News & Planning Information
Should you buy a business vehicle before year end?
One way to reduce your 2017 tax bill is to buy a business vehicle before year end. But don’t make a purchase without first looking at what your 2017 deduction would be and whether tax reform legislation could affect the tax benefit of a 2017 vs. 2018 purchase.
Your 2017 deduction
Business-related purchases of new or used vehicles may be eligible for Section 179 expensing, which allows you to immediately deduct, rather than depreciate over a period of years, some or all of the vehicle’s cost. But the size of your 2017 deduction will depend on several factors. One is the gross vehicle weight rating.
The normal Sec. 179 expensing limit generally applies to vehicles with a gross vehicle weight rating of more than 14,000 pounds. The limit for 2017 is $510,000, and the break begins to phase out dollar-for-dollar when total asset acquisitions for the tax year exceed $2.03 million.
But a $25,000 limit applies to SUVs rated at more than 6,000 pounds but no more than 14,000 pounds. Vehicles rated at 6,000 pounds or less are subject to the passenger automobile limits. For 2017, under current law, the depreciation limit is $3,160. And the amount that may be deducted under the combination of Modified Accelerated Cost Recovery System (MACRS) depreciation and Sec. 179 for the first year is limited under the luxury auto rules to $11,160.
In addition, if a vehicle is used for business and personal purposes, the associated expenses, including depreciation, must be allocated between deductible business use and nondeductible personal use. The depreciation limit is reduced if the business use is less than 100%. If the business use is 50% or less, you can’t use Sec. 179 expensing or the accelerated regular MACRS; you must use the straight-line method.
Factoring in tax reform
If tax reform legislation is signed into law and it will cause your marginal rate to go down in 2018, then purchasing a vehicle by December 31, 2017, could save you more tax than waiting until 2018. Why? Tax deductions are more powerful when rates are higher. But if your 2017 Sec. 179 expense deduction would be reduced or eliminated because of the asset acquisition phaseout, then you might be better off waiting until 2018 to buy.
Also be aware that tax reform legislation could affect the depreciation limits for passenger vehicles, even if purchased in 2017.
These are just a few factors to look at. Many additional rules and limits apply to these breaks. So if you’re considering a business vehicle purchase, contact us to discuss whether it would make more tax sense to buy this year or next.
2018 Q1 tax calendar: Key deadlines for businesses and other employers
Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2018. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
- File 2017 Forms W-2, “Wage and Tax Statement,” with the Social Security Administration and provide copies to your employees.
- Provide copies of 2017 Forms 1099-MISC, “Miscellaneous Income,” to recipients of income from your business where required.
- File 2017 Forms 1099-MISC reporting nonemployee compensation payments in Box 7 with the IRS.
- File Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” for 2017. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it’s more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 12 to file the return.
- File Form 941, “Employer’s Quarterly Federal Tax Return,” to report Medicare, Social Security and income taxes withheld in the fourth quarter of 2017. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until February 12 to file the return. (Employers that have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944,“Employer’s Annual Federal Tax Return.”)
- File Form 945, “Annual Return of Withheld Federal Income Tax,” for 2017 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on accounts such as pensions, annuities and IRAs. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 12 to file the return.
- File 2017 Forms 1099-MISC with the IRS if 1) they’re not required to be filed earlier and 2) you’re filing paper copies. (Otherwise, the filing deadline is April 2.)
- If a calendar-year partnership or S corporation, file or extend your 2017 tax return and pay any tax due. If the return isn’t extended, this is also the last day to make 2017 contributions to pension and profit-sharing plans.
Accrual-basis taxpayers: These year-end tips could save you tax
With the possibility that tax law changes could go into effect next year that would significantly reduce income tax rates for many businesses, 2017 may be an especially good year to accelerate deductible expenses. Why? Deductions save more tax when rates are higher.
Timing income and expenses can be a little more challenging for accrual-basis taxpayers than for cash-basis ones. But being an accrual-basis taxpayer also offers valuable year-end tax planning opportunities when it comes to deductions.
Tracking incurred expenses
The key to saving tax as an accrual-basis taxpayer is to properly record and recognize expenses that were incurred this year but won’t be paid until 2018. This will enable you to deduct those expenses on your 2017 federal tax return. Common examples of such expenses include:
- Commissions, salaries and wages,
- Payroll taxes,
- Insurance, and
- Property taxes.
You can also accelerate deductions into 2017 without actually paying for the expenses in 2017 by charging them on a credit card. (This works for cash-basis taxpayers, too.)
As noted, accelerating deductible expenses into 2017 may be especially beneficial if tax rates go down for 2018.
Also review all prepaid expense accounts. Then write off any items that have been used up before the end of the year.
If you prepay insurance for a period of time beginning in 2017, you can expense the entire amount this year rather than spreading it between 2017 and 2018, as long as a proper method election is made. This is treated as a tax expense and thus won’t affect your internal financials.
And there’s more …
Here are a few more year-end tax tips to consider:
- Review your outstanding receivables and write off any receivables you can establish as uncollectible.
- Pay interest on all shareholder loans to or from the company.
- Update your corporate record book to record decisions and be better prepared for an audit.
To learn more about how these and other year-end tax strategies may help your business reduce its 2017 tax bill, contact us.
Getting around the $25 deduction limit for business gifts
At this time of year, it’s common for businesses to make thank-you gifts to customers, clients, employees and other business entities and associates. Unfortunately, the tax rules limit the deduction for business gifts to $25 per person per year, a limitation that has remained the same since it was added into law back in 1962. Fifty-five years later, the $25 limit is unrealistically small in many business gift-giving situations. Fortunately, there are a few exceptions.
Here’s a quick rundown of the major exceptions to the $25 limit:
Gifts to a business entity. The $25 limit applies only to gifts directly or indirectly given to an individual. Gifts given to a company for use in the business aren’t subject to the limit. For example, a gift of a $200 reference manual to a company for its employees to use while doing their jobs would be fully deductible because it’s used in the company’s business.
Gifts to a married couple. If you have a business connection with both spouses and the gift is for both of them, the $25 limit doubles to $50.
Incidental costs of making a gift. Such costs aren’t subject to the limit. For example, the costs of custom engraving on jewelry or of packing, insuring and mailing a gift are deductible over and above the $25 limit for the gift itself.
Gifts to employees. Although employee gifts have their own limitations and may be treated as taxable compensation, an employer is generally allowed to deduct the full cost of gifts made to employees.
Gifts vs. entertainment expenses
In some situations related to gifts of tickets to sporting or other events, a taxpayer may choose whether to claim the deduction as a gift or as entertainment. Under current law, entertainment expenses are normally 50% deductible, so the gift deduction is a better deal for lower-priced tickets. But once the combined price of the gifted tickets exceeds $50, claiming them as an entertainment expense is more beneficial.
Be aware, however, that the elimination of the entertainment expense deduction has been included in proposed tax reform legislation. If legislation with such a provision is signed into law, it likely won’t go into effect until 2018.
Track and document
To the extent your business qualifies for any of these exceptions, be sure to track the qualifying expenses separately (typically by charging them to a separate account in your accounting records) so that a full deduction can be claimed.
In addition, you must retain documentation of the following:
- A description of the gift,
- The gift’s cost,
- The date the gift was made,
- The business purpose of the gift, and
- The business relationship to the taxpayer of the person receiving the gift.
If you have any questions regarding the types of gifts or gift-giving situations that may qualify for a full deduction or how to properly isolate and account for them in your records, please contact us.
Reduce your 2017 tax bill by buying business assets
Two valuable depreciation-related tax breaks can potentially reduce your 2017 taxes if you acquire and place in service qualifying assets by the end of the tax year. Tax reform could enhance these breaks, so you’ll want to keep an eye on legislative developments as you plan your asset purchases.
Section 179 expensing
Sec. 179 expensing allows businesses to deduct up to 100% of the cost of qualifying assets (new or used) in Year 1 instead of depreciating the cost over a number of years. Sec. 179 can be used for fixed assets, such as equipment, software and real property improvements.
The Sec. 179 expensing limit for 2017 is $510,000. The break begins to phase out dollar-for-dollar for 2017 when total asset acquisitions for the tax year exceed $2.03 million. Under current law, both limits are indexed for inflation annually.
Under the initial version of the House bill, the limit on Sec. 179 expensing would rise to $5 million, with the phaseout threshold increasing to $20 million. These higher amounts would be adjusted for inflation, and the definition of qualifying assets would be expanded slightly. The higher limits generally would apply for 2018 through 2022.
The initial version of the Senate bill also would increase the Sec. 179 expensing limit, but only to $1 million, and would increase the phaseout threshold, but only to $2.5 million. The higher limits would be indexed for inflation and generally apply beginning in 2018. Significantly, unlike under the House bill, the higher limits would be permanent under the Senate bill. There would also be some small differences in which assets would qualify under the Senate bill vs. the House bill.
First-year bonus depreciation
For qualified new assets (including software) that your business places in service in 2017, you can claim 50% first-year bonus depreciation. Examples of qualifying assets include computer systems, software, machinery, equipment, office furniture and qualified improvement property. Currently, bonus depreciation is scheduled to drop to 40% for 2018 and 30% for 2019 and then disappear for 2020.
The initial House bill would boost bonus depreciation to 100% for qualifying assets (which would be expanded to include certain used assets) acquired and placed in service after September 27, 2017, and before January 1, 2023 (with an additional year for certain property with a longer production period).
The initial Senate bill would allow 100% bonus depreciation for qualifying assets acquired and placed in service during the same period as under the House bill, though there would be some differences in which assets would qualify.
If you’ve been thinking about buying business assets, consider doing it before year end to reduce your 2017 tax bill. If, however, you could save more taxes under tax reform legislation, for now you might want to limit your asset investments to the maximum Sec.179 expense election currently available to you, and then consider additional investments depending on what happens with tax reform. It’s still uncertain what the final legislation will contain and whether it will be passed and signed into law this year. Contact us to discuss the best strategy for your particular situation.
2017 might be your last chance to hire veterans and claim a tax credit
With Veterans Day on November 11, it’s an especially good time to think about the sacrifices veterans have made for us and how we can support them. One way businesses can support veterans is to hire them. The Work Opportunity tax credit (WOTC) can help businesses do just that, but it may not be available for hires made after this year.
As released by the Ways and Means Committee of the U.S. House of Representatives on November 2, the Tax Cuts and Jobs Act would eliminate the WOTC for hires after December 31, 2017. So you may want to consider hiring qualifying veterans before year end.
The WOTC up close
You can claim the WOTC for a portion of wages paid to a new hire from a qualifying target group. Among the target groups are eligible veterans who receive benefits under the Supplemental Nutrition Assistance Program (commonly known as “food stamps”), who have a service-related disability or who have been unemployed for at least four weeks. The maximum credit depends in part on which of these factors apply:
- Food stamp recipient or short-term unemployed (at least 4 weeks but less than 6 months): $2,400
- Disabled: $4,800
- Long-term unemployed (at least 6 months): $5,600
- Disabled and long-term unemployed: $9,600
The amount of the credit also depends on the wages paid to the veteran and the number of hours the veteran worked during the first year of employment.
You aren’t subject to a limit on the number of eligible veterans you can hire. For example, if you hire 10 disabled long-term-unemployed veterans, the credit can be as much as $96,000.
Before claiming the WOTC, you generally must obtain certification from a “designated local agency” (DLA) that the hired individual is indeed a target group member. You must submit IRS Form 8850, “Pre-Screening Notice and Certification Request for the Work Opportunity Credit,” to the DLA no later than the 28th day after the individual begins work for you.
Also be aware that veterans aren’t the only target groups from which you can hire and claim the WOTC. But in many cases hiring a veteran will provided the biggest credit. Plus, research assembled by the Institute for Veterans and Military Families at Syracuse University suggests that the skills and traits of people with a successful military employment track record make for particularly good civilian employees.
It’s still uncertain whether the WOTC will be repealed. The House bill likely will be revised as lawmakers negotiate on tax reform, and it’s also possible Congress will be unable to pass tax legislation this year. Under current law, the WOTC is scheduled to be available through 2019.
But if you’re looking to hire this year, hiring veterans is worth considering for both tax and nontax reasons. Contact us for more information on the WOTC or on other year-end tax planning strategies in light of possible tax law changes.
Research credit can offset a small business’s payroll taxes
Does your small business engage in qualified research activities? If so, you may be eligible for a research tax credit that you can use to offset your federal payroll tax bill.
This relatively new privilege allows the research credit to benefit small businesses that may not generate enough taxable income to use the credit to offset their federal income tax bills, such as those that are still in the unprofitable start-up phase where they owe little or no federal income tax.
Under the Protecting Americans from Tax Hikes Act of 2015, a qualified small business (QSB) can elect to use up to $250,000 of its research credit to reduce the Social Security tax portion of its federal payroll tax bills. Under the old rules, businesses could use the credit to offset only their federal income tax bills. However, many small businesses owe little or no federal income tax, especially small start-ups that tend to incur significant research expenses.
For the purposes of the research credit, a QSB is generally defined as a business with:
- Gross receipts of less than $5 million for the current tax year, and
- No gross receipts for any taxable year preceding the five-taxable-year period ending with the current tax year.
The allowable payroll tax reduction credit can’t exceed the employer portion of the Social Security tax liability imposed for any calendar quarter. Any excess credit can be carried forward to the next calendar quarter, subject to the Social Security tax limitation for that quarter.
Research activities that qualify
To be eligible for the research credit, a business must have engaged in “qualified” research activities. To be considered “qualified,” activities must meet the following four-factor test:
- The purpose must be to create new (or improve existing) functionality, performance, reliability or quality of a product, process, technique, invention, formula or computer software that will be sold or used in your trade or business.
- There must be an intention to eliminate uncertainty.
- There must be a process of experimentation. In other words, there must be a trial-and-error process.
- The process of experimentation must fundamentally rely on principles of physical or biological science, engineering or computer science.
Expenses that qualify for the credit include wages for time spent engaging in supporting, supervising or performing qualified research, supplies consumed in the process of experimentation, and 65% of any contracted outside research expenses.
The ability to use the research credit to reduce payroll tax is a welcome change for eligible small businesses, but the rules are complex and we’ve only touched on the basics here. We can help you determine whether you qualify and, if you do, assist you with making the election for your business and filing payroll tax returns to take advantage of the new privilege.
How to maximize deductions for business real estate
Currently, a valuable income tax deduction related to real estate is for depreciation, but the depreciation period for such property is long and land itself isn’t depreciable. Whether real estate is occupied by your business or rented out, here’s how you can maximize your deductions.
Segregate personal property from buildings
Generally, buildings and improvements to them must be depreciated over 39 years (27.5 years for residential rental real estate and certain other types of buildings or improvements). But personal property, such as furniture and equipment, generally can be depreciated over much shorter periods. Plus, for the tax year such assets are acquired and put into service, they may qualify for 50% bonus depreciation or Section 179 expensing (up to $510,000 for 2017, subject to a phaseout if total asset acquisitions for the tax year exceed $2.03 million).
If you can identify and document the items that are personal property, the depreciation deductions for those items generally can be taken more quickly. In some cases, items you’d expect to be considered parts of the building actually can qualify as personal property. For example, depending on the circumstances, lighting, wall and floor coverings, and even plumbing and electrical systems, may qualify.
Carve out improvements from land
As noted above, the cost of land isn’t depreciable. But the cost of improvements to land is depreciable. Separating out land improvement costs from the land itself by identifying and documenting those improvements can provide depreciation deductions. Common examples include landscaping, roads, and, in some cases, grading and clearing.
Convert land into a deductible asset
Because land isn’t depreciable, you may want to consider real estate investment alternatives that don’t involve traditional ownership. Such options can allow you to enjoy tax deductions for land costs that provide a similar tax benefit to depreciation deductions. For example, you can lease land long-term. Rent you pay under such a “ground lease” is deductible.
Another option is to purchase an “estate-for-years,” under which you own the land for a set period and an unrelated party owns the interest in the land that begins when your estate-for-years ends. You can deduct the cost of the estate-for-years over its duration.
More limits and considerations
There are additional limits and considerations involved in these strategies. Also keep in mind that tax reform legislation could affect these techniques. For example, immediate deductions could become more widely available for many costs that currently must be depreciated. If you’d like to learn more about saving income taxes with business real estate, please contact us.
Which tax-advantaged health account should be part of your benefits package?
On October 12, an executive order was signed that, among other things, seeks to expand Health Reimbursement Arrangements (HRAs). HRAs are just one type of tax-advantaged account you can provide your employees to help fund their health care expenses. Also available are Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs). Which one should you include in your benefits package? Here’s a look at the similarities and differences:
HRA. An HRA is an employer-sponsored account that reimburses employees for medical expenses. Contributions are excluded from taxable income and there’s no government-set limit on their annual amount. But only you as the employer can contribute to an HRA; employees aren’t allowed to contribute.
Also, the Affordable Care Act puts some limits on how HRAs can be offered. The October 12 executive order directs the Secretaries of the Treasury, Labor, and Health and Human Services to consider proposing regs or revising guidance to “increase the usability of HRAs,” expand the ability of employers to offer HRAs to their employees, and “allow HRAs to be used in conjunction with nongroup coverage.”
HSA. If you provide employees a qualified high-deductible health plan (HDHP), you can also sponsor HSAs for them. Pretax contributions can be made by both you and the employee. The 2017 contribution limits (employer and employee combined) are $3,400 for self-only coverage and $6,750 for family coverage. The 2018 limits are $3,450 and $6,900, respectively. Plus, for employees age 55 or older, an additional $1,000 can be contributed.
The employee owns the account, which can bear interest or be invested, growing tax-deferred similar to an IRA. Withdrawals for qualified medical expenses are tax-free, and employees can carry over a balance from year to year.
FSA. Regardless of whether you provide an HDHP, you can sponsor FSAs that allow employees to redirect pretax income up to a limit you set (not to exceed $2,600 in 2017 and expected to remain the same for 2018). You, as the employer, can make additional contributions, generally either by matching employer contributions up to 100% or by contributing up to $500. The plan pays or reimburses employees for qualified medical expenses.
What employees don’t use by the plan year’s end, they generally lose — though you can choose to have your plan allow employees to roll over up to $500 to the next year or give them a 2 1/2-month grace period to incur expenses to use up the previous year’s contribution. If employees have an HSA, their FSA must be limited to funding certain “permitted” expenses.
If you’d like to offer your employees a tax-advantaged way to fund health care costs but are unsure which type of account is best for your business and your employees, please contact us. We can provide the additional details you need to make a sound decision.
Accelerate your retirement savings with a cash balance plan
Business owners may not be able to set aside as much as they’d like in tax-advantaged retirement plans. Typically, they’re older and more highly compensated than their employees, but restrictions on contributions to 401(k) and profit-sharing plans can hamper retirement-planning efforts. One solution may be a cash balance plan.
Defined benefit plan with a twist
The two most popular qualified retirement plans — 401(k) and profit-sharing plans — are defined contribution plans. These plans specify the amount that goes into an employee’s retirement account today, typically a percentage of compensation or a specific dollar amount.
In contrast, a cash balance plan is a defined benefit plan, which specifies the amount a participant will receive in retirement. But unlike traditional defined benefit plans, such as pensions, cash balance plans express those benefits in the form of a 401(k)-style account balance, rather than a formula tied to years of service and salary history.
The plan allocates annual “pay credits” and “interest credits” to hypothetical employee accounts. This allows participants to earn benefits more uniformly over their careers, and provides a clearer picture of benefits than a traditional pension plan.
Greater savings for owners
A cash balance plan offers significant advantages for business owners — particularly those who are behind on their retirement saving and whose employees are younger and lower-paid. In 2017, the IRS limits employer contributions and employee deferrals to defined contribution plans to $54,000 ($60,000 for employees age 50 or older). And nondiscrimination rules, which prevent a plan from unfairly favoring highly compensated employees (HCEs), can reduce an owner’s contributions even further.
But cash balance plans aren’t bound by these limits. Instead, as defined benefit plans, they’re subject to a cap on annual benefit payouts in retirement (currently, $215,000), and the nondiscrimination rules require that only benefits for HCEs and non-HCEs be comparable.
Contributions may be as high as necessary to fund those benefits. Therefore, a company may make sizable contributions on behalf of owner/employees approaching retirement (often as much as three or four times defined contribution limits), and relatively smaller contributions on behalf of younger, lower-paid employees.
There are some potential risks. The most notable one is that, unlike with profit-sharing plans, you can’t reduce or suspend contributions during difficult years. So, before implementing a cash balance plan, it’s critical to ensure that your company’s cash flow will be steady enough to meet its funding obligations.
Right for you?
Although cash balance plans can be more expensive than defined contribution plans, they’re a great way to turbocharge your retirement savings. We can help you decide whether one might be right for you.
Timing strategies could become more powerful in 2017, depending on what happens with tax reform
Projecting your business income and expenses for this year and next can allow you to time when you recognize income and incur deductible expenses to your tax advantage. Typically, it’s better to defer tax. This might end up being especially true this year, if tax reform legislation is signed into law.
Timing strategies for businesses
Here are two timing strategies that can help businesses defer taxes:
1. Defer income to next year. If your business uses the cash method of accounting, you can defer billing for your products or services. Or, if you use the accrual method, you can delay shipping products or delivering services.
2. Accelerate deductible expenses into the current year. If you’re a cash-basis taxpayer, you may make a state estimated tax payment before December 31, so you can deduct it this year rather than next. Both cash- and accrual-basis taxpayers can charge expenses on a credit card and deduct them in the year charged, regardless of when the credit card bill is paid.
Potential impact of tax reform
These deferral strategies could be particularly powerful if tax legislation is signed into law this year that reflects the nine-page “Unified Framework for Fixing Our Broken Tax Code” that President Trump and congressional Republicans released on September 27.
Among other things, the framework calls for reduced tax rates for corporations and flow-through entities as well as the elimination of many business deductions. If such changes were to go into effect in 2018, there could be a significant incentive for businesses to defer income to 2018 and accelerate deductible expenses into 2017.
But if you think you’ll be in a higher tax bracket next year (such as if your business is having a bad year in 2017 but the outlook is much brighter for 2018 and you don’t expect that tax rates will go down), consider taking the opposite approach instead — accelerating income and deferring deductible expenses. This will increase your tax bill this year but might save you tax over the two-year period.
Because of tax law uncertainty, in 2017 you may want to wait until closer to the end of the year to implement some of your year-end tax planning strategies. But you need to be ready to act quickly if tax legislation is signed into law. So keep an eye on developments in Washington and contact us to discuss the best strategies for you this year based on your particular situation.
2 ways spouse-owned businesses can reduce their self-employment tax bill
If you own a profitable, unincorporated business with your spouse, you probably find the high self-employment (SE) tax bills burdensome. An unincorporated business in which both spouses are active is typically treated by the IRS as a partnership owned 50/50 by the spouses. (For simplicity, when we refer to “partnerships,” we’ll include in our definition limited liability companies that are treated as partnerships for federal tax purposes.)
For 2017, that means you’ll each pay the maximum 15.3% SE tax rate on the first $127,200 of your respective shares of net SE income from the business. Those bills can mount up if your business is profitable. To illustrate: Suppose your business generates $250,000 of net SE income in 2017. Each of you will owe $19,125 ($125,000 × 15.3%), for a combined total of $38,250.
Fortunately, there are ways spouse-owned businesses can lower their combined SE tax hit. Here are two.
1. Establish that you don’t have a spouse-owned partnership
While the IRS creates the impression that involvement by both spouses in an unincorporated business automatically creates a partnership for federal tax purposes, in many cases, it will have a tough time making the argument — especially when:
- The spouses have no discernible partnership agreement, and
- The business hasn’t been represented as a partnership to third parties, such as banks and customers.
If you can establish that your business is a sole proprietorship (or a single-member LLC treated as a sole proprietorship for tax purposes), only the spouse who is considered the proprietor owes SE tax.
Let’s assume the same facts as in the previous example, except that your business is a sole proprietorship operated by one spouse. Now you have to calculate SE tax for only that spouse. For 2017, the SE tax bill is $23,023 [($127,200 × 15.3%) + ($122,800 × 2.9%)]. That’s much less than the combined SE tax bill from the first example ($38,250).
2. Establish that you don’t have a 50/50 spouse-owned partnership
Even if you do have a spouse-owned partnership, it’s not a given that it’s a 50/50 one. Your business might more properly be characterized as owned, say, 80% by one spouse and 20% by the other spouse, because one spouse does much more work than the other.
Let’s assume the same facts as in the first example, except that your business is an 80/20 spouse-owned partnership. In this scenario, the 80% spouse has net SE income of $200,000, and the 20% spouse has net SE income of $50,000. For 2017, the SE tax bill for the 80% spouse is $21,573 [($127,200 × 15.3%) + ($72,800 × 2.9%)], and the SE tax bill for the 20% spouse is $7,650 ($50,000 × 15.3%). The combined total SE tax bill is only $29,223 ($21,573 + $7,650).
More-complicated strategies are also available. Contact us to learn more about how you can reduce your spouse-owned business’s SE taxes.
Should your business use per diem rates for travel reimbursement?
Updated travel per diem rates go into effect October 1. To simplify recordkeeping, they can be used for reimbursement of ordinary and normal business expenses incurred while employees travel away from home.
Per diem advantages
As long as employees properly account for their business-travel expenses, reimbursements are generally tax-free to the employees and deductible by the employer. But keeping track of actual costs can be a headache.
With the per diem rates, employees don’t have to keep receipts for covered travel expenses. They just need to document the time, place and business purpose of the travel. Assuming that the travel qualifies as a business expense, the employer simply pays the employee the per diem allowance designated for the specific travel destination and deducts the per diem paid.
Although the per diem rates are set by the General Services Administration (GSA) to cover travel by government employees, private employers may use them for tax purposes. The rates are updated annually for the following areas:
- The 48 states in the continental United States and the District of Columbia (CONUS),
- Nonstandard Areas (NSAs) that are in CONUS but have per diem rates higher than the standard CONUS rates,
- Certain areas outside the continental United States, including Alaska, Hawaii, Puerto Rico and U.S. possessions (OCONUS), and
- Foreign countries.
The rates include amounts for lodging and for meals and incidental expenses (M&IE) but not airfare and other transportation costs.
For October 1, 2017, through September 30, 2018, the per diem standard CONUS rate is $144, an increase of $2 over the prior year. This rate consists of $93 for lodging and $51 for M&IE. Also effective October 1, there are 332 NSAs. The following locations have moved from NSAs into the standard CONUS rate:
- California: Redding
- Iowa: Cedar Rapids
- Idaho: Bonners Ferry / Sandpoint
- North Dakota: Dickenson / Beulah
- New York: Watertown
- Ohio: Youngstown
- Oklahoma: Enid
- Pennsylvania: Mechanicsburg
- Texas: Laredo, McAllen, Pearsall and San Angelo
- Wyoming: Gillette.
There are no new NSA locations.
What’s right for you?
As noted earlier, the per diem changes go into effect on October 1, 2017. During the last three months of 2017, an employer may switch to the new rates or continue with the old rates. But an employer must select one set of rates for this quarter and stick with it; it can’t use the old rates for some employees and the new rates for others.
Because travel expenses often attract IRS attention, they require careful recordkeeping. The per diem method can help, but it’s not the best solution for all employers. An even simpler “high-low” per diem method is also available. And, in some cases, a policy of reimbursing actual expenses could be beneficial, despite the recordkeeping hassles. If you have questions regarding travel expense reimbursements, please contact us.
2017 Q4 tax calendar: Key deadlines for businesses and other employers
Here are some of the key tax-related deadlines affecting businesses and other employers during the fourth quarter of 2017. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
- If a calendar-year C corporation that filed an automatic six-month extension:
- File a 2016 income tax return (Form 1120) and pay any tax, interest and penalties due.
- Make contributions for 2016 to certain employer-sponsored retirement plans.
- Report income tax withholding and FICA taxes for third quarter 2017 (Form 941) and pay any tax due. (See exception below.)
- Report income tax withholding and FICA taxes for third quarter 2017 (Form 941), if you deposited on time and in full all of the associated taxes due.
- If a calendar-year C corporation, pay the fourth installment of 2017 estimated income taxes.
Tax planning critical when buying a business
If you acquire a company, your to-do list will be long, which means you can’t devote all of your time to the deal’s potential tax implications. However, if you neglect tax issues during the negotiation process, the negative consequences can be serious. To improve the odds of a successful acquisition, it’s important to devote resources to tax planning before your deal closes.
Complacency can be costly
During deal negotiations, you and the seller should discuss such issues as whether and how much each party can deduct their transaction costs and how much in local, state and federal tax obligations the parties will owe upon signing the deal. Often, deal structures (such as asset sales) that typically benefit buyers have negative tax consequences for sellers and vice versa. So it’s common for the parties to wrangle over taxes at this stage.
Just because you seem to have successfully resolved tax issues at the negotiation stage doesn’t mean you can become complacent. With adequate planning, you can spare your company from costly tax-related surprises after the transaction closes and you begin to integrate the acquired business. Tax management during integration can also help your company capture synergies more quickly and efficiently.
You may, for example, have based your purchase price on the assumption that you’ll achieve a certain percentage of cost reductions via postmerger synergies. However, if your taxation projections are flawed or you fail to follow through on earlier tax assumptions, you may not realize such synergies.
Merging accounting functions
One of the most important tax-related tasks is the integration of your seller’s and your own company’s accounting departments. There’s no time to waste: You generally must file federal and state income tax returns — either as a combined entity or as two separate sets — after the first full quarter following your transaction’s close. You also must account for any short-term tax obligations arising from your acquisition.
To ensure the two departments integrate quickly and are ready to prepare the required tax documents, decide well in advance of closing which accounting personnel you’ll retain. If you and your seller use different tax processing software or follow different accounting methods, choose between them as soon as feasible. Understand that, if your acquisition has been using a different accounting method, you’ll need to revise the company’s previous tax filings to align them with your own accounting system.
The tax consequences of M&A decisions may be costly and could haunt your company for years. We can help you ensure you plan properly and minimize any potentially negative tax consequences.
Larger deduction might be available to businesses providing meals to their employees
When businesses provide meals to their employees, generally their deduction is limited to 50%. But there are exceptions. One is if the meal qualifies as a de minimis fringe benefit under the Internal Revenue Code.
A recent U.S. Tax Court ruling could ultimately mean that more employer-provided meals will be 100% deductible under this exception. The court found that the Boston Bruins hockey team’s pregame meals to players and personnel at out-of-town hotels qualified as a de minimis fringe benefit.
For meals to qualify as a de minimis fringe benefit, generally they must be occasional and have so little value that accounting for them would be unreasonable or administratively impracticable. But meals provided at an employer-operated eating facility for employees can also qualify.
For meals at an employer-operated facility, one requirement is that they be provided in a nondiscriminatory manner: Access to the eating facility must be available “on substantially the same terms to each member of a group of employees, which is defined under a reasonable classification set up by the employer that doesn’t discriminate in favor of highly compensated employees.”
Assuming that definition is met, employee meals generally constitute a de minimis fringe benefit if the following conditions also are met:
- The eating facility is owned or leased by the employer.
- The facility is operated by the employer.
- The facility is located on or near the business premises of the employer.
- The meals furnished at the facility are provided during, or immediately before or after, the employee’s workday.
The meals generally also must be furnished for the convenience of the employer rather than primarily as a form of additional compensation.
On the road
What’s significant about the Bruins case is that the meals were provided at hotels while the team was on the road. The Tax Court determined that the Bruins met all of the de minimis tests related to an employer-operated facility for their away-game team meals. The court’s reasoning included the following:
- Pregame meals were made available to all Bruins traveling hockey employees (highly compensated, non-highly compensated, players and nonplayers) on substantially the same terms.
- The Bruins agreements with the hotels were substantively leases.
- By engaging in its process with away-city hotels, the Bruins were “contract[ing] with another to operate an eating facility for its employees.”
- Away-city hotels were part of the Bruins’ business premises, because staying at out-of-town hotels was necessary for the teams to prepare for games, maintain a successful hockey operation and navigate the rigors of an NHL-mandated schedule.
- For every breakfast and lunch, traveling hockey employees were required to be present in the meal rooms.
- The meals were furnished for the convenience of the Bruins.
If your business provides meals under similar circumstances, it’s possible you might also be eligible for a 100% deduction. But be aware that the facts of this case are specific and restrictive. Also the IRS could appeal, and an appeals court could rule differently.
Questions about deducting meals you’re providing to employees? Contact us.
Could captive insurance reduce health care costs and save your business taxes?
If your business offers health insurance benefits to employees, there’s a good chance you’ve seen a climb in premium costs in recent years — perhaps a dramatic one. To meet the challenge of rising costs, some employers are opting for a creative alternative to traditional health insurance known as “captive insurance.” A captive insurance company generally is wholly owned and controlled by the employer. So it’s essentially like forming your own insurance company. And it provides tax advantages, too.
Potential benefits of forming a captive insurance company include:
- Stabilized or lower premiums,
- More control over claims,
- Lower administrative costs, and
- Access to certain types of coverage that are unavailable or too expensive on the commercial health insurance market.
You can customize your coverage package and charge premiums that more accurately reflect your business’s true loss exposure.
Another big benefit is that you can participate in the captive’s underwriting profits and investment income. When you pay commercial health insurance premiums, a big chunk of your payment goes toward the insurer’s underwriting profit. But when you form a captive, you retain this profit through the captive.
Also, your business can enjoy investment and cash flow benefits by investing premiums yourself instead of paying them to a commercial insurer.
A captive insurance company may also save you tax dollars. For example, premiums paid to a captive are tax-deductible and the captive can deduct most of its loss reserves. To qualify for federal income tax purposes, a captive must meet several criteria. These include properly priced premiums based on actuarial and underwriting considerations and a sufficient level of risk distribution as determined by the IRS.
Recent U.S. Tax Court rulings have determined that risk distribution exists if there’s a large enough pool of unrelated risks — or, in other words, if risk is spread over a sufficient number of employees. This is true regardless of how many entities are involved.
Additional tax benefits may be available if your captive qualifies as a “microcaptive” (a captive with $2.2 million or less in premiums that meets certain additional tests): You may elect to exclude premiums from income and pay taxes only on net investment income. Be aware, however, that you’ll lose certain deductions with this election.
Also keep in mind that there are some potential drawbacks to forming a captive insurance company. Contact us to learn more about the tax treatment and other pros and cons of captive insurance. We can help you determine whether this alternative may be right for your business.
Material participation key to deducting LLC and LLP losses
If your business is a limited liability company (LLC) or a limited liability partnership (LLP), you know that these structures offer liability protection and flexibility as well as tax advantages. But they once also had a significant tax disadvantage: The IRS used to treat all LLC and LLP owners as limited partners for purposes of the passive activity loss (PAL) rules, which can result in negative tax consequences. Fortunately, these days LLC and LLP owners can be treated as general partners, which means they can meet any one of seven “material participation” tests to avoid passive treatment.
The PAL rules
The PAL rules prohibit taxpayers from offsetting losses from passive business activities (such as limited partnerships or rental properties) against nonpassive income (such as wages, interest, dividends and capital gains). Disallowed losses may be carried forward to future years and deducted from passive income or recovered when the passive business interest is sold.
There are two types of passive activities: 1) trade or business activities in which you don’t materially participate during the year, and 2) rental activities, even if you do materially participate (unless you qualify as a “real estate professional” for federal tax purposes).
The 7 tests
Material participation in this context means participation on a “regular, continuous and substantial” basis. Unless you’re a limited partner, you’re deemed to materially participate in a business activity if you meet just one of seven tests:
- You participate in the activity at least 500 hours during the year.
- Your participation constitutes substantially all of the participation for the year by anyone, including nonowners.
- You participate more than 100 hours and as much or more than any other person.
- The activity is a “significant participation activity” — that is, you participate more than 100 hours — but you participate less than one or more other people yet your participation in all of your significant participation activities for the year totals more than 500 hours.
- You materially participated in the activity for any five of the preceding 10 tax years.
- The activity is a personal service activity in which you materially participated in any three previous tax years.
- Regardless of the number of hours, based on all the facts and circumstances, you participate in the activity on a regular, continuous and substantial basis.
The rules are more restrictive for limited partners, who can establish material participation only by satisfying tests 1, 5 or 6.
In many cases, meeting one of the material participation tests will require diligently tracking every hour spent on your activities associated with that business. Questions about the material participation tests? Contact us.
Put your audit in reverse to save sales and use tax
It’s a safe bet that state tax authorities will let you know if you haven’t paid enough sales and use taxes, but what are the odds that you’ll be notified if you’ve paid too much? The chances are slim — so slim that many businesses use reverse audits to find overpayments so they can seek refunds.
Take all of your exemptions
In most states, businesses are exempt from sales tax on equipment used in manufacturing or recycling, and many states don’t require them to pay taxes on the utilities and chemicals used in these processes, either. In some states, custom software, computers and peripherals are exempt if they’re used for research and development projects.
This is just a sampling of sales and use tax exemptions that might be available. Unless you’re diligent about claiming exemptions, you may be missing out on some to which you’re entitled.
Many businesses have sales and use tax compliance systems to guard against paying too much, but if you haven’t reviewed yours recently, it may not be functioning properly. Employee turnover, business expansion or downsizing, and simple mistakes all can take their toll.
Look back and broadly
The audit should extend across your business, going back as far as the statute of limitations on state tax reviews. If your state auditors can review all records for the four years preceding the audit, for example, your reverse audit should encompass the same timeframe.
What types of payments should be reviewed? You may have made overpayments on components of manufactured products as well as on the equipment you use to make the products. Other areas where overpayments may occur, depending on state laws, include:
- Pollution control equipment and supplies,
- Safety equipment,
- Warehouse equipment,
- Software licenses,
- Maintenance fees,
- Protective clothing, and
- Service transactions.
When considering whether you may have overpaid taxes in these and other areas, a clear understanding of your operations is key. If, for example, you want to ensure you’re receiving maximum benefit from industrial processing exemptions, you must know where your manufacturing process begins and ends.
Save now and later
Reverse audits can be time consuming and complicated, but a little pain can bring significant gain. Use your reverse audit not only to reap tax refund rewards now but also to update your compliance systems to help ensure you don’t overpay taxes in the future.
Rules and regulations surrounding state sales and use tax refunds are complicated. We can help you understand them and ensure your refund claims are properly prepared before you submit them.
6 ways to control your unemployment tax costs
Unemployment tax rates for employers vary from state to state. Your unemployment tax bill may be influenced by the number of former employees who’ve filed unemployment claims with the state, your current number of employees and your business’s age. Typically, the more claims made against a business, the higher the unemployment tax bill.
Here are six ways to control your unemployment tax costs:
1. Buy down your unemployment tax rate if your state permits it. Some states allow employers to annually buy down their rate. If you’re eligible, this could save you substantial dollars in unemployment taxes.
2. Hire new staff conservatively. Remember, your unemployment payments are based partly on the number of employees who file unemployment claims. You don’t want to hire employees to fill a need now, only to have to lay them off if business slows. A temporary staffing agency can help you meet short-term needs without permanently adding staff, so you can avoid layoffs. This is also a good way to try out a candidate.
3. Assess candidates before hiring them. Often it’s worth a small financial investment to have job candidates undergo prehiring assessments to see if they’re the right match for your business and the position available. Hiring carefully will increase the likelihood that new employees will work out.
4. Train for success. Many unemployment insurance claimants are awarded benefits despite employer assertions that the employee failed to perform adequately. Often this is because the hearing officer concluded the employer hadn’t provided the employee with enough training to succeed in the position.
5. Handle terminations thoughtfully. If you must terminate an employee, consider giving him or her severance as well as offering outplacement benefits. Severance pay may reduce or delay the start of unemployment insurance benefits. Effective outplacement services may hasten the end of unemployment insurance benefits, because the claimant has found a new job.
6. Leverage an acquisition. If you’ve recently acquired another company, it may have a lower established tax rate that you can use instead of the tax rate that’s been set for your existing business. You also may be able to request the transfer of the previous company’s unemployment reserve fund balance.
If you have questions about unemployment taxes and how you can reduce them, contact our firm. We’d be pleased to help.
ESOPs offer businesses tax and other benefits
With an employee stock ownership plan (ESOP), employee participants take part ownership of the business through a retirement savings arrangement. Meanwhile, the business and its existing owner(s) can benefit from some potential tax breaks, an extra-motivated workforce and potentially a smoother path for succession planning.
How ESOPs work
To implement an ESOP, you establish a trust fund and either:
- Contribute shares of stock or money to buy the stock (an “unleveraged” ESOP), or
- Borrow funds to initially buy the stock, and then contribute cash to the plan to enable it to repay the loan (a “leveraged” ESOP).
The shares in the trust are allocated to individual employees’ accounts, often using a formula based on their respective compensation. The business has to formally adopt the plan and submit plan documents to the IRS, along with certain forms.
Among the biggest benefits of an ESOP is that contributions to qualified retirement plans such as ESOPs typically are tax-deductible for employers. However, employer contributions to all defined contribution plans, including ESOPs, are generally limited to 25% of covered payroll. In addition, C corporations with leveraged ESOPs can deduct contributions used to pay interest on the loan. That is, the interest isn’t counted toward the 25% limit.
Dividends paid on ESOP stock passed through to employees or used to repay an ESOP loan, so long as they’re reasonable, may be tax-deductible for C corporations. Dividends voluntarily reinvested by employees in company stock in the ESOP also are usually deductible by the business. (Employees, however, should review the tax implications of dividends.)
In another potential benefit, shareholders in some closely held C corporations can sell stock to the ESOP and defer federal income taxes on any gains from the sale, with several stipulations. One is that the ESOP must own at least 30% of the company’s stock immediately after the sale. In addition, the sellers must reinvest the proceeds (or an equivalent amount) in qualified replacement property securities of domestic operation corporations within a set period of time.
Finally, when a business owner is ready to retire or otherwise depart the company, the business can make tax-deductible contributions to the ESOP to buy out the departing owner’s shares or have the ESOP borrow money to buy the shares.
More tax considerations
There are tax benefits for employees, too. Employees don’t pay tax on stock allocated to their ESOP accounts until they receive distributions. But, as with most retirement plans, if they take a distribution before they turn 59½ (or 55, if they’ve terminated employment), they may have to pay taxes and penalties — unless they roll the proceeds into an IRA or another qualified retirement plan.
Also be aware that an ESOP’s tax impact for entity types other than C corporations varies somewhat from what we’ve discussed here. And while an ESOP offers many potential benefits, it also presents risks. For help determining whether an ESOP makes sense for your business, contact us.
3 midyear tax planning strategies for business
Tax reform has been a major topic of discussion in Washington, but it’s still unclear exactly what such legislation will include and whether it will be signed into law this year. However, the last major tax legislation that was signed into law — back in December of 2015 — still has a significant impact on tax planning for businesses. Let’s look at three midyear tax strategies inspired by the Protecting Americans from Tax Hikes (PATH) Act:
1. Buy equipment. The PATH Act preserved both the generous limits for the Section 179 expensing election and the availability of bonus depreciation. These breaks generally apply to qualified fixed assets, including equipment or machinery, placed in service during the year. For 2017, the maximum Sec. 179 deduction is $510,000, subject to a $2,030,000 phaseout threshold. Without the PATH Act, the 2017 limits would have been $25,000 and $200,000, respectively. Higher limits are now permanent and subject to inflation indexing.
Additionally, for 2017, your business may be able to claim 50% bonus depreciation for qualified costs in excess of what you expense under Sec. 179. Bonus depreciation is scheduled to be reduced to 40% in 2018 and 30% in 2019 before it’s set to expire on December 31, 2019.
2. Ramp up research. After years of uncertainty, the PATH Act made the research credit permanent. For qualified research expenses, the credit is generally equal to 20% of expenses over a base amount that’s essentially determined using a historical average of research expenses as a percentage of revenues. There’s also an alternative computation for companies that haven’t increased their research expenses substantially over their historical base amounts.
In addition, a small business with $50 million or less in gross receipts may claim the credit against its alternative minimum tax (AMT) liability. And, a start-up company with less than $5 million in gross receipts may claim the credit against up to $250,000 in employer Federal Insurance Contributions Act (FICA) taxes.
3. Hire workers from “target groups.” Your business may claim the Work Opportunity credit for hiring a worker from one of several “target groups,” such as food stamp recipients and certain veterans. The PATH Act extended the credit through 2019. It also added a new target group: long-term unemployment recipients.
Generally, the maximum Work Opportunity credit is $2,400 per worker. But it’s higher for workers from certain target groups, such as disabled veterans.
One last thing to keep in mind is that, in terms of tax breaks, “permanent” only means that there’s no scheduled expiration date. Congress could still pass legislation that changes or eliminates “permanent” breaks. But it’s unlikely any of the breaks discussed here would be eliminated or reduced for 2017. To keep up to date on tax law changes and get a jump start on your 2017 tax planning, contact us.
All fringe benefits aren’t created equal for tax purposes
According to IRS Publication 5137, Fringe Benefit Guide, a fringe benefit is “a form of pay (including property, services, cash or cash equivalent), in addition to stated pay, for the performance of services.” But the tax treatment of a fringe benefit can vary dramatically based on the type of benefit.
Generally, the IRS takes one of four tax approaches to fringe benefits:
1. Taxable/includable. The value of benefits in this category are taxable because they must be included in employees’ gross income as wages and reported on Form W-2. They’re usually also subject to federal income tax withholding, Social Security tax (unless the employee has already reached the current year Social Security wage base limit) and Medicare tax. Typical examples include cash bonuses and the personal use of a company vehicle.
2. Nontaxable/excludable. Benefits in this category are considered nontaxable because you may exclude them from employees’ wages under a specific section of the Internal Revenue Code. Examples include:
- Working-condition fringe benefits, which are expenses that, if employees had paid for the item themselves, could have been deducted on their personal tax returns (such as subscriptions to business periodicals or websites and some types of on-the-job training),
- De minimis fringe benefits, which include any employer-provided property or service that has a value so small that accounting for it is “unreasonable or administratively impracticable” (such as occasional coffee, doughnuts or soft drinks and permission to make occasional local telephone calls),
- Properly documented work-related travel expenses (such as transportation and lodging),
- Up to $50,000 in group term-life insurance, as long as the policy meets certain IRS requirements, and
- Employer-paid health care premiums under a qualifying plan.
3. Partially taxable. In some cases, the value of a fringe benefit will be excluded under an IRC section up to a certain dollar limit with the remainder taxable. A public transportation subsidy under Section 132 is one example.
4. Tax-deferred. This designation applies to fringe benefits that aren’t taxable when received but that will be subject to tax later. A common example is employer contributions to a defined contribution plan, such as a 401(k) plan.
Are you applying the proper tax treatment to each fringe benefit you provide? If not, you could face unexpected tax liabilities or other undesirable consequences. Please contact us with any questions you have about the proper tax treatment of a particular benefit you currently offer or are considering offering.
Keep real estate separate from your business’s corporate assets to save tax
It’s common for a business to own not only typical business assets, such as equipment, inventory and furnishings, but also the building where the business operates — and possibly other real estate as well. There can, however, be negative consequences when a business’s real estate is included in its general corporate assets. By holding real estate in a separate entity, owners can save tax and enjoy other benefits, too.
Capturing tax savings
Many businesses operate as C corporations so they can buy and hold real estate just as they do equipment, inventory and other assets. The expenses of owning the property are treated as ordinary expenses on the company’s income statement. However, if the real estate is sold, any profit is subject to double taxation: first at the corporate level and then at the owner’s individual level when a distribution is made. As a result, putting real estate in a C corporation can be a costly mistake.
If the real estate is held instead by the business owner(s) or in a pass-through entity, such as a limited liability company (LLC) or limited partnership, and then leased to the corporation, the profit on a sale of the property is taxed only once — at the individual level.
LLC: The entity of choice
The most straightforward and seemingly least expensive way for an owner to maximize the tax benefits is to buy the real estate outright. However, this could transfer liabilities related to the property (such as for injuries suffered on the property) directly to the owner, putting other assets — including the business — at risk. In essence, it would negate part of the rationale for organizing the business as a corporation in the first place.
So, it’s generally best to put real estate in its own limited liability entity. The LLC is most often the vehicle of choice for this. Limited partnerships can accomplish the same ends if there are multiple owners, but the disadvantage is that you’ll incur more expense by having to set up two entities: the partnership itself and typically a corporation to serve as the general partner.
We can help you create a plan of ownership for real estate that best suits your situation.
3 breaks for business charitable donations you may not know about
Donating to charity is more than good business citizenship; it can also save tax. Here are three lesser-known federal income tax breaks for charitable donations by businesses.
1. Food donations
Charitable write-offs for donated food (such as by restaurants and grocery stores) are normally limited to the lower of the taxpayer’s basis in the food (generally cost) or fair market value (FMV), but an enhanced deduction equals the lesser of:
- The food’s basis plus one-half the FMV in excess of basis, or
- Two times the basis.
To qualify, the food must be apparently wholesome at the time it’s donated. Your total charitable write-off for food donations under the enhanced deduction provision can’t exceed:
- 15% of your net income for the year (before considering the enhanced deduction) from all sole proprietorships, S corporations and partnership businesses (including limited liability companies treated as partnerships for tax purposes) from which food donations were made, or
- For a C corporation taxpayer, 15% of taxable income for the year (before considering the enhanced deduction).
2. Qualified conservation contributions
Qualified conservation contributions are charitable donations of real property interests, including remainder interests and easements that restrict the use of real property. For qualified C corporation farming and ranching operations, the maximum write-off for qualified conservation contributions is increased from the normal 10% of adjusted taxable income to 100% of adjusted taxable income.
Qualified conservation contributions in excess of what can be written off in the year of the donation can be carried forward for 15 years.
3. S corporation appreciated property donations
A favorable tax basis rule is available to shareholders of S corporations that make charitable donations of appreciated property. For such donations, each shareholder’s basis in the S corporation stock is reduced by only the shareholder’s pro-rata percentage of the company’s tax basis in the donated asset.
Without this provision, a shareholder’s basis reduction would equal the passed-through write-off for the donation (a larger amount than the shareholder’s pro-rata percentage of the company’s basis in the donated asset). This provision is generally beneficial to shareholders, because it leaves them with higher tax basis in their S corporation shares.
If you believe you may be eligible to claim one or more of these tax breaks, contact us. We can help you determine eligibility, prepare the required documentation and plan for charitable donations in future years.
2017 Q3 tax calendar: Key deadlines for businesses and other employers
Here are some of the key tax-related deadlines affecting businesses and other employers during the second quarter of 2017. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
- Report income tax withholding and FICA taxes for second quarter 2017 (Form 941), and pay any tax due. (See exception below.)
- File a 2016 calendar-year retirement plan report (Form 5500 or Form 5500-EZ) or request an extension.
- Report income tax withholding and FICA taxes for second quarter 2017 (Form 941), if you deposited on time and in full all of the associated taxes due.
- If a calendar-year C corporation, pay the third installment of 2017 estimated income taxes.
- If a calendar-year S corporation or partnership that filed an automatic six-month extension:
- File a 2016 income tax return (Form 1120S, Form 1065 or Form 1065-B) and pay any tax, interest and penalties due.
- Make contributions for 2016 to certain employer-sponsored retirement plans.
Dot the “i’s” and cross the “t’s” on loans between your business and its owners
It’s common for closely held businesses to transfer money into and out of the company, often in the form of a loan. However, the IRS looks closely at such transactions: Are they truly loans, or actually compensation, distributions or contributions to equity?
Loans to owners
When an owner withdraws funds from the company, the transaction can be characterized as compensation, a distribution or a loan. Loans aren’t taxable, but compensation is and distributions may be.
If the company is a C corporation and the transaction is considered a distribution, it can trigger double taxation. If a transaction is considered compensation, it’s deductible by the corporation, so it doesn’t result in double taxation — but it will be taxable to the owner and subject to payroll taxes.
If the company is an S corporation or other pass-through entity and the transaction is considered a distribution, there’s no entity-level tax, so double taxation won’t be an issue. But distributions reduce an owner’s tax basis, which makes it harder to deduct business losses. If the transaction is considered compensation, as with a C corporation, it will be taxable to the owner and subject to payroll taxes.
Loans to the business
There are also benefits to treating transfers of money from owners to the business as loans. If such advances are treated as contributions to equity, for example, any reimbursements by the company may be taxed as distributions.
Loan payments, on the other hand, aren’t taxable, apart from the interest, which is deductible by the company. A loan may also give the owner an advantage in the event of the company’s bankruptcy, because debt obligations are paid before equity is returned.
Is it a loan or not?
To enjoy the tax advantages of a loan, it’s important to establish that a transaction is truly a loan. Simply calling a withdrawal or advance a “loan” doesn’t make it so.
Whether a transaction is a loan is a matter of intent. It’s a loan if the borrower has an unconditional intent to repay the amount received and the lender has an unconditional intent to obtain repayment. Because the IRS and the courts aren’t mind readers, it’s critical to document loans and treat them like other arm’s-length transactions. This includes:
- Executing a promissory note,
- Charging a commercially reasonable rate of interest — generally, no less than the applicable federal rate,
- Establishing and following a fixed repayment schedule,
- Securing the loan using appropriate collateral, which will also give the lender bankruptcy priority over unsecured creditors,
- Treating the transaction as a loan in the company’s books, and
- Ensuring that the lender makes reasonable efforts to collect in case of default.
Also, to avoid a claim that loans to owner-employees are disguised compensation, you must ensure that they receive reasonable salaries.
If you’re considering a loan to or from your business, contact us for more details on how to help ensure it will be considered a loan by the IRS.
Choosing the best way to reimburse employee travel expenses
If your employees incur work-related travel expenses, you can better attract and retain the best talent by reimbursing these expenses. But to secure tax-advantaged treatment for your business and your employees, it’s critical to comply with IRS rules.
Reasons to reimburse
While unreimbursed work-related travel expenses generally are deductible on a taxpayer’s individual tax return (subject to a 50% limit for meals and entertainment) as a miscellaneous itemized deduction, many employees won’t be able to benefit from the deduction. Why?
It’s likely that some of your employees don’t itemize. Even those who do may not have enough miscellaneous itemized expenses to exceed the 2% of adjusted gross income floor. And only expenses in excess of the floor can actually be deducted.
On the other hand, reimbursements can provide tax benefits to both your business and the employee. Your business can deduct the reimbursements (also subject to a 50% limit for meals and entertainment), and they’re excluded from the employee’s taxable income — provided that the expenses are legitimate business expenses and the reimbursements comply with IRS rules. Compliance can be accomplished by using either the per diem method or an accountable plan.
Per diem method
The per diem method is simple: Instead of tracking each individual’s actual expenses, you use IRS tables to determine reimbursements for lodging, meals and incidental expenses, or just for meals and incidental expenses. (If you don’t go with the per diem method for lodging, you’ll need receipts to substantiate those expenses.)
The IRS per diem tables list localities here and abroad. They reflect seasonal cost variations as well as the varying costs of the locales themselves — so London’s rates will be higher than Little Rock’s. An even simpler option is to apply the “high-low” per diem method within the continental United States to reimburse employees up to $282 a day for high-cost localities and $189 for other localities.
You must be extremely careful to pay employees no more than the appropriate per diem amount. The IRS imposes heavy penalties on businesses that routinely fail to do so.
An accountable plan is a formal arrangement to advance, reimburse or provide allowances for business expenses. To qualify as “accountable,” your plan must meet the following criteria:
- It must pay expenses that would otherwise be deductible by the employee.
- Payments must be for “ordinary and necessary” business expenses.
- Employees must substantiate these expenses — including amounts, times and places — ideally at least monthly.
- Employees must return any advances or allowances they can’t substantiate within a reasonable time, typically 120 days.
If you fail to meet these conditions, the IRS will treat your plan as nonaccountable, transforming all reimbursements into wages taxable to the employee, subject to income taxes (employee) and employment taxes (employer and employee).
Whether you have questions about which reimbursement option is right for your business or the additional rules and limits that apply to each, contact us. We’d be pleased to help.
Consider the tax consequences before making an employee a partner
In today’s competitive environment, offering employees an equity interest in your business can be a powerful tool for attracting, retaining and motivating quality talent. If your business is organized as a partnership, however, there are some tax traps you should watch out for. Once an employee becomes a partner, you generally can no longer treat him or her as an employee for tax and benefits purposes, which has significant tax implications.
Employees pay half of the Social Security and Medicare taxes on their wages, through withholdings from their paychecks. The employer pays the other half. Partners, on the other hand, are treated as being self-employed — they pay the full amount of “self-employment” taxes through quarterly estimates.
Often, when employees receive partnership interests, the partnership continues to treat them as employees for tax purposes, withholding employment taxes from their wages and paying the employer’s share. The problem with this practice is that, because a partner is responsible for the full amount of employment taxes, the partnership’s payment of a portion of those taxes will likely be treated as a guaranteed payment to the partner.
That payment would then be included in income and trigger additional employment taxes. Any employment taxes not paid by the partnership on a partner’s behalf are the partner’s responsibility.
Treating a partner as an employee can also result in overpayment of employment taxes. Suppose your partnership pays half of a partner’s employment taxes and the partner also has other self-employment activities — for example, interests in other partnerships or sole proprietorships. If those activities generate losses, the losses will offset the partner’s earnings from your partnership, reducing or even eliminating self-employment taxes.
Partners and employees are treated differently for purposes of many benefit plans. For example, employees are entitled to exclude the value of certain employer-provided health, welfare and fringe benefits from income, while partners must include the value in their income (although they may be entitled to a self-employed health insurance deduction). And partners are prohibited from participating in a cafeteria plan.
Continuing to treat a partner as an employee for benefits purposes may trigger unwanted tax consequences. And it could disqualify a cafeteria plan.
There are techniques that allow you to continue treating newly minted partners as employees for tax and benefits purposes. For example, you might create a tiered partnership structure and offer employees of a lower-tier partnership interests in an upper-tier partnership. Because these employees aren’t partners in the partnership that employs them, many of the problems discussed above will be avoided.
If your business is contemplating offering partnership interests to key employees, contact us for more information about the potential tax consequences and how to avoid any pitfalls.
Business owners: When it comes to IRS audits, be prepared
If you recently filed your 2016 income tax return (rather than filing for an extension) you may now be wondering whether it’s likely that your business could be audited by the IRS based on your filing. Here’s what every business owner should know about the process.
Catching the IRS’s eye
Many business audits occur randomly, but a variety of tax-return-related items are likely to raise red flags with the IRS and may lead to an audit. Here are a few examples:
- Significant inconsistencies between previous years’ filings and your most current filing,
- Gross profit margin or expenses markedly different from those of other businesses in your industry, and
- Miscalculated or unusually high deductions.
An owner-employee salary that’s inordinately higher or lower than those in similar companies in his or her location can also catch the IRS’s eye, especially if the business is structured as a corporation.
If you’re selected for an audit, you’ll be notified by letter. Generally, the IRS won’t make initial contact by phone. But if there’s no response to the letter, the agency may follow up with a call.
The good news is that many audits simply request that you mail in documentation to support certain deductions you’ve taken. Others may ask you to take receipts and other documents to a local IRS office. Only the most severe version, the field audit, requires meeting with one or more IRS auditors.
More good news: In no instance will the agency demand an immediate response. You’ll be informed of the discrepancies in question and given time to prepare. To do so, you’ll need to collect and organize all relevant income and expense records. If any records are missing, you’ll have to reconstruct the information as accurately as possible based on other documentation.
If the IRS selects you for an audit, our firm can help you:
- Understand what the IRS is disputing (it’s not always crystal clear),
- Gather the specific documents and information needed, and
- Respond to the auditor’s inquiries in the most expedient and effective manner.
Don’t let an IRS audit ruin your year — be it this year, next year or whenever that letter shows up in the mail. By taking a meticulous, proactive approach to how you track, document and file your company’s tax-related information, you’ll make an audit much less painful and even decrease the chances that one happens in the first place.
Hire your children to save taxes for your business and your family
It can be difficult in the current job market for students and recent graduates to find summer or full-time jobs. If you’re a business owner with children in this situation, you may be able to provide them with valuable experience and income while generating tax savings for both your business and your family overall.
By shifting some of your business earnings to a child as wages for services performed by him or her, you can turn some of your high-taxed income into tax-free or low-taxed income. For your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child’s wages must be reasonable.
Here’s an example of how this works: A business owner operating as a sole proprietor is in the 39.6% tax bracket. He hires his 17-year-old son to help with office work full-time during the summer and part-time into the fall. The son earns $6,100 during the year and doesn’t have any other earnings.
The business owner saves $2,415.60 (39.6% of $6,100) in income taxes at no tax cost to his son, who can use his $6,350 standard deduction (for 2017) to completely shelter his earnings. The business owner can save an additional $2,178 in taxes if he keeps his son on the payroll longer and pays him an additional $5,500. The son can shelter the additional income from tax by making a tax-deductible contribution to his own IRA.
Family taxes will be cut even if the employee-child’s earnings exceed his or her standard deduction and IRA deduction. That’s because the unsheltered earnings will be taxed to the child beginning at a rate of 10% instead of being taxed at the parent’s higher rate.
Saving employment taxes
If your business isn’t incorporated or a partnership that includes nonparent partners, you might also save some employment tax dollars. Services performed by a child under age 18 while employed by a parent aren’t considered employment for FICA tax purposes. And a similar exemption applies for federal unemployment tax (FUTA) purposes. It exempts earnings paid to a child under age 21 while employed by his or her parent.
If you have questions about how these rules apply in your particular situation or would like to learn about other family-related tax-saving strategies, contact us.
Operating across state lines presents tax risks — or possibly rewards
It’s a smaller business world after all. With the ease and popularity of e-commerce, as well as the incredible efficiency of many supply chains, companies of all sorts are finding it easier than ever to widen their markets. Doing so has become so much more feasible that many businesses quickly find themselves crossing state lines.
But therein lies a risk: Operating in another state means possibly being subject to taxation in that state. The resulting liability can, in some cases, inhibit profitability. But sometimes it can produce tax savings.
Do you have “nexus”?
Essentially, “nexus” means a business presence in a given state that’s substantial enough to trigger that state’s tax rules and obligations.
Precisely what activates nexus in a given state depends on that state’s chosen criteria. Triggers can vary but common criteria include:
- Employing workers in the state,
- Owning (or, in some cases even leasing) property there,
- Marketing your products or services in the state,
- Maintaining a substantial amount of inventory there, and
- Using a local telephone number.
Then again, one generally can’t say that nexus has a “hair trigger.” A minimal amount of business activity in a given state probably won’t create tax liability there. For example, an HVAC company that makes a few tech calls a year across state lines probably wouldn’t be taxed in that state. Or let’s say you ask a salesperson to travel to another state to establish relationships or gauge interest. As long as he or she doesn’t close any sales, and you have no other activity in the state, you likely won’t have nexus.
If your company already operates in another state and you’re unsure of your tax liabilities there — or if you’re thinking about starting up operations in another state — consider conducting a nexus study. This is a systematic approach to identifying the out-of-state taxes to which your business activities may expose you.
Keep in mind that the results of a nexus study may not be negative. You might find that your company’s overall tax liability is lower in a neighboring state. In such cases, it may be advantageous to create nexus in that state (if you don’t already have it) by, say, setting up a small office there. If all goes well, you may be able to allocate some income to that state and lower your tax bill.
The complexity of state tax laws offers both risk and opportunity. Contact us for help ensuring your business comes out on the winning end of a move across state lines.
Choosing between a calendar tax year and a fiscal tax year
Many business owners use a calendar year as their company’s tax year. It’s intuitive and aligns with most owners’ personal returns, making it about as simple as anything involving taxes can be. But for some businesses, choosing a fiscal tax year can make more sense.
What’s a fiscal tax year?
A fiscal tax year consists of 12 consecutive months that don’t begin on January 1 or end on December 31 — for example, July 1 through June 30 of the following year. The year doesn’t necessarily need to end on the last day of a month. It might end on the same day each year, such as the last Friday in March.
Flow-through entities (partnerships, S corporations and, typically, limited liability companies) using a fiscal tax year must file their return by the 15th day of the third month following the close of their fiscal year. So, if their fiscal year ends on March 31, they would need to file their return by June 15. (Fiscal-year C corporations generally must file their return by the 15th day of the fourth month following the fiscal year close.)
When a fiscal year makes sense
A key factor to consider is that if you adopt a fiscal tax year you must use the same time period in maintaining your books and reporting income and expenses. For many seasonal businesses, a fiscal year can present a more accurate picture of the company’s performance.
For example, a snowplowing business might make the bulk of its revenue between November and March. Splitting the revenue between December and January to adhere to a calendar year end would make obtaining a solid picture of performance over a single season difficult.
In addition, if many businesses within your industry use a fiscal year end and you want to compare your performance to your peers, you’ll probably achieve a more accurate comparison if you’re using the same fiscal year.
Before deciding to change your fiscal year, be aware that the IRS requires businesses that don’t keep books and have no annual accounting period, as well as most sole proprietorships, to use a calendar year.
It can make a difference
If your company decides to change its tax year, you’ll need to obtain permission from the IRS. The change also will likely create a one-time “short tax year” — a tax year that’s less than 12 months. In this case, your income tax typically will be based on annualized income and expenses. But you might be able to use a relief procedure under Section 443(b)(2) of the Internal Revenue Code to reduce your tax bill.
Although choosing a tax year may seem like a minor administrative matter, it can have an impact on how and when a company pays taxes. We can help you determine whether a calendar or fiscal year makes more sense for your business.
Do you know the tax implications of your C corp.’s buy-sell agreement?
Private companies with more than one owner should have a buy-sell agreement to spell out how ownership shares will change hands should an owner depart. For businesses structured as C corporations, the agreements also have significant tax implications that are important to understand.
A buy-sell agreement sets up parameters for the transfer of ownership interests following stated “triggering events,” such as an owner’s death or long-term disability, loss of license or other legal incapacitation, retirement, bankruptcy, or divorce. The agreement typically will also specify how the purchase price for the departing owner’s shares will be determined, such as by stating the valuation method to be used.
Another key issue a buy-sell agreement addresses is funding. In many cases, business owners don’t have the cash readily available to buy out a departing owner. So insurance is commonly used to fund these agreements. And this is where different types of agreements — which can lead to tax issues for C corporations — come into play.
Under a cross-purchase agreement, each owner buys life or disability insurance (or both) that covers the other owners, and the owners use the proceeds to purchase the departing owner’s shares. Under a redemption agreement, the company buys the insurance and, when an owner exits the business, buys his or her shares.
Sometimes a hybrid agreement is used that combines aspects of both approaches. It may stipulate that the company gets the first opportunity to redeem ownership shares and that, if the company is unable to buy the shares, the remaining owners are then responsible for doing so. Alternatively, the owners may have the first opportunity to buy the shares.
C corp. tax consequences
A C corp. with a redemption agreement funded by life insurance can face adverse tax consequences. First, receipt of insurance proceeds could trigger corporate alternative minimum tax.
Second, the value of the remaining owners’ shares will probably rise without increasing their basis. This, in turn, could drive up their tax liability if they later sell their shares.
Heightened liability for the corporate alternative minimum tax is generally unavoidable under these circumstances. But you may be able to manage the second problem by revising your buy-sell as a cross-purchase agreement. Under this approach, owners will buy additional shares themselves — increasing their basis.
Naturally, there are downsides. If owners are required to buy a departing owner’s shares, but the company redeems the shares instead, the IRS may characterize the purchase as a taxable dividend. Your business may be able to mitigate this risk by crafting a hybrid agreement that names the corporation as a party to the transaction and allows the remaining owners to buy back the shares without requiring them to do so.
For more information on the tax ramifications of buy-sell agreements, contact us. And if your business doesn’t have a buy-sell in place yet, we can help you figure out which type of funding method will best meet your needs while minimizing any negative tax consequences.
Bartering may be cash-free, but it’s not tax-free
Bartering might seem like something that happened only in ancient times, but the practice is still common today. And the general definition remains the same: the exchange of goods and services without the exchange of money. Because no cash changes hands in a typical barter transaction, it’s easy to forget about taxes. But, as one might expect, you can’t cut Uncle Sam out of the deal.
A taxing transaction
The IRS generally treats a barter exchange similarly to a transaction involving cash, so you must report as income the fair market value of the products or services you receive. If there are business expenses associated with the transaction, those can be deducted. Any income arising from a bartering arrangement is generally taxable in the year you receive the bartered product or service.
And income tax liability isn’t the only thing you’ll need to consider. Barter activities may also trigger self-employment taxes, employment taxes or an excise tax.
Barter in action
Let’s look at an example. Mike, a painting contractor, requires legal representation for a lawsuit. He engages Maria as legal counsel to represent him during the litigation. Maria charges Mike $6,000 for her work on the case.
Being short of cash, Mike agrees to paint Maria’s office in exchange for her $6,000 fee. Both Mike and Maria must report $6,000 of taxable gross income during the year the exchange takes place. Because Mike and Maria each operate a viable business, they’re entitled to deduct any business expenses resulting from the barter transaction.
Using an exchange company
You may wish to arrange a bartering deal though an exchange company. For a fee, one of these companies can allow you to network with other businesses looking to trade goods and services. For tax purposes, a barter exchange company typically must issue a Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions,” annually to its clients or members.
Although bartering may appear cut and dried, the tax implications can complicate the deal. We can help you assess a bartering arrangement and manage the tax impact.
What are the most tax-advantaged ways to reimburse employees’ education expenses?
Reimbursing employees for education expenses can both strengthen the capabilities of your staff and help you retain them. In addition, you and your employees may be able to save valuable tax dollars. But you have to follow IRS rules. Here are a couple of options for maximizing tax savings.
A fringe benefit
Qualifying reimbursements and direct payments of job-related education costs are excludable from employees’ wages as working condition fringe benefits. This means employees don’t have to pay tax on them. Plus, you can deduct these costs as employee education expenses (as opposed to wages), and you don’t have to withhold income tax or withhold or pay payroll taxes on them.
To qualify as a working condition fringe benefit, the education expenses must be ones that employees would be allowed to deduct as a business expense if they’d paid them directly and weren’t reimbursed. Basically, this means the education must relate to the employees’ current occupations and not qualify them for new jobs. There’s no ceiling on the amount employees can receive tax-free as a working condition fringe benefit.
An educational assistance program
Another approach is to establish a formal educational assistance program. The program can cover both job-related and non-job-related education. Reimbursements can include costs such as:
- Undergraduate or graduate-level tuition,
- Books, and
- Equipment and supplies.
Reimbursement of materials employees can keep after the courses end (except for textbooks) aren’t eligible.
You can annually exclude from the employee’s income and deduct up to $5,250 (or an unlimited amount if the education is job related) of eligible education reimbursements as an employee benefit expense. And you don’t have to withhold income tax or withhold or pay payroll taxes on these reimbursements.
To pass muster with the IRS, such a program must avoid discrimination in favor of highly compensated employees, their spouses and their dependents, and it can’t provide more than 5% of its total annual benefits to shareholders, owners and their dependents. In addition, you must provide reasonable notice about the program to all eligible employees that outlines the type and amount of assistance available.
Train and retain
If your company has employees who want to take their professional skill sets to the next level, don’t let them go to a competitor to get there. By reimbursing education costs as a fringe benefit or setting up an educational assistance program, you can keep your staff well trained and evolving toward the future and save taxes, too. Please contact us for more details.
A refresher on tax-related ACA provisions affecting businesses
Now that the bill to repeal and replace the Affordable Care Act (ACA) has been withdrawn and it’s uncertain whether there will be any other health care reform legislation this year, it’s a good time to review some of the tax-related ACA provisions affecting businesses:
Small employer tax credit. Qualifying small employers can claim a credit to cover a portion of the cost of premiums paid to provide health insurance to employees. The maximum credit is 50% of premiums paid by the employer, provided it contributes at least 50% of the total premium or of a benchmark premium.
Penalties for not offering complying coverage. Applicable large employers (ALEs) — those with at least 50 full-time employees (or the equivalent) — are required to offer full-time employees affordable health coverage that meets certain minimum standards. If they don’t, they can be charged a penalty if just one full-time employee receives a tax credit for purchasing his or her own coverage through a health care marketplace. This is sometimes called the “employer mandate.”
Reporting of health care costs to employees. The ACA generally requires employers who filed 250 or more W-2 forms in the preceding year to annually report to employees the value of health insurance coverage they provide. The reporting requirement is informational only; it doesn’t cause health care benefits to become taxable.
Additional 0.9% Medicare tax. This applies to:
- Wages and/or self-employment (SE) income above $200,000 for single and head of household filers, or
- Combined wages and/or SE income above $250,000 for married couples filing jointly ($125,000 for married couples filing separately).
While there is no employer portion of this tax, employers are responsible for withholding the tax once an employee’s compensation for the calendar year exceeds $200,000, regardless of the employee’s filing status or income from other sources.
Cap on health care FSA contributions. The Flexible Spending Account (FSA) cap is indexed for inflation. For 2017, the maximum annual FSA contribution by an employee is $2,600.
There’s also one significant change that hasn’t kicked in yet: Beginning in 2020, the ACA calls for health insurance companies that service the group market and administrators of employer-sponsored health plans to pay a 40% excise tax on premiums that exceed the applicable threshold, generally $10,200 for self-only coverage and $27,500 for family coverage. This is commonly referred to as the “Cadillac tax.”
The ACA remains the law, at least for now. Contact us if you have questions about how it affects your business’s tax situation.
2017 Q2 tax calendar: Key deadlines for businesses and other employers
Here are some of the key tax-related deadlines affecting businesses and other employers during the second quarter of 2017. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
- If a calendar-year C corporation, file a 2016 income tax return (Form 1120) or file for an automatic six-month extension (Form 7004), and pay any tax due. If the return isn’t extended, this is also the last day to make 2016 contributions to pension and profit-sharing plans.
- If a calendar-year C corporation, pay the first installment of 2017 estimated income taxes.
- Report income tax withholding and FICA taxes for first quarter 2017 (Form 941), and pay any tax due. (See exception below.)
- Report income tax withholding and FICA taxes for first quarter 2017 (Form 941), if you deposited on time and in full all of the associated taxes due.
- If a calendar-year C corporation, pay the second installment of 2017 estimated income taxes.
Make sure the IRS won’t consider your business to be a “hobby”
If you run a business “on the side” and derive most of your income from another source (whether from another business you own, employment or investments), you may face a peculiar risk: Under certain circumstances, this on-the-side business might not be a business at all in the eyes of the IRS. It may be a hobby.
The hobby loss rules
Generally, a taxpayer can deduct losses from profit-motivated activities, either from other income in the same tax year or by carrying the loss back to a previous tax year or forward to a future tax year. But, to ensure these pursuits are really businesses — and not mere hobbies intended primarily to offset other income — the IRS enforces what are commonly referred to as the “hobby loss” rules.
If you haven’t earned a profit from your business in three out of five consecutive years, including the current year, you’ll bear the burden of proof to show that the enterprise isn’t merely a hobby. But if this profit test can be met, the burden falls on the IRS. In either case, the agency looks at factors such as the following to determine whether the activity is a business or a hobby:
- Do you carry on the activity in a business-like manner?
- Does the time and effort put into the activity indicate an intention to make a profit?
- Do you depend on income from the activity?
- If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
- Have you changed methods of operation to improve profitability?
- Do you (or your advisors) have the knowledge needed to carry on the activity as a successful business?
- Have you made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Do you expect to make a profit in the future from the appreciation of assets used in the activity?
Dangers of reclassification
If your enterprise is reclassified as a hobby, you can’t use a loss from the activity to offset other income. You may still write off certain expenses related to the hobby, but only to the extent of income the hobby generates. If you’re concerned about the hobby loss rules, we can help you evaluate your situation.
The Section 1031 exchange: Why it’s such a great tax planning tool
Like many business owners, you might also own highly appreciated business or investment real estate. Fortunately, there’s an effective tax planning strategy at your disposal: the Section 1031 “like kind” exchange. It can help you defer capital gains tax on appreciated property indefinitely.
How it works
Section 1031 of the Internal Revenue Code allows you to defer gains on real or personal property used in a business or held for investment if, instead of selling it, you exchange it solely for property of a “like kind.” In fact, these arrangements are often referred to as “like-kind exchanges.” Thus, the tax benefit of an exchange is that you defer tax and, thereby, have use of the tax savings until you sell the replacement property.
Personal property must be of the same asset or product class. But virtually any type of real estate will qualify as long as it’s business or investment property. For example, you can exchange a warehouse for an office building, or an apartment complex for a strip mall.
Executing the deal
Although an exchange may sound quick and easy, it’s relatively rare for two owners to simply swap properties. You’ll likely have to execute a “deferred” exchange, in which you engage a qualified intermediary (QI) for assistance.
When you sell your property (the relinquished property), the net proceeds go directly to the QI, who then uses them to buy replacement property. To qualify for tax-deferred exchange treatment, you generally must identify replacement property within 45 days after you transfer the relinquished property and complete the purchase within 180 days after the initial transfer.
An alternate approach is a “reverse” exchange. Here, an exchange accommodation titleholder (EAT) acquires title to the replacement property before you sell the relinquished property. You can defer capital gains by identifying one or more properties to exchange within 45 days after the EAT receives the replacement property and, typically, completing the transaction within 180 days.
The rules for like-kind exchanges are complex, so these arrangements present some risks. If, say, you exchange the wrong kind of property or acquire cash or other non-like-kind property in a deal, you may still end up incurring a sizable tax hit. Be sure to contact us when exploring a Sec. 1031 exchange.
Filing deadline rapidly approaching for flow-through entities
The federal income tax filing deadline for calendar-year partnerships, S corporations and limited liability companies (LLCs) treated as partnerships or S corporations for tax purposes is March 15. While this deadline is nothing new for S corporation returns, it’s earlier than previous years for partnership returns.
In addition to providing continued funding for federal transportation projects, the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 changed the due dates for several types of tax and information returns, including partnership income tax returns. The revised due dates are generally effective for tax years beginning after December 31, 2015. In other words, they apply to the tax returns for 2016 that are due in 2017.
The new deadlines
The new due date for partnerships with tax years ending on December 31 to file federal income tax returns is March 15. For partnerships with fiscal year ends, tax returns are due the 15th day of the third month after the close of the tax year.
Under prior law, returns for calendar-year partnerships were due April 15. And returns for fiscal-year partnerships were due the 15th day of the fourth month after the close of the fiscal tax year.
One of the primary reasons for moving up the partnership filing deadline was to make it easier for owners to file their personal returns by the April 15 deadline (April 18 in 2017 because of a weekend and a Washington, D.C., holiday). After all, partnership (and S corporation) income flows through to the owners. The new date should allow owners to use the information contained in the partnership forms to file their personal returns.
If you haven’t filed your partnership or S corporation return yet, you may be thinking about an extension. Under the new law, the maximum extension for calendar-year partnerships is six months (until September 15). This is up from five months under prior law. So the extension deadline doesn’t change — only the length of the extension. The extension deadline for calendar-year S corporations also remains at September 15. But you must file for the extension by March 15.
Keep in mind that, to avoid potential interest and penalties, you still must (with a few exceptions) pay any tax due by the unextended deadline. There may not be any tax liability from the partnership or S corporation return. But if filing for an extension for the entity return causes you to also have to file an extension for your personal return, you need to keep this in mind related to the individual tax return April 18 deadline.
Filing for an extension can be tax-smart if you’re missing critical documents or you face unexpected life events that prevent you from devoting sufficient time to your return right now. Please contact us if you need help or have questions about the filing deadlines that apply to you or avoiding interest and penalties.
Tangible property safe harbors help maximize deductions
If last year your business made repairs to tangible property, such as buildings, machinery, equipment or vehicles, you may be eligible for a valuable deduction on your 2016 income tax return. But you must make sure they were truly “repairs,” and not actually “improvements.”
Why? Costs incurred to improve tangible property must be depreciated over a period of years. But costs incurred on incidental repairs and maintenance can be expensed and immediately deducted.
What’s an “improvement”?
In general, a cost that results in an improvement to a building structure or any of its building systems (for example, the plumbing or electrical system) or to other tangible property must be capitalized. An improvement occurs if there was a betterment, restoration or adaptation of the unit of property.
Under the “betterment test,” you generally must capitalize amounts paid for work that is reasonably expected to materially increase the productivity, efficiency, strength, quality or output of a unit of property or that is a material addition to a unit of property.
Under the “restoration test,” you generally must capitalize amounts paid to replace a part (or combination of parts) that is a major component or a significant portion of the physical structure of a unit of property.
Under the “adaptation test,” you generally must capitalize amounts paid to adapt a unit of property to a new or different use — one that isn’t consistent with your ordinary use of the unit of property at the time you originally placed it in service.
2 safe harbors
Distinguishing between repairs and improvements can be difficult, but a couple of IRS safe harbors can help:
1. Routine maintenance safe harbor. Recurring activities dedicated to keeping property in efficient operating condition can be expensed. These are activities that your business reasonably expects to perform more than once during the property’s “class life,” as defined by the IRS.
Amounts incurred for activities outside the safe harbor don’t necessarily have to be capitalized, though. These amounts are subject to analysis under the general rules for improvements.
2. Small business safe harbor. For buildings that initially cost $1 million or less, qualified small businesses may elect to deduct the lesser of $10,000 or 2% of the unadjusted basis of the property for repairs, maintenance, improvements and similar activities each year. A qualified small business is generally one with gross receipts of $10 million or less.
There is also a de minimis safe harbor as well as an exemption for materials and supplies up to a certain threshold. Contact us for details on these safe harbors and exemptions and other ways to maximize your tangible property deductions.
Can the WOTC save tax for your business?
Employers that hire individuals who are members of a “target group” may be eligible for the Work Opportunity tax credit (WOTC). If you made qualifying hires in 2016 and obtained proper certification, you can claim the WOTC on your 2016 tax return. Whether or not you’re eligible for 2016, keep the WOTC in mind in your 2017 hiring, because the credit is also available for 2017.
In fact, the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) extended the WOTC through 2019. The PATH Act also expanded the credit beginning in 2016 to apply to employers that hire qualified individuals who have been unemployed for 27 weeks or more.
What are the “target groups’?
Besides the long-term unemployed, target groups include:
- Designated community residents who live in Empowerment Zones or rural renewal counties,
- Long-term family assistance recipients,
- Qualified ex-felons,
- Qualified recipients of Temporary Assistance for Needy Families (TANF),
- Qualified veterans,
- Summer youth employees,
- Supplemental Nutrition Assistance Program (SNAP) recipients,
- Supplemental Security Income benefits recipients, and
- Vocational rehabilitation referrals for individuals who suffer from an employment handicap resulting from a physical or mental handicap.
How much is the credit worth?
Qualifying employers can claim the WOTC as a general business credit against their income tax. The amount of the credit depends on the:
- Target group of the individual hired,
- Wages paid to that individual, and
- Number of hours that individual worked during the first year of employment.
The maximum credit that can be earned for each member of a target group is generally $2,400 per employee. The credit can be as high as $9,600 for certain veterans. Employers aren’t subject to a limit on the number of eligible individuals they can hire. In other words, if there are 10 individuals that qualify, the credit can be 10 times the amount listed.
Before you can claim the WOTC, you must obtain certification from a “designated local agency” (DLA) that the hired individual is indeed a target group member. You must submit IRS Form 8850, “Pre-Screening Notice and Certification Request for the Work Opportunity Credit,” to the DLA no later than the 28th day after the individual begins work for you.
But if you hired long-term unemployment recipients between January 1, 2016, and May 31, 2016, the IRS extended the deadline to June 29, 2016, as long as the individuals started work for you on or after January 1, 2016, and before June 1, 2016.
The WOTC can lower your company’s tax liability when you hire qualified new employees. We can help you determine whether an employee qualifies, calculate the applicable credit and answer other questions you might have.
SEPs: A powerful retroactive tax planning tool
Simplified Employee Pensions (SEPs) are sometimes regarded as the “no-brainer” first choice for high-income small-business owners who don’t currently have tax-advantaged retirement plans set up for themselves. Why? Unlike other types of retirement plans, a SEP is easy to establish and a powerful retroactive tax planning tool: The deadline for setting up a SEP is favorable and contribution limits are generous.
SEPs do have a couple of downsides if the business has employees other than the owner: 1) Contributions must be made for all eligible employees using the same percentage of compensation as for the owner, and 2) employee accounts are immediately 100% vested.
Deadline for set-up and contributions
A SEP can be established as late as the due date (including extensions) of the business’s income tax return for the tax year for which the SEP is to first apply. For example:
- A calendar-year partnership or S corporation has until March 15, 2017, to establish a SEP for 2016 (September 15, 2017, if the return is extended).
- A calendar-year sole proprietor or C corporation has until April 18, 2017 (October 16, 2017, if the return is extended), because of their later filing deadlines.
The deadlines for limited liability companies (LLCs) depend on the tax treatment the LLC has elected. Furthermore, the business has until these same deadlines to make 2016 contributions and still claim a potentially hefty deduction on its 2016 return.
Generally, other types of retirement plans would have to have been established by December 31, 2016, in order for 2016 contributions to be made (though many of these plans do allow 2016 contributions to be made in 2017).
Contributions to SEPs are discretionary. The business can decide what amount of contribution it will make each year. The contributions go into SEP-IRAs established for each eligible employee.
For 2016, the maximum contribution that can be made to a SEP-IRA is 25% of compensation (or 20% of self-employed income net of the self-employment tax deduction) of up to $265,000, subject to a contribution cap of $53,000. The 2017 limits are $270,000 and $54,000, respectively.
Setting up a SEP is easy
A SEP is established by completing and signing the very simple Form 5305-SEP (“Simplified Employee Pension — Individual Retirement Accounts Contribution Agreement”). Form 5305-SEP is not filed with the IRS, but it should be maintained as part of the business’s permanent tax records. A copy of Form 5305-SEP must be given to each employee covered by the SEP, along with a disclosure statement.
Of course, additional rules and limits do apply to SEPs, but they’re generally much less onerous than those for other retirement plans. If you think a SEP might be good for your business, please contact us.
Take small-business tax credits where credits are due
Tax credits reduce tax liability dollar-for-dollar, making them particularly valuable. Two available credits are especially for small businesses that provide certain employee benefits. And one of them might not be available after 2017.
1. Small-business health care credit
The Affordable Care Act (ACA) offers a credit to certain small employers that provide employees with health coverage. The maximum credit is 50% of group health coverage premiums paid by the employer, provided it contributes at least 50% of the total premium or of a benchmark premium.
For 2016, the full credit is available for employers with 10 or fewer full-time equivalent employees (FTEs) and average annual wages of $25,000 or less per employee. Partial credits are available on a sliding scale to businesses with fewer than 25 FTEs and average annual wages of less than $52,000.
To qualify for the credit, online enrollment in the Small Business Health Options Program (SHOP) generally is required. In addition, the credit can be claimed for only two years, and they must be consecutive. (Credits claimed before 2014 don’t count, however.)
If you meet the eligibility requirements but have been waiting to claim the credit until a future year when you think it might provide more savings, claiming the credit for 2016 may be a good idea. Why? It’s possible the credit will go away for 2018 because lawmakers in Washington are starting to take steps to repeal or replace the ACA.
Most likely any ACA repeal or replacement wouldn’t go into effect until 2018 (or possibly later). So if you claim the credit for 2016, you may also be able to claim it on your 2017 return next year (provided you again meet the eligibility requirements). That way, you could take full advantage of the credit while it’s available.
2. Retirement plan credit
Small employers (generally those with 100 or fewer employees) that create a retirement plan may be eligible for a $500 credit per year for three years. The credit is limited to 50% of qualified start-up costs.
Of course, you generally can deduct contributions you make to your employees’ accounts under the plan. And your employees enjoy the benefit of tax-advantaged retirement saving.
If you didn’t create a retirement plan in 2016, it might not be too late. Simplified Employee Pensions (SEPs) can be set up as late as the due date of your tax return, including extensions.
Maximize tax savings
Be aware that additional rules apply beyond what we’ve discussed here. We can help you determine whether you’re eligible for these credits. We can also advise you on what other credits you might be eligible for when you file your 2016 return so that you can maximize your tax savings.
The “manufacturers’ deduction” isn’t just for manufacturers
The Section 199 deduction is intended to encourage domestic manufacturing. In fact, it’s often referred to as the “manufacturers’ deduction.” But this potentially valuable tax break can be used by many other types of businesses besides manufacturing companies.
Sec. 199 deduction 101
The Sec. 199 deduction, also called the “domestic production activities deduction,” is 9% of the lesser of qualified production activities income or taxable income. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts.
Yes, the deduction is available to traditional manufacturers. But businesses engaged in activities such as construction, engineering, architecture, computer software production and agricultural processing also may be eligible.
The deduction isn’t allowed in determining net self-employment earnings and generally can’t reduce net income below zero. But it can be used against the alternative minimum tax.
How income is calculated
To determine a company’s Sec. 199 deduction, its qualified production activities income must be calculated. This is the amount of domestic production gross receipts (DPGR) exceeding the cost of goods sold and other expenses allocable to that DPGR. Most companies will need to allocate receipts between those that qualify as DPGR and those that don’t — unless less than 5% of receipts aren’t attributable to DPGR.
DPGR can come from a number of activities, including the construction of real property in the United States, as well as engineering or architectural services performed stateside to construct real property. It also can result from the lease, rental, licensing or sale of qualifying production property, such as:
- Tangible personal property (for example, machinery and office equipment),
- Computer software, and
- Master copies of sound recordings.
The property must have been manufactured, produced, grown or extracted in whole or “significantly” within the United States. While each situation is assessed on its merits, the IRS has said that, if the labor and overhead incurred in the United States accounted for at least 20% of the total cost of goods sold, the activity typically qualifies.
Contact us to learn whether this potentially powerful deduction could reduce your business’s tax liability when you file your 2016 return.
Why 2016 may be an especially good year to take bonus depreciation
Bonus depreciation allows businesses to recover the costs of depreciable property more quickly by claiming additional first-year depreciation for qualified assets. The PATH Act, signed into law a little over a year ago, extended 50% bonus depreciation through 2017.
Claiming this break is generally beneficial, though in some cases a business might save more tax in the long run if they forgo it. However, 2016 may be an especially good year to take bonus depreciation. Keep this in mind when you’re filing your 2016 tax return.
New tangible property with a recovery period of 20 years or less (such as office furniture and equipment) qualifies for bonus depreciation. So does off-the-shelf computer software, water utility property and qualified improvement property. And beginning in 2016, the qualified improvement property doesn’t have to be leased
It isn’t enough, however, to have acquired the property in 2016. You must also have placed the property in service in 2016.
Now vs. later
If you’re eligible for bonus depreciation and you expect to be in the same or a lower tax bracket in future years, taking bonus depreciation (to the extent you’ve exhausted any Section 179 expensing available to you) is likely a good tax strategy. It will defer tax, which generally is beneficial.
But if your business is growing and you expect to be in a higher tax bracket in the near future, you may be better off forgoing bonus depreciation. Why? Even though you’ll pay more tax for 2016, you’ll preserve larger depreciation deductions on the property for future years, when they may be more powerful — deductions save more tax when you’re paying a higher tax rate.
Making a decision for 2016
The greater tax-saving power of deductions when rates are higher is why 2016 may be a particularly good year to take bonus depreciation. With both President Trump and the Republican-controlled Congress wishing to reduce tax rates, there’s a good chance that such legislation could be signed into law.
This means your tax rate could be lower for 2017 (if changes go into effect for 2017) and future years. If that happens, there’s a greater likelihood that taking bonus depreciation for 2016 would save you more tax than taking all of your deduction under normal depreciation schedules over a period of years.
Also keep in mind that, under the PATH Act, bonus depreciation is scheduled to drop to 40% for 2018, drop to 30% for 2019, and expire Dec. 31, 2019. Of course, Congress could pass legislation extending 50% bonus depreciation or making it permanent — or it could eliminate it or reduce the bonus depreciation percentage sooner.
If you’re unsure whether you should take bonus depreciation on your 2016 return — or you have questions about other depreciation-related breaks, such as Sec. 179 expensing — contact us.
Can you defer taxes on advance payments?
Many businesses receive payment in advance for goods and services. Examples include magazine subscriptions, long-term supply contracts, organization memberships, computer software licenses and gift cards.
Generally, advance payments are included in taxable income in the year they’re received, even if you defer a portion of the income for financial reporting purposes. But there are exceptions that might provide you some savings when you file your 2016 income tax return.
The IRS allows limited deferral of income related to advance payments for:
- Goods or services,
- Intellectual property licenses or leases,
- Computer software sales, leases or licenses,
- Warranty contracts,
- Certain organization memberships,
- Eligible gift card sales, and
- Any combination of the above.
In the year you receive an advance payment (Year 1), you may defer the same amount of income you defer in an “applicable financial statement.” The remaining income must be recognized in the following year (Year 2), regardless of the amount of income you recognize in Year 2 for financial reporting purposes. Let’s look at an example.
Fred and Ginger are in the business of giving dance lessons. On November 1, 2016, they receive an advance payment from Gene for a two-year contract that provides up to 96 one-hour lessons. Gene takes eight lessons in 2016, 48 lessons in 2017 and 40 lessons in 2018.
In their applicable financial statements, Fred and Ginger recognize 1/12 of the advance payment in their 2016 revenues, 6/12 in their 2017 revenues and 5/12 in their 2018 revenues. For federal income tax purposes, they need to include only 1/12 of the advance payment in their 2016 gross income. But they must include the remaining 11/12 in their 2017 gross income.
The applicable financial statement
An applicable financial statement is one that’s audited by an independent CPA or filed with the SEC or certain other government agencies. If you don’t have this statement, it’s still possible to defer income; you simply need a reasonable method for determining the extent to which advance payments are earned in Year 1.
Suppose, for example, that a company issues gift certificates but doesn’t track their use and doesn’t have an applicable financial statement. The company may be able to defer income based on a statistical study that indicates the percentage of gift certificates expected to be redeemed in Year 1.
If your business receives advance payments, consult your tax advisor to determine whether you can reduce your 2016 tax bill by deferring some of this income to 2017. And make sure you abide by the IRS’s rules on these payments.
New HRA offers small employers an attractive, tax-advantaged health care option
In December, Congress passed the 21st Century Cures Act. The long and complex bill covers a broad range of health care topics, but of particular interest to some businesses should be the Health Reimbursement Arrangement (HRA) provision. Specifically, qualified small employers can now use HRAs to reimburse employees who purchase individual insurance coverage, rather than providing employees with costly group health plans.
The need for HRA relief
Employers can use HRAs to reimburse their workers’ medical expenses, including health insurance premiums, up to a certain amount each year. The reimbursements are excludable from employees’ taxable income, and untapped amounts can be rolled over to future years. HRAs generally have been considered to be group health plans for tax purposes.
But the Affordable Care Act (ACA) prohibits group health plans from imposing annual or lifetime benefits limits and requires such plans to provide certain preventive services without any cost-sharing by employees. And according to previous IRS guidance, “standalone HRAs” — those not tied to an existing group health plan — didn’t comply with these rules, even if the HRAs were used to purchase health insurance coverage that did comply. Businesses that provided the HRAs were subject to fines of $100 per day for each affected employee.
The IRS position was troublesome for smaller businesses that struggled to pay for traditional group health plans or to administer their own self-insurance plans. The changes in the Cures Act give these employers a third option for providing one of the benefits most valued by today’s employees.
Under the Cures Act, certain small employers can maintain general purpose, standalone HRAs that aren’t “group health plans” for most purposes under the Internal Revenue Code, Employee Retirement Income Security Act and Public Health Service Act.
More specifically, the legislation allows employers that aren’t “applicable large employers” under the ACA to provide a Qualified Small Employer HRA (QSEHRA) if they don’t offer a group health plan to any of their employees. Annual benefits under a QSEHRA:
- Can’t exceed an indexed maximum of $4,950 per year ($10,000 if family members are covered),
- Must be employer-funded (no salary reductions), and
- Can be used for only IRC Section 213(d) medical care.
QSEHRA benefits must be offered on the same terms to all “eligible employees” (certain individuals can be disregarded) and may be excluded from income only if the recipient has minimum essential coverage. There is a notice requirement and employees’ permitted benefits must be reported on Form W-2.