Feeling Charitable? Be Sure You Can Substantiate Your Gifts

As the end of the year approaches, many people give more thought to supporting charities they favor. To avoid losing valuable charitable deductions if you itemize, you’ll need specific documentation, depending on the type and size of your gift. Here’s a breakdown of the rules:

Cash gifts under $250. A canceled check, bank statement or credit card statement will do. Or ask the charity for a receipt or “other reliable written record” that provides the organization’s name, the date and the amount of the gift.

Cash gifts of $250 or more. You’ll need a contemporaneous written acknowledgment from the charity stating the amount of the gift. That means you received the acknowledgment before the earlier of your tax return due date (including extensions) or the date you file your return. If you make multiple separate gifts to the same charity of less than $250 each (monthly contributions, for example) that total $250 or more for the year, you can still follow the substantiation rules for cash gifts under $250.

Noncash gifts under $250. Get a receipt showing the charity’s name, the date and location of the donation, and a description of the property.

Noncash gifts of $250 or more. Obtain a contemporaneous written acknowledgment from the charity that contains the information required for cash gifts, plus a description of the property.

Noncash gifts of more than $500: In addition to the above, keep records showing the date you acquired the property, how you acquired it and your adjusted basis in it. Also, file Form 8283.

Noncash gifts of more than $5,000 ($10,000 for closely held stock). In addition to the above, obtain a qualified appraisal and include an appraisal summary, signed by the appraiser and the charity, with your return. (No appraisal is required for publicly traded securities.)

Noncash gifts of more than $500,000 ($20,000 for art). In addition to the above, include a copy of the signed appraisal, not just a summary, with your return.

Finally, if you received anything in exchange for your donation, such as a book for making an online donation or food and drink at a fundraising event, ask the charity for the fair market value of the item(s). You’ll need to subtract it from your charitable deduction.

Saving taxes isn’t the primary motivator for charitable donations, but it may affect the amount you can afford to give. Substantiate your donations to ensure you receive the deductions you deserve.

Unlocking Tax Savings: The Benefits Of A Cost Segregation Study

A cost segregation study allows a business property owner to accelerate depreciation deductions. That, in turn, enables the owner to reduce current taxable income and increase cash flow.

A cost segregation study combines accounting and engineering techniques to identify building costs that are properly allocable to tangible personal property rather than real property. It then allows the personal property to be reclassified for tax purposes and deducted over a much shorter depreciation period. This strategy has been consistently upheld in the courts.

Fundamentals of depreciation

Business buildings generally have a 39-year depreciation period. Typically, companies depreciate a building’s structural components (such as walls, windows, HVAC systems, 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.

Often, businesses allocate all, or most, of their buildings’ 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, removable partitions, awnings, canopies, window treatments and signs.

Shine a light on outdoor savings

Rules for outdoor lighting, parking lots, landscaping and fencing are tricky but can still lead to current tax deductions in certain situations. These expenditures are generally treated as capital improvements, subject to the 15-year depreciation rule. For instance, if you replace your business lighting to upgrade it or provide greater security at night, it qualifies as a deductible capital improvement. Similarly, landscaping projects designed to boost your curb appeal or provide environmental benefits are considered capital improvements.

On the other hand, routine maintenance (such as the costs of mowing and watering the lawn surrounding your business building) typically fall into the category of deductible business expenses, just like minor repairs.

Worth checking out

Although the relative costs and benefits of a cost segregation study will depend on your particular facts and circumstances, it can be a valuable investment.

And, under the Tax Cuts and Jobs Act, the potential benefits of a cost segregation study may be even greater than they were years ago because of enhancements to certain depreciation-related tax breaks.

Contact the office for further details.

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Year-end Tax Planning Strategies For Businesses

Now is a good time to consider year-end strategies to help reduce your business’s 2024 income taxes. The effectiveness of a particular action depends on the circumstances of your business. Here are several possibilities.

Defer income, accelerate deductions

A tried-and-true tactic for tax minimization is to defer income to next year and accelerate deductible expenses into this year. For example, a business that follows the cash method of accounting can defer income by postponing invoices until late in the year or accelerate deductions by paying certain expenses this year.

Businesses that use the accrual method have less flexibility in timing, but there are still actions you can take. For example, you can deduct year-end bonuses accrued this year even if you don’t pay them until next year (no later than March 15, 2025). You might also be able to defer until next year income from certain advance payments, including licensing fees, subscriptions and membership dues, depending on how the payments were recorded.

Deferring income and accelerating deductions may not suit every business. The opposite approach is sometimes more beneficial, such as if you anticipate being in a higher tax bracket next year.

Purchase assets by year end

One effective way to generate tax deductions is to buy equipment, machinery and other fixed assets. Ordinarily, these assets are capitalized and depreciated over several years, but there are ways to deduct more of these asset costs immediately. For example, in 2024, under Section 179 you can deduct $1.22 million in qualifying tangible property and certain computer software costs, subject to phaseout when expenditures exceed $3.05 million in 2024.

Similarly, under bonus depreciation, you can deduct up to 60% of the cost of eligible tangible property, including most equipment and machinery, plus off-the-shelf computer software and certain improvements to nonresidential building interiors placed in service in 2024. Unless Congress takes action to increase the bonus deduction limit, it will drop to 40% in 2025, to 20% in 2026 and to 0% in 2027.

Set up a retirement plan

Establishing a retirement plan is an effective way to generate tax benefits. It can also improve employee recruitment and retention efforts.

Certain employers are entitled to tax credits for starting a new plan. Whether you started a new plan or already had one in place, depending on the type of plan, you may be able to take 2024 deductions for contributions made after year end. Some plans, including simplified employee pensions, can be adopted and funded after year end but deducted for this year.

Write off bad debts

Review your receivables to determine whether any bona fide business debts have become worthless or uncollectible. If so, you may be able to reduce 2024 taxes by claiming a bad debt deduction.

You must show you’ve taken reasonable steps to collect the debt and that there’s no realistic expectation of payment (such as if the debtor is in bankruptcy). You must also show that the debt was charged off this year.

Finally, the receivable must have been previously included in taxable income. Thus, an accrual-basis business can deduct an eligible bad debt if it’s already accrued the receivable, but a cash-basis business can’t.

See the big picture

Whichever year-end tax strategies you explore, consider how they interact with other tax code provisions. Contact the office for help determining the best combination of year-end planning strategies for your business.

Year-end Tax Planning Moves For Individuals

During the holiday season, income taxes probably aren’t top of mind for most taxpayers. But along with the festivities, it’s a good time to consider tax strategies that may reduce this year’s taxes, and possibly future years’ taxes as well. Here are three tax planning moves that might trim the fat off your 2024 taxes.

1. Donate stock to charities

If you itemize deductions and want to donate to IRS-approved public charities, you can combine your generosity with a revamping of your taxable investment portfolio. Here are some tax-smart principles to follow:

Sell underperforming stocks and donate the proceeds. Stocks worth less than they cost can be sold at a tax-saving capital loss. You can then donate the sales proceeds to charity and claim a charitable deduction.

Donate appreciated stocks. If you’ve held a stock for over a year and donate it to charity, you can claim a deduction for its market value while avoiding capital gains tax you’d owe if you sold it. Stocks held for less than a year can also be donated, but the deduction is limited to cost basis.

2. Prepay higher education bills

If you paid higher education expenses for you, your spouse or a dependent, you may qualify you for one of the following credits:

The American Opportunity credit. This credit is equal to 100% of the first $2,000 of qualified postsecondary education expenses, plus 25% of the next $2,000, for the first four years of postsecondary education in pursuit of a degree or recognized credential. The maximum annual credit is $2,500 per qualified student.

The Lifetime Learning credit. This credit is equal to 20% of up to $10,000 of qualified education expenses. The maximum credit is $2,000 per tax return.

For 2024, both credits phase out if your modified adjusted gross income (MAGI) is between:

• $80,000 and $90,000 for unmarried people, or
• $160,000 and $180,000 for married couples filing jointly.

Various other restrictions also apply. If you’re eligible for either credit and your 2024 expenses don’t already exceed the applicable limit, consider prepaying college tuition for academic periods from January through March 2025.

If your credit will be partially or fully phased out because of your MAGI for 2024, consider whether there’s anything you could do to reduce your MAGI so you could maximize your 2024 education credit. (Reducing your MAGI could also increase the benefit of certain other tax breaks.)

3. Consider a Roth conversion

If you anticipate being in a higher tax bracket during retirement than you are now and have a traditional IRA, consider a Roth conversion. The downside is that this will generate a current tax cost. Why? Because a conversion is considered a taxable liquidation, followed by a nondeductible contribution to a Roth account. However, post-Roth conversion, all qualified withdrawals from the account will be federal-income-tax-free. Qualified withdrawals occur after:

• The Roth account has been open for over five years, and
• You’ve reached age 59½, become disabled, or passed away (withdrawals made to a beneficiary).

A Roth conversion makes it possible to avoid potentially higher future tax rates, because you’ve already paid the tax.

For more ideas

Federal tax law may be uncertain for the next year or so because many of the Tax Cuts and Jobs Act provisions are scheduled to expire at the end of 2025 but could be extended. There also could be other tax law changes as a result of the election. Contact the office to discuss tax planning moves that may work for you.

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Boost Morale And Save Taxes With Achievement Awards

Some small businesses struggle with employee morale for a variety of reasons, one of which may be economic uncertainty. If you want to boost employees’ spirits without a big financial outlay, an achievement awards program is a relatively low-cost fringe benefit that may be a win-win addition.

Under such an initiative, you can hand out awards at an appointed time, such as a year-end ceremony or holiday party. And, as long as you follow the rules, the awards will be tax-deductible for your company and tax-free for recipient employees.

Fulfilling the requirements

To qualify for favorable tax treatment, achievement awards must be granted to employees for either promoting safety in the workplace or length of service. The award can’t be disguised compensation or a payoff for closing a big deal. In addition, they must be tangible items, ranging from a gold watch or a smartphone to a plaque or a trophy. Examples of awards that would violate the rules are gift certificates, vacations, or tickets to sporting events or concerts.

Additional requirements apply each type of award:

1. Safety awards. These can’t go to managers, administrators, clerical workers or other professional employees. Also, safety awards won’t qualify for favorable tax treatment if the company grants them to more than 10% of eligible employees in the same year.

2. Length-of-service awards. To receive such an award, an employee must have worked for the business for at least five years. In addition, the employee can’t have received a length-of-service award within the last five years.

Also keep in mind that the award must be part of a “meaningful presentation.” That doesn’t mean you have to host a gala awards dinner at the Ritz, but the award should be marked by a ceremony befitting the occasion.

Nonqualified vs. qualified

There are limits on an award’s value depending on whether the achievement awards program is nonqualified or qualified. For a nonqualified program, the annual maximum award is $400. For a qualified program the maximum is $1,600 (including nonqualified awards). Any excess above these amounts is nondeductible for the employer and taxable to the employee. If an employee receives multiple awards in one year, these figures apply to the total, not to each individual award.

To establish a qualified program, and therefore benefit from the higher limit, you must meet two additional requirements. First, awards must be granted under a written plan and the plan must be open to all eligible employees without favoritism. Second, the program must not discriminate in favor of highly compensated employees as to eligibility or benefits. For 2024, the salary threshold for a highly compensated employee is $155,000.

Awards of nominal value are generally not taxable. These are small, infrequent gifts such as a coffee mug, a t-shirt or an occasional meal.

Explore the idea

If an achievement awards program makes sense for your company, be sure that these requirements are met. Otherwise, you and your employees could suffer negative tax consequences. Contact the office for guidance in setting up a program that checks all the boxes.

When Is Employer-paid Life Insurance Taxable?

If the fringe benefits of your job include employer-paid group term life insurance, a portion of the premiums for the coverage may be taxable. And that could result in undesirable income tax consequences for you.

The cost of the first $50,000 of group term life insurance paid by your employer is excluded from taxable income. But the employer-paid cost of coverage over $50,000 is taxable to you and included in the taxable wages reported on your Form W-2, even if you never actually receive any benefits from it. That’s called “phantom income.”

Have you reviewed your W-2?

If you’re receiving employer-paid group term life insurance coverage in excess of $50,000 , check your W-2 to see the impact on your taxable wages. If there’s a dollar amount in Box 12 (with code “C”), that’s the amount your employer paid to provide you with group term life insurance over $50,000, minus any amount that you paid for the coverage. You’re responsible for any taxes due on the amount in Box 12, including employment tax.

The amount in Box 12 is already included as part of your total “Wages, tips and other compensation” in Box 1 of the W-2. It’s the amount in Box 1 that’s reported on your tax return.

What are your options?

If the tax cost seems too high for the benefit you’re getting, ask your employer if they have a “carve-out” plan, which allows certain employees to opt out of the group coverage. If there’s no such option, ask your employer if they’d be willing to create one.

Carve-out plans vary, but one option is for your employer to continue to provide $50,000 of group-term coverage at no cost to you. Your employer could then provide you with an individual permanent policy for the balance of the coverage. Or it could pay you a cash bonus representing the amount it would have spent for the excess coverage, and you could use that money to pay premiums for an individual policy. There would still be tax consequences, but the tax liability might be smaller and the coverage might better meet your needs.

We can help

You may have other tax questions about life insurance. Feel free to contact the office for answers.

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Are You Aware Of The Business Credits And Other Tax Benefits Available?

It’s a challenging time for many businesses. Therefore, any help you can get, such as tax incentives and sales tax exemptions, can make a big difference. Unfortunately, these benefits often go unclaimed because businesses don’t know about them or erroneously think they’re ineligible.

1. Statutory incentives

Some credits are available “as of right.” That is, if your business meets the specified requirements, you just need to claim the benefit on a timely filed tax return to receive it.

State and federal tax credits and exemptions are designed as incentives for businesses to engage in certain activities or invest in specific economically distressed areas. Here are a few:

Work Opportunity Tax Credit (WOTC). The WOTC is a federal credit ranging from $2,400 to $9,600 per eligible new hire from certain disadvantaged groups. Examples include convicted felons, welfare recipients, veterans and workers with disabilities. Other steps must also be taken, such as completing paperwork.

State and federal research and development tax credits. These credits may be available to an eligible business that invests in developing new products or techniques, improving processes, or developing software for internal use, regardless of size. The federal “increasing research activities” credit is generally equal to 20% of the amount by which the business increases qualified research expenditures, compared to a base amount.

The credit is available even to businesses with no income tax liability and may be carried forward to offset taxable income in future years. If eligible, a start-up company can claim the federal research credit against up to $500,000 in employer-paid payroll taxes.

Empowerment zone incentives. Certain tax breaks are available to companies that operate in federally designated, economically distressed “empowerment zones.” Tax credits may be worth up to $3,000 for each eligible employee.

Industry-based and investment credits. Many states and other jurisdictions offer tax credits and other incentives to attract certain types of businesses, such as manufacturing or film and television production. Jurisdictions may also offer investment tax credits for capital investments within their borders.

2. Discretionary incentives

Discretionary tax breaks must be negotiated with government representatives. Typically, these incentives are intended to persuade a business to stay in or relocate to a certain state or locality.

To secure these incentives, a business must show it’ll bring benefits to the jurisdiction, such as job creation and revenue generation. Discretionary incentives may include income and payroll tax credits, property tax abatements and utility rate reductions.

3. Sales tax exemptions

States with sales taxes provide exemptions for some business purchases. Common exemptions include purchases by:

• Retailers for the purpose of resale,
• Manufacturers of equipment, raw materials or components used in the manufacturing process,
• Specific tax-exempt entities, and
• Agricultural businesses that buy such items as farming equipment and fuel, feed, seeds, fertilizer, and chemical sprays.

Businesses should familiarize themselves with the exemptions available where they do business and what it takes to qualify. For example, they may need to prove to the sellers that they have a resale or exemption certificate.

Don’t miss these opportunities

Every year, a vast amount of tax credits and incentives aren’t claimed because businesses are unaware of them or erroneously believe they’re ineligible. Many more examples exist. Contact the office for help ensuring that your business receives all the tax breaks it deserves.

Home Sale: Failure To Plan May Raise Your Tax Bill

As the saying goes, there’s nothing certain in life except for death and taxes. But when it comes to selling your home, proactive tax planning can help you reduce your federal income tax bill.

A costly mistake to avoid

Let’s say Tom is a soon-to-be married homeowner who’s looking to sell his principal residence. If certain tests are met, an unmarried individual may be able to exclude up to $250,000 of taxable gain.

Just before the wedding, Tom sells the home he’d purchased 20 years earlier. The home had appreciated by $500,000. He and his future wife, Stacy, plan to move into her much smaller fixer-upper home after the wedding.

As an unmarried taxpayer, Tom can exclude $250,000 of the gain from the sale of his home, leaving a taxable gain of $250,000 ($500,000 minus the $250,000 federal home sale gain exclusion). He owes 15% federal income tax on the gain, plus the 3.8% net investment income tax and state income tax.

Instead, suppose that Tom and Stacy had taken the time to seek tax planning advice. Their tax advisor would have let them know that the home sale gain exclusion for married couples is $500,000 if various tests are met, including that both spouses have resided in the home as their principal residence for at least two years.

Rather than sell Tom’s house before the wedding, they might have kept it and lived in it as a married couple for two years. That would have allowed them to avoid the full $500,000 in taxable gain and the resulting taxes when they later sold it. Even if Stacy had sold her fixer-upper home before the wedding, the gain would likely have been much smaller and may have been fully sheltered with her $250,000 home sale gain exclusion.

Slow down and seek advice

Proactive tax planning is generally worth the effort, especially if you have a lot at stake and/or tax rates increase. Even if you don’t need advice on the subject of home sales, other issues may be much more complicated and a lack of knowledge could lead to costly mistakes. Contact the office to get the best tax planning results for your circumstances.

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Tax Considerations When Choosing A Business Entity

Are you in the process of starting a business or contemplating changing your business entity? If so, you’ll need to decide how to organize your company. Should you operate as a C corporation or as a pass-through entity such as a partnership, limited liability company (LLC) or S corporation? Among the important factors to consider are the potential tax consequences.

Tax treatment basics

Currently, the corporate federal income tax is a flat 21% rate and individual federal income tax rates begin at 10% and go up to 37%. With a pass-through entity, income the business passes through to the owners is taxed at individual rates, which currently range from 10% to 37%. So, the overall rate, if you choose to organize as a C corporation, may be lower than if you operate the business as a pass-through entity.

But the difference in rates can be alleviated by the qualified business income (QBI) deduction, which is available to eligible pass-through entity owners who are individuals, and some estates and trusts.

The QBI deduction will expire Dec. 31, 2025, unless Congress acts to extend it. The 21% corporate rate is permanent, but Congress could still change it by passing new legislation.

More to consider

There are other tax-related factors you should take into account. For example:

Will most of the business profits be distributed to the owners? If so, it may be preferable to operate as a pass-through entity because C corporation shareholders will be taxed on dividend distributions from the corporation (double taxation). Owners of a pass-through entity will be taxed only once on business income, at the personal level.

Does the business own assets that are likely to appreciate? If so, it may be better to operate as a pass-through entity because the owner’s basis is stepped up by an owner’s interest in the entity. That can result in less taxable gain for the owner when his or her interests in the entity are sold.

Is the business expected to incur tax losses for a while? If so, you may want to structure it as a pass-through entity, so that you can deduct the losses against other income. Conversely, if you have insufficient other income or the losses aren’t usable (for example, because they’re limited by the passive loss rules), it may be preferable to organize as a C corporation, because it’ll be able to offset future income with the losses.

Is the business owner subject to the alternative minimum tax (AMT)? If so, it might be better to organize as a C corporation, because only the very largest corporations are subject to corporate AMT. AMT rates on individuals are 26% or 28%.

Contemplate the issues

Clearly, many factors are involved in determining which entity type is best for your business. This covers only a few of them. Contact the office to talk over the details in light of your situation.

A Tax Break For Educators

Teachers who are getting ready for a new school year often pay for some of their classroom supplies out-of-pocket. They may be able to get some of that cost back by taking advantage of a special tax break for educators.

History of the deduction

Before 2018, employees who had unreimbursed out-of-pocket expenses could potentially deduct them if they were ordinary and necessary to the “business” of being an employee. A teacher’s out-of-pocket classroom expenses could qualify and be claimed as a miscellaneous deduction, subject to a 2% of adjusted gross income (AGI) floor. That meant that only taxpayers who itemized deductions could enjoy a tax benefit, and then only to the extent that their eligible expenses exceeded the 2% floor.

For 2018 through 2025, the Tax Cuts and Jobs Act (TCJA) has suspended miscellaneous itemized deductions subject to the 2% of AGI floor. Fortunately, qualifying educators can still deduct some unreimbursed out-of-pocket classroom costs using the educator expense deduction.

Back in 2002, Congress created this above-the-line deduction, which means the deduction is subtracted from your gross income to determine your AGI. It can be claimed even if you don’t itemize deductions.

For 2024, qualifying elementary and secondary school teachers and other eligible educators (such as counselors and principals) can deduct up to $300 of qualified expenses. (This limit will rise in $50 increments in future years, based on inflation adjustments.) Two eligible married educators who file a joint tax return can deduct up to $600 of unreimbursed expenses, limited to $300 each.

Qualified expenses include amounts paid or incurred during the tax year for books, supplies, computer equipment, related software, services, and other equipment and materials used in classrooms. The cost of certain professional development courses may also be deductible. However, homeschooling supplies and nonathletic supplies for health or physical education courses aren’t eligible.

Head of the tax class

Some additional rules apply to this deduction. If you’re an educator or you know one who might benefit from this tax break, feel free to contact the office for more details.

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Independent Contractors: Classify Carefully

Many businesses use independent contractors to help keep their costs down and provide flexibility for short-term needs. But the question of whether a worker is an employee or an independent contractor is complex. Be careful that your independent contractors are properly classified for federal tax and employment tax purposes, because if the IRS reclassifies them as employees, it can be an expensive mistake.

Differing obligations

If a worker is an employee, your company must withhold federal income tax and the employee’s share of Social Security and Medicare taxes, pay the employer’s share of Social Security and Medicare taxes, and pay federal unemployment tax. State tax obligations may also apply. A business generally must also provide that worker with fringe benefits if it makes them available to other employees.

However, if a worker is an independent contractor, these obligations don’t apply. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if it’s $600 or more). The contractor is responsible for paying self-employment tax and, generally, making estimated tax payments for income tax purposes in relation to the amount paid.

Key factors

Who’s an “employee?” Unfortunately, there’s no one definition of the term. The IRS and courts have generally ruled that one of the key factors that determines the difference between an employee and a contractor is the right to control and direct the person in the jobs they’re performing, even if that control isn’t exercised. The issue of control is evaluated by asking several questions, including:

• Who sets the worker’s schedule?
• Are the worker’s activities subject to supervision?
• Is the work technical in nature?
• Is the worker free to work for others?

Another important factor is whether the worker has the opportunity for profit or loss based on his or her managerial skills. That is, can the worker apply independent judgment and business acumen to affect the success or failure of the work being performed? If there’s a lack of such opportunity, that’s one indication of employee status.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Section 530. This protection generally applies only if an employer meets certain requirements. For example, the employer must file all federal returns consistent with its treatment of a worker as a contractor and it must treat all similarly situated workers as contractors. Be aware, Section 530 doesn’t apply to certain types of workers.

Think carefully before asking the IRS

You can ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, you should also be aware that the IRS has a history of classifying workers as employees rather than independent contractors.

So, before you file Form SS-8, contact the office for a consultation. Filing this form may alert the IRS that your business has worker classification issues, and it may unintentionally trigger an employment tax audit. It may be better to properly set up a relationship with workers to treat them as independent contractors so that your business complies with the tax rules.

Workers who want an official determination of their status can also file Form SS-8. Dissatisfied workers you’ve treated as independent contractors may do so because they feel entitled to employee benefits and want to eliminate their self-employment tax liabilities. If a worker files Form SS-8, the IRS will notify the business with a letter that identifies the worker and includes a blank Form SS-8. The business will be asked to complete and return the form to the IRS, which will render a classification decision.

Need more help?

Worker classification is complex. In addition to what’s been discussed here, there are differing rules that apply for labor law purposes, which can impact minimum wage and overtime pay requirements. If you have questions, contact the office to assist you in ensuring that your workers are properly classified.

Renting To Family Members

As rents continue to rise in many areas, you may decide to help your financially challenged family members by renting a property to them at a discount. But this can lead to the loss of significant tax deductions. Here’s a look at the tax treatment that applies when you rent to unrelated parties and how the rules change when you rent to relatives.

Business vs. personal

If you use real estate strictly for business purposes, that is, as a rental property, you must report the income and can deduct mortgage interest, property taxes, utilities, depreciation, maintenance and other expenses. You may claim a loss (subject to limitations) if your expenses exceed your rental income.

Suppose you use a property as a personal residence (such as your primary residence or a vacation home) and rent it out for fewer than 15 days per year. In that case, you don’t need to report the rental income, but you can’t deduct related expenses. If you itemize, you can still claim personal deductions, to the extent allowable, for mortgage interest and property taxes.

Suppose instead that you rent out the residence for 15 or more days per year. In that case, it’s treated as a mixed-use property. You must report the rental income and allocate your expenses between the property’s personal and business uses. You generally can claim the personal use portion as itemized deductions. The business use portion of these and other expenses are deductible as rental expenses, but they can’t create a loss. Disallowed deductions may be carried forward to future years.

Family matters

Renting property to family members means you risk losing the ability to deduct rental expenses. That’s because use by family members is considered personal use, even if your relative pays rent, unless two requirements are met. The family member:

1. Uses the property as a principal residence, and

2. Pays fair market rent (not discounted).

If these requirements aren’t met, then you must report the rental income (if you rented the property for 15 days or more per year). But related expenses won’t be deductible.

If you want to avoid losing valuable tax benefits, set the rent at or above fair market value and document fair market rent with comparable local rental rates. If you give family members financial gifts to help with the rent, the IRS will likely view this as discounted rent.

Know what you’re getting into

Helping family members with housing expenses is a nice thing to do. But be aware of the tax consequences of renting to relatives. Contact the office for assistance with these decisions.

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What Expenses Can’t Be Written Off By Your Business?

If you check the Internal Revenue Code, you may be surprised to find that most business deductions aren’t specifically listed there. For example, the tax law doesn’t explicitly state that you can deduct office supplies and certain other expenses. Some expenses are detailed in the tax code, but the general rule is contained in the first sentence of Section 162, which states you can write off “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

Basic definitions

In general, an expense is ordinary if it’s considered common or customary in the particular trade or business. For example, insurance premiums to protect a store would be an ordinary business expense in the retail industry.

A necessary expense is one that’s helpful or appropriate. For example, a car dealership may purchase an automatic defibrillator. It may not be necessary for the business operation, but it might be helpful if an employee or customer suffers a heart attack. It’s possible for an ordinary expense to be unnecessary. But to be deductible, an expense must be ordinary and necessary.

A deductible amount must be reasonable in relation to the benefit expected. For example, if you’re attempting to land a $3,000 deal, a $65 lunch with the potential client should be OK with the IRS. (The Tax Cuts and Jobs Act eliminated most deductions for entertainment expenses but retained a 50% deduction for business meals.)

How the courts may view expenses

The deductibility of some expenses is clear, while others are more complicated. Not surprisingly, the IRS and courts don’t always agree with taxpayers about what is ordinary and necessary. To illustrate, here are three recent U.S. Tax Court cases in which specific taxpayer deductions were disallowed:

1. A married couple owned an engineering firm. For two tax years, they claimed depreciation of $76,264 on three vehicles, but didn’t provide required details, including each vehicle’s ownership, cost and useful life. They claimed $34,197 in mileage deductions and provided receipts and mileage logs, but the court found they didn’t show related business purposes. The court also found the mileage claimed included commuting costs, which can’t be written off. The court disallowed these deductions and assessed taxes and penalties. (TC Memo 2023-39)

2. The court ruled that a married couple wasn’t entitled to business tax deductions because the husband’s consulting company failed to show that it was engaged in a trade or business. In fact, invoices produced by the consulting company predated its incorporation. And the court ruled that even if the expenses were legitimate, they weren’t properly substantiated. (TC Memo 2023-80)

3. A physician specializing in gene therapy deducted legal expenses of $360,295 for two years on Schedule C of his joint tax returns. The court found that most of the legal fees were to defend the husband against personal conduct issues. The court denied the deduction for personal legal expenses but allowed a deduction for $13,000 for business-related legal expenses. (TC Memo 2023-42)

These cases and others should show the importance of maintaining careful, detailed records. Make sure that only business costs are claimed.

Proceed with caution!

If an expense seems like it’s not normal in your industry or could be considered personal or extravagant, proceed with caution. Contact the office with questions about deductibility and proper documentation.

Sending The Kids To Day Camp May Bring A Tax Break

Among the many challenges of parenthood is childcare for kids when school lets out. Babysitters are one option, or you might consider sending them to a day camp. There’s no one-size-fits-all answer, but if you do choose a day camp, you could be eligible for a tax break. (Unfortunately, overnight camps don’t qualify.)

Dollar-for-dollar savings

Day camp can be a qualified expense under the child and dependent care tax credit. The credit is worth 20% to 35% of the qualifying costs, subject to an income cap. The maximum amount of expenses that can be claimed is $3,000 for one qualifying child or $6,000 for two or more children, multiplied by the percentage that applies to your income level.

For those qualifying for the 35% rate with maximum expenses of $3,000, the credit equals $1,050, or $2,100 for two children with expenses of at least $6,000. The applicable credit percentage drops as adjusted gross income (AGI) rises. When AGI exceeds $43,000, the percentage is 20% of qualified expenses, subject to the $3,000 or $6,000 limit.

Tax credits are particularly valuable because they reduce your tax liability dollar-for-dollar, that is, $1 of tax credit saves $1 of taxes. This is compared to deductions, which simply reduce the amount of income subject to tax. So, if you’re in the 24% tax bracket, a $1 deduction saves you only $0.24 of taxes.

Qualifying for the credit

Only dependents under age 13 generally qualify. However, the credit may also be claimed for expenses paid to care for a dependent relative, such as an in-law or parent, who is incapable of self-care. Eligible care costs are those incurred while you work or look for work.

Expenses paid from, or reimbursed by, an employer-sponsored Flexible Spending Account can’t be used to claim the credit. The same is true for a dependent care assistance program.

Determining eligibility

Additional rules apply to this credit. Contact the office if you have questions about your eligibility for the credit and the exceptions.

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The Advantages Of Hiring Your Minor Children For Summer Jobs

If you’re a small-business owner and you hire your children this summer, you may be able to secure tax breaks and other nontax benefits. The kids can gain bona fide on-the-job experience, save for college and learn how to manage money. You may be able to shift some of your high-taxed income into tax-free or low-taxed income, and, depending on the situation, you may realize payroll tax savings. Perhaps best of all, your kids will spend time with you.

A legitimate job and tax savings, too

If you hire your child, you’ll get a business tax deduction for employee wage expenses. In turn, the deduction reduces your federal income tax bill and possibly your self-employment tax bill and your state income tax bill if they apply. However, for the wages to be a deductible business expense, the work performed by the child must be legitimate and the child’s pay must be reasonable.

Let’s say you operate as a sole proprietor in the 37% tax bracket. You hire your 16-year-old daughter to help with office work full-time during the summer and part-time in the fall. She earns $10,000 during 2024 and doesn’t have any other earnings.

You save $3,700 (37% of $10,000) in income taxes at no tax cost to your daughter. That’s because she can use her $14,600 standard deduction for 2024 to completely shelter her earnings.

Your family’s taxes are lower even if your daughter’s earnings exceed her standard deduction. Why? The unsheltered earnings will be taxed to her beginning at a rate of 10%, instead of being taxed at your higher rate.

Reduced payroll taxes

If your business isn’t incorporated and certain conditions are met, your child’s wages are exempt from Social Security, Medicare and federal unemployment taxes. Your child must be under age 18 for this to apply (or under age 21 for the federal unemployment tax exemption). Contact the office to learn how this works.

Be aware that there’s no payroll tax exemption for employing your child if your business is incorporated or is a partnership that includes nonparent partners. And payments for the services of your child are subject to income tax withholding, regardless of age, no matter what type of entity you operate.

Extra time to make your child’s retirement garden grow

An early start on saving for retirement can be key to building wealth. A child who earns income from a job can contribute to a traditional IRA or a Roth IRA and begin funding a nest egg. For the 2024 tax year, a working child can contribute the lesser of his or her earned income or $7,000 to a traditional or Roth IRA. And the money may be tapped penalty-free for certain eligible reasons, such as paying education costs and making a down payment of up to $10,000 on a first home.

What if your business has a retirement plan? Depending on its terms, your child may qualify to begin earning retirement benefits that can grow for many decades.

The importance of accurate records

Hiring your child can be a tax-smart idea. Be sure to keep the same records (such as timesheets and job descriptions) as you would for other employees to substantiate the hours worked and duties performed. Also issue your child a Form W-2. Contact the office with questions about how these rules apply to your situation.

To Get An “Early” Refund, Adjust Your Withholding

If you received a large refund this year, you may want to adjust your withholding. Each year, millions of taxpayers claim an income tax refund. To be sure, receiving a payment from the IRS for a few thousand dollars can be a pleasant influx of cash. But it means you were essentially giving the government an interest-free loan for close to a year, which isn’t the best use of your money.

Fortunately, there’s a way to begin collecting your 2024 refund now: You can review the amounts you’re having withheld, and any estimated tax payments you’re making, and adjust them to keep more money in your pocket during the year.

Choosing to adjust

It’s particularly important to check your withholding and/or estimated tax payments if you have:

• Received an especially large 2023 refund,
• Gotten married, divorced or added a dependent,
• Bought a home, or
• Started or lost a job.

Withholding or estimated tax payment changes might also be warranted if your investment income has changed significantly.

Making a change

You can modify your withholding at any time during the year, or even more than once a year. To do so, simply submit a new Form W-4 to your employer. Changes typically will go into effect several weeks after the new Form W-4 is submitted. For estimated tax payments, you can adjust each time quarterly payments are due.

While reducing your withholding or estimated tax payments will put more money in your pocket now, you also need to be careful that you don’t reduce them too much. If you don’t pay enough tax throughout the year on a timely basis, you could end up owing interest and penalties when you file your return, even if you pay your outstanding tax liability by the deadline in April 2025.

Getting help

One reason to consider adjusting your withholding is the passage of any new tax legislation. For example, several years ago when the Tax Cuts and Jobs Act was enacted, the IRS needed to revise withholding tables to account for the increased standard deductions, suspension of personal exemptions, and changes in tax rates and brackets. If you’d like help determining your withholding or estimated tax payments for the rest of the year, please contact the office.

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Tax Records: What Can You Toss And What Should You Keep?

Generally, the IRS has three years to audit a tax return, from the later of the due date of the return or the date you file. You can also file an amended return within this time frame if you overlooked something.

Here’s what you need to know about keeping financial records involved in your tax returns.

Federal tax records

Despite the three-year guideline, many tax advisors recommend retaining copies of your finished tax returns indefinitely to prove that you filed. Even if you don’t keep returns indefinitely, at least keep them for six years after the returns are due or filed, whichever is later.

It’s a good idea to keep the records that support items on your individual tax returns until the three-year statute of limitations runs out. Examples of supporting records include canceled checks, charitable contributions receipts, and documents showing your mortgage interest payments and retirement plan contributions. These documents may also support an amended tax return if you find you overlooked something.

So which records can you throw away today? Generally, based on the three-year rule, you’ll soon be able to throw out most records associated with your 2020 return if you filed by the due date (which was extended to May 17, 2021, due to the pandemic). Extended 2020 returns could still be vulnerable to audit until October 15, 2024.

Also, some tax issues are still subject to scrutiny after the three years. If the IRS suspects that income has been understated by 25% or more, the statute of limitations for audit rises to six years. If no return was filed or if fraud is suspected, there’s no limit of time for the IRS to launch an inquiry.

Certain records that support figures that may affect multiple years, such as carryovers of charitable deductions, should be saved until the deductions no longer have effect. Also, don’t toss out records that support deductions for bad debts or worthless securities that could result in refund claims. You have up to seven years to claim them.

State tax records

The previous guidelines are geared toward complying with federal tax obligations. Contact the office for information regarding your state’s statute of limitations.

Plus, states generally have the right to resolve their own issues related to federal tax returns that have been audited. So, hold on to records related to an IRS audit for a year after it’s completed.

Real estate records

Retain real estate records for as long as you own a property, plus three years after you dispose of it and report the transaction on your tax return. Throughout ownership, keep records of the purchase, home improvements, relevant insurance claims and refinancing documents.

These documents help prove your adjusted basis in the home, which is needed to figure any taxable gain at the time of sale. They can also support rental property or home office deductions.

Investment account statements

To accurately report taxable events involving stocks and bonds, you must maintain detailed records of purchases and sales. Records should include dates, quantities, prices, dividend reinvestment and related expenses. Keep these records for as long as you own the investments plus additional time until the statute of limitations for the relevant tax returns expires.

The IRS requires you to keep copies of Forms 8606, 5498 and 1099-R until all the money is withdrawn from your IRAs. It’s even more important to retain records of all transactions relating to Roth IRAs, in case you’re ever questioned.

Purge with caution

Old tax records take up space and could lead to stolen identities if not properly disposed of. But purging too soon may leave you without a defense if the IRS has questions. When in doubt, hang on to records a little longer than you think is necessary. Contact the office with questions.

4 Ways Corporate Business Owners Can Help Ensure Compensation Is “Reasonable”

If you own a C corporation, you know there’s a tax advantage to taking money out as compensation rather than as dividends. The reason: A corporation can deduct the salaries and bonuses that it pays executives, but it can’t deduct dividend payments. Therefore, if funds are paid as dividends, they’re taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is taxed only once, to the recipient employee.

However, the amount of money you can take out of the corporation this way is limited. Under tax law, only compensation deemed to be reasonable can be deducted. Any unreasonable portion isn’t deductible and may be taxed as if it were a dividend paid to a shareholder.

Steps to help protect yourself

There’s no simple way to determine what’s reasonable. If the IRS audits your tax return, it will examine the amount that companies in similar industries would pay for comparable services under comparable circumstances. Factors considered include the employee’s duties and the amount of time spent on those duties, as well as the employee’s skills, expertise and compensation history. Other factors that may be reviewed are the complexities of the business and its gross and net income.

There are steps you can take to make it more likely that the compensation you earn will be considered “reasonable” and therefore deductible by your corporation. For example, you can:

1. Keep compensation in line with what similar businesses are paying their executives. Be sure to retain whatever evidence you find about what others are paying.

2. Contemporaneously document the reasons for compensation paid in the minutes of your corporation’s board of directors. For example, if compensation is being increased in the current year to make up for earlier years when it was low, be sure the minutes reflect this. Cite any executive compensation or industry studies that back up your compensation amounts.

3. Avoid paying compensation in direct proportion to the stock owned by the corporation’s shareholders. This can look like a disguised dividend and will probably be treated as such by the IRS.

4. Pay at least some dividends if the business is profitable. This avoids giving the impression that the corporation is trying to pay out all of its profits as compensation.

Keep in mind that the IRS is generally very interested in unreasonable compensation payments made to anyone “related” to a corporation, which may include not only a shareholder-employee but also a member of a shareholder’s family.

Plan ahead

The challenges are many, but you can avoid some problems by planning ahead. Contact the office if you have questions or concerns about your situation.

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Retirement Saving Options For Your Small Business

If you’re looking for a retirement plan for yourself and your employees but worried about the financial commitment and administrative burdens involved, there are some options to consider. One possibility is a Simplified Employee Pension (SEP). This plan, which comes with relative ease of administration and the discretion to make or not make annual contributions, is especially attractive for small businesses.

There’s still time to see tax savings on your 2023 tax return by establishing and contributing to a 2023 SEP, right up to the extended due date of the return. For example, if you’re a sole proprietor who extends your 2023 Form 1040 to October 15, 2024, you have until that date to establish a SEP and make the initial contribution, which you can then deduct on your 2023 return.

SEP involves easy setup

You can set up a SEP easily using the IRS model SEP, Form 5305-SEP. This form, which doesn’t have to be filed with the IRS, satisfies the SEP requirements. (You can opt for an individually designed SEP instead, depending on your needs.)

As the employer, you’ll get a current income tax deduction for contributions you make on behalf of your employees. Your employees won’t be taxed when the contributions are made but will be taxed later when distributions are made, usually at retirement.

The maximum deductible contribution that you can make to a SEP-IRA, and that can be excluded from taxable income, is the lesser of: 1) 25% of compensation, or 2) $69,000 for 2024 (up from $66,000 for 2023) per employee. Note, however, that if you, as the business owner, don’t receive a W-2 from the business (for instance, you’re an unincorporated sole proprietor), the calculation for the contribution to be made on behalf of yourself varies slightly. The deduction for your contributions to employees’ SEP-IRAs isn’t limited by the deduction ceiling applicable to an individual’s own contribution to a regular IRA.

Your employees control their individual SEP IRAs and the investments in them as well as the tax-deferred earnings. However, they can’t contribute.

There are other requirements you’ll have to meet to be eligible to establish and make contributions to a SEP. Essentially, all regular employees must elect to participate in the program, and contributions can’t discriminate in favor of highly compensated employees. But these requirements are minor compared to the bookkeeping and other administrative burdens connected with traditional qualified retirement and profit-sharing plans.

SEPS don’t require the detailed records that traditional plans must maintain. Also, there are no annual reports to file with the IRS, and the recordkeeping that is required can be done by a trustee of the SEP-IRA, usually a bank or mutual fund.

Another option: SIMPLEs

If your business has 100 or fewer employees, you may want to consider a Savings Incentive Match Plan for Employees (SIMPLE). An advantage is that employees can also contribute. A disadvantage is that you, as the employer, are required to make certain annual contributions. Also, a SIMPLE has more limitations on when it can be set up and when it can be contributed to than a SEP.

You establish a SIMPLE IRA for each eligible employee, generally making matching contributions based on amounts elected by participating employees under a qualified salary reduction arrangement. The SIMPLE is also subject to much less stringent requirements than traditional qualified retirement plans.

Another option: An employer can adopt a SIMPLE 401(k) plan, with similar features to a SIMPLE IRA. It’s not subject to the otherwise complex nondiscrimination rules that apply to regular 401(k) plans.

For 2024, SIMPLE employee deferrals are limited to $16,000 (up from $15,500 for 2023). Additional $3,500 catch-up contributions are also allowed for employees ages 50 and older.

More information

Additional rules and limits apply to both SEPs and SIMPLEs. Contact us for more information. We can also provide information about any other aspect of your retirement planning.

Have You Recently Reviewed Your Life Insurance Needs?

At one time, life insurance played a much larger part in an estate plan than it does now. Why? Families would often use life insurance payouts to pay estate taxes. But with the federal gift and estate tax exemption at $13.61 million for 2024, far fewer families currently are affected by estate tax.

However, life insurance remains a powerful tool to help provide for your loved ones in the event of your death. The amount of life insurance that’s right for you depends on your personal circumstances, so it’s critical to review your life insurance needs regularly in light of changing circumstances.

Reasons to reevaluate

In addition to watching for changes to the estate tax exemption amount, consider reevaluating your insurance coverage if you’re:

• Buying a home or paying off a mortgage,
• Getting married or divorced,
• Having children,
• Approaching retirement, or
• Facing health issues.

The right amount of insurance depends on your family’s current and expected future income and expenses, as well as the amount of income your family would lose should you pass away. The events listed above can change the equation, so it’s a good idea to revisit your life insurance needs as you reach these milestones. For example, if you have kids, your current and future obligations are likely to increase significantly for expenses related not only to providing for their needs on a day-to-day basis but also potentially for childcare and college tuition.

As you get older, your expenses may go up or down, depending on your circumstances. For example, as your children become financially independent, they’ll no longer rely on you for financial support.

On the other hand, your health care expenses may increase. When you retire, you’ll no longer have a salary, but you may have new sources of income from retirement plans and Social Security. You may or may not have paid off your mortgage, student loans or other debts. And you may or may not have accumulated sufficient wealth to provide for your family.

Periodic reassessment a must

There are many factors that affect your need for life insurance, and these factors change over time. To make sure you’re not over- or underinsured, reassess your insurance needs periodically, especially when your life circumstances change. Also keep in mind that, absent Congressional action, the gift and estate tax exemption will drop to an inflation-adjusted $5 million in 2026. We can help you assess whether you have an adequate amount of life insurance coverage.

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Traveling For Business In 2024? What’s Deductible?

If you and your employees will be traveling for business this year, there are many factors to keep in mind. Under the tax law, certain requirements for out-of-town business travel within the United States must be met before you can claim a deduction. The rules apply if the business conducted reasonably requires an overnight stay.

Note: Under the Tax Cuts and Jobs Act, employees can’t deduct their unreimbursed travel expenses through 2025 on their own tax returns. That’s because unreimbursed employee business expenses are “miscellaneous itemized deductions” that aren’t deductible through 2025. Self-employed individuals can continue to deduct business expenses, including away-from-home travel expenses.

Rules that come into play

The actual costs of travel (for example, plane fare and cabs to the airport) are generally deductible for out-of-town business trips. You’re also allowed to deduct the cost of lodging. And a percentage of your meals is deductible even if the meals aren’t connected to a business conversation or other business function. For 2024, the law allows a 50% deduction for business meals.

No deduction is allowed for meal or lodging expenses that are “lavish or extravagant,” a term that generally means “unreasonable.” Also, personal entertainment costs on trips aren’t deductible, but business-related costs such as those for dry cleaning, phone calls and computer rentals can be written off.

Mixing business with pleasure

Some allocations may be required if the trip is a combined business/pleasure trip; for example, if you fly to a location for four days of business meetings and stay on for an additional three days of vacation. Only the costs of meals, lodging and so on incurred during the business days are deductible, not those incurred for the personal vacation days.

On the other hand, with respect to the cost of the travel itself (for example, plane fare), if the trip is primarily for business purposes, the travel cost can be deducted in its entirety and no allocation is required. Conversely, if the trip is primarily personal, none of the travel costs are deductible. An important factor in determining if the trip is primarily business or personal is the amount of time spent on each (though this isn’t the sole factor).

Suppose a trip isn’t for the actual conduct of business but is for the purpose of attending a convention or seminar. The IRS may check the nature of the meetings carefully to make sure they aren’t vacations in disguise, so retain all material helpful in establishing the business or professional nature of this travel.

Also, personal expenses you incur at home related to the trip aren’t deductible. This might include costs such as boarding a pet while you’re away.

Is your spouse joining you?

The rules for deducting the costs of a spouse who accompanies you on a business trip are very restrictive. No deduction is allowed unless the spouse is an employee of yours or of your company. If that isn’t the case, then even if there’s a bona fide business purpose for having your spouse make the trip, you probably won’t be able to fully deduct his or her travel costs (though you can deduct some costs).

Specifically, the restrictions apply only to additional costs incurred by having your non-employee spouse travel with you. For example, the expense of a hotel room or for traveling by car would likely be fully deductible since the cost to rent the room or to travel alone or with another person would be the same, even in a rented car.

Before you hit the road

Contact the office with any questions you may have about travel deductions to help you stay in the right lane.

Tracking Down Donation Substantiation

If you’re like many Americans, your mailbox may have been filling up in recent weeks with letters from your favorite charities acknowledging your 2023 donations. But what happens if you haven’t received such a letter for a contribution? Can you still claim a deduction on your 2023 income tax return for the gift? It depends.

What’s required

To support a charitable deduction, you need to comply with IRS substantiation requirements. This generally includes obtaining a contemporaneous written acknowledgment from the charity stating the amount of the donation if it’s cash. If the donation is property, the acknowledgment must describe the property, but the charity isn’t required to provide a value. The donor must determine the property’s value.

“Contemporaneous” means the earlier of the date you file your tax return or the extended due date of your return. So, if you donated in 2023 but haven’t yet received substantiation from the charity, it’s not too late, as long as you haven’t filed your 2023 return. Contact the charity and request a written acknowledgment.

Keep in mind that, if you made a cash gift of under $250 with a check or credit card, generally a canceled check, bank statement or credit card statement is sufficient to support your donation. However, if you received something in return for the donation, you generally must reduce your deduction by its value and the charity is required to provide you a written acknowledgment as described earlier, listing the value of the item you received.

Itemized Deductions or Standard?

You may remember that in recent tax years (2020 and 2021) there was a special provision of tax law that allowed taxpayers who take the standard deduction on their tax returns to claim a limited deduction.

Many people don’t realize that this provision wasn’t reauthorized for subsequent years. Since the tax break has expired, it’s no longer available to nonitemizers. So, to deduct your charitable donations, you must opt to itemize deductions on your tax return, rather than taking the standard deduction.

Ask questions

If you aren’t sure about some of your donations, contact the office for answers to your questions and help determining whether you have sufficient substantiation for the donations you hope to deduct on your 2023 return. It’s also important to have the substantiation you’ll need for charitable gifts you’re planning this year to ensure you can enjoy the desired deductions when you file your 2024 tax return.

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Sec. 179 Expensing And Bonus Depreciation: Beware Of Pitfalls

If eligible, you can elect to use Section 179 expensing or bonus depreciation to deduct a large portion of the cost (and in some cases the full cost) of eligible property in the year it’s placed in service. Alternatively, you may follow regular depreciation rules and spread deductions over several years or decades, depending on how the asset is classified under the tax code.

While taking current deductions can significantly lower your company’s taxable income, it isn’t always the smartest move.

Sec. 179 and bonus depreciation 101

Section 179 expensing may allow you to currently deduct the full cost of purchasing eligible new or used assets, such as equipment, furniture, off-the-shelf computer software, and qualified improvement property (QIP). An annual expensing limit applies ($1.16 million for 2023 and $1.22 million for 2024), which begins to phase out dollar for dollar when asset acquisitions for the year exceed the applicable threshold ($2.89 million for 2023 and $3.05 million for 2024). You can claim the election only to offset net income, not to reduce it below zero to create a net operating loss.

First-year bonus depreciation is available for qualified assets, which include new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), off-the-shelf computer software and water utility property. Under the TCJA, through 2026, the definition has been expanded to include used property and qualified film, television and live theatrical productions. In addition, QIP is now eligible for bonus depreciation. For 2023, bonus depreciation was 80%. It drops to 60% for 2024, to 40% for 2025 and to 20% for 2026. After that, it will be eliminated, unless Congress acts to extend it.

When to consider forgoing these breaks

Here are two examples when it may be preferable to forgo Sec. 179 expensing and bonus depreciation:

1. You’re planning to sell QIP. If you claim Sec. 179 expense or bonus depreciation on QIP and sell the building soon, this current write-off may be a tax trap. That’s because your gain on the sale up to the amount of Sec. 179 or bonus depreciation deductions you’ve claimed will be treated as “recaptured” depreciation that’s taxable at ordinary-income tax rates, up to 37%. But if you deduct the cost of QIP under regular depreciation rules (generally, over 15 years) and sell the building, any long-term gain attributable to the deductions will be taxable at a top rate of 25%.

2. You’re eligible for the qualified business income (QBI) deduction. This deduction allows eligible business owners to deduct up to 20% of their QBI from certain pass-through entities, such as partnerships, limited liability companies and sole proprietorships. The deduction can’t exceed 20% of an owner’s taxable income, excluding net capital gains. (Other restrictions apply.)

Claiming Sec. 179 or bonus depreciation deductions reduces your taxable income, which may deprive you of an opportunity to maximize the QBI deduction. Because the QBI deduction is scheduled to expire after 2025, taking full advantage of it while you can generally will make sense.

Timing is everything

Keep in mind that only the timing of deductions is affected by the strategy you choose. You’ll still have an opportunity to write off the full cost of eligible assets if you forgo Sec. 179 expensing and bonus depreciation; it will just be over a longer time period. Your tax advisor can analyze your company’s overall tax benefit picture and help you determine the optimal strategy.

Appraisals Aren’t Just For Businesses

Whether you’re in the process of making a retirement or estate plan or you intend to donate property to charity, you’ll need to know the value of your assets. For many hard-to-value items, such as closely held business interests, real estate, art and collectibles, an appraisal may be necessary.

Retirement and estate planning

To enjoy a comfortable retirement, you’ll need to calculate the income that can support your lifestyle when you’re no longer working. This means understanding the value of the assets you own. Once you have this information, you may decide to move your retirement date up or back.

Knowing the value of your assets is also necessary to assess whether you’ll potentially be subject to gift and estate taxes. It also allows you to identify strategies for minimizing or eliminating those taxes. In addition, without appraisals of hard-to-value assets, it’s nearly impossible to divide your overall property equally among your children (if that’s your wish).

Appraisals may also be necessary to avoid running afoul of tax basis consistency rules. The rules are intended to prevent heirs from arguing that estate property was undervalued, which would raise their basis for income tax purposes. According to these rules, the income tax basis of inherited property equals the property’s fair market value as finally determined for estate tax purposes. Appraisals can help ensure that your heirs receive the basis they deserve.

Gifts and charitable giving

The IRS has an unlimited amount of time to challenge the value of gifts for gift and estate tax purposes, unless they’re “adequately disclosed,” which generally binds the IRS to a three-year statute of limitations. A qualified professional appraisal with a timely filed gift tax return is the best way to disclose the value of a gift of a hard-to-value asset.

Charitable gifts of property valued at more than $5,000 (other than publicly traded securities) must be substantiated with a qualified appraisal by a qualified appraiser. This means that the appraiser meets certain education and experience requirements.

Know what you have

Without appraisals of your hard-to-value assets, it’s difficult to develop a realistic financial plan, to create an estate plan that will achieve your desired results and to avoid unwelcome tax liabilities. Asset values can fluctuate dramatically over time, so make sure you get updated appraisals periodically.

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Use The Tax Code To Make Business Losses Less Painful

Whether you’re operating a new company or an established business, losses can happen. The federal tax code may help soften the blow by allowing businesses to apply losses to offset taxable income in future years, subject to certain limitations.

Qualifying for a deduction

The net operating loss (NOL) deduction addresses the tax inequities that can exist between businesses with stable income and those with fluctuating income. It essentially lets the latter average out their income and losses over the years and pay tax accordingly.

Eligibility for the NOL deduction depends on having deductions for the tax year that exceed your income. The loss generally must be caused by deductions related to your:

• Business (Schedules C and F losses, or Schedule K-1 losses from partnerships or S corporations),
• Casualty and theft losses from a federally declared disaster, or
• Rental property (Schedule E).

The following generally aren’t part of the NOL determination:

• Capital losses that exceed capital gains,
• The exclusion for gains from the sale or exchange of qualified small business stock,
• Nonbusiness deductions that exceed nonbusiness income,
• The NOL deduction itself, and
• The Section 199A qualified business income deduction.

Individuals and C corporations are eligible to claim the NOL deduction. Partnerships and S corporations generally aren’t eligible, but partners and shareholders can calculate individual NOLs using their separate shares of business income and deductions.

Limitations

Prior to the Tax Cuts and Jobs Act (TCJA), taxpayers could carry back NOLs for two years and carry them forward 20 years. They also could apply NOLs against 100% of their taxable income.

The TCJA limits NOL deductions to 80% of taxable income for the year and eliminates the carryback of NOLs (except for certain farming losses). However, it does allow NOLs to be carried forward indefinitely.

If your NOL carryforward is more than your taxable income for the year you carry it to, you may have an NOL carryover. That’s the excess of the NOL deduction over your modified taxable income for the carryforward year. If your NOL deduction includes multiple NOLs, you must apply them against your modified taxable income in the same order you incurred them, beginning with the earliest.

A limit on excess business losses

The TCJA also established an “excess business loss” limitation, effective beginning in 2021. For partnerships or S corporations, this limitation applies at the partner or shareholder level, after applying the outside basis, at-risk and passive activity loss limitations.

Under the rule, noncorporate taxpayers’ business losses can offset only business-related income or gain, plus an inflation-adjusted threshold. For 2023, that threshold is $289,000, or $578,000 if married filing jointly. Remaining losses are treated as a net operating loss (NOL) carryforward to the next tax year. That is, you can’t fully deduct them because they become subject to the 80% income limitation on NOLs, reducing their tax value.

Important: Under the Inflation Reduction Act, the excess business loss limitation applies to tax years beginning before January 1, 2029. Under the TCJA, it had been scheduled to expire after December 31, 2026.

Planning ahead

The tax rules regarding business losses are complex, especially the interaction between NOLs and other potential tax breaks. We can help you chart the best course forward.

Consider The Flexibility Of A Self-directed IRA

Traditional and Roth IRAs can be relatively “safe” retirement-saving vehicles, though, depending on what they’re invested in, they limit your investment choices. For more flexibility in investment choices (but also more risk), another option is a self-directed IRA.

Gaining more control

A self-directed IRA is simply an IRA that provides greater control over investment decisions. Traditional and Roth IRAs typically offer a selection of stocks, bonds and mutual funds. Self-directed IRAs (available at certain financial institutions) offer greater diversification and potentially higher returns by permitting you to select virtually any type of investment, including real estate, closely held stock, limited liability company and partnership interests, loans, precious metals, and commodities (such as lumber, oil and gas).

A self-directed IRA can be a traditional or Roth IRA, a Simplified Employee Pension plan, or a Savings Incentive Match Plan for Employees. Other possibilities include a self-directed individual 401(k) plan, Health Savings Account or Coverdell Education Savings Account. The tax- free growth these accounts offer makes them powerful estate planning tools.

Navigating tax traps

To avoid pitfalls that can lead to unwanted tax consequences, exercise caution when using self-directed IRAs. The most dangerous traps are the prohibited transaction rules. These rules are designed to limit dealings between an IRA and “disqualified persons,” including account holders, certain members of their families, businesses controlled by account holders or their families, and certain IRA advisors or service providers.

Among other things, disqualified persons can’t sell property or lend money to the IRA, buy property from the IRA, provide goods or services to the IRA, guarantee a loan to the IRA, pledge IRA assets as security for a loan, receive compensation from the IRA, or personally use IRA assets.

The penalty for engaging in a prohibited transaction is severe: The IRA is disqualified and its assets are deemed to have been distributed on the first day of the year in which the transaction took place, subject to income taxes and potentially, to penalties. This makes it very difficult to manage a business, real estate or other investments held in a self-directed IRA. Unless you’re prepared to accept a purely passive role with respect to the IRA’s assets, this strategy isn’t for you.

Considering the option

If you’d like to invest in assets such as precious metals, energy or other alternative investments, a self-directed IRA may be worth considering. But it’s critical to understand the risks.

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How To Be Ready To Secure A Business Bad Debt Deduction On Your 2023 Tax Return

Is your business having trouble collecting payments from clients or vendors? You might be able to claim a bad debt deduction on your tax return. But if you hope to take the deduction on your 2023 return, you’ll have to get busy, because you must be able to show that you’ve made a “reasonable” effort to collect the debt.

Requirements

First, a cash-basis taxpayer may claim a business bad debt deduction only if the amount that’s owed was previously included in gross income. Second, a business must establish that the debt is legitimate and can’t be recovered from the debtor. To this end, as mentioned, you must make a reasonable effort to collect the amount that’s due.

This doesn’t necessarily mean you have to file a lawsuit against the debtor. But you can’t just make a single phone call either. Give it your best shot. You might actually be able to collect the debt! But if you can’t, you’ll have put yourself in a position to potentially claim a bad debt deduction.

Partially or totally worthless

Often, the specific charge-off method (also called the direct write-off method) is used for writing off bad debts. In this case, you can deduct business bad debts that became either partially or totally worthless during the year.

For tax purposes, partially and totally worthless are defined as follows:

Partially worthless. The deduction is limited to the amount charged off on your books. You don’t have to charge off and deduct your partially worthless debts annually, so you can postpone this to a later year. However, you can’t deduct any part of a debt after the year it becomes totally worthless.

Totally worthless. If a debt becomes totally worthless in the current tax year, you can deduct the entire amount (less any amount deducted in an earlier tax year when the debt was partially worthless).

Note that you don’t have to make an actual charge-off on your books to claim a bad debt deduction for a totally worthless debt. But if you don’t record a charge-off and the IRS later rules the debt is only partially worthless, you won’t be allowed a deduction for the debt in that tax year. Reason: A deduction of a partially worthless bad debt is limited to the amount actually charged off.

Time is short

If you haven’t started your collection efforts yet but hope to claim a business bad debt deduction for 2023, time is short. So, spring into action now. For instance, you might start collection efforts through phone and email contacts. If that doesn’t work, you may want to follow up with a series of letters or even hire a collection agency. Finally, if all else fails, ask your tax advisor about the prospects of claiming a business bad debt deduction on your 2023 return.

Is Disability Income Taxable?

If you may be eligible for disability income should you become disabled, it’s important to know whether that income will be taxable. As is often the case with tax questions, the answer is “it depends.”

Key factor

The key factor is who paid it. If your employer will directly pay the disability income to you, it will be taxable to you as ordinary salary and wages would be. Taxable benefits are also subject to federal income tax withholding, though, depending on the disability plan, disability benefits sometimes aren’t subject to Social Security tax.

Frequently, the payments aren’t made by an employer but by an insurer under a policy providing disability coverage or under an arrangement having the effect of accident or health insurance. In such cases, the tax treatment depends on who paid for the coverage. If your employer paid for it, the disability income will be taxed to you, as if paid directly to you by the employer. But if you paid for the policy, the payments you receive under it won’t be taxable.

Even if your employer arranges for the coverage (in other words, it’s a policy made available to you at work), the benefits won’t be taxed to you as long as you paid the premiums. For these purposes, if the premiums were paid by your employer but the amount paid was included as part of your taxable income from work, the premiums will also be treated as paid by you and the benefits won’t be taxable.

Two examples

For simplicity, let’s say your salary is $1,000 a week ($52,000 a year). Under a disability insurance arrangement made available to you by your employer, $10 a week ($520 for the year) is paid on your behalf by your employer to an insurance company. You include $52,520 in income as your wages for the year: the $52,000 paid to you plus the $520 in disability insurance premiums. In this case, the insurance is treated as paid for by you. If you become disabled and receive benefits, they won’t be taxable income to you.

Now, let’s look at an example with the same facts as above, except that the amount paid for the insurance coverage qualifies as excludable under the rules for employer-provided health and accident plans. In this case, you include only $52,000 in income as your wages for the year because the insurance is treated as paid for by your employer. So, if you become disabled and receive benefits, they will be taxable income to you.

Note: There are special rules in the case of a permanent loss (or loss of the use) of a part or function of the body, or a permanent disfigurement.

How much coverage is needed?

In deciding how much disability coverage you need to protect yourself and your family, take tax treatment into consideration. If you’re buying the policy, you need to replace only your after-tax, “take-home” income because your benefits won’t be taxed. On the other hand, if your employer pays for the benefit, you’ll lose a percentage to taxes.

If your current coverage is insufficient, you may wish to supplement an employer benefit with a policy you take out personally.

Any questions?

This discussion doesn’t cover the tax treatment of Social Security disability benefits, which may be taxed under different rules. Contact us to discuss this further or if you have questions about regular disability income.

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Do You Run A Business From Home?

The pandemic changed the landscape of work for a lot of people, including the numerous business owners who began running their businesses from their homes. Many are still working from their home offices, whether full-time or on a hybrid basis. If you’re self-employed and run your business from home, or perform certain functions there, you might be able to claim deductions for home office expenses against your business income.

How to qualify

In general, self-employed taxpayers qualify for home office deductions if part of their home is used “regularly and exclusively” as the principal place of business.

If your home isn’t your principal place of business, you may still be able to deduct home office expenses if:

1. You physically meet with patients, clients or customers on your premises, or

2. You use a storage area in your home (or a separate free-standing structure, such as a garage) exclusively and regularly for business.

Keep in mind the requirement that the space be used exclusively for business. For example, if your home office is also a guest bedroom, you can’t deduct the entire space as a home office expense. But if you use the desk area of the room exclusively for business, you can deduct that portion of the room, as long as you otherwise qualify.

Expenses you can deduct

Many eligible taxpayers deduct actual expenses when they claim home office deductions. Deductible home office expenses may include:

• Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,
• A proportionate share of indirect expenses, including mortgage interest, rent, property taxes, utilities, repairs and insurance, and
• Depreciation.

But keeping track of actual expenses can take time, and it requires organized recordkeeping.

The simpler method

Fortunately, there’s a simplified method: You can deduct $5 for each square foot of home office space, up to $1,500.

The cap can make the simplified method less valuable for larger home office spaces. Even for small spaces, taxpayers may qualify for bigger deductions using the actual expense method. So tracking your actual expenses can be worth it.

When claiming home office deductions, you’re not stuck with a particular method. For instance, you might have chosen the actual expense method when you filed your 2022 return, but then use the simplified method when you file your 2023 return next year, and the following year switch back to the actual expense method. The choice is yours.

More considerations

The amount of your deductions is subject to limitations based on the income attributable to your use of the office. Other rules and limitations may apply. But eligible home office expenses that can’t be deducted because of these limitations can be carried forward and may be able to be deducted in later years.

Also be aware that, if you sell a home on which you claimed home office deductions, there may be tax implications. Contact us for more information.

A valuable deduction

You might be wondering why only business owners and the self-employed have been addressed here. Unfortunately, the Tax Cuts and Jobs Act suspended home office deductions from 2018 through 2025 for employees, even if you’re currently working from home because your employer doesn’t provide office space.

But the home office deduction can be valuable to those who’re eligible for it. We can help you determine if you’re eligible and the best method for claiming the deduction in your situation.

The Deductibility Of Medical Expenses

Individual taxpayers may be able to claim medical expense deductions on their tax returns. However, the rules can be challenging, and qualifying can be difficult.

5 key points

Here are five points to keep in mind:

1. You must itemize to claim the deduction and have a lot of expenses. The medical expense deduction can be claimed only to the extent your unreimbursed costs exceed 7.5% of your adjusted gross income. If your total itemized deductions in 2023 will exceed your standard deduction, moving or “bunching” nonurgent medical procedures and other controllable expenses into this year may allow you to exceed the 7.5% floor and benefit from the deduction.

2. Health insurance premiums may help. These can total thousands of dollars a year. You may be able deduct the portion of the premiums that you pay for employer-provided health coverage, but only if they aren’t taken out of your paycheck pre-tax. Long-term care insurance premiums are also included as medical expenses, subject to limits based on age.

3. Transportation counts. The cost of getting to and from medical appointments counts as a medical expense. This includes taxis, public transportation or using your own vehicle. Vehicle costs can be calculated at 22 cents a mile for miles driven in 2023, plus tolls and parking. Alternatively, you can deduct certain actual costs (such as for gas and oil) that directly relate to your medical transportation.

4. Controllable costs are key. These include the costs of glasses, hearing aids, dental work, mental health counseling and other ongoing expenses in connection with medical needs. Purely cosmetic expenses generally aren’t eligible. Prescription drugs (including insulin) qualify, but over-the-counter medications and supplements such as aspirin and vitamins don’t. The services of therapists and nurses can qualify if they relate to medical conditions.

5. Don’t overlook smoking-cessation and weight-loss programs. Amounts paid for participating in smoking-cessation programs and for prescribed drugs designed to alleviate nicotine withdrawal are deductible. However, nonprescription nicotine gum and patches aren’t. A weight-loss program is deductible if undertaken as treatment for a disease diagnosed by a physician. Deductible expenses include fees paid to join a program and attend periodic meetings. The cost of diet food isn’t deductible.

Still unsure?

IRS Publication 502, Medical and Dental Expenses, provides complete details on this topic. Or contact us with questions.

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An “Innocent Spouse” May Be Able To Escape Tax Liability

When a married couple files a joint tax return, each spouse is “jointly and severally” liable for the full amount of tax on the couple’s combined income. That means the IRS can pursue either spouse to collect the entire tax, not just the part that’s attributed to one spouse or the other. This includes any tax deficiency that the IRS assesses after an audit, as well as any penalties and interest.

In some cases, however, one spouse may be eligible for “innocent spouse relief.” This generally occurs when one spouse was unaware of a tax understatement that was attributable to the other spouse.

Qualifying for relief

To qualify for innocent spouse relief, you must show not only that you didn’t know about the understatement, but also that there was nothing that should have made you suspicious. In addition, the circumstances must make it inequitable to hold you liable for the tax.

Innocent spouse relief is available even if you’re still married and living with your spouse. In addition, if you’re widowed, divorced, legally separated or have lived apart for at least one year, you may be able to limit liability for any tax deficiency on a joint return.

Election to limit liability

If you make the innocent spouse relief election, the tax items that gave rise to the deficiency will be allocated between you and your spouse as if you’d filed separate returns. For example, you’d generally be liable for the tax on any unreported wage income only to the extent that you earned the wages.

The election won’t provide relief from your spouse’s tax items if the IRS proves that you knew about the items or had reason to know when you signed the return, unless you can show that you signed the return under duress. Also, the limitation on your liability is increased by the value of any assets that your spouse transferred to you in order to avoid the tax.

An “injured” spouse

In addition to innocent spouse relief, there’s also relief for “injured” spouses. What’s the difference? An injured spouse claim asks the IRS to allocate part of a joint refund to one spouse.

In these cases, an injured spouse has had all or part of a refund from a joint return applied against past-due federal tax, state tax, child or spousal support, or a federal nontax debt (such as a student loan) owed by the other spouse. If you’re an injured spouse, you may be entitled to recoup your share of the refund.

Moving on

Whether, and to what extent, you can take advantage of the above relief depends on the facts of your situation. If you’re interested in trying to obtain relief, there’s paperwork that must be filed and deadlines that must be met.

Even if you’re not in need of any such relief now, as you file tax returns in the future, be mindful of “joint and several liability.” Generally filing a joint tax return results in lower taxes for a married couple. But if you want to ensure that you’re responsible only for your own tax, filing separate returns might be a better choice for you, even if your marriage is intact. Contact us with any questions or concerns.

Plan Ahead For Health Savings Accounts In 2024

The IRS has released guidance that includes the 2024 inflation-adjusted amounts for Health Savings Accounts (HSAs). HSAs allow taxpayers to save money for health care expenses in a tax-advantaged way. But contributions can be made only if the taxpayer has a high-deductible health plan (HDHP).

Employers that offer HDHPs can also offer HSAs as a way for employees to fund the high deductibles and other medical expenses pre-tax from their paychecks. (Employer contributions are optional.) Individuals with an HDHP who don’t have an employer-provided HSA, such as the self-employed, can set up their own HSA and make tax-deductible contributions to it.

What are the benefits?

The benefits of HSAs include the following:

• Contributions are made on a pretax or tax-deductible basis.
• Funds can be withdrawn tax-free to pay for a variety of medical expenses, such as doctor visits, prescriptions, and long-term care insurance premiums (up to applicable limits).
• HSAs have no “use-it-or-lose-it” requirement. The full unused account balance can carry over from year to year, with no time limit on when it must be used.
• HSAs are “portable,” meaning the account stays with the employee even if he or she changes jobs or leaves the workforce.

As noted earlier, to be eligible to contribute, an individual must be covered under a an HDHP (defined below). Participants in an HSA cannot be enrolled in Medicare or have other health coverage, though there are exceptions, which include dental, vision, long-term care, accident and specific disease insurance.

The annual HSA contribution limitation as well as the annual HDHP minimum deductible and maximum out-of-pocket expenses under the tax code are adjusted annually for inflation.

Inflation adjustments for next year

In Revenue Procedure 2023-23, the IRS released the 2024 inflation-adjusted figures for contributions to HSAs, which are as follows:

Annual contribution limitation. For calendar year 2024, the annual contribution limitation for an individual with self-only coverage under a HDHP will be $4,150. For an individual with family coverage, the amount will be $8,300. This is up from $3,850 and $7,750, respectively, in 2023.

There’s an additional $1,000 “catch-up” contribution amount for those age 55 and older in 2024 (same as for 2023).

HDHP defined. For calendar year 2024, an HDHP will be a health plan with an annual deductible that isn’t less than $1,600 for self-only coverage or $3,200 for family coverage (up from $1,500 and $3,000, respectively, in 2023). In addition, annual out-of-pocket expenses (deductibles, co-payments and other amounts, but not premiums) won’t be able to exceed $8,050 for self-only coverage or $16,100 for family coverage (up from $7,500 and $15,000, respectively, in 2023).

Questions?

HSAs can be beneficial to both employers and individual taxpayers. Contact your employee benefits and tax advisors if you have questions about HSAs.

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Determining The Right Time To Transfer Wealth To Your Heirs

To gift or not to gift? It’s a deceptively complex question. The temporary doubling of the gift and estate tax exemption (to an inflation-adjusted $12.92 million in 2023) is viewed by many as a “use it or lose it” proposition. In other words, if you have a large estate, you should make gifts now to take advantage of the high exemption before it sunsets at the end of 2025 (or sooner if lawmakers decide to reduce it earlier).

But giving away wealth now isn’t right for everyone. Depending on your circumstances, there may be tax advantages to keeping assets in your estate.

Lifetime gifts vs. bequests at death

The primary advantage of making lifetime gifts is that, by removing assets from your estate, you shield future appreciation from estate taxes. But there’s a tradeoff: The recipient receives a “carryover” tax basis, meaning that the recipient assumes your basis in the asset. If a gifted asset has a low basis relative to its fair market value (FMV), then a sale will trigger capital gains tax on the difference.

An asset transferred at death, however, receives a “stepped-up” basis equal to its date-of-death FMV. That means the recipient can sell it with little or no capital gains tax liability. So, the question becomes, which strategy has the lower tax cost: transferring an asset by gift (now) or by bequest (later)?

The answer depends on several factors, including the asset’s basis-to-FMV ratio, the likelihood that its value will continue appreciating, your current or potential future exposure to gift and estate taxes, and the recipient’s time horizon (how long you expect the recipient to hold the asset after receiving it).

3 examples

Let’s looks at some examples. To keep things simple, we’ll always assume that you and your heirs are subject to tax on capital gains at a rate of 23.8% (the top capital gains rate of 20% plus the 3.8% rate on net investment income) and that the gift and estate tax rate is 40% of amounts in excess of the applicable exemption.

Example #1. You have $8 million in publicly traded securities with a $3 million basis and $3 million in other assets. You haven’t used any of your exemption amount. If you give the securities to your son, who sells them immediately for $8 million, he’ll owe $1.19 million in capital gains taxes [23.8% × ($8 million - $3 million)].

Suppose, instead, that you hold the securities for life, that the inflation-adjusted exemption in the year you die is $14 million, that the securities’ value has grown to $11 million, and that your other assets have grown to $4 million. If your son inherits the securities, he’ll receive a stepped-up basis of $11 million and can sell them tax-free. Your estate will be subject to estate taxes of $400,000 [40% × ($15 million - $14 million exemption)]. In this scenario, holding the securities is the better strategy from a tax perspective.

Example #2. Same facts as in the first example, except that your son plans to hold the securities for life rather than sell them. In this scenario, gifting the securities now is the better strategy because, by holding them, your son avoids capital gains taxes and there’s no estate tax because the future appreciation on the securities is removed from your estate.

Example #3. Again, the same facts as in the first example, except that when you die the exemption has dropped to $8 million, so your estate is subject to estate taxes of $2.8 million [40% × ($15 million - $8 million exemption)]. In this scenario, gifting the securities now results in a substantially lower tax bill, even if your son sells them immediately.

These three examples are highly simplified to illustrate the decision-making process. In the real world, many other factors may affect the overall economics, including an asset’s income-earning potential, the applicability of state income and estate taxes, and potential changes in capital gains and gift and estate tax rates.

Dealing with uncertainty

Determining whether to hold or gift assets is challenging because the best course of action may depend on future events. Work with your tax and estate planning advisors to monitor legislative developments and adjust your estate plan accordingly. And consider tools for building flexibility into your plan to soften the blow of future tax changes.

A Possible Tax Quirk Of Being A Business Partner

If you’re a partner in a business, you may have encountered a situation that gave you pause. In any given year, you may have been taxed on more partnership income than was distributed to you. The cause of this quirk of taxation lies in the way partnerships and partners are taxed.

Partnership taxation up close

Unlike regular corporations, partnerships aren’t subject to income tax. Instead, each partner is taxed on the earnings of the partnership, even if the earnings aren’t distributed. Similarly, if a partnership has a loss, the loss is passed through to the partners. (However, various rules may prevent partners from currently using their shares of the partnership’s loss to offset other income.)

While a partnership isn’t subject to income tax, it’s treated as a separate entity for purposes of determining its income, gains, losses, deductions and credits. This makes it possible to pass through to partners their share of these items.

A partnership must file an information return, which is IRS Form 1065, “U.S. Return of Partnership Income.” On this form, the partnership separately identifies income, deductions, credits and other items. This is so partners can properly treat items that are subject to limits or other rules that could affect their treatment at the partner level. Examples of items that may require special treatment include capital gains and losses, interest expense on investment debts, and charitable contributions.

Each partner gets a Schedule K-1 showing his or her share of partnership items for the year just ended.

Basis and distribution rules ensure that partners aren’t taxed twice. A partner’s initial basis in his or her partnership interest (which varies depending on how the interest was acquired) is increased by his or her share of partnership taxable income. When that income is paid out to partners in cash, they aren’t taxed on the cash if they have sufficient basis. Instead, partners reduce their basis by the distribution amount. If a cash distribution exceeds a partner’s basis, then the excess is taxed to the partner as a gain.

Questions?

While the pass-through taxation of partnerships offers many advantages, it also has some quirks that can be confusing. Contact us with whatever questions you may have.

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Family Businesses Must Beware of Fraud

Family businesses make up a huge percentage of companies in the United States and produce much of the country’s gross domestic product. Often defined as companies that are majority owned by a single family with two or more family members involved in their management, family businesses can be a significant source of wealth. However, they may also potentially face higher fraud risks.

Major obstacles involved

Why might family businesses be more vulnerable to fraud than other companies? For one thing, prevention efforts can be hampered by loyalty and affection. One of the biggest obstacles to fraud prevention is simply acknowledging that someone in the family could be capable of initiating or overlooking unethical or illegal activities.

But like any other business, family enterprises should include internal controls that make fraud difficult to perpetrate. It may be awkward to exercise authority over members of one’s own family, but someone needs to take charge if or when issues arise. Sometimes family businesses need to hit the reset button and reestablish a hierarchy and process of authority while moving forward with the enterprise.

Advantage of independent advice

Of course, the person in charge potentially could be the one defrauding the company. That’s why independent auditors and legal advisors are critical. Your family business should look outside its immediate circles of relatives and friends and retain professional advisors who can be objective when assessing the company. Audited financial statements from independent accountants protect the business and its stakeholders.

If your company is large enough to have a board of directors, it should include at least one outsider who’s strong enough to tell you things you may not want to hear. In some extreme cases, members of all-family boards have been known to work together to bilk their companies. This becomes much more difficult when collusion requires the assistance of an outsider.

Punishing the perpetrator

Another factor that makes preventing fraud in family businesses hard is how they tend to handle fraud incidents. Even when legal action is an option, families rarely can bring themselves to pursue action against one of their own. Sometimes families choose to save the fraudster from public scandal or punishment rather than maintain ethical professional standards. Many fraud perpetrators know that.

If you discover a family member is committing fraud, consult with a trusted attorney or accountant. An advisor may want to explain to the perpetrator the illegality and possible consequences of the fraudulent actions. If such interventions don’t work, however, you and other family members may have no choice but to seek prosecution.

Avoid blind trust

There are plenty of advantages to working with family members, but you also need to watch for pitfalls. To maintain high ethical standards and prevent fraud, rely on professional advisors and nonfamily officers to provide perspective and objective advice. Contact us for help with internal controls.

Are Scholarships Taxable?

If your child has been awarded a scholarship, that’s cause for celebration. For some students, a scholarship means the difference between going to the college of their choice and starting at community college, or even not going at all. But be aware that scholarships may bring tax consequences.

Generally, but not always

Scholarships (and fellowships) are generally tax-free for students at elementary, middle and high schools, as well as those attending college, graduate school or accredited vocational schools. It doesn’t matter if the scholarship makes a direct payment to the individual or reduces tuition.

However, subject to limited exceptions, a scholarship isn’t tax-free if the payments are linked to services that the student performs as a condition for receiving the award, even if the services are required of all degree candidates. Therefore, a stipend a student receives for required teaching, research or other services is taxable, even if the student uses the money for tuition or related expenses.

What if you, or a family member, is fortunate enough to be an employee of an educational institution that provides reduced or free tuition to employees and their families? Such a reduction in tuition isn’t included in the employee’s income or subject to tax.

Returns and recordkeeping

If a scholarship is tax-free and the student has no other income, the award doesn’t have to be reported on a tax return. However, any portion of an award that’s taxable as payment for services is treated as wages. Estimated tax payments may have to be made if the payor doesn’t withhold enough tax.

The student should receive a Form W-2, “Wage and Tax Statement,” showing the amount of these wages and the amount of tax withheld. But any portion of the award that’s taxable must be reported even if no Form W-2 is received.

Basic rules

These are just a few of the basic rules. Other rules and limitations may apply. For example, if your child’s scholarship is taxable, it may limit other higher education tax benefits to which you or your child are entitled. As we approach the new school year, best wishes for your child’s success. Please contact us if you wish to discuss this or any other tax matter.

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Is It A Good Time For A Roth Conversion?

The volatility in the stock market may have caused the value of your retirement account to decrease. But if you have a traditional IRA invested in stocks, a decline may provide a valuable opportunity by allowing you to convert your traditional IRA to a Roth IRA at a lower tax cost.

Traditional vs. Roth

Here are some key differences between these two types of accounts:

Traditional IRA. Contributions to a traditional IRA may be deductible, depending on your modified adjusted gross income (MAGI) and whether you (or your spouse) participate in a qualified retirement plan, such as a 401(k). Funds in the account grow tax-deferred.

However, you generally must pay income tax on withdrawals. You’ll also face a penalty if you withdraw funds before age 59½, unless you qualify for an exception. And you may face an even larger penalty if you don’t take your required minimum distributions (RMDs) after you reach age 73 (up from 72 for 2022 and going up to age 75 if you don’t reach age 73 before Jan. 1, 2033).

Roth IRA. Roth IRA contributions aren’t deductible. But withdrawals (including earnings) are tax-free as long as you are age 59½ or older and the account has been open at least five years. Plus, you’re allowed to withdraw contributions at any time tax- and penalty-free. In addition, you won’t be subject to RMDs.

If you won’t need the money for retirement, you can let the entire Roth IRA balance continue to grow tax-free for the benefit of your heirs. Beneficiaries generally will be required to take distributions, but the distributions will be tax free. (There could be estate tax consequences at your death if you have a very large estate.)

However, the ability to contribute to a Roth IRA is subject to limits based on your MAGI. Fortunately, no matter how high your income, you’re eligible to convert a traditional IRA to a Roth. But you’ll have to pay income tax on the amount converted.

Conversion considerations

If you’ve been considering a Roth conversion and your traditional IRA has lost value, converting now instead of waiting could minimize your tax hit. You’ll also avoid tax on future appreciation if the value of your account goes back up.

Before converting, take time to think through the details. Here are two key issues to consider:

1. Money to pay the tax bill. If you don’t have the cash on hand to cover the taxes owed on the conversion, you may have to dip into your retirement funds, eroding your nest egg. The more money you convert and the higher your tax bracket, the bigger the tax hit.

2. When you plan to retire. Typically, you wouldn’t convert a traditional IRA to a Roth IRA if you expect to retire soon and will start drawing down on the account right away. Usually, the goal is to allow the funds to grow and compound over time without any tax erosion.

Stretch out the tax bill

If the idea of paying the tax bite related to converting from a traditional IRA to a Roth IRA is daunting or simply unaffordable, consider a gradual conversion. It’s not an all-or-nothing process, so you can stretch out the tax bill over time, depending on how long you expect to wait to retire.

Suppose you have $100,000 in a traditional IRA. You could, for example, convert that in five steps: $20,000 per year for five years. We can estimate what the tax bite will be at varying steps.

Right for you?

There are also other issues that need to be considered before executing a Roth IRA conversion. If this sounds like something you’re interested in, contact us to discuss whether a conversion is right for you.

The Tax Obligations If Your Business Closes Its Doors

Sadly, many businesses have been forced to shut down recently due to economic challenges. If this is your situation, we can help you meet the various tax responsibilities that go with closing a business.

Tax returns

Of course, a business must file a final income tax return and some other related forms for the year it closes its doors. The type of return to be filed depends on the type of business you have. Here’s a rundown of the basic requirements:

Sole proprietorships. Your tax preparer will need to file the usual Schedule C, “Profit or Loss from Business,” with your individual return (Form 1040) for the year you close the business. You may also need to report self-employment tax.

Partnerships. A partnership must file Form 1065, “U.S. Return of Partnership Income,” for the year it closes. The “final return” box must be checked, and the same must be done on Schedule K-1, “Partner’s Share of Income, Deductions, Credits, etc.”

All corporations. Form 966, “Corporate Dissolution or Liquidation,” must be filed if you adopt a resolution or plan to dissolve a corporation or liquidate any of its stock.

C corporations. Form 1120, “U.S. Corporate Income Tax Return,” must be filed for the year you close, with the “final return” box checked.

S corporations. Form 1120-S, “U.S. Income Tax Return for an S Corporation,” must be filed for the year of closing. The “final return” box must be checked on this form as well as on Schedule K-1.

All businesses. Other forms may need to be filed to report sales of business property and asset acquisitions if you sell your business.

Employees and contract workers

If you have employees, you must pay them final wages and compensation owed, make final federal tax deposits and report employment taxes. Failure to withhold or deposit employee income tax, Social Security tax and Medicare tax can result in full personal liability for what’s known as the “Trust Fund Recovery Penalty.”

If you’ve paid any contractors at least $600 during the calendar year in which you close your business, you must report those payments on Form 1099-NEC, “Nonemployee Compensation.”

Other tax issues

If your business has a retirement plan for employees, you’ll want to terminate the plan and distribute benefits to participants. There are detailed notices, funding, timing and filing requirements that must be met by a terminating plan. There are also complex requirements related to Flexible Spending Accounts, Health Savings Accounts and other programs for your employees.

We can assist you with many other complicated tax issues related to closing your business, including debt cancellation, use of net operating losses, freeing up any remaining passive activity losses, depreciation recapture and possible bankruptcy issues.

We can also advise you on the length of time you need to keep business records. In addition, you’ll need to cancel your Employer Identification Number and close your IRS business account.

If your business is unable to pay all the taxes it owes, we can explain the available payment options. Contact us to discuss these issues and get answers to any questions.

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3 Things To Know After Filing Your Tax Return

Most people feel a sense of relief after filing their income tax returns each year. But even if you’ve successfully filed your 2022 return with the IRS, there may still be some issues to bear in mind. Here are three important things to know:

1. You can check on your refund. The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Get Your Refund Status.” You’ll need your Social Security number, filing status and the exact refund amount.

2. You can file an amended return if you forgot to report something. In general, you can file an amended tax return and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later. So, if you file your 2022 tax return on April 18, 2023 (the due date for 2022 returns), you’d typically have until April 18, 2026, to file an amended return.

However, there are a few situations when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.

3. You can throw out some tax records. You should keep tax records related to your return for as long as the IRS can audit your return or assess additional taxes. The statute of limitations is generally three years after you file your return.

That means you can probably dispose of most tax-related records for the 2019 tax year and earlier years. (If you filed an extension for your 2019 return, hold on to your records until at least three years from when you filed the extended return.)

However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.

You’ll need to hang on to certain tax-related records longer. For example, keep actual tax returns indefinitely so you can prove to the IRS that you filed legitimately. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)

Keep records associated with a retirement account until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset so you can prove your tax basis, plus at least three years after you sell it and report the sale on your tax return. (You may want to keep these records for six years if to be extra safe.)

Always available

Contact us if you have further questions about your refund, filing an amended return or record retention. We’re here all year!

Business Bartering Is Taxable

During these times of high inflation, many cash-challenged businesses have bartered for goods and services instead of paying dollars for them. If your company gets involved in such transactions, remember that the fair market value of goods that you receive is taxable income. And if you exchange services with another business, the transaction results in taxable income for both parties.

A couple of examples

Let’s say a computer consultant agrees to exchange services with an advertising agency. Both parties will be taxed on the fair market value of the services received. This is the amount they’d normally charge for the same services. If the parties agree to the value of the services in advance, that will be considered the fair market value unless contrary evidence exists.

In addition, if services are exchanged for property, income is realized. Say a construction company does work for a retail business in exchange for unsold inventory. The contractor will incur income equal to the inventory’s fair market value.

Barter exchanges

Many businesses join barter clubs that facilitate these transactions. Generally, these clubs use a system of “credit units” that are awarded to members who provide goods and services. The credits can be redeemed for goods and services from other members.

Bartering is generally taxable in the year it occurs. If you participate in a barter club, however, you may be taxed on the value of credit units at the time they’re added to your account — even if you don’t redeem them for actual goods and services until a later year.

By January 31 of each year, a barter club will send participants a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” which shows the value of cash, property, services and credits that they received from exchanges during the previous year. The IRS will also receive this information.

If you join a barter club, expect to provide your Social Security number or employer identification number. You’ll also be asked to certify that you aren’t subject to backup withholding. Unless you make this certification, the club will withhold tax from your bartering income.

Potentially beneficial

So long as you’re aware of the federal and state tax consequences, business bartering transactions may be beneficial. Contact us if you need assistance or would like more information.

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Thinking About Converting Your Home Into A Rental Property?

In some cases, homeowners move to new residences, but keep their present homes and rent them out. If you’re thinking of doing this, you’re probably aware of the financial risks and rewards. However, you also should know that renting out your home carries potential tax benefits and pitfalls.

Rental real estate rules

If you’re no longer personally using your home at all, you’re generally treated as a regular real estate landlord once you begin renting it out. That means you must report rental income on your tax return, but you’re also entitled to offsetting deductions for the money you spend on utilities, operating expenses, incidental repairs and maintenance (for example, fixing a leak in the roof).

Additionally, you can claim depreciation deductions for the home. You may be able to fully offset rental income with allowable landlord deductions.

Passive activity rules

However, under the passive activity loss (PAL) rules, you may not be able to currently deduct the rent-related deductions that exceed your rental income unless an exception applies. Under the most widely applicable exception, the PAL rules won’t affect your converted property for a tax year in which your adjusted gross income doesn’t exceed $100,000, you actively participate in running the home-rental business, and your losses from all rental real estate activities in which you actively participate don’t exceed $25,000.

You should also be aware that potential tax pitfalls may arise from renting your residence. Unless your rentals are strictly temporary and are made necessary by adverse market conditions, you could forfeit an important tax break for home sellers if you finally sell the home at a profit. In general, you can escape tax on up to $250,000 ($500,000 for married couples filing jointly) of gain on the sale of your principal home. However, this tax-free treatment is conditioned on your having used the residence as your principal residence for at least two of the five years preceding the sale. So, renting your home out for an extended time could jeopardize a big tax break.

What if you don’t rent out your home long enough to jeopardize your principal residence exclusion? The tax break you would have gotten on the sale (the $250,000/$500,000 exclusion) won’t apply to the extent of any depreciation allowable with respect to the rental or business use of the home for periods after May 6, 1997. It also won’t apply to any gain allocable to a period of nonqualified use (any period during which the property isn’t used as the principal residence for you, your spouse or former spouse) after December 31, 2008. A maximum tax rate of 25% will apply to this gain (attributable to recapture of depreciation deductions).

Selling at a loss

Some homeowners who bought at the height of the market may ultimately sell at a loss. In such situations, the loss is available for tax purposes only if the owner can establish that the home was in fact converted permanently into income-producing property. Here, a longer lease period helps an owner.

However, if you’re in this situation, be aware that you may not wind up with much of a loss for tax purposes. That’s because the beginning basis (the cost for tax purposes) when the home is first converted to a rental property is equal to the lesser of actual cost or the property’s fair market value when it’s converted to rental property. So, if a home was bought for $300,000, converted to a rental when it was worth $250,000, and ultimately sold for $225,000, the loss would be only $25,000. Keep in mind that depreciation deductions while it was a rental property also reduce basis.

Be Prepared For Taxes On Social Security Benefits

Whether you’ve filed your 2022 tax return or soon will, one thing you don’t want to experience is a surprise. Many older people are caught off guard when they find that some of their Social Security benefits are taxable.

How much might you have to pay? Depending on your other income, between 50% and 85% of your Social Security benefits could be hit with federal income tax. (There could also be state tax.) This doesn’t mean you’ll pay 50% to 85% of your benefits back to the government. It means you may have to include 50% to 85% of them in your income subject to regular tax rates.

Calculate provisional income

To determine how much, if any, of your benefits are taxed, you must calculate your “provisional income.” Doing so involves adding certain amounts (for example, tax-exempt interest from municipal bonds) to the adjusted gross income on your tax return.

If you file jointly, you’ll need to add your spouse’s income, and then further add half of the Social Security benefits that you and your spouse received during the year. The result is your joint provisional income.

If you file a joint tax return and your joint provisional income isn’t above $32,000, none of your Social Security benefits are taxed. If your provisional income is $32,001 to $44,000, you must report up to 50% of your Social Security benefits as income. If your provisional income is more than $44,000, you need to report up to 85% of your Social Security benefits as income on Form 1040.

For single taxpayers, if your provisional income is between $25,001 and $34,000, you must report up to 50% of your Social Security benefits as income. And if your provisional income is more than $34,000, the general rule is that you need to report up to 85% of your Social Security benefits as income.

Sidestep a surprise

If you aren’t paying tax on your Social Security benefits now because your income is below the floor, or you’re paying tax on only 50% of those benefits, an unplanned increase in your income can have a significant tax cost. Not only will you pay tax on the additional income, but you may also have to pay tax on (or on more of) your Social Security benefits and you may get pushed into a higher tax bracket.

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Protect Your Business With Meticulous Records

If you run a business, you know that you need to support expenses with detailed records. To be deductible, every expense on your tax return might have to be defended if your company is subject to an audit. Plus, failing to operate in a businesslike manner, complete with good records, might lead the IRS to deem the activity a hobby rather than a business, in which case your deductions may be limited or disallowed.

While there’s no one right way to keep business records, some types of expenses do require more details. For example, records relating to automobile, travel, meal and home-office costs are subject to special requirements or limitations.

An activity must be engaged in for profit

For a business expense to be deductible, the taxpayer must establish that the primary objective of the activity is making a profit. The expense must also be substantiated and be an “ordinary and necessary” business expense. In one court case (Gaston v. IRS, 2021), a taxpayer claimed deductions that created a loss, which she used to shelter other income from tax.

She engaged in various activities that included acting in the entertainment industry and selling jewelry. The IRS found her activities were more like hobbies than businesses engaged in for profit, and it disallowed her deductions.

The taxpayer did, however, have some success when she took her case to the U.S. Tax Court. The court found that she was engaged in the business of acting for profit during the years at issue, though not all of the claimed expenses were ordinary and necessary business expenses. The court allowed deductions for expenses including headshots, casting agency fees and lessons to enhance the taxpayer’s acting skills. But the court disallowed other deductions because it found insufficient evidence “to firmly establish a connection” between the expenses and the business.

In addition, the court found that that taxpayer didn’t prove that she engaged in her jewelry sales activity for profit. She didn’t operate it in a businesslike manner, spend sufficient time on it or seek out expertise in the jewelry industry. Therefore, all deductions related to that activity were disallowed.

Proper records are required

In another case (Elbasha v. IRS, 2022), a taxpayer worked as a contract emergency room doctor at a medical center. He also started a business to provide emergency room physicians overseas. On Schedule C of his tax return, he deducted expenses related to his home office, travel, driving, continuing education, cost of goods sold and interest. The IRS disallowed most of the deductions.

In court, the doctor used charts to illustrate his expenses but didn’t provide receipts or other substantiation showing the expenses were actually paid. He also failed to account for the portion of expenses attributable to personal activity.

The U.S. Tax Court disallowed the deductions, stating that his charts weren’t enough and didn’t substantiate that the expenses were ordinary and necessary in his business. It noted that “even an otherwise deductible expense may be denied without sufficient substantiation.” The doctor also didn’t qualify to take home office deductions because he didn’t prove it was his principal place of business.

We can help

Contact us if you need assistance determining how to maintain adequate business records. Taking a meticulous, proactive approach can protect your deductions and prevent the IRS from viewing your business as a hobby.

Can You Deduct The Costs Of A Spouse On A Business Trip?

If you own a company and travel for business, you may wonder whether you can deduct all the costs of having your spouse accompany you on trips. It may be possible, but the rules are restrictive. In general, your spouse must be your employee. And even then, strict rules apply. But there is some good news: Bringing your spouse on a business trip generally doesn’t reduce deductions for your own travel costs.

A spouse-employee

If your spouse is your employee and his or her presence on the trip serves a bona fide business purpose, then you can deduct travel costs. But it isn’t enough for your spouse to merely be “helpful” in incidental ways, such as by typing your meeting notes. Your spouse’s presence must serve a necessary business purpose.

In most cases, a spouse’s participation in social functions, for example as a host or hostess, isn’t enough to establish a business purpose. That is, if his or her purpose is to establish general goodwill for customers or associates, this is usually insufficient. Further, if there’s a vacation element to the trip (for example, if your spouse spends time sightseeing), it will be more difficult to establish a business purpose for his or her presence on the trip. On the other hand, a bona fide business purpose exists if your spouse’s presence is necessary to care for a serious medical condition that you have.

If these tests are satisfied in relation to your spouse, the normal deductions for your spouse’s business travel away from home can be claimed. These include the costs of transportation, meals, lodging, and incidentals such as dry cleaning and phone calls.

A nonemployee spouse

Suppose your spouse’s travel doesn’t satisfy these requirements. You may still be able to deduct a substantial portion of the trip’s costs. This is because the rules don’t require you to allocate 50% of your travel costs to your spouse, but only any additional costs you incur for him or her.

For example, in many hotels the cost of a single room isn’t that much lower than the cost of a double. If a single would cost you $150 a night and a double would cost you and your spouse $200, the disallowed portion of the cost allocable to your spouse would only be $50. In other words, you can write off the cost of what you would have paid traveling alone. To prove your deduction, ask the hotel for a room rate schedule showing single rates for the days you’re staying.

If you drive your own car or rent one, the whole cost will be fully deductible even if your spouse is along. Of course, if public transportation is used, and for meals, any separate costs incurred by your spouse won’t be deductible.

Contact us if you have questions about this or other tax-related topics.

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SECURE 2.0 Law May Make You More Secure In Retirement

A new law was recently signed that will help Americans save more for retirement, though many of the provisions don’t kick in for a few years. The Setting Every Community Up for Retirement Enhancement 2.0 Act (SECURE 2.0) is meant to build on the original SECURE Act of 2019, which made major changes to the required minimum distribution (RMD) rules and other retirement provisions.

Retirement highlights

Here are some of the significant retirement plan changes and when they’ll become effective:

• The age for beginning RMDs is going up. Employer-sponsored qualified retirement plans, traditional IRAs and individual retirement annuities are subject to RMD rules. They require that benefits start being distributed by a specific beginning date. Under the new law, the age used to determine distributions increases from age 72 to age 73 starting on January 1, 2023. It will then increase to age 75 starting on January 1, 2033.
• There will be higher “catch-up” contributions for 401(k) participants ages 60 through 63. Currently, participants in certain retirement plans can make additional catch-up contributions if they’re age 50 and older. The limit on catch-up contributions to 401(k) plans is $7,500 for 2023. Secure 2.0 will raise the 401(k) plan catch-up contribution limits to the greater of $10,000 or 150% of the regular catch-up amount for individuals ages 60 through 63. The higher amounts will be indexed for inflation after 2025. This provision will take effect for taxable years beginning after December 31, 2024. (There will also be increased catch-up amounts for SIMPLE plans.)
• Tax-free rollovers will be allowed from 529 accounts to Roth IRAs. SECURE 2.0 will permit beneficiaries of 529 college savings accounts to make direct trustee-to-trustee rollovers from a 529 account in their names to their Roth IRAs without tax or penalty. Several rules apply. This provision is effective for distributions after December 31, 2023.
• “Matching” contributions will be permitted for employees with student loan debt. The new law will allow an employer to make matching contributions to 401(k) and certain other retirement plans with respect to “qualified student loan payments.” The result of this provision is that employees who can’t afford to save money for retirement because they’re repaying student loan debt can still receive matching contributions from their employers into retirement plans. Taxpayers can receive these matching contributions even if they aren’t contributing to their own retirement accounts. This will take effect starting after December 31, 2023.

Nonretirement provisions

There are also some parts of the law that aren’t related to retirement plans, including a change to Achieving a Better Life Experience (ABLE) accounts. Tax-exempt ABLE programs are established by states to assist individuals with disabilities.

Currently, in order to be the beneficiary of an ABLE account, an individual’s disability or blindness must have occurred before age 26. SECURE 2.0 increases this age limit to 46, which will make more people eligible to benefit from an ABLE account. This provision is effective for tax years beginning after December 31, 2025.

Just the beginning

These are only some of the many provisions in SECURE 2.0. Contact us if you have any questions about your situation.

Qualifying For The Home Office Deduction

In recent years, many people have pivoted to working from home, and that brings up tax questions. If you’re one of those people, you might wonder, “Can I claim the home office deduction on my 2022 tax return?”

The short answer is: only if you’re self-employed. Employees can’t currently claim home office expenses, and even self-employed taxpayers must follow strict rules to claim deductions.

Numerous write-offs

If you qualify, you can deduct the “direct expenses” of a home office. This includes the costs of painting or repairing the home office and depreciation deductions for furniture and fixtures used there. You can also deduct the “indirect” expenses of maintaining the office. This includes the allocable share of utility costs, depreciation and insurance for your home, as well as the allocable share of mortgage interest, real estate taxes and casualty losses.

In addition, if your home office is your “principal place of business,” the eligible costs of traveling between your home office and other work locations are deductible transportation expenses, rather than nondeductible commuting costs.

Tests for deductibility

You can deduct your expenses if you meet any of these three tests:

1. Principal place of business. You’re entitled to deductions if you use your home office, exclusively and regularly, as your principal place of business. Your home office is your principal place of business if it satisfies one of two tests. You satisfy the “management or administrative activities test” if you use your home office for administrative or management activities of your business, and you meet certain other requirements. You meet the “relative importance test” if your home office is the most important place where you conduct business, compared with all the other locations where you conduct that business.

2. Meeting place. You’re entitled to home office deductions if you use your home office, exclusively and regularly, to meet or deal with patients, clients or customers. The patients, clients or customers must physically come to the office.

3. Separate structure. You’re entitled to home office deductions for a home office, used exclusively and regularly for business, that’s located in a separate unattached structure on the same property as your home. For example, this could be in an unattached garage, artist’s studio or workshop.

You may also be able to deduct the expenses of certain storage space for storing inventory or product samples. If you’re in the business of selling products at retail or wholesale, and if your home is your sole fixed business location, you can deduct home expenses allocable to space that you use to store inventory or product samples.

Know the limitations

The amount of home office deductions for self-employed taxpayers is subject to various limitations. Proper planning is key to claiming the maximum deduction for your home office expenses. Contact us if you’d like to discuss your situation.

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6 Key Tax Questions for 2023

Right now, you may be more concerned about your 2022 tax bill than you are about how to handle your personal finances in the new year. However, as you deal with your annual tax filing, it’s a good idea to also familiarize yourself with pertinent amounts that may have changed for 2023.

Not all tax figures are adjusted for inflation. And even if they are, during times of low inflation the changes may be slight. When inflation is higher, as it currently is, the changes are generally more substantial. In addition, some tax amounts can change only with new tax legislation. Here are the answers to six commonly asked questions about 2023 tax-related figures:

1. How much can I contribute to an IRA for 2023? If you’re eligible, you can contribute up to $6,500 for 2023 to a traditional or Roth IRA (up from $6,000 for 2022). If you’re age 50 or older, you can make another $1,000 “catch-up” contribution.

2. I have a 401(k) plan through my job. How much can I contribute to it? For 2023, you can contribute up to $22,500 to a 401(k) or 403(b) plan. You can make an additional $7,500 catch-up contribution if you’re age 50 or older. (These figures for 2022 were $20,500 and $6,500, respectively).

3. I sometimes hire a babysitter and a cleaning person. Do I have to withhold and pay FICA tax on the amounts I pay them? The threshold for when a domestic employer must withhold and pay FICA for babysitters, house cleaners and other domestic employees has increased to $2,600 for 2023 (up from $2,400).

4. How much do I have to earn in 2023 before I can stop paying Social Security tax on my salary? The Social Security tax wage base is $160,200 for 2023, up from $147,000 for 2022. That means that you don’t owe Social Security tax on amounts earned above that. (You must pay Medicare tax on all amounts that you earn.)

5. On my last income tax return, my itemized deductions didn’t exceed my standard deduction. What’s my standard deduction for 2023? If the total amount of your itemized deductions (such as charitable gifts and mortgage interest) is less than your applicable standard deduction amount, itemizing won’t save you taxes. The Tax Cuts and Jobs Act eliminated the tax benefit of itemizing for many people by increasing the standard deduction and reducing or eliminating various itemized deductions. For 2023, the standard deduction amount is $27,700 for married couples filing jointly (up from $25,900 for 2022). For single filers, the amount is $13,850 (up from $12,950), and, for heads of households, it’s $20,800 (up from $19,400).

6. How much can I give to one person without having to file a gift tax return for 2023? The annual gift tax exclusion for 2023 is $17,000 (up from $16,000 in 2022). This amount is adjusted only in $1,000 increments, so it typically increases only every few years.

These are only some of the tax figures that may apply to you. For more information about your tax picture, or if you have questions, don’t hesitate to contact us.

Is Your Business At Risk of Retirement Plan Leakage?

Generally, the term “leakage” has negative connotations. So, it’s not surprising that the same is true in the context of retirement planning, where leakage refers to pre-retirement withdrawals from a retirement account. Now, as a business owner who sponsors a qualified retirement plan, you might say, “Well, that’s my participants’ business, not mine.”

However, there are valid reasons to address the issue with employees who participate in your plan.

Why does it matter?

For starters, leakage can lead to higher plan expenses. Fees are often determined on a per-account or per-participant basis. When a plan loses funds to leakage, total assets and individual account sizes shrink, which tends to hurt administrative efficiency and raise costs.

More broadly, if your employees are taking pre-retirement withdrawals, it could indicate they’re facing unusual financial challenges. These issues may have a negative impact on productivity and work quality and leave them unable to retire when they planned to.

What can you do?

The most important thing business owners can do to limit leakage is to remind employees about how pre-retirement withdrawals can diminish their accounts and delay their anticipated retirement dates. While you’re at it, consider providing broader financial education to help workers better manage their money, amass savings, and minimize or avoid the need for early withdrawals.

Some companies offer emergency loans that are repayable through payroll deductions to reduce the use of retirement funds. Others have revised their plan designs to limit the situations under which plan participants can take out hardship withdrawals or loans.

Can you eliminate the problem?

According to a 2021 report by the Joint Committee on Taxation, roughly 22% of net contributions made by people ag 50 or younger leaks out of the retirement savings system in a given year. Some percentage of retirement plan leakage will probably always occur, but becoming aware of the problem and taking steps to minimize it are still worthwhile for any business.

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What’s Your Taxpayer Filing Status?

For many people, December 31 means a New Year’s Eve celebration. However, from a tax perspective, it’s a key date in determining the filing status you’ll use when filing your tax return for the year. The one you’ll use depends partly on whether you’re married on that date.

The five statuses

When you file your federal tax return, you do so with one of five filing statuses. First, there’s “single” status, which is generally used if you’re unmarried, divorced or legally separated. A second status, “married filing jointly,” is for married couples who file a tax return together. If your spouse passes away, you can usually still file a joint return for that year. A third status, “married filing separately,” is for married couples who choose to file separate returns. In some cases, doing so may result in less tax owed.

“Head of household” is a fourth status. Certain unmarried taxpayers with dependents qualify to use it and potentially pay less tax. Finally, there’s a fifth status: “qualifying widow(er) with a dependent child.” It may be used if your spouse died during one of the previous two years and you have a dependent child. (Other conditions apply.)

Head of household

Let’s focus on head-of-household status because it’s often misunderstood and can be more favorable than filing as a single taxpayer. To qualify, you must “maintain a household” that, for more than half the year, is the principal home of a “qualifying child” or other relative that you can claim as a dependent.

A qualifying child is defined as someone who lives in your home for more than half the year and is your child, stepchild, foster child, sibling, stepsibling or a descendant of any of these. A qualifying child must also be under 19 years old (or a full-time student under age 24) and be unable to provide over half of his or her own support for the year.

Different rules may apply if a child’s parents are divorced. Also, a child isn’t a qualifying child if he or she is married and files jointly or isn’t a U.S. citizen or resident.

For head-of-household filing status, you’re considered to maintain a household if you live in it for the tax year and pay more than half the cost of running it. This includes property taxes, mortgage interest, rent, utilities, property insurance, repairs, upkeep and food consumed in the home. Medical care, clothing, education, life insurance and transportation aren’t included.

Under a special rule, you can qualify as head of household if you maintain a home for a parent even if you don’t live with the parent. To qualify, you must be able to claim the parent as your dependent.

You must generally be unmarried to claim head-of-household status. However, if you’ve lived apart from your spouse for the last six months of the year, you have a qualifying child living with you and you maintain the household, you’re typically considered unmarried. In this case, you may be able to qualify as head of household.

Not always obvious

Filing status may seem obvious, but there can be situations when it warrants careful consideration. If you have questions about yours, contact us.

Have You Considered A Cost Segregation Study?

Because of the economic impact of inflation, many companies may need to conserve cash and not buy much equipment. As a result, you may not be able to claim as many depreciation tax deductions as in the past. However, if your company owns real property, there may be another approach to depreciation to consider: a cost segregation study.

Depreciation basics

Business buildings generally have a 39-year depreciation period (27.5 years for residential rental properties). Typically, companies depreciate a building’s structural components (including walls, windows, HVAC systems, 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, such as fences, outdoor lighting and parking lots, are depreciable over 15 years.

Often, businesses allocate all or most of their buildings’ 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, removable partitions, awnings, canopies, window treatments, signs and decorative lighting.

Pinpointing costs

A cost segregation study combines accounting and engineering techniques to identify building costs that are properly allocable to tangible personal property rather than real property. Although the relative costs and benefits of a cost segregation study will depend on your particular facts and circumstances, it can be a valuable investment.

It may allow you to accelerate depreciation deductions on certain items, thereby reducing taxes and boosting cash flow. And, thanks to the Tax Cuts and Jobs Act, the potential benefits of a cost segregation study are even greater than they were years ago because of enhancements to certain depreciation-related tax breaks.

Worth a look

Cost segregation studies have costs all their own, but the potential long-term tax benefits may make it worth your while to undertake the process. Contact our firm for further details.

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Year-end Gifts And The Gift Tax Annual Exclusion

With the holidays and year-end approaching, you might be considering making gifts of stock or cash to family members and other loved ones. By using your gift tax annual exclusion, those gifts can reduce the size of your taxable estate. For 2022, the annual exclusion is $16,000. The exclusion will increase to $17,000 for 2023.

How it works

The annual exclusion applies to gifts on a per recipient, per year, basis. Therefore, a taxpayer with three children can transfer a total of $48,000 to them in 2022 free of federal gift taxes and another $51,000 gift-tax-free in 2023.

If these are the only gifts made in the applicable year, there’s no need to file a federal gift tax return. If an annual gift exceeds the exclusion, only the excess amount is a taxable gift, though it may not result in tax liability. (See “More ways to save gift tax,” below.)

However, keep in mind that the exclusion doesn’t carry over from year to year. For example, if you don’t make an annual exclusion gift to someone this year, you can’t add $16,000 to your 2023 annual exclusion and make a $33,000 tax-free gift to that person next year.

Married taxpayers and gift splitting

If you’re married, a gift can be treated as split between you and your spouse, even if only one of you gives the gift. That means, by gift splitting, a married couple can use their two exclusions to give a recipient up to $32,000 in 2022 and $34,000 in 2023. For example, in 2022 a married couple with three married children can transfer a total of $192,000 to their children and the children’s spouses ($32,000 for each of six recipients).

Because more than the exclusion amount is being transferred by a spouse, a gift tax return (or returns) will have to be filed, even if the spouses’ combined exclusion covers the total gift. If gift splitting is involved, both spouses must consent to it and that consent should be indicated on each gift tax return (or returns) that each spouse files.

Speaking of married taxpayers, gifts from one spouse to the other aren’t covered here, because these gifts are free of gift tax under separate marital deduction rules, as long as the recipient spouse is a U.S citizen.

More ways to save gift tax

Gifts that are taxable because they aren’t covered by the annual exclusion may still not result in a tax liability. This is because the lifetime gift and estate tax exemption wipes out the federal gift tax liability on taxable gifts up to a cumulative $12.06 million for 2022 (increasing to $12.92 million for 2023). The amount of the exemption you use during your life reduces or eliminates the exemption available for federal estate tax purposes upon your death.

Gifts made directly to an educational institution to pay tuition or to a health care provider to pay for medical expenses on behalf of someone else do not count towards the exclusion. For example, you can pay $20,000 directly to your grandson’s college for his tuition this year, plus still give him a tax-free direct cash gift of up to $16,000.

Why 2022 gifts make sense

Annual exclusion gifts reduce the taxable value of your estate. While the lifetime gift and estate tax exemption amount is historically high right now, it’s scheduled to fall in 2026 to around $7 or $8 million, depending on inflation. Congress could act to extend today’s higher exemption or could change estate tax law in other ways. Making large tax-free gifts now could help insulate you against any later reduction in the gift and estate tax exemption.

Selling Trade Or Business Property? Know The Tax Effects

Many rules can potentially apply to the sale of business property, but what are the tax consequences? For simplicity, let’s assume that the property you want to sell is depreciable property used in your business and you’ve held it for more than one year.

General rules

Under the Internal Revenue Code, your gains and losses from sales of business property are netted against each other. The net gain or loss qualifies for tax treatment as follows:

1. If the netting process results in a net gain, then long-term capital gain treatment results, subject to “recapture” rules discussed below. This treatment is generally more favorable than ordinary income treatment.

2. If the netting of gains and losses results in a net loss, that loss is fully deductible against ordinary income (so, none of the rules that limit the deductibility of capital losses apply).

Recapture rules

The availability of long-term capital gain treatment for business property net gain is limited by recapture rules. Recapture rules specify that amounts are treated as ordinary income rather than capital gain because of previous ordinary loss or deduction treatment for these amounts (such as depreciation, for example).

There’s a special recapture rule that applies only to business property. Under this rule, to the extent you’ve had a business property net loss within the previous five years, any business property net gain is treated as ordinary income, not as long-term capital gain.

More tax code details

Here are some more details about two types of property:

Section 1245 property. This is all depreciable personal property, tangible or intangible, and certain depreciable real property (usually, real property with specific functions). If you sell this property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset.

Section 1250 property. This type of property generally includes buildings and their structural components. If you sell such property that was placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to depreciation recapture. (Additional rules apply for Section 1250 property placed in service in 1986 or earlier.)

However, for most noncorporate taxpayers, the gain attributable to depreciation deductions up to the amount of the business property net gain will be taxed at no higher than 28.8% (as reduced by the business property recapture rule above). That’s 25% plus the 3.8% net investment income tax (NIIT), rather than the maximum 23.8% rate (20% plus the 3.8% NIIT) that generally applies to long-term capital gains of noncorporate taxpayers.

Proceed with caution

As you can see, the tax treatment of the sale of business assets can be complex. And different rules apply based on property type, such as property held for sale to customers, intellectual property, low-income housing, and farming or livestock property. Contact us for help with specific transactions or additional questions.

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Beware of “Wash Sales” When Selling Securities

If you’re planning to sell stock or other securities at a loss to offset gains you realized earlier in the year, beware of the “wash sale” rule. It comes into play when an investor wants to realize a loss on a security for tax purposes while continuing to invest in the security. Under the wash rule, selling securities for a loss and buying back substantially identical securities within 30 days before or after the sale date means the loss can’t be claimed for tax purposes.

The rule

The wash sale rule is designed to prevent taxpayers from benefiting from a loss without actually parting with ownership. Note that the rule applies not only to buying back stock within 30 days after selling it but also to a 30-day period before the sale date to prevent “buying the stock back” before it’s even sold.

Although the loss can’t be claimed on a wash sale, the disallowed amount is added to the cost of the new stock to increase its tax basis. So, the disallowed amount can be claimed when the new stock is finally sold at some point in the future (other than in a wash sale).

An example

Assume you buy 500 shares of XYZ Inc. for $10,000 and sell them on November 1 for $3,000. On November 15, you buy 500 shares of XYZ again for $3,200. Because the shares were “bought back” within 30 days of the sale, the wash sale rule applies. Therefore, you can’t claim a $7,000 loss. Your basis in the new 500 shares is $10,200: the actual cost plus the $7,000 disallowed loss.

If only a portion of the stock sold is repurchased, only that portion of the loss is disallowed. In the example above, if 60% of the shares sold were bought back, you’d be able to claim 40% of the loss on the sale. The remaining loss would be disallowed and added to your cost basis of the repurchased shares.

No surprises

The wash sale rule can deliver a nasty surprise at tax time. Contact us with questions as you’re contemplating year-end tax planning strategies for your investment portfolio.

Internal Controls Reduce Check Kiting Risk

A check kiting scheme relies on “float” time, which is the period between when a check is deposited and when the bank collects the funds on the check. In recent years, the float time has narrowed, but there’s still opportunity to capitalize on that delay. So it’s important for businesses to put internal controls in place to protect against this fraud risk.

No small matter

Check kiting schemes typically involve two or more banks, though some schemes can involve multiple accounts at one bank if there’s a lag in how the institution processes checks. The perpetrator’s goal is to falsely inflate the balance of a checking account so that written checks that otherwise would bounce, clear.

Check kiting is a federal crime that can lead to up to 30 years in federal prison, plus hefty fines. Even if a bank doesn’t press charges, it may close the account and report the incident to ChexSystems (similar to a credit bureau), making it difficult to open a new business account.

Strategies for grounding the kite

Here are five strategies your organization can implement to keep people from using your company’s accounts for check kiting:

1. Educate employees about bank fraud. Describe the types of transactions that qualify as bank fraud and their red flags. That makes workers aware of suspicious activities and demonstrates management’s commitment to preventing fraud.

2. Rotate key accounting roles. Segregate accounting duties. Rotate tasks among staffers if possible to help uncover ongoing schemes and limit opportunities to steal.

3. Reconcile bank accounts daily. Make sure someone trustworthy, who isn’t involved in issuing payments, reconciles every company bank account.

4. Maintain control of paper checks. Store blank checks in a locked cabinet or safe and periodically inventory the blank check stock. Also limit who’s allowed to order new ones.

5. Go digital. The most effective way to prevent most check fraud is to stop using paper checks altogether. Consider replacing them with ACH payments or another form of electronic payments.

Tighten up

Check kiting is relatively easy to perpetrate, particularly if your company isn’t vigilant about its check stock and bank account activity. For help tightening your internal controls, contact us.

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Offset Nursing Home Costs With Possible Tax Breaks

If you have a parent entering a nursing home, taxes are probably the last thing on your mind. But you should know that several tax breaks may be available to help offset some of the costs.

Medical expense deductions

The costs of qualified long-term care (LTC), such as nursing home care, may be deductible as medical expenses to the extent they, along with other qualified expenses, exceed 7.5% of adjusted gross income (AGI). But keep in mind that the medical expense deduction is an itemized deduction. And itemizing deductions saves taxes only if total itemized deductions exceed the applicable standard deduction.

Amounts paid to a nursing home are deductible as medical expenses if a person is staying at the facility principally for medical, rather than custodial care. Also, for those individuals, only the portion of the fee that’s allocable to actual medical care qualifies as a deductible expense.

If the individual is chronically ill, all qualified LTC services are deductible. Qualified LTC services are those required by a chronically ill individual and administered by a licensed health care practitioner. They include diagnostic, preventive, therapeutic, curing, treating, mitigating and rehabilitative services, and maintenance or personal-care services.

For your parent to qualify as chronically ill, a physician or other licensed health care practitioner must certify him or her as unable to perform at least two activities of daily living (ADLs) for at least 90 days due to a loss of functional capacity or severe cognitive impairment. ADLs include eating, toileting, transferring, bathing, dressing and continence.

Qualifying as a dependent

If your parent qualifies as your dependent, you can add medical expenses you incur for him or her to your own medical expenses when calculating your deduction. We can help with this determination.

If you aren’t married and you meet the dependency tests for your parent, you may qualify for head-of-household filing status, which has a higher standard deduction and lower tax rates than filing as single. You may be eligible to use this status even if the parent for whom you claim an exemption doesn't live with you.

Selling your parent’s home

In many cases, a move to a nursing home also means selling the parent’s home. Fortunately, up to $250,000 of gain from the sale of a principal residence may be tax-free. To qualify for the $250,000 exclusion, the seller must generally have owned the home for at least two years of the five years before the sale.

Also, the seller must have used the home as a principal residence for at least two of the five years before the sale. However, there’s an exception to the two-of-five-year use test for a seller who becomes physically or mentally unable to care for him- or herself during the five-year period.

LTC insurance

Perhaps your parent is still in good health but is paying for LTC insurance (or you’re paying LTC insurance premiums for yourself). If so, be aware that premiums paid for a qualified LTC insurance contract are deductible as medical expenses (subject to limits) to the extent that they, when combined with other medical expenses, exceed the 7.5%-of-AGI threshold. Such a contract doesn’t provide payment for costs covered by Medicare, is guaranteed renewable and doesn't have a cash surrender value.

The amount of qualified LTC premiums that can be included as medical expenses is based on the age of the insured individual. For 2022 for those 61 to 70 years old, the limit on deductible premiums is $4,510 and for those over 70, the limit is $5,640.

Need more information?

This is just a brief overview of tax breaks that may help offset nursing home and related costs. Contact us if you need more information or assistance.

Large Cash Business Transactions Must Be Reported To The IRS

If your business receives large amounts of cash or cash equivalents, you may be required to report these transactions to the IRS. Here are some details.

The requirements

Each person who, while operating a trade or business, receives more than $10,000 in cash in one transaction (or at least two related transactions), must file Form 8300. What constitutes “related transactions?” Related transactions are conducted within a 24-hour period. But transactions that occur in a greater than 24-hour period may also be deemed related if the recipient knows, or has reason to know, that the transactions are connected.

To complete a Form 8300, you’ll need certain information about the person making the payment. This includes a Social Security or taxpayer identification number.

Reasons behind the reporting

Although many cash transactions are legitimate, the IRS explains that “information reported on (Form 8300) can help stop those who evade taxes, profit from the drug trade, engage in terrorist financing and conduct other criminal activities. The government can often trace money from these illegal activities through the payments reported on Form 8300 and other cash reporting forms.”

It’s important to keep a copy of each Form 8300 for five years from the date you file it, according to the IRS.

“Cash” and “cash equivalents” defined

For Form 8300 reporting purposes, cash includes U.S. currency and coins, as well as foreign money. It also includes cash equivalents such as cashier’s checks (sometimes called bank checks), bank drafts, traveler’s checks and money orders. Money orders and cashier’s checks under $10,000, when used in combination with other forms of cash for a single transaction that exceeds $10,000, are defined as cash for Form 8300 reporting purposes.

Note: Under a separate reporting requirement, banks and other financial institutions report cash purchases of cashier’s checks, treasurer’s checks and/or bank checks, bank drafts, traveler’s checks and money orders with a face value of more than $10,000 by filing currency transaction reports.

Options for filing

Businesses required to file reports of large cash transactions on Form 8300 should know that in addition to filing on paper, e-filing is an option. The form is due 15 days after a transaction and there’s no charge for the e-file option. Businesses that file electronically get an automatic acknowledgment of receipt when they file.

The IRS also reminds businesses that they can “batch file” their reports. This is especially helpful to those required to file many forms.

Setting up an electronic account

To file Form 8300 electronically, a business must set up an account with FinCEN’s Bank Secrecy Act E-Filing System. For more information, visit: bsaefiling.fincen.treas.gov or contact us with questions.

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When Is Employer-provided Life Insurance Taxable?

If your employee benefits include group term life insurance paid by your employer, a portion of the premiums paid for the coverage may be taxable. Depending on the amount of coverage you’re provided, some of it may create undesirable income tax consequences for you.

The cost of the first $50,000 of group term life insurance coverage that your employer pays for is excluded from taxable income and doesn’t add anything to your income tax bill. That’s good news. But the employer-paid cost of group term coverage over $50,000 is taxable income to you. That means it will be included in the taxable wages reported on your Form W-2.

Have you reviewed your W-2?

If you think the tax cost of employer-provided group term life insurance may be too high, first you should determine whether this is actually the case. If a specific dollar amount appears in Box 12 of your Form W-2 (with code “C”), that dollar amount represents your employer’s cost to provide you with group-term life insurance coverage of more than $50,000, minus any amount you paid for the coverage. You’re responsible for federal, state and local taxes on the amount that appears in Box 12 and for the associated employee portion of Social Security and Medicare taxes as well.

But keep in mind that the amount in Box 12 is already included as part of your total “Wages, tips and other compensation” in Box 1 of the W-2. It’s the amount in Box 1 that is reported on your tax return.

How is phantom income calculated?

The cost of employer-provided group term life insurance that will be taxable income to you is determined using the IRS Premium Table based on preset factors such as age. Under these determinations, the amount of taxable income attributed to an older employee is often higher than the premium the employee would pay for comparable coverage under an individual term policy.

This tax trap gets worse as employees gets older and as the amount of their compensation increases.

What are your options?

If you decide that the tax cost is too high for the benefit you’re getting in return, you should find out whether your employer has a “carve-out” plan. That’s a plan that allows selected employees to carve out from the group term coverage. If your employer’s plan doesn’t offer a carve-out, ask if they’d be willing to create one.

There are several types of carve-out plans that employers can offer to their employees. For example, the employer can continue to provide $50,000 of group term insurance (since there’s no tax cost for the first $50,000 of coverage). Then, the employer can either provide the employee with an individual policy for the balance of the coverage or give the employee the amount the employer would have spent for the excess coverage as a cash bonus that the employee can use to pay the premiums on an individual policy.

Do you have questions?

You may have questions about this important topic, such as how much your group term life insurance benefit is adding to your income. Contact us for help with this and other questions.

Too Much Inventory At Your Business? Trim the Fat!

Businesses need to have inventory on hand. But having excess inventory is expensive, so it’s important to keep it as lean as possible. Here are some ways to trim the fat from your inventory without compromising revenue and customer service.

Accuracy first

Effective inventory management starts with an accurate physical inventory count. This allows you to determine your true cost of goods sold and to identify and remedy discrepancies between your physical count and perpetual inventory records. A CPA can introduce an element of objectivity to the counting process and help minimize errors.

Next, compare your inventory costs to those of other companies in your industry. Trade associations often publish benchmarks for:

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

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

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

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

Product mix

Cutting your days-in-inventory ratio should be done based on individual product margins. Stock more products with high margins and high demand and less of everything else. Whenever possible, return excessive supplies of slow-moving materials or products to your suppliers.

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

Reality check

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

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Using Alternative Energy For Business Can Bring Tax Benefits

If you’re a business owner, you might be wondering if using alternative energy technologies in your company can help you manage energy costs and improve your bottom line. If this sounds interesting, you should know there’s also a valuable federal income tax benefit that applies to the acquisition of many types of alternative energy property: the business energy credit.

The credit is intended primarily for business users. But be aware that other energy tax breaks apply if you use alternative energy in your home or if you produce energy for sale.

What property is eligible?

The business energy credit is equal to a portion of the cost of the following types of property (with the caveat that construction must begin before 2024):

• Equipment that uses solar energy to generate electricity for heating and cooling structures, for hot water, or for heat used in industrial or commercial processes (except for swimming pools),
• Equipment that uses solar energy to illuminate a structure inside using fiber-optic-distributed sunlight,
• Specific fuel-cell property,
• Certain small wind energy property,
• Specific waste energy property, and
• Certain offshore wind facilities with construction beginning before 2026.

If construction of equipment that uses solar energy to generate electricity for heating and cooling structures, for hot water, or for heat used in industrial or commercial processes begins this year, the credit rate is 26%. It’s reduced to 22% for construction beginning in calendar year 2023. And if the property isn’t placed in service before 2026, the credit is 10%.

For the other types of property mentioned above, if construction begins this year, the credit is also 26%. It’s also reduced to 22% for construction beginning in 2023. But if the property isn’t placed in service before 2026, the credit is 0%.

The only exception is the final type of property mentioned above, certain offshore wind facilities. This type of property isn’t subject to a phaseout.

The business energy credit is equal to 10% of the following types of property with construction beginning before 2024:

• Specific equipment that is used to produce, distribute, or use energy derived from a geothermal deposit,
• Certain cogeneration property,
• Some microturbine property, and
• Certain equipment that uses the ground, or ground water, to heat or cool a structure.

The downside and the upside

There are several restrictions related to the credit. For example, it isn't available for property acquired with certain nonrecourse financing. Additionally, if the credit is allowable for property, the “basis” of that property is reduced by 50% of the allowable credit.

On the other hand, a favorable aspect is that, for the same property, the credit can sometimes be used in combination with other benefits. Examples include federal income tax expensing, state tax credits and utility rebates.

There are business considerations unrelated to the tax and nontax benefits that may influence your decision to use alternative energy. And even if you choose to use it, you might do so without owning the equipment, which would mean forgoing the business energy credit.

Still wondering?

As you can see, there are many issues to consider and you may have questions. We can help you work through the tax and other financial aspects of these alternative energy tax considerations.

A Tax Break For Educators Gets An Update

Teachers who are setting up their classrooms for a new school year often pay for some of their classroom supplies out-of-pocket. They can recoup some of that cost by taking advantage of a special tax break for educators. This deduction gained new importance after the 2017 passage of the Tax Cuts and Jobs Act (TCJA). For 2022, the deduction amount has increased for the first time since it was enacted.

The old-school way

Before 2018, employees who had unreimbursed out-of-pocket expenses could potentially deduct them if they were ordinary and necessary to the “business” of being an employee. A teacher’s out-of-pocket classroom expenses could qualify. Those expenses were claimed as a miscellaneous deduction, subject to a 2% of adjusted gross income (AGI) floor. That meant that only taxpayers who itemized deductions could enjoy a tax benefit, and then only to the extent that their deductions exceeded the 2% floor.

For 2018 through 2025, the TCJA has suspended miscellaneous itemized deductions subject to the 2% of AGI floor. Fortunately, qualifying educators can still deduct some unreimbursed out-of-pocket classroom costs using the educator expense deduction.

The new-school way

Back in 2002, Congress created the above-the-line educator expense deduction. An above-the-line deduction is one that’s subtracted from your gross income to determine your AGI. It can be claimed even by taxpayers who don’t itemize deductions. This is especially significant because, under the TCJA, the standard deduction has nearly doubled, which means that fewer taxpayers now itemize deductions.

For 2022, qualifying elementary and secondary school teachers and other eligible educators (such as counselors and principals) can deduct up to $300 of qualified expenses. This is up from $250 for 2021. Two married educators who file a joint tax return can deduct up to $600 of unreimbursed expenses, limited to $300 each.

Qualified expenses include amounts paid or incurred during the tax year for books, supplies, computer equipment, related software, services, and other equipment and materials used in classrooms. The cost of certain professional development courses may be deductible. Also, protective items to prevent the spread of COVID-19 such as hand sanitizers, disinfectant and other items recommended by the Centers for Disease Control for this purpose are also deductible. However, homeschooling supplies and nonathletic supplies for health or physical education courses aren’t deductible.

More details

Some additional rules apply to the educator expense deduction. If you’re an educator or you know one who might be interested in this tax break, please contact us for more details.

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Deducting The Costs Of A Self-managed Portfolio

Do you have significant investment-related expenses, including payment for financial service subscriptions, home office maintenance and clerical support? Under the 2017 Tax Cuts and Jobs Act (TCJA), these expenses aren’t deductible if they’re considered investment expenses to produce income. But they are deductible if they’re considered trade or business expenses.

Changing rules

For years before 2018, production-of-income expenses were deductible as miscellaneous itemized deductions subject to a 2%-of-adjusted-gross-income floor. But the TCJA generally suspended such miscellaneous deductions through 2025.

As a result, only the trade or business expense deduction is currently available for investment-related expenses. If you do a significant amount of trading, you should know which category your investment expenses fall into, because qualifying for trade or business expense treatment is more advantageous now.

A trader vs. an investor

To be able to deduct your investment-related expenses as business expenses, you must be engaged in a trade or business. The U.S. Supreme Court held many years ago that individual taxpayers aren’t engaged in a trade or business merely because they manage their own securities investments, regardless of the amount or the extent of the work required.

However, if you can show that your investment activities rise to the level of carrying on a trade or business, you may be considered a trader, who is engaged in a trade or business, rather than an investor, who isn’t. As a trader, you’re entitled to deduct your investment-related expenses as business expenses.

A trader is also entitled to deduct home office expenses if the home office is used exclusively on a regular basis as the trader’s principal place of business. An investor, on the other hand, isn’t entitled to home office deductions because the investment activities aren’t a trade or business.

A two-part test

Since the Supreme Court decision, there has been extensive litigation on the issue of whether a taxpayer is a trader or investor. The U.S. Tax Court has developed a two-part test, both parts of which must be satisfied for a taxpayer to be considered a trader:

1. The taxpayer’s trading is substantial (in other words, sporadic trading isn’t considered a trade or business), and

2. The taxpayer seeks to profit from short-term market swings, rather than from long-term holding of investments.

A taxpayer’s investment activities may be regular, extensive and continuous. But that itself isn’t sufficient for determining that the taxpayer is a trader. To be considered a trader (and therefore entitled to deduct investment-related business expenses) you must show that you buy and sell securities with reasonable frequency with the goal of making a profit on a short-term basis.

In one U.S. Tax Court case, a taxpayer made more than 1,000 trades a year with trading activities averaging about $16 million annually. Even so, the individual was deemed to be an investor rather than a trader, because the holding periods for stocks sold averaged about one year.

Passing the test

Again, to pass the trader test, both parts one and two must be satisfied. Contact us if you have questions or would like to figure out whether you’re an investor or a trader for tax purposes.

How Start-up Costs Of A New Business Affect Your Tax Return

Despite the COVID-19 pandemic, there has been a large increase in the number of new businesses being launched. The latest data available from the U.S. Census Bureau shows that, for the period of June 2020 through June 2021, business applications were up 18.6%. The Bureau measures this by the number of businesses applying for an employer identification number.

Entrepreneurs often don’t know that many of the expenses incurred by start-ups can’t be currently deducted. You should be aware that the way you handle some of your initial expenses can make a large difference in your federal tax bill.

How to treat expenses for tax purposes

If you’re starting or planning to launch a new business, keep these three rules in mind:

1. Start-up costs include those incurred or paid while creating an active trade or business. The costs of investigating the creation of a new business or the acquisition of one are also considered start-up costs.

2. Under the tax code, taxpayers can make a special election to deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the business begins. As you know, $5,000 doesn’t go very far these days! And the $5,000 deduction is reduced dollar-for-dollar by the amount by which your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis.

3. No deductions or amortization deductions are allowed until the year when “active conduct” of your new business begins. Generally, that means the year when the business has all the pieces in place to start earning revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask questions such as: Did the taxpayer undertake the activity intending to earn a profit? Was the taxpayer regularly and actively involved? Did the activity commence?

Be sure to keep detailed records and receipts for these costs, so that nothing falls through the cracks.

Eligible expenses

In general, “start-up” expenses that qualify for the special election are those you make to:

• Investigate the creation or acquisition of a business,
• Create a business, or
• Engage in a for-profit activity in anticipation of that activity becoming an active business.

An expense also must be one that would be deductible if it were incurred after a business began. One example is money you spend analyzing potential markets for a new product or service.

To be eligible as an “organization expense” under the special election, an expense must be related to establishing a corporation or partnership. Examples of organization expenses include legal and accounting fees for services related to organizing a new business and filing fees paid to the state of incorporation.

Plan now

If you have start-up expenses that you’d like to deduct this year, you need to decide whether to take the election described above. Recordkeeping is critical. Contact us about your start-up plans. We can help with the tax and other aspects of your new business.

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Hiring Your Minor Children For Summer Jobs

If you’re a business owner and you hire your children this summer, you can obtain tax breaks and other nontax benefits. The kids can gain on-the-job experience, save for college and learn how to manage money. And you may be able to:

• Shift some of your high-taxed income into tax-free or low-taxed income, and
• Realize payroll tax savings (depending on the child’s age and how your business is organized).

Plus, you can spend more time with your kids.

A legitimate job

If you hire your child, you get a business tax deduction for employee wage expenses. In turn, the deduction reduces your federal income tax bill, your self-employment tax bill (if applicable) and your state income tax bill (if applicable). However, for your business to deduct the wages as a business expense, the work performed by the child must be legitimate and the child’s pay must be reasonable.

Let’s say you operate as a sole proprietor and you’re in the 37% tax bracket. You hire your 16-year-old daughter to help with office work on a full-time basis during the summer and part-time into the fall. Your daughter earns $10,000 during 2022 and doesn’t have any other earnings.

You save $3,700 (37% of $10,000) in income taxes at no income tax cost to your daughter. She can use her standard deduction of $12,950 for 2022 to completely shelter her earnings.

Your family’s taxes are cut even if your daughter’s earnings exceed her standard deduction. Why? The unsheltered earnings will be taxed to your daughter beginning at a rate of 10%, instead of being taxed at your higher rate.

How payroll taxes might be saved

If your business isn’t incorporated and certain other conditions are met, your child’s wages are exempt from Social Security, Medicare and FUTA taxes. Your child must be under age 18 for this to apply (or under age 21 for the FUTA tax exemption). Contact us for how this works.

Be aware that there’s no FICA or FUTA exemption for employing a child if your business is incorporated or a partnership that includes nonparent partners. And payments for the services of your child are subject to income tax withholding, regardless of age, no matter what type of entity you operate.

Keep accurate records

Hiring your child can be a tax-smart idea. Be sure to keep the same records as you would for other employees to substantiate the hours worked and duties performed (such as timesheets and job descriptions). Issue your child a Form W-2. Contact us with questions about how these rules apply to your situation.

After Filing Your Taxes, What Records Can You Toss?

If you’ve filed your 2021 tax return, you may want to do some spring cleaning, starting with tax-related paper clutter. Paring down is good. Just be careful to hold on to essential records that may be needed in the event of an IRS audit. Some documents may be needed to help you collect a future refund or assist with filing your return next year. Before you start tossing or shredding documents, read the rules to learn what must be kept (and for how long) and what can be safely discarded.

The general rules

At a minimum, you should keep tax records for as long as the IRS can audit your tax return or assess additional taxes. That’s usually three years after you file your return. This means you potentially can get rid of most records related to tax returns for 2018 and earlier years.

However, the statute of limitations extends to six years for taxpayers who understate their adjusted gross income by more than 25%. What constitutes an understatement may go beyond simply not reporting items of income. So, to be safe, a general rule of thumb is to save tax records for six years from filing.

Keep some records longer

You need to hang on to some tax-related records beyond the statute of limitations. For example:

• Keep the tax returns themselves indefinitely, so you can prove to the IRS that you did file a legitimate return. (If you didn’t file a return or if you filed a fraudulent return, there’s no statute of limitations.)
• Retain W-2 forms until you begin receiving Social Security benefits. That may seem long, but if questions arise regarding your work record or earnings for a particular year, you’ll need your W-2 forms to help provide the documentation needed.
• Keep records related to real estate or investments for as long as you own the assets, plus at least three years after you sell them and report the sales on your tax return (or six years if you want extra protection).
• Hang on to records associated with retirement accounts until you’ve depleted the accounts and reported the last withdrawal on your tax return, plus three (or six) years.

If you’re still not sure about a specific document, feel free to ask us.

Other reasons to retain records

Keep in mind that these are the federal tax record retention guidelines. Your state and local tax record requirements may differ. In addition, lenders, co-op boards and other private parties may require you to produce copies of your tax returns as a condition of lending money, approving a purchase or otherwise doing business with you. Contact us with questions or concerns about recordkeeping.

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Could You Be Hit With The Trust Fund Recovery Penalty?

There’s a harsh tax penalty that you could be personally responsible to pay if you own or manage a business with employees. It’s called the Trust Fund Recovery Penalty. It applies to the Social Security and income taxes required to be withheld by a business from the wages of its employees.

Because taxes are considered property of the government, the employer holds them in “trust” on the government’s behalf until they’re paid over. The penalty is also sometimes called the “100% penalty” because the person liable and responsible for the taxes can be penalized 100% of the taxes due. Accordingly, the amounts the IRS seeks when the penalty is applied are usually substantial, and the IRS is aggressive in enforcing the penalty.

A wide-reaching penalty

The Trust Fund Recovery Penalty is among the more dangerous tax penalties because it applies both to a broad range of actions and to a wide range of people involved in a business.

Here are some questions and answers to help you avoid incurring the penalty:

What actions are penalized? The Trust Fund Recovery Penalty applies to willful failures to collect or truthfully account for and pay over Social Security and income taxes required to be withheld from employees’ wages.

Who is at risk? The penalty can be imposed on anyone “responsible” for collection and payment of the tax. This has been broadly defined to include corporate officers, directors and shareholders who are under a duty to collect and pay the tax, and a partnership’s partners or any employee of the business with such a duty. Even voluntary board members of tax-exempt organizations, who are generally exempt from responsibility, may be subject to this penalty under certain circumstances. In some cases, responsibility has even been extended to family members close to the business, and to attorneys and accountants.

According to the IRS, responsibility is a matter of status, duty and authority. Anyone with the power to see that the taxes are (or aren’t) paid may be responsible. There’s often more than one responsible person in a business, but each is at risk for the entire penalty. You may not be directly involved with the payroll tax withholding process in your business. But if you learn of a failure to pay over withheld taxes and you have the power to pay them but instead you make payments to creditors and others, you become a responsible person.

Although a taxpayer held liable can sue other responsible people for contribution, this action must be taken after the penalty is paid. It isn’t part of the IRS collection process.

What is considered “willful?” For actions to be willful, they don’t have to include an overt intent to evade taxes. Simply bending to business pressures and paying bills or obtaining supplies instead of paying over withheld taxes that are due to the federal government is willful behavior. The IRS specifically defines “willfully” in this instance as “voluntarily, consciously and intentionally” paying other expenses instead of the withholding taxes.

Just because you delegate these responsibilities to someone else doesn’t necessarily mean you’re off the hook. Your failure to deal with the task yourself can be treated as the willful element.

Never borrow from taxes

Under no circumstances should you ever fail to withhold taxes or “borrow” from withheld amounts. All funds that have been withheld from employee paychecks should be paid over to the government in full and on time. Contact us with any questions about making tax payments.

Taking Casualty Loss Tax Deductions Is Now Harder

Unexpected disasters can happen anywhere, causing damage to your home and personal property. Before the Tax Cuts and Jobs Act (TCJA), eligible casualty loss victims could claim a deduction on their tax returns. But restrictions make it tougher to qualify for these deductions.

What’s considered a casualty for tax purposes? It’s a sudden, unexpected or unusual event, such as a hurricane, tornado, flood, earthquake, fire, act of vandalism or terrorist attack.

Higher hurdles to qualify

The TCJA generally eliminates deductions for personal casualty losses through 2025, unless the losses are due to a federally declared disaster.

There is an exception to the general rule, however: If you receive insurance proceeds that result in a personal casualty gain, you can deduct personal casualty losses up to the amount of the gain, even without a federal disaster declaration.

Special election

If your casualty loss is due to a federally declared disaster, a special election allows you to deduct the loss on your tax return for the preceding year and claim a refund. If you’ve already filed your tax return for that year, you may file an amended return and elect to claim the deduction for the earlier year. This may help you get extra cash when you need it.

The election must be made no later than six months after the due date (without extensions) for filing your tax return for the year in which the disaster occurs. However, the election itself must be made on an original or amended return for the preceding year.

Calculating the deduction

These three steps must be taken to calculate the casualty loss deduction for personal-use property in an area declared a federal disaster:

1. Subtract any insurance proceeds,

2. Subtract $100 per casualty event, and

3. Combine the results from steps 1 and 2, then subtract 10% of your adjusted gross income for the year you claim the loss deduction.

Be aware that another factor that complicates your ability to claim a casualty loss is that you must itemize deductions to do so. The TCJA significantly raised the standard deduction through 2025. For 2022, it is $12,950 for single filers, $19,400 for heads of household and $25,900 for married couples filing jointly. A higher standard deduction means fewer individuals will itemize deductions. So, even if you qualify for a casualty loss deduction, you might not see a tax benefit if you don’t have enough itemized deductions.

Contact us

The rules described here are for personal property. Keep in mind, the rules for business or income-producing property are different. It’s easier to secure a business property casualty loss deduction. If you’re a victim of a disaster (business or personal), we can help you navigate the complex rules.

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Slim Your 2021 Tax Bill By Fattening Your IRA

If you didn’t get around to contributing to an IRA in 2021 and you’re looking for ways to lower your tax bill, you may still have an option. Qualified taxpayers can make deductible contributions to traditional IRAs until the tax filing date of April 18, 2022, and claim the benefit on their 2021 returns.

Who is eligible?

You can make a deductible contribution to a traditional IRA if:

• You (and your spouse) aren’t active participants in an employer-sponsored retirement plan, or
• You (or your spouse) are active participants in an employer plan, but your modified adjusted gross income (MAGI) doesn’t exceed certain levels that vary from year to year by filing status.

For 2021, joint tax return filers who are covered by an employer plan have a deductible IRA contribution phaseout range of $105,000 to $125,000 of MAGI. For taxpayers who are single or a head of household, the phaseout range is $66,000 to $76,000. For married filing separately, the phaseout range is $0 to $10,000. For 2021, if you’re not an active participant in an employer-sponsored retirement plan, but your spouse is, the deductible IRA contribution phaseout range is $198,000 to $208,000 of MAGI.

Deductible IRA contributions reduce your current tax bill, and earnings within the IRA are tax deferred. However, every dollar you take out is taxed in full (and subject to a 10% penalty before age 59½, unless an exception applies).

IRAs are often referred to as “traditional” IRAs to distinguish them from “Roth” IRAs. You also have until April 18 to make a Roth IRA contribution, though, unlike traditional IRA contributions, Roth IRA contributions aren’t deductible. Withdrawals from a Roth IRA are tax-free if the account has been open at least five years and you’re age 59½ or older. (Contributions to a Roth IRA are subject to income limits.)

What’s the contribution limit?

For 2021, if you’re eligible, you can make deductible traditional IRA contributions of up to $6,000. If you were age 50 or older on Dec. 31, 2021, you also may be eligible to make a “catch-up” contribution of up to $1,000.

Alternatively, small business owners can set up and contribute to a Simplified Employee Pension (SEP) IRA up until the due date for their returns, including extensions. For 2021, the maximum SEP contribution is $58,000.

2 alternate IRA strategies

Here are a couple of other ways you may be able to save tax with an IRA:

1. Turn a nondeductible Roth IRA contribution into a deductible IRA contribution. Did you make a Roth IRA contribution in 2021? That’s helpful in the future when you take tax-free payouts from the account, but the contribution isn’t deductible. If a deduction is important now, you can convert a Roth IRA contribution into a traditional IRA contribution using a “recharacterization” mechanism. Assuming you meet the requirements, you may then take a traditional IRA deduction.

2. Make a deductible IRA contribution, even if you don’t work. Generally, you must have wages or other earned income to make a deductible traditional IRA contribution. An exception applies if your spouse is the breadwinner and you’re a homemaker. If so, you may be able to take advantage of a spousal IRA.

For more information about how IRAs or SEPs can help you save the maximum tax-advantaged amount for retirement, contact us.

Hiring? You May Be Eligible For A Valuable Credit

If you’re a business owner who needs to hire, be aware that a law enacted at the end of 2020 extended through 2025 a tax credit for employers that hire individuals from one or more targeted groups. The Work Opportunity Tax Credit (WOTC) is generally worth $2,400 for each eligible employee but can be worth more, in some cases much more.

Targeted groups

Generally, an employer is eligible for the credit only for qualified wages paid to members of a targeted group. These groups are:

1. Qualified members of families that receive assistance under the Temporary Assistance for Needy Families program,

2. Qualified veterans,

3. Qualified ex-felons,

4. Designated community residents,

5. Vocational rehabilitation referrals,

6. Qualified summer youth employees,

7. Qualified members of families in the Supplemental Nutritional Assistance Program (SNAP),

8. Qualified Supplemental Security Income recipients,

9. Long-term family assistance recipients, and

10. Long-term unemployed individuals.

Employer eligibility and requirements

Employers of all sizes are eligible to claim the WOTC. This includes both taxable and certain tax-exempt employers located in the United States and in some U.S. territories. Taxable employers can claim the WOTC against income taxes. However, eligible tax-exempt employers can only claim the WOTC against payroll taxes and only for wages paid to members of the qualified veteran targeted group.

Many additional conditions must be fulfilled before employers can qualify for the credit. Each employee must have completed a minimum of 120 hours of service for the employer. Also, the credit isn’t available for employees who are related to the employer or who previously worked for the employer.

Credit amounts

The credit amounts differ for specific employees. The maximum credit available for the first year’s wages is $2,400 for each employee, or $4,000 for a recipient of long-term family assistance. In addition, for those receiving long-term family assistance, there’s a 50% credit for up to $10,000 of second-year wages. The maximum credit available over two years for these employees is $9,000 ($4,000 for Year 1 and $5,000 for Year 2).

For some veterans, the limits are $4,800, $5,600 or $9,600. For summer youth employees, the wages must be paid for services performed during any 90-day period between May 1 and September 15. The maximum WOTC credit available for summer youth workers is $1,200 per employee.

Worth pursuing

Additional rules and requirements apply. And in limited circumstances, the rules may prohibit the credit or require an allocation of it. However, for most employers that hire from targeted groups, the credit can be valuable. Contact us with questions or for more information about your situation.

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Get more worms by filing your tax return early

They say the early bird gets the worm. Early federal income tax filers may get a couple worms, which is a good thing in this metaphor.

Although it may seem like a quaint tradition to wait until the deadline (usually April 15, but actually April 18 in 2022), there’s more than one valid reason for getting your return completed and submitted well before this date. But you have to have the necessary documents to do so.

Prevent identity theft

In one tax identity theft scheme, a thief uses another individual’s personal information to file a fraudulent tax return early in the filing season and claim a bogus refund. The real taxpayer discovers the fraud when he or she files a return and is told by the IRS that the return is being rejected because one with the same Social Security number has already been filed for the tax year.

While the taxpayer should ultimately be able to prove that his or her return is the legitimate one, tax identity theft can be a hassle to straighten out and significantly delay a refund. Filing early may be your best defense: If you file first, it will be the tax return filed by a potential thief that will be rejected, not yours.

Get a potentially earlier refund

Another reason to file early is you may put yourself closer to the front of the line to receive your tax refund (if you’re owed one). The IRS website still indicates that it expects to issue most refunds for the 2021 tax year within the usual 21 days, despite the massive pandemic-related delays that affected millions of 2020 tax returns.

The time is typically shorter if you file electronically and receive a refund by direct deposit into a bank account. Direct deposit also avoids the possibility that a refund check could be lost, stolen, returned to the IRS as undeliverable or caught in mail delays.

Look for your documents

To file your tax return, you need your Form W-2s (if you’re an employee) and Form 1099s (if you’ve worked as an independent contractor or “gig worker”). January 31 is the deadline for employers to issue 2021 Form W-2s to employees and, generally, for businesses to issue Form 1099s to recipients of any 2021 interest, dividend or reportable miscellaneous income payments (including those made to independent contractors).

If you haven’t received a W-2 or 1099 by February 1, first contact the entity that should have issued it. If that doesn’t work, you can contact the IRS for assistance.

Don’t wait!

As of this writing, some taxpayers may still be waiting to receive their 2020 federal income tax refunds. A few people (mostly on social media) have floated the idea of refusing to file their 2021 income tax returns until they receive their refund. Is this a good idea?

No, it’s not. Failing to file your return will only lead to bigger headaches later, possibly even penalties and criminal prosecution. Plus, if you’re owed a 2021 refund, you may receive that money before your 2020 refund. But the only way to get it is to file!

If you have questions or would like an appointment to prepare your return, please contact us. We can help you ensure you file an accurate return that takes advantage of all the breaks available to you.

Businesses can still deduct 100% of restaurant meals

Business owners, 2022 is well underway. So, don’t forget that a provision tucked inside 2020’s Consolidated Appropriations Act suspended the 50% deduction limit for certain business meals for calendar years 2021 and 2022. That means your business can deduct 100% of the cost of business-related meals provided by a restaurant.

A closer look

As you may recall, previously you could generally deduct only 50% of the “ordinary and necessary” food and beverage costs you incurred while operating your business. Now you can deduct your full eligible costs.

What’s more, the legislation refers to food and beverages provided “by” a restaurant rather than “in” a restaurant. So, takeout and delivery restaurant meals also are fully deductible.

Remember the rules

Some familiar IRS requirements still apply:

• The food and beverages can’t be lavish or extravagant under the circumstances.
• The meal must involve a current or prospective customer, client, supplier, employee, agent, partner or professional advisor with whom you could reasonably expect to engage in the due course of business.
• You or one of your employees must be present when the food or beverages are served.

Entertainment expenses still aren’t deductible, but meals served during entertainment events can be deductible if charged separately. If food or beverages are provided at an entertainment activity, further rules apply.

More information

Also be aware that, in November of last year, the IRS issued guidance on per diems related to the temporary 100% deduction for restaurant food and beverages. Contact us for further details about when you can deduct meal expenses.

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Could your company reap tax benefits from a heavy SUV purchase?

Many businesses need to invest in heavy sport utility vehicles (SUVs) to transport equipment and provide timely services. Fortunately, they may be able to claim valuable tax deductions for the purchases. If you’re thinking about buying one (or if your bought one in 2021), be sure to brush up on the tax rules.

Bonus depreciation

Under current law, first-year bonus depreciation is available for qualified new and used property that’s acquired and placed in service during the tax year. New and pre-owned heavy SUVs, pickups and vans acquired and put to business use in 2021 or 2022 are potentially eligible for 100% first-year bonus depreciation.

Be aware that this generous tax break is scheduled to begin to be reduced for vehicles that are acquired and placed in service after December 31, 2022. That’s added incentive to invest in a heavy SUV this year.

The 100% first-year bonus depreciation write-off will reduce your federal income tax bill and self-employment tax bill, if applicable. You might get a state income tax deduction, too.

Weight and use requirements

100% bonus depreciation is available only if the manufacturer’s gross vehicle weight rating (GVWR) is above 6,000 pounds. You can verify a vehicle’s GVWR by looking at the manufacturer’s label, usually found on the inside edge of the driver’s side door where the door hinges meet the frame.

Another requirement is that you must use the vehicle more than 50% for business. If your business use is between 51% and 99%, you can deduct that percentage of the cost in the first year the vehicle is placed in service.

Detailed, contemporaneous expense records are essential in case the IRS challenges your business-use percentage. So, keep track of the miles you’re driving for business purposes, compared to the vehicle’s total mileage for the year. Recordkeeping is easier today because of the many mobile apps designed for this purpose.

You could also simply keep a handwritten calendar or mileage log in your vehicle and record details as business trips occur. Maintaining contemporaneous records is critical; calendars or logs compiled after the fact may not withstand IRS scrutiny.

The right moves

Did you purchase an eligible vehicle and place it in service in 2021? Or are you considering doing so in 2022? Consult with us to help evaluate the right business tax moves.

Tracking down donation substantiation

If you’re like many Americans, letters from your favorite charities may be appearing in your mailbox acknowledging your 2021 donations. But what happens if you haven’t received such a letter? Can you still claim a deduction for the gift on your 2021 income tax return? It depends.

What’s required

To support a charitable deduction, you need to comply with IRS substantiation requirements. This generally includes obtaining a contemporaneous written acknowledgment from the charity stating the amount of the donation if it’s cash. If the donation is property, the acknowledgment must describe the property, but the charity isn’t required to provide a value. The donor must determine the property’s value.

“Contemporaneous” means the earlier of the date you file your tax return or the extended due date of your return. So, if you donated in 2021 but haven’t yet received substantiation from the charity, it’s not too late (as long as you haven’t filed your 2021 return). Contact the charity and request a written acknowledgment.

Keep in mind that, if you made a cash gift of under $250 with a check or credit card, generally a canceled check, bank statement or credit card statement is sufficient. However, if you received something in return for the donation, you generally must reduce your deduction by its value and the charity is required to provide you a written acknowledgment as described earlier.

Deduction for nonitemizers

Generally, taxpayers who don’t itemize their deductions (and instead claim the standard deduction) can’t claim a charitable deduction. But, under the CARES Act, individuals who didn’t itemize deductions could claim a federal income tax write-off for up to $300 of cash contributions to IRS-approved charities for the 2020 tax year.

Fortunately, the Consolidated Appropriations Act extended this tax break to cover $300 of cash contributions made in 2021. The law also doubled the deduction limit to $600 for married, joint-filing couples for cash contributions made in 2021.

Let us assist you

Additional substantiation requirements apply to some types of donations. We can help you determine whether you have sufficient substantiation for the donations you hope to deduct on your 2021 income tax return. We also can guide you on the substantiation you’ll need for gifts you’re planning this year to ensure you can enjoy the desired deductions on your 2022 return.

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