Did You Repair Your Business Property or Improve It?

Repairs to tangible property, such as buildings, machinery, equipment or vehicles, can provide businesses a valuable current tax deduction — as long as the so-called repairs weren’t actually “improvements.”

The costs of incidental repairs and maintenance can be immediately expensed and deducted on the current year’s income tax return. But costs incurred to improve tangible property must be capitalized and recovered through depreciation.

Betterment, Restoration, or Adaptation

Generally, a cost must be depreciated if it results in an improvement to a building structure, or any of its building systems (for example, the plumbing or electrical system), or to other tangible property. An improvement occurs if there was a betterment, restoration or adaptation of the unit of property.

Under the “betterment test,” you generally must depreciate amounts paid for work that is reasonably expected to materially increase the productivity, efficiency, strength, quality or output of a unit of property or that is a material addition to a unit of property.

Under the “restoration test,” you generally must depreciate amounts paid to replace a part (or combination of parts) that is a major component or a significant portion of the physical structure of a unit of property.

Under the “adaptation test,” you generally must depreciate amounts paid to adapt a unit of property to a new or different use — one that isn’t consistent with your ordinary use of the unit of property at the time you originally placed it in service.

Safe Harbors

A couple of IRS safe harbors can help distinguish between repairs and improvements:

  1. Routine maintenance safe harbor. Recurring activities dedicated to keeping property in efficient operating condition can be expensed. These are activities that your business reasonably expects to perform more than once during the property’s “class life,” as defined by the IRS. Amounts incurred for activities outside the safe harbor don’t necessarily have to be depreciated, though. These amounts are subject to analysis under the general rules for improvements.
  2. Small business safe harbor. For buildings that initially cost $1 million or less, qualified small businesses may elect to deduct the lesser of $10,000 or 2% of the unadjusted basis of the property for repairs, maintenance, improvements and similar activities each year. A qualified small business is generally one with gross receipts of $10 million or less.

More to Learn

To learn more about these safe harbors and other ways to maximize your tangible property deductions, contact us.

Deducting Charitable Gifts Depends on a Variety of Factors

Whether you’re planning to claim charitable deductions on your 2018 return or make donations for 2019, be sure you know how much you’re allowed to deduct. Your deduction depends on more than just the actual amount you donate.


What You Give

Among the biggest factors affecting your deduction is what you give. For example:

Cash or ordinary-income property. You may deduct the amount of gifts made by check, credit card or payroll deduction. For stocks and bonds held one year or less, inventory, and property subject to depreciation recapture, you generally may deduct only the lesser of fair market value or your tax basis.

Long-term capital gains property. You may deduct the current fair market value of appreciated stocks and bonds held for more than one year.

Tangible personal property. Your deduction depends on the situation. If the property isn’t related to the charity’s tax-exempt function (such as a painting donated for a charity auction), your deduction is limited to your basis. But if the property is related to the charity’s tax-exempt function (such as a painting donated to a museum for its collection), you can deduct the fair market value.

Vehicle. Unless the vehicle is being used by the charity, you generally may deduct only the amount the charity receives when it sells the vehicle.

Use of property or provision of services. Examples include use of a vacation home and a loan of artwork. Generally, you receive no deduction because it isn’t considered a completed gift. When providing services, you may deduct only your out-of-pocket expenses, not the fair market value of your services. You can deduct 14 cents per charitable mile driven.

Other Factors

First, you’ll benefit from the charitable deduction only if you itemize deductions rather than claim the standard deduction. Also, your annual charitable deductions may be reduced if they exceed certain income-based limits.

In addition, your deduction generally must be reduced by the value of any benefit received from the charity. Finally, various substantiation requirements apply, and the charity must be eligible to receive tax-deductible contributions.

Planning Ahead

For 2018 through 2025, the Tax Cuts and Jobs Act nearly doubles the standard deduction ― plus, it limits or eliminates some common itemized deductions. As a result, you may no longer have enough itemized deductions to exceed the standard deduction, in which case your charitable donations won’t save you tax.

You might be able to preserve your charitable deduction by “bunching” donations into alternating years, so that you’ll exceed the standard deduction and can claim a charitable deduction (and other itemized deductions) every other year.

The Years Ahead

Your charitable giving strategy may need to change in light of tax law reform or other factors. Let us know if you have questions about how much you can deduct on your 2018 return or what’s best to do in the years ahead.

Weigh the Tax Impact of Income vs. Growth When Investing

As the 2018 tax-filing season heats up, investors have much to consider. Whether you structured your portfolio to emphasize income over growth — or vice versa, or perhaps a balance of the two — will have a substantial impact on your tax liability. Let’s take a look at a couple of the most significant “big picture” issues that affect income vs. growth.


Differing Dividends

One benefit of dividends is that they may qualify for preferential long-term capital gains tax rates. For the 2018 tax year, the top rate is 20% for high-income taxpayers (income of $425,800 or more). For those with incomes between $38,601 and $425,800, the rate is 15%. Individuals with incomes of $38,600 and below pay 0% on long-term capital gains.

Keep in mind, however, that only “qualified dividends” are eligible for these rates. Nonqualified dividends are taxed as ordinary income at rates as high as 37% for 2018. Qualified dividends must meet two requirements. First, the dividends must be paid by a U.S. corporation or a qualified foreign corporation. Second, the stock must be held for at least 61 days during the 121-day period that starts 60 days before the ex-dividend date and ends 60 days after that date.

A qualified foreign corporation is one that’s organized in a U.S. possession or in a country that has a current tax treaty with the United States, or whose stock is readily tradable on an established U.S. market. The ex-dividend date is the cutoff date for declared dividends. Investors who purchase stock on or after that date won’t receive a dividend payment.

Timing is Everything

One disadvantage of dividend-paying stocks (or mutual funds that invest in dividend-paying stocks) is that they accelerate taxes. Regardless of how long you hold the stock, you’ll owe taxes on dividends as they’re paid, which erodes your returns over time.

When you invest in growth stocks (or mutual funds that invest in growth stocks), you generally have greater control over the timing of the tax bite. These companies tend to reinvest their profits in the companies rather than pay them out as dividends, so taxes on the appreciation in value are deferred until you sell the stock.

Keeping an Eye Out

Regardless of your investment approach, you need to understand the tax implications of various investments so you can make informed decisions. You should also keep an eye on Congress. As of this writing, further tax law reform beyond the Tax Cuts and Jobs Act of 2017 isn’t on the horizon — but it’s being discussed. Contact our firm for the latest news and to discuss your tax and investment strategies.

 

Sidebar: What are your investment objectives?

When re-evaluating your investment portfolio, it’s important to consider whether your objectives have changed. There are many factors to consider, both tax and nontax. Some investors seek dividends because they need the current income or they believe that companies with a history of paying healthy dividends are better managed. Others prefer to defer taxes by investing in growth stocks. And, of course, there’s something to be said for a balanced portfolio that includes both income and growth investments. When preparing to file your 2018 taxes, take a moment to identify your objectives and determine if you met them or fell short.

Throwing Snowballs at Your Mountain of Debt

Many people start the year intending to get out of debt, yet end the year owing just as much, if not more. One approach that might yield success is called “throwing snowballs.”

Under this method, you organize your debts from the lowest balance to the highest balance and begin paying off the debt on top of the list. The idea is to throw as many “snowballs” as you can gather or earn at that first creditor until the debt is gone.

While you hurl these snowballs, pay the minimum amount to your other creditors. Avoid trying to send an extra $20 or so a month to each one. If you want to contribute extra money, throw it at your primary target.

Once the first debt is paid off, you should have even more money to send to the next one. Over time you can start heaving bigger and bigger snowballs at the remaining targets because, as you pay off each debt, you’ll have more money to pay toward remaining debts.

The objective is to start an avalanche of payoffs until your debts disappear. Under this method, the best predictor of success isn’t the number of dollars you pay off but rather the number of accounts that you close.

Please note: There’s some debate on the practicality of throwing snowballs. Opponents argue that you should first pay off debts with the highest interest rates. We can help you choose a debt-reduction strategy that’s right for you.

You’ve Got Time: Small Businesses Can Still Set Up a 2018 SEP Plan

Are you a high-income small-business owner who doesn’t currently have a tax-advantaged retirement plan set up for yourself? A Simplified Employee Pension (SEP) plan may be just what you need, and now may be a great time to establish one.

A SEP plan has high contribution limits and is simple to set up. Best of all, there’s still time to establish one for 2018 and make contributions to it that you can deduct on your 2018 income tax return.

2019 Deadlines for 2018

A SEP plan can be set up as late as the due date (including extensions) of your income tax return for the tax year for which the plan is to first apply. That means you can establish a plan for 2018 in 2019 if you do it before your 2018 return filing deadline. You have until the same deadline to make 2018 contributions and still claim a potentially hefty deduction on your 2018 return.

Generally, other types of retirement plans would have to have been established by December 31, 2018, for 2018 contributions to be made (though many of these plans do allow 2018 contributions to be made in 2019).

High Contribution Limits

Contributions to SEP plans are discretionary. You can decide how much to contribute each year. But be aware that, if your business has employees other than you, 1) contributions must be made for all eligible employees using the same percentage of compensation as for you, and 2) employee accounts are immediately 100% vested. The contributions go into SEP-IRAs established for each eligible employee.

For 2018, the maximum contribution that can be made to a SEP-IRA is 25% of compensation (or 20% of self-employed income net of the self-employment tax deduction) of up to $275,000, subject to a contribution cap of $55,000. (The 2019 limits are $280,000 and $56,000, respectively.)

Simple to Set Up

A SEP plan is established by completing and signing the very simple Form 5305-SEP (“Simplified Employee Pension — Individual Retirement Accounts Contribution Agreement”). Form 5305-SEP isn’t filed with the IRS, but it should be maintained as part of the business’s permanent tax records. A copy of the form must be given to each employee covered by the plan, along with a disclosure statement.

Because of their simplicity and the great flexibility you have in making contributions, SEP plans are good “starter” retirement plans for small businesses. They’re also well suited for cash-flow dependent businesses such as construction companies, restaurants and seasonal businesses that may not always have dollars at the ready to contribute.

Less Onerous

Additional rules and limits do apply to these plans, but they’re generally much less onerous than those for other retirement plans. Contact us to learn more about SEP plans and how they might reduce your tax bill for 2018 and beyond.

Multistate Resident? Watch Out For Double Taxation

Contrary to popular belief, there’s nothing in the U.S. Constitution or federal law that prohibits multiple states from collecting tax on the same income. Although many states provide tax credits to prevent double taxation, those credits are sometimes unavailable. If you maintain residences in more than one state, here are some points to keep in mind.


Domicile vs. Residence

Generally, if you’re “domiciled” in a state, you’re subject to that state’s income tax on your worldwide income. Your domicile isn’t necessarily where you spend most of your time. Rather, it’s the location of your “true, fixed, permanent home” or the place “to which you intend to return whenever absent.” Your domicile doesn’t change — even if you spend little or no time there — until you establish domicile elsewhere.

Residence, on the other hand, is based on the amount of time you spend in a state. You’re a resident if you have a “permanent place of abode” in a state and spend a minimum amount of time there — for example, at least 183 days per year. Many states impose their income taxes on residents’ worldwide income even if they’re domiciled in another state.

Potential Solution

Suppose you live in State A and work in State B. Given the length of your commute, you keep an apartment in State B near your office and return to your home in State A only on weekends. State A taxes you as a domiciliary, while State B taxes you as a resident. Neither state offers a credit for taxes paid to another state, so your income is taxed twice.

One possible solution to such double taxation is to avoid maintaining a permanent place of abode in State B. However, State B may still have the power to tax your income from the job in State B because it’s derived from a source within the state. Yet State B wouldn’t be able to tax your income from other sources, such as investments you made in State A.

Minimize Unnecessary Taxes

This example illustrates just one way double taxation can arise when you divide your time between two or more states. We can research applicable state law and identify ways to minimize exposure to unnecessary taxes.

 

Sidebar: How to Establish Domicile

Under the law of each state, tax credits are available only with respect to income taxes that are “properly due” to another state. But, when two states each claim you as a domiciliary, neither believes that taxes are properly due to the other. To avoid double taxation in this situation, you’ll need to demonstrate your intent to abandon your domicile in one state and establish it in the other.

There are various ways to do so. For example, you might obtain a driver’s license and register your car in the new state. You could also open bank accounts in the new state and use your new address for important financially related documents (such as insurance policies, tax returns, passports and wills). Other effective measures may include registering to vote in the new jurisdiction, subscribing to local newspapers and seeing local health care providers. Bear in mind, of course, that laws regarding domicile vary from state to state.

Fewer Taxpayers to Qualify for Home Office Deduction

Working from home has become commonplace for people in many jobs. But just because you have a home office space doesn’t mean you can deduct expenses associated with it. Beginning with the 2018 tax year, fewer taxpayers will qualify for the home office deduction. Here’s why.


Changes Under the TCJA

For employees, home office expenses used to be a miscellaneous itemized deduction. Way back in 2017, this meant one could enjoy a tax benefit only if these expenses plus other miscellaneous itemized expenses (such as unreimbursed work-related travel, certain professional fees and investment expenses) exceeded 2% of adjusted gross income.

Starting in 2018 and continuing through 2025, however, employees can’t deduct any home office expenses. Why? The Tax Cuts and Jobs Act (TCJA) suspends miscellaneous itemized deductions subject to the 2% floor for this period.

Note: If you’re self-employed, you can still deduct eligible home office expenses against your self-employment income during the 2018 through 2025 period.

Other Eligibility Requirements

If you’re self-employed, generally your home office must be your principal place of business, though there are exceptions.

Whether you’re an employee or self-employed, the space must be used regularly (not just occasionally) and exclusively for business purposes. If, for example, your home office is also a guest bedroom or your children do their homework there, you can’t deduct the expenses associated with that space.

Deduction Options

If eligible, you have two options for claiming the home office deduction. First, you can deduct a portion of your mortgage interest, property taxes, insurance, utilities and certain other expenses, as well as the depreciation allocable to the office space. This requires calculating, allocating and substantiating actual expenses.

A second approach is to take the “safe harbor” deduction. Here, only one simple calculation is necessary: $5 multiplied by the number of square feet of the office space. The safe harbor deduction is capped at $1,500 per year, based on a maximum of 300 square feet.

More Rules and Limits

Be aware that we’ve covered only a few of the rules and limits here. If you think you may qualify for the home office deduction on your 2018 return or would like to know if there’s anything additional you need to do to become eligible, contact us.

Seven Ways to Prevent Elder Financial Abuse

As tax season ramps up, so do the efforts of scam artists looking to steal people’s financial data and money. Such fraudulent activities often target older adults. Whether you’re in this age bracket or worry about senior parents and other relatives, here are seven ways to prevent elder financial abuse:
  1. Keep both paper and online financial documents in a secure place. Monitor accounts and retain statements.
  2. Exercise caution when making financial decisions. If someone exerts pressure or promises unreasonably high or guaranteed returns, walk away.
  3. Write checks only to legitimate financial institutions, rather than to a person.
  4. Be alert for phony phone calls. The IRS doesn’t collect money this way. Another scam involves someone pretending to be a grandchild who’s in trouble and needs money. Don’t provide confidential information or send money until you can verify the caller’s identity.
  5. Beware of emails requesting personal data — even if they appear to be from a real financial institution. After all, shouldn’t your banker or financial professional already know these things? Ignore contact information provided in the email. Instead, contact the financial institution through a known telephone number.
  6. As much as possible, maintain a social network. Criminals target isolated people because often they’re less aware of scams and lack trusted confidants.
  7. Work only with qualified professionals, including accountants, bankers and attorneys.

How to Trim Fat From Your Inventory

Inventory is expensive, so it needs to be as lean as possible. Here are some ways to trim the fat from your inventory without compromising revenue and customer service.


Objective Inventory Counts

Effective inventory management starts with a physical inventory count. Accuracy is essential to knowing your cost of goods sold — and to identifying and remedying discrepancies between your physical count and perpetual inventory records. A CPA can introduce an element of objectivity to the counting process and help minimize errors.

The next step is to compare your inventory costs to those of other companies in your industry. Trade associations often publish benchmarks for:

  • Gross margin ([revenue – cost of sales] / revenue),
  • Net profit margin (net income / revenue), and
  • Days in inventory (annual revenue / average inventory × 365 days).

Your company should strive to meet — or beat — industry standards. For a retailer or wholesaler, inventory is simply purchased from the manufacturer. But the inventory account is more complicated for manufacturers and construction firms. It’s a function of raw materials, labor and overhead costs.

The composition of your company’s cost of goods will guide you on where to cut. In a tight labor market, it’s hard to reduce labor costs. But it may be possible to renegotiate prices with suppliers.

And don’t forget the carrying costs of inventory, such as storage, insurance, obsolescence and pilferage. You can also improve margins by negotiating a net lease for your warehouse, installing antitheft devices or opting for less expensive insurance coverage.

Product Mix

To cut your days-in-inventory ratio, compute product-by-product margins. Stock more products with high margins and high demand — and less of everything else. Whenever possible, return excessive supplies of slow-moving materials or products to your suppliers.

Product mix should be sufficiently broad and in tune with consumer needs. Before cutting back on inventory, you might need to negotiate speedier delivery from suppliers or give suppliers access to your perpetual inventory system. These precautionary measures can help prevent lost sales due to lean inventory.

Reality Check

Often management is so focused on sales, HR issues and product innovation that they lose control over inventory. Contact us for a reality check.

Installment Sales: A Viable Option for Transferring Assets

Are you considering transferring real estate, a family business or other assets you expect to appreciate dramatically in the future? If so, an installment sale may be a viable option. Its benefits include the ability to freeze asset values for estate tax purposes and remove future appreciation from your taxable estate.


Giving Away vs. Selling

From an estate planning perspective, if you have a taxable estate it’s usually more advantageous to give property to your children than to sell it to them. By gifting the asset you’ll be depleting your estate and thereby reducing potential estate tax liability, whereas in a sale the proceeds generally will be included in your taxable estate.

But an installment sale may be desirable if you’ve already used up your $11.18 million (for 2018) lifetime gift tax exemption or if your cash flow needs preclude you from giving the property away outright. When you sell property at fair market value to your children or other loved ones rather than gifting it, you avoid gift taxes on the transfer and freeze the property’s value for estate tax purposes as of the sale date. All future appreciation benefits the buyer and won’t be included in your taxable estate.

Because the transaction is structured as a sale rather than a gift, your buyer must have the financial resources to buy the property. But by using an installment note, the buyer can make the payments over time. Ideally, the purchased property will generate enough income to fund these payments.

Advantages and Disadvantages

An advantage of an installment sale is that it gives you the flexibility to design a payment schedule that corresponds with the property’s cash flow, as well as with your and your buyer’s financial needs. You can arrange for the payments to increase or decrease over time, or even provide for interest-only payments with an end-of-term balloon payment of the principal.

One disadvantage of an installment sale over strategies that involve gifted property is that you’ll be subject to tax on any capital gains you recognize from the sale. Fortunately, you can spread this tax liability over the term of the installment note. As of this writing, the long-term capital gains rates are 0%, 15% or 20%, depending on the amount of your net long-term capital gains plus your ordinary income.

Also, you’ll have to charge interest on the note and pay ordinary income tax on the interest payments. IRS guidelines provide for a minimum rate of interest that must be paid on the note. On the bright side, any capital gains and ordinary income tax you pay further reduces the size of your taxable estate.

Simple Technique, Big Benefits

An installment sale is an approach worth exploring for business owners, real estate investors and others who have gathered high-value assets. It can help keep a family-owned business in the family or otherwise play an important role in your estate plan.

Bear in mind, however, that this simple technique isn’t right for everyone. We can review your situation and help you determine whether an installment sale is a wise move for you.