Tax News July 2017

WHY YOU SHOULD (OR SHOULDN’T) PURSUE AN ACQUISITION

Like so many aspects of the national and global economies, merger and acquisition (M&A) activity tends to wax and wane. Nonetheless, billions of dollars continue to change hands annually, and an acquisition can be a great way to grow a business. So if one of these deals comes your way, it’s important to carefully consider both the pros and cons.

Look at the possibilities

Merging with, or acquiring, another company is one of the best ways to grow rapidly. You might be able to significantly boost revenue, literally overnight, by acquiring another business. Achieving a comparable rate of growth organically — by increasing sales of existing products and services or adding new product and service lines — can take years.

An acquisition also might enable your company to expand into new geographic areas and new customer segments more quickly and easily. You can do this via a horizontal acquisition (acquiring another company that’s similar to yours) or a vertical acquisition (acquiring another company along your supply chain).

In addition, you can realize synergies by acquiring the right type of company. Synergies are business characteristics and capabilities that complement and work well with those of your own company. The idea is to find an acquisition target that offers the right synergies so that the new combined entity will be stronger than either business would have been on its own.

Be aware of drawbacks

Although there are many potential benefits to acquiring another business, there are some potential drawbacks as well. For example, completing an acquisition is a costly process, from both a financial and a time-commitment perspective.

Therefore, you should determine how much the transaction will cost and how it will be financed before beginning the M&A process. Also try to get an idea of how much time you and your key managers will have to spend on M&A-related tasks in the coming months — and how this could impact your existing operations.

A loss of control is another potential drawback to consider. Depending on the deal’s structure, some degree of control may have to be shared with the owners of the business you’re acquiring, especially if the owners aren’t retiring but intend to be actively involved with the merged entity.

It’s also critical to try to ensure that the cultures of the two merging businesses will be compatible. Mismatched corporate cultures have been the main cause of numerous failed mergers, including some high-profile megamergers. For instance, if one company has a more formal and buttoned-down culture while the other is more casual and laid back, conflicts will likely ensue unless you plan carefully for how the two divergent cultures will be blended together.

Perform due diligence

The best way to reduce the risk involved in buying another business is to perform solid due diligence on your acquisition target. Your objective should be to confirm claims made by the seller about the company regarding its financial condition, clients, contracts, employees and management team.

The most important step in M&A due diligence is a careful examination of the company’s financial statements — specifically, the income statement, cash flow statement and balance sheet. Also scrutinize the existing client base and client contracts (if any exist) because projected future earnings and cash flow will largely hinge on these.

Finally, try to get a good feel for the knowledge, skills and experience possessed by the company’s employees and key managers. In some circumstances, you might consider offering key executives ownership shares if they’ll commit to staying with the company for a certain length of time after the merger.

Map your course

An acquisition is one way to expand and grow your company. But be sure to map your course thoroughly before heading down the M&A road. Our firm can help steer you in the right direction.

LEASING PROPERTY TO YOUR BUSINESS MIGHT TRIGGER UNDESIRABLE TAX CONSEQUENCES

If you own property and a business, there’s an obvious temptation to lease that property to the business. Such an arrangement can make sense from many perspectives.

You’re no doubt familiar with the property and its advantages to your company; the deal could be carried out quickly; and the money changing hands would stay between you and your company. And if you participate in other loss-producing passive activities, you may be hoping to offset the net rental income with those losses.

There’s just one big problem: You’d risk triggering the “self-rental rule” and not achieving your desired tax outcome.

Self-rental rule in a nutshell

Internal Revenue Code (IRC) Section 469 generally prohibits taxpayers from deducting passive activity losses (PALs).

It typically applies to “flow-through” income and losses from partnerships, limited liability companies (if they’ve elected to be treated as a partnership for tax purposes), S corporations and trusts.

The rules define “passive activity” as any trade or business in which the taxpayer doesn’t materially participate. Rental real estate activities generally are considered passive activities regardless of whether the taxpayer materially participates. (There’s an exception if the taxpayer qualifies as a real estate professional.)

A PAL is the amount by which the taxpayer’s aggregate losses from all passive activities for the year exceed the aggregate income from all of those activities. A PAL can usually be used only to offset passive income, though there are a few exceptions.

The self-rental rule in IRC Sec. 469 applies when you rent property to a business in which you or your spouse materially participates. Under the rule, any net rental losses are still considered passive, but the net rental income is deemed nonpassive. That means your net rental income can’t be offset by other passive losses, yet net rental losses generally can offset only other passive income. This could have negative tax consequences if you’re hoping to offset your self-rental net income with passive losses from other activities.

The power of grouping

You may be able to avoid the negative tax consequences of IRC Sec. 469’s self-rental rule by “grouping.” The regulations allow you to group your separately owned rental building with your business to treat them as one activity for purposes of the passive loss rules if they constitute an “appropriate economic unit.”

The regulations determine this based on factors such as common ownership and control, types of activities and location. As long as you materially participate in the business — and the business isn’t a C corporation — the rental activity won’t be treated as passive for the purposes of income or losses.

To take advantage of this option, you must own both the rental property and the business. You could also use grouping if the rental activity is “insubstantial” (a term undefined by the regulations) in relation to the business activity.

Finding the best arrangement

Renting property to a business in which you materially participate can seem like a great idea. But doing so can turn out to be a lose-lose proposition when it comes to taxes — particularly for S corporation owners who may not understand the rules. Please contact our firm for help devising the most beneficial arrangement for your situation.

WHICH TYPE OF MORTGAGE LOAN MEETS YOUR NEEDS?

Few purchases during your lifetime will be as expensive as buying a home. Whether it’s your primary residence, a vacation home or an investment property, how you choose to pay for it can have a significant impact on your financial situation over time. If you’re considering a mortgage loan, understanding the main categories of mortgages — fixed-rate and adjustable-rate — and the situations they’re best designed for will help you match the right type for your needs.

Fixed-rate loans offer stability

A fixed-rate mortgage, as its name suggests, is a loan whose interest rate remains constant for the life of the loan — typically 15 or 30 years. One of the primary benefits of a fixed-rate loan is that it provides a measure of certainty about one of the biggest expenses in your monthly budget. With interest rates likely to rise after an extended period of historically low rates, you won’t have to worry about potentially higher payments in the future if you select a fixed-rate loan.

That said, if interest rates were to fall again, your fixed-rate loan would leave you unable to take advantage of the shift unless you refinance, which might involve fees. You’re also paying a premium for the stability offered by a fixed-rate mortgage. You could consider a 15-year fixed-rate loan, which would charge a lower rate than a 30-year loan, but the tradeoff will be higher monthly payments.

ARMs provide flexibility

Adjustable-rate mortgages (ARMs) typically offer a fixed interest rate for an initial period of years. This rate, which is usually lower than that of a comparable fixed-rate mortgage, resets periodically based on a benchmark interest rate. For example, a 5/1 ARM means that your interest rate is fixed for the first five years and then will adjust every year after that.

Paying less interest in the beginning frees your cash for other investments. You might also take advantage of an ARM if you’re confident that you’ll have more money in the future than you do today, or if you plan on selling your house before or soon after the initial fixed-rate period expires. When considering an ARM, you’ll need to assess your ability to keep up with potentially higher payments — say, if the initial period expires, your rate goes up and you’re unable to sell the home, or if your income changes.

The best for you

The right loan type depends, naturally, on your financial position. But whether you’re buying a primary residence, vacation home or investment property also plays a role. Regardless of which type of home you’re purchasing, having a basic knowledge of the loan types can help ease the buying process. Let our firm assist you in evaluating the best mortgage for your needs.

KNOW YOUR TAX HAND WHEN IT COMES TO GAMBLING

A royal flush can be quite a rush. But the IRS casts a wide net when defining gambling income. It includes winnings from casinos, horse races, lotteries and raffles, as well as any cash or prizes (appraised at fair market value) from contests. If you participate in any of these activities, you must report such winnings as income on your federal return.

If you’re a casual gambler, report your winnings as “Other income” on Form 1040. You may also take an itemized deduction for gambling losses, but the deduction is limited to the amount of winnings.

In some cases, casinos and other payers provide IRS Form W-2G, “Certain Gambling Winnings” — particularly if the entity in question withholds federal income tax from winnings. The information from these forms needs to be included on your tax return.

If you gamble often and actively, you might qualify as a professional gambler, which comes with tax benefits: It allows you to deduct not only losses, but also wagering-related business expenses — such as transportation, meals and entertainment, tournament and casino admissions, and applicable website and magazine subscriptions.

To qualify as a professional, you must be able to demonstrate to the IRS that a “profit motive” exists. The agency looks at a list of nonexclusive factors when making this determination, including:

  • Whether the taxpayer conducts the gambling activity in a “businesslike” manner,
  • The quantity of time spent gambling, and
  • How much income is earned from nongambling activities.

But don’t “go pro” for the tax benefits, since doing so is a major financial risk. If you enjoy the occasional game of chance, or particularly if you’re considering gambling as a profession, please contact our firm. We can help you manage the tax impact.

TAX CALENDAR

July 17 — If the monthly deposit rule applies, employers must deposit the tax for payments in June for Social Security, Medicare, withheld income tax and nonpayroll withholding.

July 31 — If you have employees, a federal unemployment tax (FUTA) deposit is due if the FUTA liability through June exceeds $500.

  • The second quarter Form 941 (“Employer’s Quarterly Federal Tax Return”) is also due today. (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 August 10 to file the return.

August 15 — If the monthly deposit rule applies, employers must deposit the tax for payments in July for Social Security, Medicare, withheld income tax and nonpayroll withholding.

September 15 — Third quarter estimated tax payments are due for individuals, trusts and calendar-year corporations.

  • If a six-month extension was obtained, partnerships should file their 2016 Form 1065 by this date.
  • If a six-month extension was obtained, calendar-year S corporations should file their 2016 Form 1120S by this date.
  • If the monthly deposit rule applies, employers must deposit the tax for payments in August for Social Security, Medicare, withheld income tax, and nonpayroll withholding.

 

 

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.

Tax News June 2017

IN DOWN YEARS, NOL RULES CAN OFFER TAX RELIEF

From time to time, a business may find that its operating expenses and other deductions for a particular year exceed its income. This is known as incurring a net operating loss (NOL).

In such cases, companies (or their owners) may be able to snatch some tax relief from this revenue defeat. Under the Internal Revenue Code, a corporation or individual may deduct an NOL from its income.

3 ways to play

Generally, you take an NOL deduction in one of three ways:

  1. Deducting the loss in previous years, called a “carryback,” which creates a refund,
  2. Deducting the loss in future years, called a “carryforward,” which lowers your future tax liability, or
  3. Doing a little bit of both.

A corporation or individual must carry back an NOL to the two years before the year it incurred the loss. But the carryback period may be increased to three years if a casualty or theft causes the NOL, or if you have a qualified small business and the loss is in a presidentially declared disaster area. The carryforward period is a maximum of 20 years.

Direction of travel

You must first carry back losses to the earliest tax year for which you qualify, depending on which carryback period applies. This can produce an immediate refund of taxes paid in the carryback years. From there, you may carry forward any remaining losses year by year up to the 20-year maximum.

You may, however, elect to forgo the carryback period and instead immediately carry forward a loss if you believe doing so will provide a greater tax benefit. But you’ll need to compare your marginal tax rate — that is, the tax rate of the last income dollar in the previous two years — with your expected marginal tax rates in future years.

For example, say your marginal tax rate was relatively low over the last two years, but you expect big profits next year. In this case, your increased income might put you in a higher marginal tax bracket. So you’d be smarter to waive the carryback period and carry forward the NOL to years in which you can use it to reduce income that otherwise would be taxed at the higher rate.

Then again, as of this writing, efforts are underway to pass tax law reform. So, if tax rates go down, it might be more beneficial to carry back an NOL as far as allowed before carrying it forward.

Whatever the reason

Many circumstances can create an NOL. Whatever the reason, the rules are complex. Let us help you work through the process.

Sidebar: AMT effect

One tricky aspect of navigating the net operating loss (NOL) rules is the impact of the alternative minimum tax (AMT). Many business owners wonder whether they can offset AMT liability with NOLs just as they can offset regular tax liability.

The answer is “yes” — you can deduct your AMT NOLs from your AMT income in generally the same manner as for regular NOLs. The excess of deductions allowed over the income recognized for AMT purposes is essentially the AMT NOL. But beware that different rules for deductions, exclusions and preferences apply to the AMT. (These rules apply to both individuals and corporations.)

ASKING THE RIGHT QUESTIONS ABOUT LONG-TERM CARE INSURANCE

Like most people, as you age into your 40s and 50s, you may wonder what the future holds for your health and well-being. Will you be as sharp mentally and robust physically as you are right now? Could a serious medical condition arise in your future that might prevent you from performing routine daily tasks?

Unfortunately, many of us require long-term care (LTC) at some point in our lives. To hedge against this considerable financial risk, insurers offer LTC coverage.

Do you really need it?

LTC insurance policies help pay for the cost of long-term nursing care or assistance with activities of daily living (ADLs), such as eating or bathing. Many policies cover care provided in the home, an assisted living facility or a nursing home, though some restrict coverage to only licensed facilities. Without this coverage, you’d likely need to pay these bills out of pocket.

Medicare or health insurance generally covers such expenses only if they’re temporary — that is, during a period over which you’re continuing to improve, such as recovering from surgery or a stroke. Once you’ve plateaued and are unlikely to improve further, health insurance or Medicare coverage typically ends.

That’s when LTC insurance may take over. But you need to balance the value of LTC insurance benefits with the cost of premiums, which can run several thousand dollars annually (though a portion may be tax deductible). Depending on your income and net worth, as well as your personal and family health history, LTC insurance may not be a worthwhile investment.

Should you buy now or later?

The younger you are when you buy a policy, the lower the premiums typically will be. And, the chance of being declined for a policy increases with age. Certain health conditions, such as Parkinson’s disease, can also make it more difficult, or impossible, for you to obtain an LTC policy. If you can still get coverage, it likely will be much more expensive.

So buying earlier in life may make sense. But, keep in mind you’ll potentially be paying premiums over a much longer period. You can often trim premium costs by choosing a longer elimination period or a shorter benefit period.

The elimination period is the amount of time between the start of the benefit trigger and the time that the policy begins paying benefits. This can range from 30 days to several months. Premium costs decrease as the elimination period increases.

Meanwhile, the benefit period is the period of time over which the policy pays for care. This can range from a year or two to an unlimited amount of time.

Boon or bust

Buying LTC insurance can be a boon or a bust. You should consider contacting our firm before making the purchase. We can help you determine whether LTC insurance is right for your situation and, if so, when to buy and the appropriate amount of coverage.

RENTING OUT YOUR VACATION HOME? ANTICIPATE THE TAX IMPACT

When buying a vacation home, the primary objective is usually to provide a place for many years of happy memories. But you might also view the property as an income-producing investment and choose to rent it out when you’re not using it. Let’s take a look at how the IRS generally treats income and expenses associated with a vacation home.

Mostly personal use

You can generally deduct interest up to $1 million in combined acquisition debt on your main residence and a second residence, such as a vacation home. In addition, you can also deduct property taxes on any number of residences.

If you (or your immediate family) use the home for more than 14 days and rent it out for less than 15 days during the year, the IRS will consider the property a “pure” personal residence, and you don’t have to report the rental income. But any expenses associated with the rental — such as advertising or cleaning — aren’t deductible.

More rental use

If you rent out the home for more than 14 days and you (or your immediate family) occupy the home for more than 14 days or 10% of the days you rent the property — whichever is greater — the IRS will still classify the home as a personal residence (in other words, vacation home), but you will have to report the rental income.

In this situation, you can deduct the personal portion of mortgage interest, property taxes and casualty losses as itemized deductions. In addition, the rental portion of your expenses is deductible up to the amount of rental income. If your rental expenses are greater than your rental income, you may not deduct the loss against other income.

If you (or your immediate family) use the vacation home for 14 days or less, or under 10% of the days you rent out the property, whichever is greater, the IRS will classify the home as a rental property. In this instance, while the personal portion of mortgage interest isn’t deductible, you may report as an itemized deduction the personal portion of property taxes. You must report the rental income and may deduct all rental expenses, including depreciation, subject to the passive activity loss rules.

Brief examination

This has been just a brief examination of some of the tax issues related to a vacation home. Please contact our firm for a comprehensive assessment of your situation.

 

THOUGHTS AND MUSINGS ON FAMILY BUDGETING

 

Simplicity is the key to a successful family budget. But every budget needs to cover all necessary items. To find the right balance, your budget should address two distinct facets of your family members’ lives: the near term and the long term.

In the near term, your budget should encompass the primary, day-to-day items that affect every family. First, housing: This is often the biggest expense in a family budget. And a budget shouldn’t include only mortgage or rent payments, but also expenses such as utilities, furnishings, maintenance and supplies.

Naturally, there are other items related to daily life for which you need to account. These include groceries, vehicle and transportation expenses, clothing, child care, insurance and out-of-pocket medical expenses. And you need to draw clear distinctions between fixed and discretionary spending.

Along with being a practical guide to family spending, a budget needs to address long-term goals. Naturally, some goals are further out than others. One of your longest-term objectives is probably to retire comfortably. So the budget should incorporate retirement plan contributions and other ways to meet this goal.

A relatively less long-term goal might be funding your children’s education. So, again, the budget should reflect this. And, as a long-term but “as soon as possible” objective, the budget needs to be structured to pay off debt and maintain a strong credit rating.

Only through careful planning and discussion can families build a budget that addresses both daily finances and long-term financial goals. We can help you get started.

 

 

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.

Employees Raise Over $5,400 for Big Brothers Big Sisters

Our employees have once again teamed up to raise funds for Big Brothers Big Sisters (BBBS) of Southwestern Illinois at the annual Bowl for Kids’ Sake fundraiser. This year our teams raised over $5,400 for the agency through their efforts, which will all be donated directly to BBBS of Southwestern Illinois.

Scheffel Boyle’s two bowling teams, the Tax Manian Devils and the Ten-Key Strikers, participated in the event on April 25th at Edison’s Entertainment Complex in Edwardsville. Our ten bowlers are responsible for doing their own fundraising for the event, and it’s a friendly competition among the coworkers as to who can raise the most money for BBBS. This year, one of our teams ranked 1st for the entire Southwestern Illinois region for total funds raised, and Scheffel Boyle placed 2nd overall in fundraising.

Big shout-out to our bowlers Elizabeth Heil, Carrie Evans, Jenna Andres, Josh Andres, Michael Brokering, Sarah Smith, Jennison Ebbert, Crystal Schulte, Chad Frerichs, and Crystal Bock. Thank you for all you do for this amazing organization!

BBBS has been changing lives of youth throughout the U.S. for more than 100 years. Their vision “that all children achieve success in life”, is supported through donations and fundraising events, such as Bowl for Kids’ Sake. For information on how you can donate or participate in a BBBS of Southwestern Illinois event, visit www.bbbsil.org.

 

Tax News: May 2017

COULD A COST SEGREGATION STUDY SAVE YOUR COMPANY TAXES?

If your business has acquired, constructed or substantially improved a building recently, consider a cost segregation study. One of these studies can enable you to identify building costs that are properly allocable to tangible personal property rather than real property. And this may allow you to accelerate depreciation deductions, reducing taxes and boosting cash flow.

Overlooked opportunities

IRS rules generally allow you to depreciate commercial buildings over 39 years (27½ years for residential properties). Often, businesses will depreciate 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, companies 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. Items that appear to be part of a building may in fact be personal property. Examples include:

  • Removable wall and floor coverings,
  • Detachable partitions,
  • Awnings and canopies,
  • Window treatments,
  • Signage, 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. Examples include reinforced flooring to support heavy manufacturing equipment, electrical or plumbing installations, and dedicated cooling systems for server rooms.

A study in action

Let’s say you acquired a nonresidential commercial building for $5 million on January 1. If the entire purchase price is allocated to 39-year real property, you’re entitled to claim $123,050 (2.461% of $5 million) in depreciation deductions the first year.

A cost segregation study may reveal that you can allocate $1 million in costs to five-year property eligible for accelerated depreciation. Reallocating the purchase price increases your first-year depreciation deductions to $298,440 ($4 million × 2.461%, plus $1 million × 20%).

Impact of tax law changes

Bear in mind that tax law changes may occur this year that could significantly affect current depreciation and expensing rules. This in turn could alter the outcome and importance of a cost segregation study. Contact our firm for the latest details.

On the other hand, any forthcoming tax law changes likely won’t affect your ability to claim deductions you may have missed in previous tax years. (For more on this concept, see “It may not be too late: Look-back studies.”)

Worthy effort

As you might suspect, a cost segregation study will entail some effort in analyzing your building’s structural components and making your case to the IRS. But you’ll likely find it a worthy effort.

 

Sidebar: It may not be too late: Look-back studies

If your business invested in depreciable buildings or improvements in previous years, it may not be too late to take advantage of a cost segregation study. A “look-back” cost segregation study allows you to claim missed deductions in qualifying previous tax years.

To claim these tax benefits, we can help you file Form 3115, “Application for Change in Accounting Method,” with the IRS and claim a one-time “catch-up” deduction on your current year’s return. There will be no need to amend previous years’ returns.

 

VIATICAL SETTLEMENTS: A FUNDING MECHANISM FOR MEDICAL COSTS

 

Someone who’s terminally or chronically ill may lack the funds to cover significant medical costs. Although insurance policies have historically been held for the death benefits, it may be possible to sell a policy to a viatical settlement provider. This way, the individual can secure much-needed and generally tax-free cash while still alive.

Buyers and sellers

Viatication allows a terminally ill person to sell an existing life insurance policy to an investor for more than its cash surrender value but less than its net death benefit. The buyer continues to pay the premiums and receives the life insurance proceeds upon the death of the insured. Many companies currently either buy the policies themselves or serve as brokers to match buyers and sellers for a fee.

In identifying a potential seller, many viatical companies limit their selection to terminally ill individuals with a certain remaining life expectancy (for example, 24 months or less). This is because the company wants to minimize its risk that the individual will outlive his or her life expectancy, resulting in a lower return from the purchase of the life insurance policy for the company.

Factors to consider

To determine whether it would be advantageous to sell a policy, the insured should consider factors such as:

  • His or her cash needs,
  • The discount in the value of the death benefit,
  • The possibility that payments will disqualify him or her for Medicaid benefits, and
  • Access to the payments by his or her creditors.

(Regarding the last point, the cash value while it remains in a life insurance contract may not be subject to the claims of creditors.)

Tax consequences

Amounts received under a life insurance contract on the life of terminally ill (or within limits, chronically ill) individuals are excluded from gross income for federal income tax purposes. A similar exclusion applies to the sale or assignment of any portion of a death benefit to a viatical settlement provider if the insured is chronically or terminally ill and the payments in question are funded by and diminish the life insurance policy’s death benefit.

However, the exclusion doesn’t apply if the accelerated death benefits are paid to someone other than the insured individual and the recipient has a business or financial relationship with the insured.

Rules and issues

Viatication is a complex and sensitive topic. Let us help you navigate the applicable rules and issues.

 

WATCH OUT FOR IRD ISSUES WHEN INHERITING MONEY

 

Once a relatively obscure concept, income in respect of a decedent (IRD) can create a surprisingly high tax bill for those who inherit certain types of property, such as IRAs or other retirement plans. Fortunately, there are ways to minimize or even eliminate the IRD tax bite.

How it works

Most inherited property is free from income taxes, but IRD assets are an exception. IRD is income a person was entitled to but hadn’t yet received at the time of his or her death. It includes:

  • Distributions from tax-deferred retirement accounts, such as 401(k)s and IRAs,
  • Deferred compensation benefits and stock option plans,
  • Unpaid bonuses, fees and commissions, and
  • Uncollected salaries, wages, and vacation and sick pay.

IRD isn’t reported on the deceased’s final income tax return, but it’s included in his or her taxable estate, which may generate estate tax liability if the deceased’s estate exceeds the $5.49 million (for 2017) estate tax exemption, less any gift tax exemption used during life. (Be aware that President Trump and congressional Republicans have proposed an estate tax repeal. It hasn’t been passed as of this writing, but check back with us for the latest information.)

Then it’s taxed — potentially a second time — as income to the beneficiaries who receive it. This income retains the character it would have had in the deceased’s hands. So, for example, income the deceased would have reported as long-term capital gains is taxed to the beneficiary as long-term capital gains.

What can be done

When IRD generates estate tax liability, the combination of estate and income taxes can devour an inheritance. The tax code alleviates this double taxation by allowing beneficiaries to claim an itemized deduction for estate taxes attributable to amounts reported as IRD. (The deduction isn’t subject to the 2% floor for miscellaneous itemized deductions.)

The estate tax attributable to IRD is equal to the difference between the actual estate tax paid by the estate and the estate tax that would have been payable if the IRD’s net value had been excluded from the estate.

Suppose, for instance, that you’re the beneficiary of an estate that includes a taxable IRA. If the estate tax is $150,000 with the retirement account and $100,000 without, the estate tax attributable to the IRD income is $50,000. But be careful, because any deductions in respect of a decedent must also be included when calculating the estate tax impact.

When multiple IRD assets and multiple beneficiaries are involved, complex calculations are necessary to properly allocate the income and deductions. Similarly, when a beneficiary receives IRD over a period of years — IRA distributions, for example — the deduction must be prorated based on the amounts distributed each year.

We can help

If you inherit property that could be considered IRD, please consult our firm for assistance in managing the tax consequences. With proper planning, you can keep the cost to a minimum.

REVIEWING THE INNOCENT SPOUSE RELIEF RULES

 

Married couples don’t always agree — and taxes are no exception. In certain cases, an “innocent” spouse can apply for relief from the responsibility of paying tax, interest and penalties arising from a spouse’s (or former spouse’s) improperly handled tax return. Although it isn’t easy to qualify, potentially affected taxpayers should review the rules.

Applicants may qualify for various forms of relief if they can meet the applicable IRS conditions. One factor that’s considered is whether the applicant received any significant direct or indirect benefit from the tax understatement. For instance, an applicant’s case could be weakened if he or she had used unreported income to pay extraordinary household expenses.

The IRS will also look at the distinctive aspects of the case. The fact that a spouse applying for relief has already divorced his or her partner is significant. Whether the applicant was abused physically or mentally will also play a role, as will whether he or she was in poor mental or physical health when the return(s) in question was signed. In addition, the IRS will consider whether the applicant would experience economic hardship without relief from a significant tax debt.

Generally, an applicant must request innocent spouse relief no later than two years after the date the IRS first attempted to collect the tax. But other forms of relief may still be available thereafter. Please contact our firm for more information.

 

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.

Tax News: April 2017

VIEWING YOUR COMPANY’S BUY-SELL AGREEMENT

If you own a business and follow professional advice, you’ve likely established a buy-sell agreement in case you or a co-owner voluntarily or involuntarily leaves the company. Assuming this is true, remember that it’s not enough to draft an agreement and put it in a safe place. You need to review and perhaps revise the document periodically.

Problems solved

The primary purpose of every buy-sell agreement is to legally confer on the owners of a business or the business itself the right or obligation to buy a departing owner’s interest. But a well-crafted agreement can also help ensure that control of your business is restricted to specified individuals, such as current owners, select family members or upper-level managers.

Another purpose of a buy-sell agreement is to establish a price for the ownership interests. You should engage a qualified appraiser to estimate the value of those interests when first making a buy-sell agreement, and periodically thereafter to ensure the price keeps up with the growing (or shrinking) value of your company.

Estate planning is also a priority for many buy-sell agreements. If your agreement was drafted more than a few years ago, you may need to update it based on recent gift and estate tax changes. For 2017, the top rate for the gift, estate and generation-skipping transfer (GST) taxes is 40% and the exemption limit is $5.49 million. However, also keep in mind that the President and Republicans in Congress have indicated a desire to repeal the estate tax, which might happen later this year.

Standard and unusual triggers

Most buy-sell agreements lie dormant for years. What can quickly bring one to life is a “triggering event,” such as when an owner:

  • Dies,
  • Becomes disabled, or
  • Retires or voluntarily leaves the company.

But you may want to make sure your agreement also covers triggers such as changes in an owner’s marital status. And to prevent fraud or inappropriate behavior, many agreements include “conviction for committing a crime, losing a professional license or certification, or becoming involved in a scandal” as a triggering event.

3 options

Buy-sell agreements typically are structured as one of the following agreements:

  1. Redemption, which permits or requires the business as a whole to repurchase an owner’s interest,
  2. Cross-purchase, which permits or requires the remaining owners of the company to buy the interest, typically on a pro rata basis, or
  3. Hybrid, which combines the two preceding structures. A hybrid agreement, for example, might require a departing owner to first make a sale offer to the company and, if it declines, sell to the remaining individual owners.

In choosing your buy-sell agreement’s initial structure, consider the tax implications. They’ll differ based on whether your company is a flow-through entity or a C corporation.

Sources of funds

Buy-sell agreements require a funding source so that remaining owners can buy their former co-owner’s shares. Life insurance is probably the most common, but there are alternatives.

If your company is cash-rich and confident in its ability to remain so, you could rely on your reserves. However, this would leave many businesses vulnerable to an unplanned cash shortfall. Another option is to create a “sinking fund” by setting aside money for paying out the agreement over time. Again, if your cash flow ebbs more than flows, you may not have enough funds when they become necessary.

Worth the effort

Keeping your buy-sell agreement updated requires some effort. But the effort will more than pay off in saved time and prevented conflicts should a triggering event occur. And if you haven’t yet established an agreement, now’s the time to do so.

 

ABLE ACCOUNTS CAN HELP SUPPORT THE DISABLED

 

The Achieving a Better Life Experience (ABLE) Act of 2014 created a tax-advantaged savings account for people who have a qualifying disability (or are blind) before age 26. Modeled after the well-known Section 529 college savings plan, ABLE accounts offer many benefits. But it’s important to understand their limitations.

Tax and funding benefits

Like Sec. 529 plans, state-sponsored ABLE accounts allow parents and other family and friends to make substantial cash contributions. Contributions aren’t tax deductible, but accounts can grow tax-free, and earnings may be withdrawn free of federal income tax if they’re used to pay qualified expenses. ABLE accounts can be established under any state ABLE program, regardless of where you or the disabled account beneficiary live.

In the case of a Sec. 529 plan, qualified expenses include college tuition, room and board, and certain other higher education expenses. For ABLE accounts, “qualified disability expenses” include a broad range of costs, such as health care, education, housing, transportation, employment training, assistive technology, personal support services, financial management, legal expenses, and funeral and burial expenses.

An ABLE account generally won’t jeopardize the beneficiary’s eligibility for means-tested government benefits, such as Medicaid or Supplemental Security Income (SSI). To qualify for these benefits, a person’s resources must be limited to no more than $2,000 in “countable assets.”

Assets in an ABLE account aren’t counted, with two exceptions: 1) Distributions used for housing expenses count, and 2) if the account balance exceeds $100,000, the beneficiary’s eligibility for SSI is suspended so long as the excess amount remains in the account.

Notable limitations

ABLE accounts offer some attractive benefits, but they’re far less generous than those offered by Sec. 529 plans. Maximum contributions to 529 plans vary from state to state, but they often reach as high as $350,000 or more. The same maximum contribution limits generally apply to ABLE accounts, but practically speaking they’re limited to $100,000, given the impact on SSI benefits.

Like a 529 plan, an ABLE account allows investment changes only twice a year. But ABLE accounts also impose an annual limit on contributions equal to the annual gift tax exclusion (currently $14,000). There’s no annual limit on contributions to Sec. 529 plans.

ABLE accounts have other limitations and disadvantages as well. Unlike a Sec. 529 plan, an ABLE account doesn’t allow the person who sets up the account to be the owner. Rather, the account’s beneficiary is the owner.

However, a person with signature authority — such as a parent, legal guardian or power of attorney holder — can manage the account if the beneficiary is a minor or otherwise unable to manage the account. Nevertheless, contributions are irrevocable and the account’s funders may not make withdrawals. The beneficiary can be changed to another disabled individual who’s a family member of the designated beneficiary.

Finally, be aware that, when an ABLE account beneficiary dies, the state may claim reimbursement of its net Medicaid expenditures from any remaining balance.

Worth exploring

If you have a child or relative with a disability in existence before age 26, it’s worth exploring the feasibility of an ABLE account. Please contact our firm for more details.

 

SO YOU JUST FILED YOUR TAXES – COULD AN AUDIT BE NEXT?

 

Like many people, you probably feel a great sense of relief wash over you after your tax return is completed and filed. Unfortunately, even professionally prepared and accurate returns may sometimes be subject to an IRS audit.

The good news? Chances are slim that it will actually happen. Only a small percentage of returns go through the full audit process. Still, you’re better off informed than taken completely by surprise should your number come up.

Red flags

A variety of red flags can trigger an audit. Your return may be selected because the IRS received information from a third party — say, the W-2 submitted by your employer — that differs from the information reported on your return. This is often the employer’s mistake or occurs following a merger or acquisition.

In addition, the IRS scores all returns through its Discriminant Inventory Function System (DIF). A higher DIF score may increase your audit chances. While the formula for determining a DIF score is a well-guarded IRS secret, it’s generally understood that certain things may increase the likelihood of an audit, such as:

  • Running a traditionally cash-oriented business,
  • Having a relatively high adjusted gross income,
  • Using valid but complex tax shelters, or
  • Claiming certain tax breaks, such as the home office deduction.

Bear in mind, though, that no single item will cause an audit. And, as mentioned, a relatively low percentage of returns are examined. This is particularly true as the IRS grapples with its own budget issues.

Finally, some returns are randomly chosen as part of the IRS’s National Research Program. Through this program, the agency studies returns to improve and update its audit selection techniques.

Careful reading

If you receive an audit notice, the first rule is: Don’t panic! Most are correspondence audits completed via mail. The IRS may ask for documentation on, for instance, your income or your purchase or sale of a piece of real estate.

Read the notice through carefully. The pages should indicate the items to be examined, as well as a deadline for responding. A timely response is important because it conveys that you’re organized and, thus, less likely to overlook important details. It also indicates that you didn’t need to spend extra time pulling together a story.

Your response (and ours)

Should an IRS notice appear in your mail, please contact our office. We can fully explain what the agency is looking for and help you prepare your response. If the IRS requests an in-person interview regarding the audit, we can accompany you — or even appear in your place if you provide authorization.

 

TAX CALENDAR

 

April 18 — Besides being the last day to file (or extend) your 2016 personal return and pay any taxes due, 2017 first quarter estimated tax payments for individuals, trusts and calendar-year corporations are due today. So are 2016 returns for trusts and calendar-year estates and C corporations, plus any final contribution you plan to make to an IRA or Education Savings Account for 2016. Simplified Employee Pension and Keogh contributions are also due today if your return isn’t being extended.

 

June 15 — Second quarter estimated tax payments for individuals, trusts, and calendar-year corporations are due today.

 

5 GROWTH STRATEGIES FOR TODAY’S BUSINESSES

 

It’s probably safe to say that nearly every business owner wants his or her company to grow. The question is: How? As you ponder your company’s ideal strategic direction, here are five common business growth strategies to consider:

  1. Creating and delivering new products and services.This is probably the most obvious growth strategy, but that doesn’t mean it’s easy. Conduct market research to determine not only which new products and services will appeal to your customers, but also which ones will be profitable.
  2. Tapping into new markets and territories.The idea here is to market and sell your existing products and services to different customer niches or to customers in different geographic areas. Extensive market research is again one of the keys to success for this growth strategy.
  3. Penetrating your existing markets.This strategy involves selling more of your existing products and services to your current customers. Start by performing a market segmentation analysis to determine which customers to target with marketing messages designed to increase specific product and service sales.
  4. Developing new sales and delivery channels.The Internet is the best example of a new sales and delivery channel for products and services. Talk with your sales and marketing executives about ways you can use the Internet or another alternative channel to grow your sales and revenue.
  5. Mergers and acquisitions (M&A).Growing through M&A is very different from the other, more organic growth strategies we’ve covered. This strategy can result in rapid growth literally overnight, as well as the realization of valuable synergies between the merged companies. But performing thorough due diligence on acquisition candidates is absolutely key to successful growth via M&A.

 

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.

 

 

 

 

Remembering Richard “Dick” Scheffel

Tax News: February 2017

CONSIDER SEPARATING REAL ESTATE ASSETS FROM YOUR BUSINESS

Many companies choose not to combine real estate and other assets into a single entity. Perhaps the business fears liability for injuries suffered on the property. Or legal liabilities encountered by the company could affect property ownership. But there are valid and potentially beneficial tax reasons for holding real estate in a separate entity as well.

Avoiding costly mistakes

Many businesses operate as C corporations so they can buy and hold real estate just as they do equipment, inventory and other assets. The expenses of owning the property are treated as ordinary expenses on the company’s income statement. However, when the real estate is sold, any profit is subject to double taxation: first at the corporate level and then at the owner’s individual level when a distribution is made. As a result, putting real estate in a C corporation can be a costly mistake.

If the real estate were held instead by the business owner(s) or in a pass-through entity, such as a limited liability company (LLC) or limited partnership, and then leased to the corporation, the profit upon a sale of the property would be taxed only once — at the individual level.

Maximizing tax benefits

The most straightforward and seemingly least expensive way for a business owner to maximize the tax benefits is to buy the property outright. However, this could transfer liabilities related to the property directly to the owner, putting other assets — including the business — at risk. In essence, it would negate part of the rationale for organizing the business as a corporation in the first place.

So it’s generally best to hold real estate in its own limited liability entity. The LLC is most often the vehicle of choice for this, but limited partnerships can accomplish the same ends if there are multiple owners. No matter which structure is used, though, make sure all entities are adequately insured.

Tailoring the right strategy

There are many complexities to a company owning real estate. And there’s no one-size-fits-all solution to protecting yourself legally while minimizing your tax liability. But if you do nothing and treat real estate like any other business asset, you could be exposing your business to substantial risk. So please contact our firm for an assessment of your situation. We can help tailor a strategy that’s right for you.

 

Sidebar: The benefits of separation for family businesses

Family businesses face many distinctive challenges. One is that several family members may participate in the ownership of the company. Under such circumstances, separating real estate ownership from the business creates more options to meet the needs of multiple owners.

Let’s say that a family business is passing from one generation to the next. One child is very interested in owning and operating the business but doesn’t have the means to finance the purchase of both the business and its real estate.

If the two are separated, it’s possible for one sibling to take over the business while other siblings hold the real estate. In this case, everyone can benefit: The child who buys the business doesn’t have to share control with the other siblings, yet they can still reap benefits as property owners.

 

FACING THE TAX CHALLENGES OF SELF-EMPLOYMENT

Today’s technology makes self-employment easier than ever. But if you work for yourself, you’ll face some distinctive challenges when it comes to your taxes. Here are some important steps to take:

Learn your liability. Self-employed individuals are liable for self-employment tax, which means they must pay both the employee and employer portions of FICA taxes. The good news is that you may deduct the employer portion of these taxes. Plus, you might be able to make significantly larger retirement contributions than you would as an employee.

However, you’ll likely be required to make quarterly estimated tax payments, because income taxes aren’t withheld from your self-employment income as they are from wages. If you fail to fully make these payments, you could face an unexpectedly high tax bill and underpayment penalties.

Distinguish what’s deductible. Under IRS rules, deductible business expenses for the self-employed must be “ordinary” and “necessary.” Basically, these are costs that are commonly incurred by businesses similar to yours and readily justifiable as needed to run your operations.

The tax agency stipulates, “An expense does not have to be indispensable to be considered necessary.” But pushing this grey area too far can trigger an audit. Common examples of deductible business expenses for the self-employed include licenses, accounting fees, equipment, supplies, legal expenses and business-related software.

Don’t forget your home office! You may deduct many direct expenses (such as business-only phone and data lines, as well as office supplies) and indirect expenses (such as real estate taxes and maintenance) associated with your home office. The tax break for indirect expenses is based on just how much of your home is used for business purposes, which you can generally determine by either measuring the square footage of your workspace as a percentage of the home’s total area or using a fraction based on the number of rooms.

The IRS typically looks at two questions to determine whether a taxpayer qualifies for the home office deduction:

  1. Is the specific area of the home that’s used for business purposes used onlyfor business purposes, not personal ones?
  2. Is the space used regularly and continuously for business?

If you can answer in the affirmative to these questions, you’ll likely qualify. But please contact our firm for specific assistance with the home office deduction or any other aspect of filing your taxes as a self-employed individual.

4 MYTHS ABOUT MANAGING YOUR DEBT

Debt is a reality for many Americans. Median household debt was estimated at $2,300 as of May 2016, according to consumer information provider ValuePenguin. And debt isn’t limited to those earning lower incomes; households with a net worth of $500,000 and over had an estimated $8,139 in credit card debt, per the same source.

Underestimating or ignoring your obligations can delay or even prevent you from accomplishing many financial goals. Here are four myths about managing your debt.

  1. My credit report is fine, and so am I

Many people glance at their credit reports, see a decent score and move on. But credit reports often contain inaccuracies that blur your true debt picture.

Review your report regularly and follow up with the issuing credit agency if there’s an inaccuracy. For example, make sure your report doesn’t reflect a lower credit limit than your actual one.

  1. Shut it down … shut it down now

Closing out credit cards may seem like elementary debt management. But eliminating them isn’t necessarily the way to go. Instead, you should limit your number of open cards, pay them off or maintain low account balances, and avoid or renegotiate high interest rates.

The major credit-reporting agencies use a combination of metrics to establish your credit score, including credit history and debt utilization (ratio of debt to available credit). Closing out a card reduces your credit history, limiting the data by which you’re evaluated, and increases your debt utilization, which hurts your credit score.

  1. I hold the golden ticket

The easiest way to deal with debt may seem a broad, sweeping strike to pay it down. Unfortunately, gathering the funds to make that move may only worsen the overall situation.

For instance, home equity loans typically offer lower interest rates than credit cards and large available balances. Plus, the interest paid on a home equity debt may be tax deductible, while credit card debt generally isn’t. But the greater obligation isn’t really wiped out — only transferred. And the borrower’s home is at risk.

Similarly, taking out a 401(k) loan offers easy, low-interest access to funds. But a significantly negative tax impact and marked reduction in one’s retirement savings are downsides. Also, interest paid on such a 401(k) loan wouldn’t be tax deductible.

  1. Bankruptcy = failure

Well, it certainly doesn’t equal success. And a bankruptcy filing should undoubtedly form the last line of defense in any debt management plan. But, rather than considering it an outright failure, you might want to look at bankruptcy as a last-chance opportunity.

In many cases, a person’s credit score can recover surprisingly quickly — sometimes as soon as three to five years. In addition, some tax liabilities that meet certain requirements may be discharged in bankruptcy.

Ask for help

Sound, timely advice can help you avoid getting in over your head when it comes to debt. Please contact our firm for a detailed assessment of your situation.

PHASEOUTS AND REDUCTIONS: A TAX-FILING REMINDER

As tax-filing season gets into full swing, there are many details to remember. One subject to keep in mind — especially if you’ve seen your income rise recently — is whether you’ll be able to reap the full value of tax breaks that you’ve claimed previously.

What could change? If your adjusted gross income (AGI) exceeds the applicable threshold, your personal exemptions will begin to be phased out and your itemized deductions reduced. For 2016, the thresholds are $259,400 (single), $285,350 (head of household), $311,300 (joint filer) and $155,650 (married filing separately). These are up from the 2015 thresholds, which were $258,250 (single), $284,050 (head of household), $309,900 (joint filer) and $154,950 (married filing separately).

The personal exemption phaseout reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer’s AGI exceeds the applicable threshold (2% for each $1,250 for married taxpayers filing separately). Meanwhile, the itemized deduction limitation reduces otherwise allowable deductions by 3% of the amount by which a taxpayer’s AGI exceeds the applicable threshold (not to exceed 80% of otherwise allowable deductions). It doesn’t apply, however, to deductions for medical expenses, investment interest, or casualty, theft or wagering losses.

If your AGI is close to the threshold, AGI-reduction strategies (such as making retirement plan and Health Savings Account contributions) may allow you to stay under it. If that’s not possible, consider the reduced tax benefit of the affected deductions before implementing strategies to accelerate or defer deductible expenses. Please contact our firm for specific strategies tailored to your situation.

 

Copyright © 2017

Tax News: January 2017

DAFS BRING AN INVESTMENT ANGLE TO CHARITABLE GIVING

If you”re planning to make significant charitable donations in the coming year, consider a donor-advised fund (DAF). These accounts allow you to take a charitable income tax deduction immediately, while deferring decisions about how much to give — and to whom — until the time is right.

Account attributes

A DAF is a tax-advantaged investment account administered by a not-for-profit “sponsoring organization,” such as a community foundation or the charitable arm of a financial services firm. Contributions are treated as gifts to a Section 501(c)(3) public charity, which are deductible up to 50% of adjusted gross income (AGI) for cash contributions and up to 30% of AGI for contributions of appreciated property (such as stock). Unused deductions may be carried forward for up to five years, and funds grow tax-free until distributed.

Although contributions are irrevocable, you”re allowed to give the account a name and recommend how the funds will be invested (among the options offered by the DAF) and distributed to charities over time. You can even name a successor advisor, or prepare written instructions, to recommend investments and charitable gifts after your death.

Technically, a DAF isn”t bound to follow your recommendations. But in practice, DAFs almost always respect donors” wishes. Generally, the only time a fund will refuse a donor”s request is if the intended recipient isn”t a qualified charity.

Key benefits

As mentioned, DAF owners can immediately deduct contributions but make gifts to charities later. Consider this scenario: Rhonda typically earns around $150,000 in AGI each year. In 2017, however, she sells her business, lifting her income to $5 million for the year.

Rhonda decides to donate $500,000 to charity, but she wants to take some time to investigate charities and spend her charitable dollars wisely. By placing $500,000 in a DAF this year, she can deduct the full amount immediately and decide how to distribute the funds in the coming years. If she waits until next year to make charitable donations, her deduction will be limited to $75,000 per year (50% of her AGI).

Even if you have a particular charity in mind, spreading your donations over several years can be a good strategy. It gives you time to evaluate whether the charity is using the funds responsibly before you make additional gifts. A DAF allows you to adopt this strategy without losing the ability to deduct the full amount in the year when it will do you the most good.

Another key advantage is capital gains avoidance. An effective charitable-giving strategy is to donate appreciated assets — such as securities or real estate. You”re entitled to deduct the property”s fair market value, and you can avoid the capital gains taxes you would have owed had you sold the property.

But not all charities are equipped to accept and manage this type of donation. Many DAFs, however, have the resources to accept contributions of appreciated assets, liquidate them and then reinvest the proceeds.

Requirements and fees

A DAF can also help you streamline your estate plan and donate to a charity anonymously. Requirements and fees vary from fund to fund, however. Please contact our firm for help finding one that meets your needs.

SLIGHT ADJUSTMENTS: COLA AMOUNTS FOR 2017 RETIREMENT PLANS

The IRS recently issued cost-of-living adjustments (or “COLAs”) for 2017. If, like most people, you”re funding a retirement plan, it”s a good idea to take a look at what”s changed and what hasn”t.

Elective deferrals to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans will remain the same at $18,000. Likewise, contributions to SIMPLEs stay unchanged at $12,500, and contributions to IRAs remain static at $5,500. Catch-up contributions stay the same, as well — $6,000 for 401(k), 403(b), 457(b)(2) and 457(c)(1) plans; $3,000 for SIMPLEs; and $1,000 for IRAs.

What has changed? The annual benefit for defined benefit plans rises from $210,000 to $215,000. Meanwhile, contributions to defined contribution plans go from $53,000 to $54,000.

Please note: Your modified adjusted gross income (MAGI) may reduce or even eliminate your ability to take advantage of IRAs. Fortunately, IRA-related MAGI phaseout range limits all will increase for 2017. Please contact our firm for these specific amounts.

We can also help you better understand other important COLA amounts — including those related to ordinary-income tax brackets, the alternative minimum tax, education- and child-related breaks, and gift and estate taxes.

NEED TO SELL REAL PROPERTY? TRY AN INSTALLMENT SALE

If your company owns real property, or you do so individually, you may not always be able to dispose of it as quickly as you”d like. One avenue for perhaps finding a buyer a little sooner is an installment sale.

Benefits and risks

An installment sale occurs when you transfer property in exchange for a promissory note and receive at least one payment after the tax year of the sale. Doing so allows you to receive interest on the full amount of the promissory note, often at a higher rate than you could earn from other investments, while deferring taxes and improving cash flow.

But there may be some disadvantages for sellers. For instance, the buyer may not make all payments and you may have to deal with foreclosure.

Methodology

You generally must report an installment sale on your tax return under the “installment method.” Each installment payment typically consists of interest income, return of your adjusted basis in the property and gain on the sale. For every taxable year in which you receive an installment payment, you must report as income the interest and gain components.

Calculating taxable gain involves multiplying the amount of payments, excluding interest, received in the taxable year by the gross profit ratio for the sale. The gross profit ratio is equal to the gross profit (the selling price less your adjusted basis) divided by the total contract price (the selling price less any qualifying indebtedness — mortgages, debts and other liabilities assumed or taken by the buyer — that doesn”t exceed your basis).

The selling price includes the money and the fair market value of any other property you received for the sale of the property, selling expenses paid by the buyer and existing debt encumbering the property (regardless of whether the buyer assumes personal liability for it).

You may be considered to have received a taxable payment even if the buyer doesn”t pay you directly. If the buyer assumes or pays any of your debts or expenses, it could be deemed a payment in the year of the sale. In many cases, though, the buyer”s assumption of your debt is treated as a recovery of your basis, rather than a payment.

Complex rules

The rules of installment sales are complex. Please contact us to discuss this strategy further.

REVIEWING YOUR COMPANY’S INVENTORY OPTIONS FOR BEST RESULTS

Robust cash flow is a must for virtually every kind of business. Yet an improperly or inadequately managed inventory system can drag down your revenues. It”s a good idea to regularly review your approach to inventory accounting.

Reconsider your approach

Generally, there are two primary inventory accounting methods for both tax accounting and financial accounting. They are:

  1. Last in, first out (LIFO).If you tend to retain inventory items (such as repair parts or durable goods) for long periods, LIFO may be your best choice. It allows you to allocate the most recent (and, therefore, higher) costs first, ideally maximizing your cost of goods sold and minimizing your taxable income.
  2. First in, first out (FIFO).This refers to selling the oldest stock first. Generally, FIFO works best with dated goods, perishable items and collectibles. In an inflationary market, this approach usually results in higher income as older purchases with lower costs are included in cost of sales. (In a deflationary market, the opposite generally holds true.)

Of the two, FIFO is used more often because it more genuinely reflects the typical normal flow of goods and is easier to account for than LIFO, which can be highly complex and deals with inventory costs (not the actual inventory) that may be many years old.

If you”re dissatisfied with your company”s method, you may be able to change it. But doing so is generally not simple. Should a business wish to change its inventory accounting method for tax purposes, it needs to request permission from the IRS. And if it wishes to change for financial accounting purposes, it needs a valid reason. This is why changes in accounting for inventory are not routine.

Tend to your garden

As you review your inventory accounting, try to drill down and pinpoint as many discrepancies as possible. By identifying the source of accuracy problems, you can figure out the best solutions. After all, your inventory is like a garden. Left untended, it will grow out of control or die on the vine. Manage yours carefully, however, and it should bear profitable fruit.

TAX CALENDAR

January 17

Individual taxpayers’ final 2016 estimated tax payment is due.

January 31

  • File 2016 Forms W-2 (“Wage and Tax Statement”) with the SSA and provide copies to your employees.
  • File 2016 Forms 1099-MISC (“Miscellaneous Income”) reporting nonemployee compensation payments in box 7 with the IRS and provide copies to recipients.
  • Most employers must file Form 941 (“Employer”s Quarterly Federal Tax Return”) to report Medicare, Social Security and income taxes withheld in the fourth quarter of 2016. 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 10 to file the return. Employers who 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 940 (“Employer”s Annual Federal Unemployment [FUTA] Tax Return”) for 2016. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it is 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 10 to file the return.
  • File Form 943 (“Employer”s Annual Federal Tax Return for Agricultural Employees”) to report Social Security, Medicare and withheld income taxes for 2016. 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 10 to file the return.
  • File Form 945 (“Annual Return of Withheld Federal Income Tax”) for 2016 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 10 to file the return.

February 28

File 2016 Forms 1099-MISC with the IRS and provide copies to recipients. (Note that Forms 1099-MISC reporting nonemployee compensation in box 7 must be filed by Jan. 31, beginning with 2016 forms filed in 2017.)

March 15

2016 tax returns must be filed or extended for calendar-year partnerships and S corporations. If the return is not extended, this is also the last day to make 2016 contributions to pension and profit-sharing plans.

 

Copyright © 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.

Tax News: December 2016

DON’T LET CAPITAL LOSSES GET YOU DOWN

No one wishes to lose money on an investment. But, if it happens to you, don’t let it get you down. You may be able to lower your tax bill to cheer yourself up.

The bright side

A capital loss occurs when you sell a security for less than your “basis,” generally the original purchase price. The upside is that you can use capital losses to offset capital gains you realize in that same tax year.

When your capital losses exceed your capital gains, you can use up to $3,000 of the excess to offset wages, interest and other ordinary income ($1,500 for married people filing separately). Then you can carry the remainder forward to future years until it’s used up.

Wash sale rule

Years ago, investors realized they could sell a security to recognize a capital loss for a given tax year and then — if they still liked the security’s prospects — buy it back immediately. To counter this strategy, Congress imposed the wash sale rule, which disallows losses in situations where an investor sells a security and then buys the same or a “substantially identical” security within 30 days of the sale, before or after.

Waiting 30 days to repurchase a security sold at a loss is one way to achieve your goals without running afoul of the wash sale rule. But there may be times when you’d rather not be forced to sit on the sidelines for a month. Instead, you might consider doubling up on a position in which you have a loss and then waiting 31 days to sell the original stake — a strategy that also avoids a wash sale violation because the purchase occurs more than 30 days before the sale.

Strategic research

If you don’t want to sit on the sidelines or double up on a position, there’s often an alternative. With a little research, you might be able to identify a security you like just as well as, or better than, the old one. Say you own stock in a networking equipment company that has lost value since you bought it. After researching the industry, you discover that the company’s chief competitor is more attractively valued and has better growth prospects.

Your solution is now simple and straightforward: Simultaneously sell the stock you own at a loss and buy the competitor’s stock, thereby avoiding violation of the “same or substantially identical” provision of the wash sale rule. In the process, you’ve added to your portfolio a stock you believe has more potential or less risk.

Seek professional advice

If you incur a capital loss, please contact us. We can discuss your options to use it to reduce your taxes and reposition your portfolio.

Sidebar: Mutual fund matters

In some cases, rather than invest in a single security, you may wish to identify a mutual fund or exchange-traded fund with a similar investment sector, strategy and size. If you’re buying mutual funds, however, it pays to know when the next capital gains distribution will occur and how large it will be. If the distribution is sufficiently large and the date is imminent (they often occur in December), you might want to delay your purchase to avoid incurring a sizable tax liability.

IRS CONTINUES TO ENFORCE “REASONABLE” SHAREHOLDER-EMPLOYEE SALARIES

If you’re a shareholder-employee of an S corporation, you more than likely considered the tax advantages of this entity choice. But those very same tax advantages also tend to draw IRS scrutiny. And the agency has made clear that its interest in S corporations — including possible audits — will continue.

What’s the problem?

The IRS pays particular attention to S corporations because, as you well know, shareholder-employees of these organizations aren’t subject to self-employment taxes on their respective shares of the company’s income. This differs from, say, general partners in a partnership.

To better manage payroll taxes, many S corporations minimize shareholder-employee salaries (which are subject to payroll taxes) and compensate them mostly via “dividend” distributions. If this holds true for you, the IRS may take a close look at your salary to determine whether it’s “unreasonably” low. The agency views overly minimized salaries as an improper means of avoiding payroll taxes.

If its case is strong enough, the IRS could recharacterize a portion of distributions paid to you and other shareholder-employees as wages and bill the employer and/or employee for unpaid taxes, interest and possibly even penalties.

How do you define it?

By following certain guidelines, your business can ensure salaries paid to you and other shareholder-employees have a higher likelihood of meeting the agency’s typical standards of reasonableness.

For starters, do some benchmarking to learn how S corporations of similar size (as indicated by capital value, net income or sales) in your industry and geographic region are paying their shareholder-employees. In addition, pay close attention to certain traits held by your shareholder-employees. These include:

  • Background and experience,
  • Specific responsibilities,
  • Work hours,
  • Professional reputation, and
  • Customer relationships.

The stronger these traits are, the higher the salary should be in the eyes of the IRS. Shareholder-employee salaries should be fairly consistent from year to year, too, without dramatic raises or cuts.

Who can help?

As your S corporation battles with its competitors and strives to meet its strategic goals, you may not be thinking all that much about the form of your compensation. But, rest assured, the IRS is paying attention. We can examine the reasonableness of the salaries that you and other shareholder-employees are receiving and help minimize the chances of an examination or audit.

AGE 50 OR OLDER? CATCH-UP CONTRIBUTIONS ARE FOR YOU

Are you in your 50s or 60s and thinking more about retirement? If so, and you’re still not completely comfortable with the size of your nest egg, don’t forget about “catch-up” contributions. These are additional amounts beyond the regular annual limits that workers age 50 or older can contribute to certain retirement accounts.

Catch-up contributions give you the chance to take maximum advantage of the potential for tax-deferred or, in the case of Roth accounts, tax-free growth.

401(k) feature

Under 2016 401(k) limits, if you’re age 50 or older, after you’ve reached the $18,000 maximum limit for all employees, you can contribute an extra $6,000, for a total of $24,000. If your employer offers a Savings Incentive Match Plan for Employees (SIMPLE) instead, your regular contribution maxes out at $12,500 in 2016. If you’re 50 or older, you’re allowed to contribute an additional $3,000 — or $15,500 in total for the year.

But, check with your employer because, while most 401(k) plans and SIMPLEs offer catch-up contributions, not all do.

IRA benefits

Another way to save more after age 50 is through a traditional IRA or a Roth IRA. With either plan, those 50 or older generally can contribute another $1,000 above the $5,500 limit for 2016. Plus, you can make 2016 IRA contributions as late as April 18, 2017.

The benefits of making the additional contribution differ depending on which account you’re considering. With a traditional IRA, contributions may be tax deductible, providing you with immediate tax savings. (The deductibility phases out at higher income levels if you or your spouse is covered by an employer retirement plan.)

Roth contributions are made with after-tax dollars, but qualified withdrawals are tax-free. By contributing to a Roth IRA and taking the tax hit up front, you won’t lose any of the income to taxes at withdrawal, provided you’re at least 59½ and have held a Roth IRA at least five years. However, be aware that the ability to contribute to a Roth IRA is phased out based on income level.

Another option if you’d like to enjoy tax-free withdrawals is to convert some or all of your traditional IRA to a Roth IRA — but you’ll also take an up-front tax hit.

Self-employed limits

If you’re self-employed, retirement plans such as an individual 401(k) — or solo 401(k) — also allow catch-up contributions. A solo 401(k) is a plan for those with no other employees. You can defer 100% of your self-employment income or compensation, up to the regular yearly deferral limit of $18,000, plus a $6,000 catch-up contribution in 2016. But that’s just the employee salary deferral portion of the contribution.

You can also make an “employer” contribution of up to 20% of self-employment income or 25% of compensation. The total combined employee-employer contribution is limited to $53,000, plus the $6,000 catch-up contribution.

Squirrel away

The year’s almost over, but you still have time to squirrel away a few extra dollars.

7 LAST-MINUTE TAX-SAVING TIPS

Where did the time go? The year is quickly drawing to a close, but there’s still time to take steps to reduce your 2016 tax liability. Here are seven last-minute tax-saving tips to consider — you just must act by December 31:

  1. Pay your 2016 property tax bill that’s due in early 2017.
  2. Pay your fourth quarter state income tax estimated payment that’s due in January 2017.
  3. Incur deductible medical expenses (if your deductible medical expenses for the year already exceed the applicable floor).
  4. Pay tuition for academic periods that will begin in January, February or March of 2017 (if it will make you eligible for a tax deduction or credit).
  5. Donate to your favorite charities.
  6. Sell investments at a loss to offset capital gains you’ve recognized this year.
  7. Ask your employer if your bonus can be deferred until January.

Keep in mind, however, that in certain situations these strategies might not make sense. For example, if you’ll be subject to the alternative minimum tax this year or be in a higher tax bracket next year, taking some of these steps could have undesirable results.

To make absolutely sure which of these tips are right for you, and learn whether there are other beneficial last-minute moves you might make, please contact our firm. We can help you maximize your tax savings for 2016.

Copyright © 2016

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 2016.

Tax News: September 2016

AMT AWARENESS: BE READY FOR ANYTHING

When it comes to tax planning, you’ve got to be ready for anything. For example, do you know whether you’re likely to be subject to the alternative minimum tax (AMT) when you file your 2016 return? If not, you need to find out now so that you can consider taking steps before year end to minimize potential liability.

Bigger bite

The AMT was established to ensure that high-income individuals pay at least a minimum tax, even if they have many large deductions that significantly reduce their “regular” income tax. If your AMT liability is greater than your regular income tax liability, you must pay the difference as AMT, in addition to the regular tax.

AMT rates begin at 26% and rise to 28% at higher income levels. The maximum rate is lower than the maximum income tax rate of 39.6%, but far fewer deductions are allowed, so the AMT could end up taking a bigger tax bite.

For instance, you can’t deduct state and local income or sales taxes, property taxes, miscellaneous itemized deductions subject to the 2% floor, or home equity loan interest on debt not used for home improvements. You also can’t take personal exemptions for yourself or your dependents, or the standard deduction if you don’t itemize your deductions.

Steps to consider

Fortunately, you may be able to take steps to minimize your AMT liability, including:

Timing capital gains. The AMT exemption (an amount you can deduct in calculating AMT liability) phases out based on income, so realizing capital gains could cause you to lose part or all of the exemption. If it looks like you could be subject to the AMT this year, you might want to delay sales of highly appreciated assets until next year (if you don’t expect to be subject to the AMT then) or use an installment sale to spread the gains (and potential AMT liability) over multiple years.

Timing deductible expenses. Try to time the payment of expenses that are deductible for regular tax purposes but not AMT purposes for years in which you don’t anticipate AMT liability. Otherwise, you’ll gain no tax benefit from those deductions. If you’re on the threshold of AMT liability this year, you might want to consider delaying state tax payments, as long as the late-payment penalty won’t exceed the tax savings from staying under the AMT threshold.

Investing in the “right” bonds. Interest on tax-exempt bonds issued for public activities (for example, schools and roads) is exempt from the AMT. You may want to convert bonds issued for private activities (for example, sports stadiums), which generally don’t enjoy the AMT interest exemption.

Appropriate strategies

Failing to plan for the AMT can lead to unexpected — and undesirable — tax consequences. Please contact us for help assessing your risk and, if necessary, implementing the appropriate strategies for your situation.

Sidebar: Does this sound familiar?

High-income earners are typically most susceptible to the alternative minimum tax. But liability may also be triggered by:

  • A large family (meaning you take many exemptions),
  • Substantial itemized deductions for state and local income taxes, property taxes, miscellaneous itemized deductions subject to the 2% floor, home equity loan interest, or other expenses that aren’t deductible for AMT purposes,
  • Exercising incentive stock options,
  • Large capital gains,
  • Adjustments to passive income or losses, or
  • Interest income from private activity municipal bonds.

5 TIPS FOR SAFE INTRAFAMILY LOANS

If a relative needs financial help, offering an intrafamily loan might seem like a good idea. But if not properly executed, such loans can carry substantial negative tax consequences — such as unexpected taxable income, gift tax or both. Here are five tips to consider:

  1. Create a paper trail.In general, to avoid undesirable tax consequences, one thing you’ll need to do is show that the loan was bona fide. Doing so should include documenting evidence of:
  • The amount and terms of the debt,
  • Interest charged,
  • Fixed repayment schedules,
  • Collateral,
  • Demands for repayment, and
  • The borrower’s solvency at the time of the loan and payments made.

Be sure to make your intentions clear — and help avoid loan-related misunderstandings — by documenting the loan and payments received, as well.

  1. Demonstrate an intention to collect.Even if you think you may eventually forgive the loan, ensure the borrower makes at least a few payments. By having some repayment history, you’ll make it harder for the IRS to argue that the loan was really an outright gift. And if a would-be borrower has no realistic chance of repaying a loan — don’t make it. If you’re audited, the IRS is sure to treat such a loan as a gift.
  2. Charge interest if the loan exceeds $10,000.If you lend more than $10,000 to a relative, charge at least the applicable federal interest rate (AFR). In any case, the interest on the loan will be taxable income to you. (If no or below-AFR interest is charged, taxable interest is calculated under the complicated below-market-rate loan rules.) However, if no or below-AFR interest is charged, all of the forgone interest over the term of the loan may have to be treated as a gift in the year the loan is made. This will increase your chances of having to use some of your lifetime exemption.
  3. Use the annual gift tax exclusion.If you want to, say, help your daughter buy a house but don’t want to use up any of your lifetime estate and gift tax exemption, make the loan, charge interest and then forgive the interest, the principal payments or both each year under the annual gift tax exclusion. For 2016, you can forgive up to $14,000 per borrower ($28,000 if your spouse joins in the gift) without paying gift taxes or using any of your lifetime exemption. But you will still have interest income in the year of forgiveness.
  4. Forgive or file suit.If an intrafamily loan that you intended to collect is in default, don’t let it sit too long. To prove this was a legitimate loan that soured, you’ll need to take appropriate legal steps toward collection. If you know you’ll never collect and can’t bring yourself to file suit, begin forgiving the loan using the annual gift tax exclusion, if possible.

FUNDING A COLLEGE EDUCATION? DON’T FORGET THE 529

When 529 plans first hit the scene, circa 1996, they were big news. Nowadays, they’re a common part of the college-funding landscape. But don’t forget about them — 529 plans remain a valid means of saving for the rising cost of tuition and more.

Flexibility is king

529 plans are generally sponsored by states, though private institutions can sponsor 529 prepaid tuition plans. Just about anyone can open a 529 plan. And you can name anyone, including a child, grandchild, friend, or even yourself, as the beneficiary.

Investment options for 529 savings plans typically include stock and bond mutual funds, as well as money market funds. Some plans offer age-based portfolios that automatically shift to more conservative investments as the beneficiaries near college age.

Earnings in 529 savings plans typically aren’t subject to federal tax, so long as the funds are used for the beneficiary’s qualified educational expenses. This can include tuition, room and board, books, fees, and computer technology at most accredited two- and four-year colleges and universities, vocational schools, and eligible foreign institutions.

Many states offer full or partial state income tax deductions or other tax incentives to residents making 529 plan contributions, at least if the contributions are made to a plan sponsored by that state.

You’re not limited to participating in your own state’s plan. You may find you’re better off with another state’s plan that offers a wider range of investments or lower fees.

The downsides

While 529 plans can help save taxes, they have some downsides. Amounts not used for qualified educational expenses may be subject to taxes and penalties. A 529 plan also might reduce a student’s ability to get need-based financial aid, because money in the plan isn’t an “exempt” asset. That said, 529 plan money is generally treated more favorably than, for instance, assets in a custodial account in the student’s name.

Just like other investments, those within 529s can fluctuate with the stock market. And some plans charge enrollment and asset management fees.

Finally, in the case of prepaid tuition plans, there may be some uncertainty as to how the benefits will be applied if the student goes to a different school.

Work with a pro

The tax rules governing 529 savings plans can be complex. So please give us a call. We can help you determine whether a 529 plan is right for you.

BARTERING BUSINESSES CAN’T CUT UNCLE SAM OUT OF THE DEAL

Bartering may seem like something that happened only in ancient times, but the practice is still common today. And the general definition remains the same: the exchange of goods and services without the exchange of money.

Because, in a typical barter transaction, no cash exchanges hands, it’s easy to forget about taxes. But, as one might expect, you can’t cut Uncle Sam out of the deal. The IRS treats a barter exchange the same as a transaction, so you must report the fair market value of the products or services you receive as income.

Any income arising from a bartering arrangement is generally taxable in the year you receive the bartered product or service. And income tax liability isn’t the only thing you’ll need to consider. Barter activities may also trigger self-employment taxes, employment taxes or an excise tax.

You may wish to arrange a bartering deal though an exchange company. For a fee, one of these firms can allow you to network with other businesses looking to trade goods and services. For tax purposes, a barter exchange typically must issue a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” annually to its clients or members.

Although bartering may appear cut and dried, the tax implications can complicate the deal. We can help you assess a bartering arrangement and manage the tax impact.

 

Copyright © 2016

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 2016.