Category Archives: Financial Tid-bits

How to determine if you need to worry about estate taxes

Among the taxes that are being considered for repeal as part of tax reform legislation is the estate tax. This tax applies to transfers of wealth at death, hence why it’s commonly referred to as the “death tax.” Its sibling, the gift tax — also being considered for repeal — applies to transfers during life. Yet most taxpayers won’t face these taxes even if the taxes remain in place.

Exclusions and exemptions

For 2017, the lifetime gift and estate tax exemption is $5.49 million per taxpayer. (The exemption is annually indexed for inflation.) If your estate doesn’t exceed your available exemption at your death, then no federal estate tax will be due.

Any gift tax exemption you use during life does reduce the amount of estate tax exemption available at your death. But every gift you make won’t use up part of your lifetime exemption. For example:

  • Gifts to your U.S. citizen spouse are tax-free under the marital deduction. (So are transfers at death — that is, bequests.)  
  • Gifts and bequests to qualified charities aren’t subject to gift and estate taxes.
  • Payments of another person’s health care or tuition expenses aren’t subject to gift tax if paid directly to the provider.
  •  Each year you can make gifts up to the annual exclusion amount ($14,000 per recipient for 2017) tax-free without using up any of your lifetime exemption.

What’s your estate tax exposure?  

Here’s a simplified way to project your estate tax exposure. Take the value of your estate, net of any debts. Also subtract any assets that will pass to charity on your death.

Then, if you’re married and your spouse is a U.S. citizen, subtract any assets you’ll pass to him or her. (But keep in mind that there could be estate tax exposure on your surviving spouse’s death, depending on the size of his or her estate.) The net number represents your taxable estate.

You can then apply the exemption amount you expect to have available at death. Remember, any gift tax exemption amount you use during your life must be subtracted. But if your spouse predeceases you, then his or her unused estate tax exemption, if any, may be added to yours (provided the applicable requirements are met).

If your taxable estate is equal to or less than your available estate tax exemption, no federal estate tax will be due at your death. But if your taxable estate exceeds this amount, the excess will be subject to federal estate tax.

Be aware that many states impose estate tax at a lower threshold than the federal government does. So you could have state estate tax exposure even if you don’t need to worry about federal estate tax.

If you’re not sure whether you’re at risk for the estate tax or if you’d like to learn about gift and estate planning strategies to reduce your potential liability, please contact us. We also can keep you up to date on any estate tax law changes.

© 2017

Summer is a good time to start your 2017 tax planning and organize your tax records

You may be tempted to forget all about taxes during summertime, when “the livin’ is easy,” as the Gershwin song goes. But if you start your tax planning now, you may avoid an unpleasant tax surprise when you file next year. Summer is also a good time to set up a storage system for your tax records. Here are some tips:

Take action when life changes occur. Some life events (such as marriage, divorce, or the birth of a child) can change the amount of tax you owe. When they happen, you may need to change the amount of tax withheld from your pay. To do that, file a new Form W-4 with your employer. If you make estimated payments, those may need to be changed as well.

Keep records accessible but safe. Put your 2016 tax return and supporting records together in a place where you can easily find them if you need them, such as if you’re ever audited by the IRS. You also may need a copy of your tax return if you apply for a home loan or financial aid. Although accessibility is important, so is safety.

A good storage medium for hard copies of important personal documents like tax returns is a fire-, water- and impact-resistant security cabinet or safe. You may want to maintain a duplicate set of records in another location, such as a bank safety deposit box. You can also store copies of records electronically. Simply scan your documents and save them to an external storage device (which you can keep in your home safe or bank safety deposit box). If opting for a cloud-based backup system, choose your provider carefully to ensure its security measures are as stringent as possible.

Stay organized. Make tax time easier by putting records you’ll need when you file in the same place during the year. That way you won’t have to search for misplaced records next February or March. Some examples include substantiation of charitable donations, receipts from work-related travel not reimbursed by your employer, and documentation of medical expenses not reimbursable by insurance or paid through a tax-advantaged account.

For more information on summertime tax planning or organizing your tax-related information, contact us.

© 2017

3 midyear tax planning strategies for individuals

In the quest to reduce your tax bill, year end planning can only go so far. Tax-saving strategies take time to implement, so review your options now. Here are three strategies that can be more effective if you begin executing them midyear:

1. Consider your bracket

The top income tax rate is 39.6% for taxpayers with taxable income over $418,400 (singles), $444,550 (heads of households) and $470,700 (married filing jointly; half that amount for married filing separately). If you expect this year’s income to be near the threshold , consider strategies for reducing your taxable income and staying out of the top bracket. For example, you could take steps to defer income and accelerate deductible expenses. (This strategy can save tax even if you’re not at risk for the 39.6% bracket or you can’t avoid the bracket.)

You could also shift income to family members in lower tax brackets by giving them income-producing assets. This strategy won’t work, however, if the recipient is subject to the “kiddie tax.” Generally, this tax applies the parents’ marginal rate to unearned income (including investment income) received by a dependent child under the age of 19 (24 for full-time students) in excess of a specified threshold ($2,100 for 2017).

2. Look at investment income

This year, the capital gains rate for taxpayers in the top bracket is 20%. If you’ve realized, or expect to realize, significant capital gains, consider selling some depreciated investments to generate losses you can use to offset those gains. It may be possible to repurchase those investments, so long as you wait at least 31 days to avoid the “wash sale” rule.

Depending on what happens with health care and tax reform legislation, you also may need to plan for the 3.8% net investment income tax (NIIT). Under the Affordable Care Act, this tax can affect taxpayers with modified adjusted gross income (MAGI) over $200,000 ($250,000 for joint filers). The NIIT applies to net investment income for the year or the excess of MAGI over the threshold, whichever is less. So, if the NIIT remains in effect (check back with us for the latest information), you may be able to lower your tax liability by reducing your MAGI, reducing net investment income or both.

3. Plan for medical expenses

The threshold for deducting medical expenses is 10% of AGI. You can deduct only expenses that exceed that floor. (The threshold could be affected by health care legislation. Again, check back with us for the latest information.)

Deductible expenses may include health insurance premiums (if not deducted from your wages pretax); long-term care insurance premiums (age-based limits apply); medical and dental services and prescription drugs (if not reimbursable by insurance or paid through a tax-advantaged account); and mileage driven for health care purposes (17 cents per mile driven in 2017). You may be able to control the timing of some of these expenses so you can bunch them into every other year and exceed the applicable floor.  
      
These are just a few ideas for slashing your 2017 tax bill. To benefit from midyear tax planning, consult us now. If you wait until the end of the year, it may be too late to execute the strategies that would save you the most tax.

© 2017

3 types of information your nonprofit’s board needs

Information is power. And regularly supplying information to your not-for-profit’s board of directors is the key to the board properly fulfilling its duties. This doesn’t mean you have to share every internal email or phone message. Board members should, however, receive and understand information that will help them work together and better serve your organization.

Three types of information are important to share with your board:

1. Financial. To fulfill their fiduciary duties, the board must receive copies of your Form 990, and the board president or treasurer should review and approve it before it’s filed. The board also must get the results of any audit you’ve conducted, salary information for key staff, monthly and quarterly financial reports showing income and expenses, and proof of directors and officers insurance, if your organization provides it.

2. Strategic. This includes reports on your nonprofit’s work, such as:

• How programs are being carried out,
• Program usage statistics,
• Progress on event timelines, and
• Membership statistics.

If your organization collects information from the audience it serves through formal or informal means, provide at least an executive summary of your findings to your board. Occasionally sharing with the board articles that relate to your nonprofit’s mission, locations or audiences also may be useful.

3. Board member. To help foster teamwork and commitment to the cause, ask that members share brief bios and other relevant background information. Also publicly share thank-yous when board members make special efforts — whether those efforts are individual (such as securing an event sponsor) or group (performing due diligence on a new executive director).

Of course, you always want to inform your board when unexpected events occur, particularly if they have the potential to negatively affect your organization or require swift action. But don’t deluge your board with so much information that they can’t keep up. If it’s something that will help them serve your nonprofit, it’s something you should share. Contact us for more information on good nonprofit governance.

© 2017

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.

© 2017

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.

© 2017

Cooking the books

What’s the most costly type of white collar crime? On average, a company is likely to lose more money from a scheme in which the financial statements are falsified or manipulated than from any other type of occupational fraud incident. The costs frequently include more than just the loss of assets — victimized companies also may suffer lost shareholder value, lower employee morale, premature tax liabilities and reputational damage. Let’s take a closer look at what’s at stake when employees “cook the books.”

Low frequency, high cost

The Report to the Nations on Occupational Fraud and Abuse published in 2016 by the Association of Certified Fraud Examiners (ACFE) found that less than 10% of the fraud schemes in its survey involved financial statement fraud. However, those cases clocked the greatest financial effect, with a median loss of $975,000. Compare that amount to the median losses for asset misappropriation ($125,000) and corruption ($200,000).

What makes financial statement fraud especially problematic is that the costs can quickly snowball out of control. For example, when an executive fudges the numbers to make a company appear more profitable, the company will likely incur greater liability for taxes or dividends.

Plus, it might be necessary to take on debt to make those payments, leading to higher interest costs. Or an acquisition of a healthy company might be pursued to hide the actual underperformance. In the end, more fraud may be necessary to pay for the original scam.

Common schemes

The ACFE defines financial statement fraud as “a scheme in which an employee intentionally causes a misstatement or omission of material information in the organization’s financial reports.” Common ploys include:

* Concealed liabilities,
* Fictitious revenues,
* Inflated asset valuations,
* Misleading disclosures, and
* Timing differences.

Revenue recognition is a particularly ripe area for financial statement fraud, especially as companies start to implement the new revenue recognition guidance for long-term contracts. Early revenue recognition can be accomplished through several avenues, including 1) keeping books open past the end of the accounting period, 2) delivering products early, 3) recording revenue before full performance of a contract, and 4) backdating sales agreements.

Preventive medicine

Victims of financial statement fraud often find their long-term survival severely threatened in a relatively short period of time. Hiring an outside forensic accounting specialist to evaluate internal controls can help identify red flags, ferret out ongoing schemes and deter would-be fraudsters. Contact us for more information.

© 2017

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.

Accountable plan

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.

©2017

My 2%’s Worth

two percentAny time I review an estate or trust income tax return, Form 1041, I pause on Line 15.  That’s the spot where a decision must be made to subject “Other deductions” to the 2% of income floor or to take full advantage of those deductions.

When I arrive at Line 15 I have already fully deducted, legitimately, several items that individuals would not be able to fully deduct on their personal returns.  For example, fiduciary fees, attorney fees, accounting fees, and return preparation fees are all fully deductible on Form 1041, but not on Form 1040.  On Form 1040, they would be subject to a 2% of adjusted gross income floor.

It is not surprising that I pause on Line 15.  This has been an unsettled area of the tax law for the past 28 years.  A lot of court cases have looked at the expenses being deducted there and compared them to the expenses incurred by individuals for the same services.  The cases have concluded that the fees are fully deductible if they were only incurred because the property is held in a trust or estate. If the fees could have been incurred by individuals owning the same type of property, the expenses are subject to the 2% floor.

This is illogical and inconsistent.  Welcome to the world of tax law.  It is just like the world of parenting, where we were often told, “You will do it that way because I said so.”

The vast majority of the expenses under scrutiny are normally labeled investment fees.  Well, we finally have final regulations about what to do with those fees, effective for tax years beginning on or after May 9, 2014.  That would include a decedent whose date of death is on or after that date.  On calendar 2015 returns, we will handle the five types of costs discussed in the regulations as follows:

1.  Ownership costs. Any costs incurred simply by owning the property will be subject to the 2% floor.   For example, these include: condominium fees, insurance premiums, maintenance and lawn service, and miscellaneous itemized deductions from passthrough entities.

2.  Tax preparation fees. Continuing to be fully deductible are the preparation of estate and GST tax returns, fiduciary income tax returns (the Form 1041), and the decedent’s final individual income tax return.

Bizarrely omitted from full deductibility is any other type of tax return, including the decedent’s final gift tax returns and final Form 114, Report of Foreign Bank and Financial Accounts.  In other words, all other return preparation costs are subject to the 2% floor.

3.  Appraisal fees. These are fully deductible by an estate or trust if incurred for determining the value of assets of a decedent’s estate; determining distributions, such as a unitrust payment; or preparing tax returns. All other appraisals are subject to the 2% floor.

4.  Fiduciary expenses. These costs to administer an estate, such as probate court costs, surety bond premiums, publishing legal notices, cost of death certificates, etc., are fully deductible.

5.  Investment advisory fees. This is usually the largest expense on Form 1041. It is now officially limited by the 2% floor. Banks and trust companies are allowed to break out the portion of their fees that relate to fiduciary, legal, and accounting fees. If broken out for you, you can fully deduct fiduciary, legal, and accounting fees.

In the years leading up the final regulations, we were at various times told we could fully deduct investment fees and could not fully deduct investment fees.  As we tend to be consistent from year to year on tax returns, we will have to be vigilant to adopt the final regulations when preparing Form 1041.

The final regulations are fairly consistent with the proposed regulations that were issued for this in 2011.  So, for 2013 and 2014 returns and beyond, we should be limiting pure investment fees to the 2% floor.

Karen S. Cohen, CPA
Principal – Packer Thomas
Feel free to contact Karen with your questions: kcohen@packerthomas.com
(800) 943-4278
(330) 533-9777