Tax News October 2017

HOW TO STEER CLEAR OF TAX ISSUES RELATED TO SHAREHOLDER LOANS

Owners occasionally need to borrow funds from their businesses. If your business is structured as a corporation and it has extra cash on hand, a shareholder loan can be a convenient and low-cost option — but it’s important to treat the transaction as a bona fide loan. If you don’t, the IRS may claim you received a taxable dividend or compensation payment rather than a loan.

Taking a closer look

A corporation can make de minimis loans of $10,000 or less to shareholders without paying interest. But, if all of the loans from the corporation to a shareholder add up to more than $10,000, the advances may be subject to a complicated set of below-market interest rules unless you charge what the IRS considers an “adequate” rate of interest. Each month the IRS publishes its applicable federal rates (AFRs), which vary depending on the term of the loan.

Right now, although interest rates are starting to rise, they’re still near historic lows, making it a good time to borrow money. For example, in July 2017, the adjusted AFR for short-term loans (of not more than three years) was only 1.22% (up from 0.71% in July 2016). The rate was 1.89% (up from 1.43% in July 2016) for midterm loans (with terms ranging from more than three years to not more than nine years).

The AFRs are typically below what a bank would charge. As long as the corporation charged interest at the AFR (or higher), the loan would be exempt from the complicated below-market interest rules the IRS imposes.

The interest rate for a demand loan — which is payable whenever the corporation wants to collect it — isn’t fixed when the loan is set up. Instead it varies depending on market conditions. So, calculating the correct AFR for a demand loan is more complicated than it is for a term loan. In general, it’s easier to administer a shareholder loan with a prescribed term than a demand note.

Staying under market

If a corporation lends money to a shareholder at an interest rate that’s below the AFR, the IRS requires it to impute interest using the below-market interest rules. These calculations can be complicated. The amount of incremental imputed interest (beyond what the corporation already charges the shareholder) depends on when the loan was set up and whether it’s a demand or term loan. There are also tax consequences for this imputed interest to both the corporation and the shareholder.

Additionally, the IRS may argue that the loan should be reclassified as either a dividend or additional compensation. The corporation may deduct the latter, but it will also be subject to payroll taxes. Both dividends and additional compensation would be taxable income to the shareholder personally, however.

Making it bona fide

When deciding whether payments made to shareholders qualify as bona fide loans, the IRS considers a variety of factors. It assesses the size of the loan, as well as the corporation’s history of earnings, dividend payments and loan repayments. It also looks at the shareholder’s ability to repay the loan and power to make corporate decisions.

In addition, the IRS will factor in whether you’ve executed a formal, written note that specifies repayment terms — including the interest rate, maturity date and collateral.

Getting started

Under the right circumstances, a shareholder loan could be a smart tax planning move to make this year. Contact our firm to help you set up and monitor your shareholder loans to ensure compliance with the IRS rules.

 

WILLS AND LIVING TRUSTS: ESTATE PLANNING IMPERATIVES

Well-crafted, up-to-date estate planning documents are an imperative for everyone. They also can help ease the burdens on your family during a difficult time. Two important examples: wills and living trusts.

The will

A will is a legal document that arranges for the distribution of your property after you die and allows you to designate a guardian for minor children or other dependents. It should name the executor or personal representative who’ll be responsible for overseeing your estate as it goes through probate. (Probate is the court-supervised process of paying any debts and taxes and distributing your property after you die.) To be valid, a will must meet the legal requirements in your state.

If you die without a will (that is, “intestate”), the state will appoint an administrator to determine how to distribute your property based on state law. The administrator also will decide who will assume guardianship of any minor children or other dependents. Bottom line? Your assets may be distributed — and your dependents provided for — in ways that differ from what you would have wanted.

The living trust

Because probate can be time-consuming, expensive and public, you may prefer to avoid it. A living trust can help. It’s a legal entity to which you, as the grantor, transfer title to your property. During your life, you can act as the trustee, maintaining control over the property in the trust. On your death, the person (such as a family member or advisor) or institution (such as a bank or trust company) you’ve named as the successor trustee distributes the trust assets to the beneficiaries you’ve named.

Assets held in a living trust avoid probate — with very limited exceptions. Another benefit is that the successor trustee can take over management of the trust assets should you become incapacitated.

Having a living trust doesn’t eliminate the need for a will. For example, you can’t name a guardian for minor children or other dependents in a trust. However, a “pour over” will can direct that assets you own outside the living trust be transferred to it on your death.

Other documents

There are other documents that can complement a will and living trust. A “letter of instruction,” for example, provides information that your family will need after your death. In it, you can express your desires for the memorial service, as well as the contact information for your employer, accountant and any other important advisors. (Note: It’s not a legal document.)

Also consider powers of attorney. A durable power of attorney for property allows you to appoint someone to act on your behalf on financial matters should you become incapacitated. A power of attorney for health care covers medical decisions and also takes effect if you become incapacitated. The person to whom you’ve transferred this power — your health care agent — can make medical decisions on your behalf.

Foundational elements

These are just a few of the foundational elements of a strong estate plan. We can work with you and your attorney to address the tax issues involved.

SHOULD YOU CHANGE YOUR BUSINESS – OR TRANSFORM IT?

As its market and technological needs evolve, every company needs to change. There’s even a formal term for the undertaking: “change management.” From an operational standpoint, change involves opening up the hood and switching out old engine parts for new ones. Even if it affects the business as a whole, change means focusing on specific areas and making alterations over relatively short periods.

At some point in the existence of many companies, the organization needs to go beyond change to transformation. This is much different. Business transformations aren’t so much about switching out parts as overhauling the entire engine, possibly modifying the frame and even applying a new coat of paint. Let’s look a little more closely at the distinction.

Reinvent yourself

Say a large commercial construction company was having trouble meeting its sales goals because of environmental regulations. So, it decided to augment its sales teams with environmental engineers who could better assess the compliance impact. The company applied change management principles — such as building a case for the idea and adjusting its business culture — and was successful. This was no doubt an important change, but the business itself wasn’t transformed.

The objective of a true transformation is to essentially reinvent the company and implement a new business model. And that model needs to be a carefully, formally devised chain of interlocking strategic initiatives that apply to the entire organization.

Perhaps the most obvious and universal example of a business transformation is Apple. The technology giant, once a head-to-head competitor with IBM on the personal computer market, found itself struggling in the 1990s. So, under the tutelage of the late Steve Jobs, it transformed itself into a mobile technology company. It still makes computers, of course, but the company’s transformative success can really be attributed to its mobile devices and operating systems.

Think and act wisely

Every business transformation differs based on the history, nature and size of the company in question. But there are best practices to keep in mind. For example, start with your customers, visualizing what they need (even if they don’t know it yet). Also, build a chain of initiatives, so you’re not trying to do everything all at once. And use metrics, so you can track specific dollar amounts and productivity goals throughout the transformation.

Above all, be ready for anything. Even the best-planned transformations can produce unpredictable results. So keep expectations in line and take a measured, patient approach to every initiative involved.

Bring along help

Successful business transformations can be spectacular and profitable. But, make no mistake, the risk level is high. So if you decide to embark on this journey, bring along your trusted financial, legal and strategic advisors.

3 STRATEGIES FOR HANDLING ESTIMATED TAX PAYMENTS

In today’s economy, many individuals are self-employed. Others generate income from interest, rent or dividends. If these circumstances sound familiar, you might be at risk of penalties if you don’t pay enough tax during the year through estimated tax payments and withholding. Here are three strategies to help avoid underpayment penalties:

  1. Know the minimum payment rules.For you to avoid penalties, your estimated payments and withholding must equal at least:
  • 90% of your tax liability for the year,
  • 110% of your tax for the previous year, or
  • 100% of your tax for the previous year if your adjusted gross income for the previous year was $150,000 or less ($75,000 or less if married filing separately).
  1. Use the annualized income installment method.This method often benefits taxpayers who have large variability in income by month due to bonuses, investment gains and losses, or seasonal income — especially if it’s skewed toward year end. Annualizing calculates the tax due based on income, gains, losses and deductions through each “quarterly” estimated tax period.
  2. Estimate your tax liability and increase withholding.If, as year end approaches, you determine you’ve underpaid, consider having the tax shortfall withheld from your salary or year-end bonus by December 31. Because withholding is considered to have been paid ratably throughout the year, this is often a better strategy than making up the difference with an increased quarterly tax payment, which may trigger penalties for earlier quarters.

Finally, beware that you also could incur interest and penalties if you’re subject to the additional 0.9% Medicare tax and it isn’t withheld from your pay and you don’t make sufficient estimated tax payments. Please contact us for help with this tricky tax task.

TAX CALENDAR

October 16 — Personal returns that received an automatic six-month extension must be filed today and any tax, interest and penalties due must be paid.

  • The Financial Crimes Enforcement Network (FinCEN) Form 114, “Report of Foreign Bank and Financial Accounts (FBAR),” must be filed by today, if it hasn’t been filed already, for offshore bank account reporting. (This report received an automatic extension to today if not filed by the original due date of April 18.)
  • If a six-month extension was obtained, calendar-year C corporations should file their 2016 Form 1120 by this date.
  • If the monthly deposit rule applies, employers must deposit the tax for payments in September for Social Security, Medicare, withheld income tax and nonpayroll withholding.

October 31 — The third quarter Form 941 (“Employer’s Quarterly Federal Tax Return”) is due today and any undeposited tax must be deposited. (If your tax liability is less than $2,500, you can pay it in full with a timely filed return.) If you deposited the tax for the quarter in full and on time, you have until November 10 to file the return.

  • If you have employees, a federal unemployment tax (FUTA) deposit is due if the FUTA liability through September exceeds $500.

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

December 15 — Calendar-year corporations must deposit the fourth installment of estimated income tax for 2017.

  • If the monthly deposit rule applies, employers must deposit the tax for payments in November 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 September 2017

DO YOU NEED THE PROTECTION OF A D&O INSURANCE POLICY?

Your efforts toward ensuring your financial security might be focused on building up your assets through wise investing or growing your business. But protecting the assets you already have is just as important. And if you serve as a director or officer of a company, or even sit on the board of a nonprofit, your assets may be vulnerable. One way to gain some protection is to obtain coverage under a directors and officers (D&O) insurance policy.

Assessing your risks

D&O insurance helps protect an organization’s directors, officers and board members from liability resulting from management decisions. Just a few examples of how such individuals can put themselves at risk include:

  • Committing a crime,
  • Failing to disclose a conflict of interest, or
  • Breaching their fiduciary responsibilities.

But even if directors or officers do nothing wrong, they still can be held financially responsible for others’ missteps if they’re sued and the organization lacks sufficient assets to protect them. Indeed, directors and officers are vulnerable to many types of lawsuits.

Employment-related litigation — covering such claims as harassment, discrimination and wrongful termination — is particularly common, while legal action also may be brought by unhappy shareholders, lenders, customers, suppliers, competitors or government regulators.

You may feel less vulnerable if you sit on the board of directors of a nonprofit. Although nonprofits do lack shareholders, they still have stakeholders — financial contributors or other individuals with a personal interest in the organization’s mission. Thus, nonprofit directors, officers and board members can find themselves at risk if these stakeholders decide to sue its leaders for mismanagement.

Contemplating coverage

When contemplating a D&O policy, determine exactly what it covers. For example, some insurers won’t cover fraud-related claims, while others specifically exclude employment-related litigation.

Next, weigh what’s covered against the specific risks you’re most likely to face. For example, if you’re thinking about joining the board of an organization with a history of rocky employee relations, determine whether you’ll be protected from employee-related lawsuits. If you uncover potential gaps in the D&O policy, or if it includes provisions that could lead to your coverage being rescinded in certain situations, you may need to obtain additional protection through supplemental liability insurance.

Building a safeguard

Make no mistake, a D&O policy can be costly because of the high financial stakes involved. So an organization in cost-cutting mode may not wish to offer you this coverage. Nonetheless, if you’re a director, officer or board member, a policy may serve as a critical safeguard for your family’s assets. Contact our firm for an assessment of your situation.

Sidebar: D&O vs. E&O

Many people mistakenly view errors and omissions (E&O) insurance as an alternative to a directors and officers (D&O) policy. Don’t be among them; the two types of policies cover different sets of risks.

E&O insurance covers the business itself against problems stemming from potential failures in the products and services a business offers its customers; D&O insurance protects individual officers and directors from financial risk stemming from management decisions — either yours or someone else’s.

 

BEWARE THE ONGOING RISK OF EMPLOYEE MISCLASSIFICATION

 

We live in an increasingly specialized society. As such, there’s a growing subset of the workforce with distinctive skill sets that can perform high-quality services. Through independent contractor relationships, companies are able to access these services without the long-term entanglements of traditional employment.

And yet, risk remains. Classifying a worker as an independent contractor frees a business from payroll tax liability and allows it to forgo providing overtime pay, unemployment compensation, and other employee benefits. Also, independent status takes an individual off the company payroll, where an employee’s share of payroll taxes, plus income taxes, is automatically withheld.

For these reasons, the federal government views misclassifying a bona fide employee as an independent contractor as forcing a square peg into a round hole.

Key factors

The IRS has long been a primary enforcer of proper worker classification. When assessing worker classification, the agency typically looks at the:

Level of behavioral control. This means the extent to which the company instructs a worker on when and where to do the work, what tools or equipment to use, whom to hire, where to purchase supplies and so on. Also, control typically involves providing training and evaluating the worker’s performance. The more control the company exercises, the more likely the worker is an employee.

Level of financial control. Independent contractors are more likely to invest in their own equipment or facilities, incur unreimbursed business expenses, and market their services to other customers. Employees are more likely to be paid by the hour or week or some other time period; independent contractors are more likely to receive a flat fee.

Relationship of the parties. Independent contractors are often engaged for a discrete project, while employees are typically hired permanently (or at least for an indefinite period). Also, workers who serve a key business function are more likely to be classified as employees.

The IRS examines a variety of factors within each category. You need to consider all of the facts and circumstances surrounding each worker relationship.

Protective measures

Once you’ve completed your review, there are several strategies you can use to minimize your exposure. When in doubt, reclassify questionable independent contractors as employees. This may increase your tax and benefit costs, but it will eliminate reclassification risk.

From there, modify your relationships with independent contractors to better ensure compliance. For example, you might exercise less behavioral control by reducing your level of supervision or allowing workers to set their own hours or work from home.

Also, consider using an employee-leasing company. Workers leased from these firms are employees of the leasing company, which is responsible for taxes, benefits and other employer obligations.

Before and during

Sometimes a company engages an independent contractor with short-term intentions only to gradually integrate the person into its staff, creating a risk of employee misclassification. Our firm can help you review the pertinent factors and use protective measures before and duringan engagement.

 

UNDERSTANDING THE DIFFERENCES BETWEEN HEALTH CARE ACCOUNTS

 

Health care costs continue to be in the news and on everyone’s mind. As a result, tax-friendly ways to pay for these expenses are very much in play for many people. The three primary players, so to speak, are Health Savings Accounts (HSAs), Flexible Spending Arrangements (FSAs) and Health Reimbursement Arrangements (HRAs).

All provide opportunities for tax-advantaged funding of health care expenses. But what’s the difference between these three types of accounts? Here’s an overview of each one:

HSAs. If you’re covered by a qualified high-deductible health plan (HDHP), you can contribute pretax income to an employer-sponsored HSA — or make deductible contributions to an HSA you set up yourself — up to $3,400 for self-only coverage and $6,750 for family coverage for 2017. Plus, if you’re age 55 or older, you may contribute an additional $1,000.

You own the account, which can bear interest or be invested, growing tax-deferred similar to an IRA. Withdrawals for qualified medical expenses are tax-free, and you can carry over a balance from year to year.

FSAs. Regardless of whether you have an HDHP, you can redirect pretax income to an employer-sponsored FSA up to an employer-determined limit — not to exceed $2,600 in 2017. The plan pays or reimburses you for qualified medical expenses.

What you don’t use by the plan year’s end, you generally lose — though your plan might allow you to roll over up to $500 to the next year. Or it might give you a 2½-month grace period to incur expenses to use up the previous year’s contribution. If you have an HSA, your FSA is limited to funding certain “permitted” expenses.

HRAs. An HRA is an employer-sponsored arrangement that reimburses you for medical expenses. Unlike an HSA, no HDHP is required. Unlike an FSA, any unused portion typically can be carried forward to the next year. And there’s no government-set limit on HRA contributions. But only your employer can contribute to an HRA; employees aren’t allowed to contribute.

Please bear in mind that these plans could be affected by health care or tax legislation. Contact our firm for the latest information, as well as to discuss these and other ways to save taxes in relation to your health care expenses.

 

5 KEYS TO DISASTER PLANNING FOR INDIVIDUALS

Disaster planning is usually associated with businesses. But individuals need to prepare for worst-case scenarios, as well. Unfortunately, the topic can seem a little overwhelming. To help simplify matters, here are five keys to disaster planning that everyone should consider:

  1. Insurance.Start with your homeowners’ coverage. Make sure your policy covers flood, wind and other damage possible in your region and that its dollar amount is adequate to cover replacement costs. Also review your life and disability insurance.
  2. Asset documentation.Create a list of your bank accounts, titles, deeds, mortgages, home equity loans, investments and tax records. Inventory physical assets not only in writing (including brand names and model and serial numbers), but also by photographing or videoing them.
  3. Document storage.Keep copies of financial and personal documents somewhere other than your home, such as a safe deposit box or the distant home of a trusted friend or relative. Also consider “cloud computing” — storing digital files with a secure Web-based provider.
  4. Cash.You may not receive insurance money right away. A good rule of thumb is to set aside three to six months’ worth of living expenses in a savings or money market account. Also maintain a cash reserve in your home in a durable, fireproof safe.
  5. An emergency plan.Establish a family emergency plan that includes evacuation routes, methods of getting in touch and a safe place to meet. Because a disaster might require you to stay in your home, stock a supply kit with water, nonperishable food, batteries and a first aid kit.

 

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 August 2017

SHOULD YOU CONVERT FROM A C CORPORATION TO AN S CORPORATION?

Many private business owners elect to incorporate, turning their companies into C corporations. But, at some point, you may consider converting to an S corporation. This isn’t necessarily a bad idea, but it’s important to know the ramifications involved.

Similarities and differences

S and C corporations use many of the same recordkeeping practices. Both types of entities maintain books, records and bank accounts separate from those of their owners. They also follow state rules regarding annual directors meetings, fees and administrative filings. And both must pay and withhold payroll taxes for working owners who are active in the business.

There are, however, a few important distinctions. First, S corporations don’t incur corporate-level tax, so they don’t report federal (and possibly state) income tax expenses on their income statements. Also, S corporations generally don’t report prepaid income taxes, income taxes payable, or deferred income tax assets and liabilities on their balance sheets.

As an S corporation owner, you’d pay tax at the personal level on your share of the corporation’s income and gains. The combined personal tax obligations of S corporation owners can be significant at higher income levels.

Dividends vs. distributions

Other financial reporting differences between a C corporation and S corporation are more subtle. For instance, when C corporations pay dividends, they’re taxed twice: They pay tax at the corporate level when the company files its annual tax return, and the individual owners pay again when dividends and liquidation proceeds are taxed at the personal level.

When S corporations pay distributions — the name for dividends paid by S corporations — the payout generally isn’t subject to personal-level tax as long as the shares have positive tax “basis.” (S corporation basis is typically a function of capital contributions, earnings and distributions.)

Risk of tax audits

C corporations may be tempted to pay owners deductible above-market salaries to get cash out of the business and avoid the double taxation that comes with dividends. Conversely, S corporation owners may try to maximize tax-free distributions and pay owners below-market salaries to minimize payroll taxes.

The IRS is on the lookout for both scenarios. Corporations that compensate owners too much or too little may find themselves under audit. Regardless of entity type, an owner’s compensation should always be commensurate with his or her skills, experience and business involvement.

The right decision

For businesses that qualify (see sidebar), an S corporation conversion may be a wise move. But, as noted, there are rules and risks to consider. Also, as of this writing, there are tax reform proposals under consideration in Washington that could affect the impact of a conversion. Our firm can help you make the right decision.

Sidebar: Which companies can elect S status?

Not every private business is eligible to be an S corporation. In order to elect S status, a company must:

  • Be a domestic corporation,
  • Have only allowable shareholders (individuals, certain trusts and estates, but not partnerships, corporations or nonresident alien shareholders),
  • Have no more than 100 shareholders,
  • Have only one class of stock, and
  • Not be an ineligible corporation, including certain financial institutions, insurance companies, and domestic international sales corporations.

All shareholders must consent to the S election by signing Form 2553, “Election by a Small Business Corporation.”

 

COOL DOWN WITH A DIP INTO YOUR TAX RECORDS

 

In many parts of the country, the dog days of summer are a good time to stay inside. If you’re looking for a practical activity while you beat the heat, consider organizing your tax records. Granted, it may not be as exhilarating as jumping off the high dive, but a dip into these important documents now may save you a multitude of headaches later.

Tax law rules

Generally, you should keep tax-related records as long as the IRS has the ability to audit your return or assess additional taxes — in other words, until the statute of limitations expires. That means three years after you file your return or, if later, three years after the tax return’s original due date.

In some cases, the statute of limitations extends beyond three years. If you understate your adjusted gross income by more than 25%, for example, the period jumps to six years. And there’s no statute of limitations if you fail to file a tax return or file a fraudulent one.

Longer periods

Although the IRS statute of limitations is a good rule of thumb, there are exceptions to consider. For example, it’s wise to keep your tax returns themselves indefinitely because you never know when you’ll need a copy of your individual income tax return.

For one thing, the IRS often destroys original returns after four or five years. So if the IRS comes back 10 years later and claims you never filed a return for a particular year, it can assess tax for that year even though the limitations period for properly filed returns has long since expired. As you can see, it would be difficult to defend yourself without a copy of your tax return.

W-2 forms also are important to keep at least until you start receiving Social Security benefits. You may need them if there’s a question about your work record or earnings in a particular year.

Property and investments

If you have property records, it’s ideal to keep closing documents and records related to initial purchases and capital improvements until at least three years (preferably six years in case you understated your income by more than 25%) after you file your return for the year in which you sell the property.

When it comes to sales of stocks or other securities, retain purchase statements and trade confirmations until at least three years (preferably six years) after you file your return for the year in which you sell these stocks or other securities.

Grains of sand

Many years’ worth of tax and financial records can accumulate like grains of sand on your favorite beach. So the better your documentation is organized, the easier time you’ll have filing your return every year and dealing with any IRS surprises. Our firm can assist you in determining what you should keep.

 

IRS PERMITS HIGH-EARNER ROTH IRA ROLLOVER OPPORTUNITY

 

Are you a highly compensated employee (HCE) approaching retirement? If so, and you have a 401(k), you should consider a potentially useful tax-efficient IRA rollover technique. The IRS has specific rules about how participants such as you can allocate accumulated 401(k) plan assets based on pretax and after-tax employee contributions between standard IRAs and Roth IRAs.

High-earner dilemma

In 2017, the top pretax contribution that participants can make to a 401(k) is $18,000 ($24,000 for those 50 and older). Plans that permit after-tax contributions (several do) allow participants to contribute a total of $54,000 ($36,000 above the $18,000 pretax contribution limit). While some highly compensated supersavers may have significant accumulations of after-tax contributions in their 401(k) accounts, the tax law income caps block the highest paid HCEs from opening a Roth IRA.

However, under IRS rules, these participants can roll dollars representing their after-tax 401(k) contributions directly into a new Roth IRA when they retire or no longer work for the companies. Thus, they’ll ultimately be able to withdraw the dollars representing the original after-tax contributions — and subsequent earnings on those dollars — tax-free.

An example

Participants can contribute rollover dollars to conventional and Roth IRAs on a pro-rata basis. For example, suppose a retiring participant had $1 million in his 401(k) plan account, $600,000 of which represents contributions. Suppose further that 70% of that $600,000 represents pretax contributions, and 30% is from after-tax contributions. IRS guidance clarifies that the participant can roll $700,000 (70% of the $1 million) into a conventional IRA, and $300,000 (30% of the $1 million) into a Roth IRA.

The IRS rules allow the retiree to roll over not only the after-tax contributions, but the earnings on those after-tax contributions (40% of the $300,000, or $120,000) to the Roth IRA provided that the $120,000 will be taxable for the year of the rollover.

Alternatively, the IRS rules allow the retiree to delay taxation on the earnings attributable to the after-tax contributions ($120,000) until the money is distributed by contributing that amount to a conventional IRA, and the remaining $180,000 to the Roth IRA.

Under each approach, the subsequent growth in the Roth IRA will be tax-free when withdrawn. Partial rollovers can also be made, and the same principles apply.

Golden years ahead

HCEs face some complex decisions when it comes to retirement planning. Let our firm help you make the right moves now for your golden years ahead.

SHIFTING CAPITAL GAINS TO YOUR CHILDREN

 

If you’re an investor looking to save tax dollars, your kids might be able to help you out. Giving appreciated stock or other investments to your children can minimize the impact of capital gains taxes.

For this strategy to work best, however, your child must not be subject to the “kiddie tax.” This tax applies your marginal rate to unearned income in excess of a specified threshold ($2,100 in 2017) received by your child who at the end of the tax year was either: 1) under 18, 2) 18 (but not older) and whose earned income didn’t exceed one-half of his or her own support for the year (excluding scholarships if a full-time student), or 3) a full-time student age 19 to 23 who had earned income that didn’t exceed half of his or her own support (excluding scholarships).

Here’s how it works: Say Bill, who’s in the top tax bracket, wants to help his daughter, Molly, buy a new car. Molly is 22 years old, just out of college, and currently looking for a job — and, for purposes of the example, won’t be considered a dependent for 2017.

Even if she finds a job soon, she’ll likely be in the 10% or 15% tax bracket this year. To finance the car, Bill plans to sell $20,000 of stock that he originally purchased for $2,000. If he sells the stock, he’ll have to pay $3,600 in capital gains tax (20% of $18,000), plus the 3.8% net investment income tax, leaving $15,716 for Molly. But if Bill gives the stock to Molly, she can sell it tax-free and use the entire $20,000 to buy a car. (The capital gains rate for the two lowest tax brackets is generally 0%.)

 

 

 

Important Information: The information contained in this newsletter was not intended or written to be used and cannot be used for the purpose of (1) avoiding tax-related penalties prescribed by the Internal Revenue Code or (2) promoting or marketing any tax-related matter addressed herein.

The Tax and Business Alert is designed to provide accurate information regarding the subject matter covered. However, before completing any significant transactions based on the information contained herein, please contact us for advice on how the information applies in your specific situation. Tax and Business Alert is a trademark used herein under license. © Copyright 2017.

Illinois Income Tax Law Changes for 2017

The Illinois House recently followed the Senate’s lead in overriding Governor Rauner’s veto of the Illinois budget. Senate Bill 9 raises around $5 billion of new permanent income taxes. The individual income tax rates increased from 3.75% to 4.95%, while the corporate rates rose from 5.25% to 7.0%. These rate increases were effective on July 1, 2017.

The difficulty with the midyear tax increase is that the law imposes the new tax rate effective July 1, 2017 so that net income is taxed at the 3.75% rate from January 1 through June 30, 2017.  Likewise an income tax rate of 4.95% is imposed on the income earned from July 1 through December 31, 2017.  Illinois taxpayers are provided two options to calculate income subject to different rates in the same tax year.  A taxpayer may divide its full year net income proportionally based on the number of months subject to the former rate and the new rate.  This would effectively result in a tax rate of 4.35% to be applied to the entire 2017 tax year for individuals.  Alternatively, a taxpayer may elect to specifically account for items of income and deduction based on when they were generated during the tax year.  See the following example for this election.

 

Example: A husband and wife file a joint Illinois income tax return for 2017. The husband earns $75,000 plus a $30,000 bonus received in January 2017. The wife earns a salary of $50,000 plus she sold a stock and received a capital gain of $10,000 in November 2017. To the best of our knowledge, the income tax calculations would be as follows:

1/1/17 – 6/30/17 7/1/17 – 12/31/17 TOTAL
Husband salary $37,500 $37,500 $75,000
Wife salary  25,000 25,000 50,000
Husband bonus received in January  30,000 —— 30,000
Wife capital gain in November —— 10,000 10,000
Total income $92,500 $72,500 $165,000
Tax rate  3.75% 4.95%
Tax $3,469 $3,589 $7,058

 

If the taxpayers did not make the election to specifically allocate income, the use of the blended rate of 4.35% would result in an Illinois income tax of $7,178 ($165,000 * 4.35%).  Therefore, the election results in savings to the taxpayers of $120 ($7,178 – $7,058).  Note that this illustration does not factor in other adjustments that may impact the calculation such as exemptions, adjustments, etc.

The corporate income tax calculation will work in the same manner. As you can see, additional work will be required on your part in breaking down your income as to whether it was received prior to July 1 or after July 1.

For those of you with businesses who have employees, obviously the Illinois withholding on wages paid after June 30, 2017 will be required to be withheld at the 4.95% rate.

Other changes included in the new law include the elimination of personal exemptions, education expense credit and the real estate tax credit for single filers with income of $250,000 per year and for joint filers with income of $500,000 per year starting in 2017. The law also increases the earned income credit from 10% to 14% for 2017 and then to 18% in 2018. The cap on the education expense credit will increase from $500 to $750 in 2017 and the teachers’ deduction (for federal purposes) of $250 will become a $250 credit for Illinois.

 

Many of these changes could greatly affect your income tax situation for 2017 and beyond. Please contact us if we can be of any assistance.

 

 

 

 

 

 

 

 

 

 

 

Illinois Income Tax Law Changes for 2017

The Illinois House recently followed the Senate’s lead in overriding Governor Rauner’s veto of the Illinois budget. Senate Bill 9 raises around $5 billion of new permanent income taxes. The individual income tax rates increased from 3.75% to 4.95%, while the corporate rates rose from 5.25% to 7.0%. These rate increases were effective on July 1, 2017.

 

The difficulty with the midyear tax increase is that the law imposes the new tax rate effective July 1, 2017 so that net income is taxed at the 3.75% rate from January 1 through June 30, 2017.  Likewise an income tax rate of 4.95% is imposed on the income earned from July 1 through December 31, 2017.  Illinois taxpayers are provided two options to calculate income subject to different rates in the same tax year.  A taxpayer may divide its full year net income proportionally based on the number of months subject to the former rate and the new rate.  This would effectively result in a tax rate of 4.35% to be applied to the entire 2017 tax year for individuals.  Alternatively, a taxpayer may elect to specifically account for items of income and deduction based on when they were generated during the tax year.  See the following example for this election.

 

Example: A husband and wife file a joint Illinois income tax return for 2017. The husband earns $75,000 plus a $30,000 bonus received in January 2017. The wife earns a salary of $50,000 plus she sold a stock and received a capital gain of $10,000 in November 2017. To the best of our knowledge, the income tax calculations would be as follows:

1/1/17 – 6/30/17 7/1/17 – 12/31/17 TOTAL
Husband salary $37,500 $37,500 $75,000
Wife salary  25,000 25,000 50,000
Husband bonus received in January  30,000 —— 30,000
Wife capital gain in November —— 10,000 10,000
Total income $92,500 $72,500 $165,000
Tax rate  3.75% 4.95%
Tax $3,469 $3,589 $7,058

 

If the taxpayers did not make the election to specifically allocate income, the use of the blended rate of 4.35% would result in an Illinois income tax of $7,178 ($165,000 * 4.35%).  Therefore, the election results in savings to the taxpayers of $120 ($7,178 – $7,058).  Note that this illustration does not factor in other adjustments that may impact the calculation such as exemptions, adjustments, etc.

 

The corporate income tax calculation will work in the same manner. As you can see, additional work will be required on your part in breaking down your income as to whether it was received prior to July 1 or after July 1.

 

For those of you with businesses who have employees, obviously the Illinois withholding on wages paid after June 30, 2017 will be required to be withheld at the 4.95% rate.

 

Other changes included in the new law include the elimination of personal exemptions, education expense credit and the real estate tax credit for single filers with income of $250,000 per year and for joint filers with income of $500,000 per year starting in 2017. The law also increases the earned income credit from 10% to 14% for 2017 and then to 18% in 2018. The cap on the education expense credit will increase from $500 to $750 in 2017 and the teachers’ deduction (for federal purposes) of $250 will become a $250 credit for Illinois.

 

Many of these changes could greatly affect your income tax situation for 2017 and beyond. Please contact us if we can be of any assistance.

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.

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.

 

 

 

 

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.

 

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