. Deductions for tax preparation fees, medical expenses, moving expenses, and personal casualty losses would be repealed, but the deduction for personal casualty losses would remain for relief provided under special disaster relief legislation. The overall limitation on itemized deductions would also be removed. The individual alternative minimum tax (AMT) would be repealed. Transition provisions would ensure taxpayers with AMT carryforwards would be able to use the remaining credits between 2018 and 2022.
Notably, most of the reform provisions are effective beginning after 2017; however, the changes to the mortgage interest expense deduction are effective for debt incurred on or after November 2, 2017.
The exclusion of gain from the sale of a principal residence would be phased out for married taxpayers with an adjusted gross income in excess of $500,000 ($250,000 for single filers) but the act changes the use requirements and calls for taxpayers to live in the residence for five of the previous eight years to qualify, up from the current requirement to use the residence for two of the previous five years. The bill further repeals the deduction for alimony payments effective for any divorce decree or separation agreement executed after 2017.
Estate, gift, and generation-skipping transfer (GST) tax exclusions for individuals would be increased to $10 million (as of 2011) and then adjusted for inflation, and the estate and GST taxes would then be repealed after 2023 but would maintain the step-up in basis provisions. Beginning in 2024, the top gift tax rate would be lowered to 35 percent with a lifetime exemption of $10 million and an annual exclusion of $14,000 (as of 2017) indexed for inflation.
Impacting businesses, the corporate tax rate would be reduced from 35 percent to 20 percent, and certain “business income” from pass-through entities would be taxed at 25 percent instead of an owner’s individual rate. Bonus depreciation of 100 percent would be available for qualifying property placed in service before January 1, 2023, new property types would qualify for bonus depreciation and expense amounts would be expanded. The bill proposes to eliminate the Domestic Production Activities Deduction and change other aspects of entertainment expenses, net operating losses, like-kind exchanges, business credits, and small-business accounting methods, among other provisions. The bill would also repeal the corporate alternative minimum tax (AMT) and make existing AMT credit carryforwards refundable over a period of five years.
Taxation of a corporation’s foreign income would change from a worldwide system to an exemption system, with a 100-percent exemption from U.S. tax for the foreign source portion of dividends paid by a foreign subsidiary to U.S. corporate shareholders that own 10 percent or more of the foreign subsidiary. To transition to the exemption system, the bill also includes a transition tax for untaxed foreign earnings accumulated under the current worldwide taxing system. The House bill also includes provisions to prevent base erosion. A separate tax alert discussing in more detail the House bill’s proposals relating to the taxation of foreign income and foreign persons is forthcoming.
The bill would impact tax-exempt entities as well through the expanded application of unrelated business income tax (UBIT) rules and a flat 1.4 percent tax of the net investment income of entities including private foundations.
Insights
The release of the House bill represents the first significant and detailed legislative step toward tax reform under the Trump Administration. As drafted, most of the provisions would be effective for the 2018 tax year. The House Ways & Means Committee is expected to formally markup the legislation the week of November 6, with full House consideration planned before Thanksgiving.
There are additional provisions in the proposed legislation effecting education credits, retirement accounts, deferred compensation, and private foundations, among others.
We recently teamed together for our annual Scheffel Boyle Shares project. Each year, we plan philanthropic activities throughout our offices to give back to our local communities. This year, our employees organized the “Write-Off Hunger” food drive which culminated in the collection of more than 5,500 food items to be donated to local food pantries!
Each of our offices strategized and found creative ways to raise the most donations possible. One office organized a “Cars for Cans” car wash in their parking lot where the fee for a wash was $5 or 5 items of non-perishable food items. Another took to social media to raise funds and “coupon shopped” to get the most out of their donated dollars. Each office exercised their entrepreneurial spirit to find innovative ways of collecting donations for the drive. We are so proud of all they accomplished!
Firm leadership also organized two “Cardinals for Cans” days, where employees could wear their St. Louis Cardinal gear for a fee of $5 or 5 cans. In addition, we also hosted a “Dress for Success” day where if an employee were to forego their normal casual Friday and dress for success instead, the firm would give $5 in their name toward their office’s donation fund.
While it was a firm-wide project, each office will donate what they raised to their own local community food bank. Some organizations who will receive donations from Write-Off Hunger include the Salvation Army Food Pantry of Jerseyville, the Glen-Ed Food Pantry, the Crisis Food Center, the Carrollton Food Pantry, Community Care Center, the Highland Area Christian Service Ministry, and the Community Hope Center, among others.
We are proud to announce that we were named a “Best Consulting Firm” by St. Louis Small Business Monthly for 2017! Thank you to all who nominated us and to our employees for always going above and beyond for our clients.
HOW TO STEER CLEAR OF TAX ISSUES RELATED TO SHAREHOLDER LOANS
Owners occasionally need to borrow funds from their businesses. If your business is structured as a corporation and it has extra cash on hand, a shareholder loan can be a convenient and low-cost option — but it’s important to treat the transaction as a bona fide loan. If you don’t, the IRS may claim you received a taxable dividend or compensation payment rather than a loan.
Taking a closer look
A corporation can make de minimis loans of $10,000 or less to shareholders without paying interest. But, if all of the loans from the corporation to a shareholder add up to more than $10,000, the advances may be subject to a complicated set of below-market interest rules unless you charge what the IRS considers an “adequate” rate of interest. Each month the IRS publishes its applicable federal rates (AFRs), which vary depending on the term of the loan.
Right now, although interest rates are starting to rise, they’re still near historic lows, making it a good time to borrow money. For example, in July 2017, the adjusted AFR for short-term loans (of not more than three years) was only 1.22% (up from 0.71% in July 2016). The rate was 1.89% (up from 1.43% in July 2016) for midterm loans (with terms ranging from more than three years to not more than nine years).
The AFRs are typically below what a bank would charge. As long as the corporation charged interest at the AFR (or higher), the loan would be exempt from the complicated below-market interest rules the IRS imposes.
The interest rate for a demand loan — which is payable whenever the corporation wants to collect it — isn’t fixed when the loan is set up. Instead it varies depending on market conditions. So, calculating the correct AFR for a demand loan is more complicated than it is for a term loan. In general, it’s easier to administer a shareholder loan with a prescribed term than a demand note.
Staying under market
If a corporation lends money to a shareholder at an interest rate that’s below the AFR, the IRS requires it to impute interest using the below-market interest rules. These calculations can be complicated. The amount of incremental imputed interest (beyond what the corporation already charges the shareholder) depends on when the loan was set up and whether it’s a demand or term loan. There are also tax consequences for this imputed interest to both the corporation and the shareholder.
Additionally, the IRS may argue that the loan should be reclassified as either a dividend or additional compensation. The corporation may deduct the latter, but it will also be subject to payroll taxes. Both dividends and additional compensation would be taxable income to the shareholder personally, however.
Making it bona fide
When deciding whether payments made to shareholders qualify as bona fide loans, the IRS considers a variety of factors. It assesses the size of the loan, as well as the corporation’s history of earnings, dividend payments and loan repayments. It also looks at the shareholder’s ability to repay the loan and power to make corporate decisions.
In addition, the IRS will factor in whether you’ve executed a formal, written note that specifies repayment terms — including the interest rate, maturity date and collateral.
Getting started
Under the right circumstances, a shareholder loan could be a smart tax planning move to make this year. Contact our firm to help you set up and monitor your shareholder loans to ensure compliance with the IRS rules.
WILLS AND LIVING TRUSTS: ESTATE PLANNING IMPERATIVES
Well-crafted, up-to-date estate planning documents are an imperative for everyone. They also can help ease the burdens on your family during a difficult time. Two important examples: wills and living trusts.
The will
A will is a legal document that arranges for the distribution of your property after you die and allows you to designate a guardian for minor children or other dependents. It should name the executor or personal representative who’ll be responsible for overseeing your estate as it goes through probate. (Probate is the court-supervised process of paying any debts and taxes and distributing your property after you die.) To be valid, a will must meet the legal requirements in your state.
If you die without a will (that is, “intestate”), the state will appoint an administrator to determine how to distribute your property based on state law. The administrator also will decide who will assume guardianship of any minor children or other dependents. Bottom line? Your assets may be distributed — and your dependents provided for — in ways that differ from what you would have wanted.
The living trust
Because probate can be time-consuming, expensive and public, you may prefer to avoid it. A living trust can help. It’s a legal entity to which you, as the grantor, transfer title to your property. During your life, you can act as the trustee, maintaining control over the property in the trust. On your death, the person (such as a family member or advisor) or institution (such as a bank or trust company) you’ve named as the successor trustee distributes the trust assets to the beneficiaries you’ve named.
Assets held in a living trust avoid probate — with very limited exceptions. Another benefit is that the successor trustee can take over management of the trust assets should you become incapacitated.
Having a living trust doesn’t eliminate the need for a will. For example, you can’t name a guardian for minor children or other dependents in a trust. However, a “pour over” will can direct that assets you own outside the living trust be transferred to it on your death.
Other documents
There are other documents that can complement a will and living trust. A “letter of instruction,” for example, provides information that your family will need after your death. In it, you can express your desires for the memorial service, as well as the contact information for your employer, accountant and any other important advisors. (Note: It’s not a legal document.)
Also consider powers of attorney. A durable power of attorney for property allows you to appoint someone to act on your behalf on financial matters should you become incapacitated. A power of attorney for health care covers medical decisions and also takes effect if you become incapacitated. The person to whom you’ve transferred this power — your health care agent — can make medical decisions on your behalf.
Foundational elements
These are just a few of the foundational elements of a strong estate plan. We can work with you and your attorney to address the tax issues involved.
SHOULD YOU CHANGE YOUR BUSINESS – OR TRANSFORM IT?
As its market and technological needs evolve, every company needs to change. There’s even a formal term for the undertaking: “change management.” From an operational standpoint, change involves opening up the hood and switching out old engine parts for new ones. Even if it affects the business as a whole, change means focusing on specific areas and making alterations over relatively short periods.
At some point in the existence of many companies, the organization needs to go beyond change to transformation. This is much different. Business transformations aren’t so much about switching out parts as overhauling the entire engine, possibly modifying the frame and even applying a new coat of paint. Let’s look a little more closely at the distinction.
Reinvent yourself
Say a large commercial construction company was having trouble meeting its sales goals because of environmental regulations. So, it decided to augment its sales teams with environmental engineers who could better assess the compliance impact. The company applied change management principles — such as building a case for the idea and adjusting its business culture — and was successful. This was no doubt an important change, but the business itself wasn’t transformed.
The objective of a true transformation is to essentially reinvent the company and implement a new business model. And that model needs to be a carefully, formally devised chain of interlocking strategic initiatives that apply to the entire organization.
Perhaps the most obvious and universal example of a business transformation is Apple. The technology giant, once a head-to-head competitor with IBM on the personal computer market, found itself struggling in the 1990s. So, under the tutelage of the late Steve Jobs, it transformed itself into a mobile technology company. It still makes computers, of course, but the company’s transformative success can really be attributed to its mobile devices and operating systems.
Think and act wisely
Every business transformation differs based on the history, nature and size of the company in question. But there are best practices to keep in mind. For example, start with your customers, visualizing what they need (even if they don’t know it yet). Also, build a chain of initiatives, so you’re not trying to do everything all at once. And use metrics, so you can track specific dollar amounts and productivity goals throughout the transformation.
Above all, be ready for anything. Even the best-planned transformations can produce unpredictable results. So keep expectations in line and take a measured, patient approach to every initiative involved.
Bring along help
Successful business transformations can be spectacular and profitable. But, make no mistake, the risk level is high. So if you decide to embark on this journey, bring along your trusted financial, legal and strategic advisors.
3 STRATEGIES FOR HANDLING ESTIMATED TAX PAYMENTS
In today’s economy, many individuals are self-employed. Others generate income from interest, rent or dividends. If these circumstances sound familiar, you might be at risk of penalties if you don’t pay enough tax during the year through estimated tax payments and withholding. Here are three strategies to help avoid underpayment penalties:
Finally, beware that you also could incur interest and penalties if you’re subject to the additional 0.9% Medicare tax and it isn’t withheld from your pay and you don’t make sufficient estimated tax payments. Please contact us for help with this tricky tax task.
TAX CALENDAR
October 16 — Personal returns that received an automatic six-month extension must be filed today and any tax, interest and penalties due must be paid.
October 31 — The third quarter Form 941 (“Employer’s Quarterly Federal Tax Return”) is due today and any undeposited tax must be deposited. (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 November 10 to file the return.
November 15 — If the monthly deposit rule applies, employers must deposit the tax for payments in October for Social Security, Medicare, withheld income tax, and nonpayroll withholding.
December 15 — Calendar-year corporations must deposit the fourth installment of estimated income tax for 2017.
Important Information: The information contained in this newsletter was not intended or written to be used and cannot be used for the purpose of (1) avoiding tax-related penalties prescribed by the Internal Revenue Code or (2) promoting or marketing any tax-related matter addressed herein.
The Tax and Business Alert is designed to provide accurate information regarding the subject matter covered. However, before completing any significant transactions based on the information contained herein, please contact us for advice on how the information applies in your specific situation. Tax and Business Alert is a trademark used herein under license. © Copyright 2017.
DO YOU NEED THE PROTECTION OF A D&O INSURANCE POLICY?
Your efforts toward ensuring your financial security might be focused on building up your assets through wise investing or growing your business. But protecting the assets you already have is just as important. And if you serve as a director or officer of a company, or even sit on the board of a nonprofit, your assets may be vulnerable. One way to gain some protection is to obtain coverage under a directors and officers (D&O) insurance policy.
Assessing your risks
D&O insurance helps protect an organization’s directors, officers and board members from liability resulting from management decisions. Just a few examples of how such individuals can put themselves at risk include:
But even if directors or officers do nothing wrong, they still can be held financially responsible for others’ missteps if they’re sued and the organization lacks sufficient assets to protect them. Indeed, directors and officers are vulnerable to many types of lawsuits.
Employment-related litigation — covering such claims as harassment, discrimination and wrongful termination — is particularly common, while legal action also may be brought by unhappy shareholders, lenders, customers, suppliers, competitors or government regulators.
You may feel less vulnerable if you sit on the board of directors of a nonprofit. Although nonprofits do lack shareholders, they still have stakeholders — financial contributors or other individuals with a personal interest in the organization’s mission. Thus, nonprofit directors, officers and board members can find themselves at risk if these stakeholders decide to sue its leaders for mismanagement.
Contemplating coverage
When contemplating a D&O policy, determine exactly what it covers. For example, some insurers won’t cover fraud-related claims, while others specifically exclude employment-related litigation.
Next, weigh what’s covered against the specific risks you’re most likely to face. For example, if you’re thinking about joining the board of an organization with a history of rocky employee relations, determine whether you’ll be protected from employee-related lawsuits. If you uncover potential gaps in the D&O policy, or if it includes provisions that could lead to your coverage being rescinded in certain situations, you may need to obtain additional protection through supplemental liability insurance.
Building a safeguard
Make no mistake, a D&O policy can be costly because of the high financial stakes involved. So an organization in cost-cutting mode may not wish to offer you this coverage. Nonetheless, if you’re a director, officer or board member, a policy may serve as a critical safeguard for your family’s assets. Contact our firm for an assessment of your situation.
Sidebar: D&O vs. E&O
Many people mistakenly view errors and omissions (E&O) insurance as an alternative to a directors and officers (D&O) policy. Don’t be among them; the two types of policies cover different sets of risks.
E&O insurance covers the business itself against problems stemming from potential failures in the products and services a business offers its customers; D&O insurance protects individual officers and directors from financial risk stemming from management decisions — either yours or someone else’s.
BEWARE THE ONGOING RISK OF EMPLOYEE MISCLASSIFICATION
We live in an increasingly specialized society. As such, there’s a growing subset of the workforce with distinctive skill sets that can perform high-quality services. Through independent contractor relationships, companies are able to access these services without the long-term entanglements of traditional employment.
And yet, risk remains. 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. Also, independent status takes an individual off the company payroll, where an employee’s share of payroll taxes, plus income taxes, is automatically withheld.
For these reasons, the federal government views misclassifying a bona fide employee as an independent contractor as forcing a square peg into a round hole.
Key factors
The IRS has long been a primary enforcer of proper worker classification. When assessing worker classification, the agency 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.
Protective measures
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.
Before and during
Sometimes a company engages an independent contractor with short-term intentions only to gradually integrate the person into its staff, creating a risk of employee misclassification. Our firm can help you review the pertinent factors and use protective measures before and duringan engagement.
UNDERSTANDING THE DIFFERENCES BETWEEN HEALTH CARE ACCOUNTS
Health care costs continue to be in the news and on everyone’s mind. As a result, tax-friendly ways to pay for these expenses are very much in play for many people. The three primary players, so to speak, are Health Savings Accounts (HSAs), Flexible Spending Arrangements (FSAs) and Health Reimbursement Arrangements (HRAs).
All provide opportunities for tax-advantaged funding of health care expenses. But what’s the difference between these three types of accounts? Here’s an overview of each one:
HSAs. If you’re covered by a qualified high-deductible health plan (HDHP), you can contribute pretax income to an employer-sponsored HSA — or make deductible contributions to an HSA you set up yourself — up to $3,400 for self-only coverage and $6,750 for family coverage for 2017. Plus, if you’re age 55 or older, you may contribute an additional $1,000.
You own the account, which can bear interest or be invested, growing tax-deferred similar to an IRA. Withdrawals for qualified medical expenses are tax-free, and you can carry over a balance from year to year.
FSAs. Regardless of whether you have an HDHP, you can redirect pretax income to an employer-sponsored FSA up to an employer-determined limit — not to exceed $2,600 in 2017. The plan pays or reimburses you for qualified medical expenses.
What you don’t use by the plan year’s end, you generally lose — though your plan might allow you to roll over up to $500 to the next year. Or it might give you a 2½-month grace period to incur expenses to use up the previous year’s contribution. If you have an HSA, your FSA is limited to funding certain “permitted” expenses.
HRAs. An HRA is an employer-sponsored arrangement that reimburses you for medical expenses. Unlike an HSA, no HDHP is required. Unlike an FSA, any unused portion typically can be carried forward to the next year. And there’s no government-set limit on HRA contributions. But only your employer can contribute to an HRA; employees aren’t allowed to contribute.
Please bear in mind that these plans could be affected by health care or tax legislation. Contact our firm for the latest information, as well as to discuss these and other ways to save taxes in relation to your health care expenses.
5 KEYS TO DISASTER PLANNING FOR INDIVIDUALS
Disaster planning is usually associated with businesses. But individuals need to prepare for worst-case scenarios, as well. Unfortunately, the topic can seem a little overwhelming. To help simplify matters, here are five keys to disaster planning that everyone should consider:
Important Information: The information contained in this newsletter was not intended or written to be used and cannot be used for the purpose of (1) avoiding tax-related penalties prescribed by the Internal Revenue Code or (2) promoting or marketing any tax-related matter addressed herein.
The Tax and Business Alert is designed to provide accurate information regarding the subject matter covered. However, before completing any significant transactions based on the information contained herein, please contact us for advice on how the information applies in your specific situation. Tax and Business Alert is a trademark used herein under license. © Copyright 2017.
SHOULD YOU CONVERT FROM A C CORPORATION TO AN S CORPORATION?
Many private business owners elect to incorporate, turning their companies into C corporations. But, at some point, you may consider converting to an S corporation. This isn’t necessarily a bad idea, but it’s important to know the ramifications involved.
Similarities and differences
S and C corporations use many of the same recordkeeping practices. Both types of entities maintain books, records and bank accounts separate from those of their owners. They also follow state rules regarding annual directors meetings, fees and administrative filings. And both must pay and withhold payroll taxes for working owners who are active in the business.
There are, however, a few important distinctions. First, S corporations don’t incur corporate-level tax, so they don’t report federal (and possibly state) income tax expenses on their income statements. Also, S corporations generally don’t report prepaid income taxes, income taxes payable, or deferred income tax assets and liabilities on their balance sheets.
As an S corporation owner, you’d pay tax at the personal level on your share of the corporation’s income and gains. The combined personal tax obligations of S corporation owners can be significant at higher income levels.
Dividends vs. distributions
Other financial reporting differences between a C corporation and S corporation are more subtle. For instance, when C corporations pay dividends, they’re taxed twice: They pay tax at the corporate level when the company files its annual tax return, and the individual owners pay again when dividends and liquidation proceeds are taxed at the personal level.
When S corporations pay distributions — the name for dividends paid by S corporations — the payout generally isn’t subject to personal-level tax as long as the shares have positive tax “basis.” (S corporation basis is typically a function of capital contributions, earnings and distributions.)
Risk of tax audits
C corporations may be tempted to pay owners deductible above-market salaries to get cash out of the business and avoid the double taxation that comes with dividends. Conversely, S corporation owners may try to maximize tax-free distributions and pay owners below-market salaries to minimize payroll taxes.
The IRS is on the lookout for both scenarios. Corporations that compensate owners too much or too little may find themselves under audit. Regardless of entity type, an owner’s compensation should always be commensurate with his or her skills, experience and business involvement.
The right decision
For businesses that qualify (see sidebar), an S corporation conversion may be a wise move. But, as noted, there are rules and risks to consider. Also, as of this writing, there are tax reform proposals under consideration in Washington that could affect the impact of a conversion. Our firm can help you make the right decision.
Sidebar: Which companies can elect S status?
Not every private business is eligible to be an S corporation. In order to elect S status, a company must:
All shareholders must consent to the S election by signing Form 2553, “Election by a Small Business Corporation.”
COOL DOWN WITH A DIP INTO YOUR TAX RECORDS
In many parts of the country, the dog days of summer are a good time to stay inside. If you’re looking for a practical activity while you beat the heat, consider organizing your tax records. Granted, it may not be as exhilarating as jumping off the high dive, but a dip into these important documents now may save you a multitude of headaches later.
Tax law rules
Generally, you should keep tax-related records as long as the IRS has the ability to audit your return or assess additional taxes — in other words, until the statute of limitations expires. That means three years after you file your return or, if later, three years after the tax return’s original due date.
In some cases, the statute of limitations extends beyond three years. If you understate your adjusted gross income by more than 25%, for example, the period jumps to six years. And there’s no statute of limitations if you fail to file a tax return or file a fraudulent one.
Longer periods
Although the IRS statute of limitations is a good rule of thumb, there are exceptions to consider. For example, it’s wise to keep your tax returns themselves indefinitely because you never know when you’ll need a copy of your individual income tax return.
For one thing, the IRS often destroys original returns after four or five years. So if the IRS comes back 10 years later and claims you never filed a return for a particular year, it can assess tax for that year even though the limitations period for properly filed returns has long since expired. As you can see, it would be difficult to defend yourself without a copy of your tax return.
W-2 forms also are important to keep at least until you start receiving Social Security benefits. You may need them if there’s a question about your work record or earnings in a particular year.
Property and investments
If you have property records, it’s ideal to keep closing documents and records related to initial purchases and capital improvements until at least three years (preferably six years in case you understated your income by more than 25%) after you file your return for the year in which you sell the property.
When it comes to sales of stocks or other securities, retain purchase statements and trade confirmations until at least three years (preferably six years) after you file your return for the year in which you sell these stocks or other securities.
Grains of sand
Many years’ worth of tax and financial records can accumulate like grains of sand on your favorite beach. So the better your documentation is organized, the easier time you’ll have filing your return every year and dealing with any IRS surprises. Our firm can assist you in determining what you should keep.
IRS PERMITS HIGH-EARNER ROTH IRA ROLLOVER OPPORTUNITY
Are you a highly compensated employee (HCE) approaching retirement? If so, and you have a 401(k), you should consider a potentially useful tax-efficient IRA rollover technique. The IRS has specific rules about how participants such as you can allocate accumulated 401(k) plan assets based on pretax and after-tax employee contributions between standard IRAs and Roth IRAs.
High-earner dilemma
In 2017, the top pretax contribution that participants can make to a 401(k) is $18,000 ($24,000 for those 50 and older). Plans that permit after-tax contributions (several do) allow participants to contribute a total of $54,000 ($36,000 above the $18,000 pretax contribution limit). While some highly compensated supersavers may have significant accumulations of after-tax contributions in their 401(k) accounts, the tax law income caps block the highest paid HCEs from opening a Roth IRA.
However, under IRS rules, these participants can roll dollars representing their after-tax 401(k) contributions directly into a new Roth IRA when they retire or no longer work for the companies. Thus, they’ll ultimately be able to withdraw the dollars representing the original after-tax contributions — and subsequent earnings on those dollars — tax-free.
An example
Participants can contribute rollover dollars to conventional and Roth IRAs on a pro-rata basis. For example, suppose a retiring participant had $1 million in his 401(k) plan account, $600,000 of which represents contributions. Suppose further that 70% of that $600,000 represents pretax contributions, and 30% is from after-tax contributions. IRS guidance clarifies that the participant can roll $700,000 (70% of the $1 million) into a conventional IRA, and $300,000 (30% of the $1 million) into a Roth IRA.
The IRS rules allow the retiree to roll over not only the after-tax contributions, but the earnings on those after-tax contributions (40% of the $300,000, or $120,000) to the Roth IRA provided that the $120,000 will be taxable for the year of the rollover.
Alternatively, the IRS rules allow the retiree to delay taxation on the earnings attributable to the after-tax contributions ($120,000) until the money is distributed by contributing that amount to a conventional IRA, and the remaining $180,000 to the Roth IRA.
Under each approach, the subsequent growth in the Roth IRA will be tax-free when withdrawn. Partial rollovers can also be made, and the same principles apply.
Golden years ahead
HCEs face some complex decisions when it comes to retirement planning. Let our firm help you make the right moves now for your golden years ahead.
SHIFTING CAPITAL GAINS TO YOUR CHILDREN
If you’re an investor looking to save tax dollars, your kids might be able to help you out. Giving appreciated stock or other investments to your children can minimize the impact of capital gains taxes.
For this strategy to work best, however, your child must not be subject to the “kiddie tax.” This tax applies your marginal rate to unearned income in excess of a specified threshold ($2,100 in 2017) received by your child who at the end of the tax year was either: 1) under 18, 2) 18 (but not older) and whose earned income didn’t exceed one-half of his or her own support for the year (excluding scholarships if a full-time student), or 3) a full-time student age 19 to 23 who had earned income that didn’t exceed half of his or her own support (excluding scholarships).
Here’s how it works: Say Bill, who’s in the top tax bracket, wants to help his daughter, Molly, buy a new car. Molly is 22 years old, just out of college, and currently looking for a job — and, for purposes of the example, won’t be considered a dependent for 2017.
Even if she finds a job soon, she’ll likely be in the 10% or 15% tax bracket this year. To finance the car, Bill plans to sell $20,000 of stock that he originally purchased for $2,000. If he sells the stock, he’ll have to pay $3,600 in capital gains tax (20% of $18,000), plus the 3.8% net investment income tax, leaving $15,716 for Molly. But if Bill gives the stock to Molly, she can sell it tax-free and use the entire $20,000 to buy a car. (The capital gains rate for the two lowest tax brackets is generally 0%.)
Important Information: The information contained in this newsletter was not intended or written to be used and cannot be used for the purpose of (1) avoiding tax-related penalties prescribed by the Internal Revenue Code or (2) promoting or marketing any tax-related matter addressed herein.
The Tax and Business Alert is designed to provide accurate information regarding the subject matter covered. However, before completing any significant transactions based on the information contained herein, please contact us for advice on how the information applies in your specific situation. Tax and Business Alert is a trademark used herein under license. © Copyright 2017.
The Illinois House recently followed the Senate’s lead in overriding Governor Rauner’s veto of the Illinois budget. Senate Bill 9 raises around $5 billion of new permanent income taxes. The individual income tax rates increased from 3.75% to 4.95%, while the corporate rates rose from 5.25% to 7.0%. These rate increases were effective on July 1, 2017.
The difficulty with the midyear tax increase is that the law imposes the new tax rate effective July 1, 2017 so that net income is taxed at the 3.75% rate from January 1 through June 30, 2017. Likewise an income tax rate of 4.95% is imposed on the income earned from July 1 through December 31, 2017. Illinois taxpayers are provided two options to calculate income subject to different rates in the same tax year. A taxpayer may divide its full year net income proportionally based on the number of months subject to the former rate and the new rate. This would effectively result in a tax rate of 4.35% to be applied to the entire 2017 tax year for individuals. Alternatively, a taxpayer may elect to specifically account for items of income and deduction based on when they were generated during the tax year. See the following example for this election.
Example: A husband and wife file a joint Illinois income tax return for 2017. The husband earns $75,000 plus a $30,000 bonus received in January 2017. The wife earns a salary of $50,000 plus she sold a stock and received a capital gain of $10,000 in November 2017. To the best of our knowledge, the income tax calculations would be as follows:
| 1/1/17 – 6/30/17 | 7/1/17 – 12/31/17 | TOTAL | |
| Husband salary | $37,500 | $37,500 | $75,000 |
| Wife salary | 25,000 | 25,000 | 50,000 |
| Husband bonus received in January | 30,000 | —— | 30,000 |
| Wife capital gain in November | —— | 10,000 | 10,000 |
| Total income | $92,500 | $72,500 | $165,000 |
| Tax rate | 3.75% | 4.95% | |
| Tax | $3,469 | $3,589 | $7,058 |
If the taxpayers did not make the election to specifically allocate income, the use of the blended rate of 4.35% would result in an Illinois income tax of $7,178 ($165,000 * 4.35%). Therefore, the election results in savings to the taxpayers of $120 ($7,178 – $7,058). Note that this illustration does not factor in other adjustments that may impact the calculation such as exemptions, adjustments, etc.
The corporate income tax calculation will work in the same manner. As you can see, additional work will be required on your part in breaking down your income as to whether it was received prior to July 1 or after July 1.
For those of you with businesses who have employees, obviously the Illinois withholding on wages paid after June 30, 2017 will be required to be withheld at the 4.95% rate.
Other changes included in the new law include the elimination of personal exemptions, education expense credit and the real estate tax credit for single filers with income of $250,000 per year and for joint filers with income of $500,000 per year starting in 2017. The law also increases the earned income credit from 10% to 14% for 2017 and then to 18% in 2018. The cap on the education expense credit will increase from $500 to $750 in 2017 and the teachers’ deduction (for federal purposes) of $250 will become a $250 credit for Illinois.
Many of these changes could greatly affect your income tax situation for 2017 and beyond. Please contact us if we can be of any assistance.
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