Thanks to the annual gift tax exclusion, you can systematically reduce your taxable estate with little effort. And while you typically don’t have to file a gift tax return, in some situations, doing so may be required or recommended.
The annual gift tax exclusion amount for 2024 is $18,000 per recipient. (It’ll increase to $19,000 per recipient beginning in 2025.)
So, for example, if you have three children and seven grandchildren, you can give up to $180,000 in 2024 ($18,000 x 10) without gift tax liability. Under this scenario, you aren’t required to file a gift tax return.
If your spouse consents to a “split gift,” you can jointly give up to $36,000 per recipient in 2024. When making split gifts, you must file a gift tax return (unless you reside in a community property state). If your gift exceeds the annual gift tax exclusion amount, the federal gift and estate tax exemption may shelter the excess from tax if a gift tax return is filed. In 2024, the exemption amount is an inflation-adjusted $13.61 million. In 2025, the exemption amount increases to an inflation-adjusted $13.99 million.
Failing to file a required gift tax return may result in a penalty of 5% per month of the tax due, up to 25%. Bear in mind that you might file a gift tax return even if you’re technically not required to do so. The return establishes the value of assets for tax purposes and provides a measure of audit protection from the IRS.
If you file a gift tax return and honestly disclose the value of the gifts, a safe-harbor rule prohibits audits after three years. However, the safe-harbor rule doesn’t apply in the event of fraudulent statements or inadequate disclosure.
The due date for filing a gift tax return for 2024 is April 15, 2025, the same due date for filing an individual income tax return. If you file for an extension, the filing due date is October 15, 2025. Contact us if you have questions about whether a gift requires filing a gift tax return.
© 2024
There are many benefits of including a revocable trust in your estate plan. This trust type allows you to minimize probate expenses, keep your financial affairs private and provide for the management of your assets in the event you become incapacitated. Importantly, they offer flexibility: You’re free to amend the terms of the trust or even revoke it altogether at any time.
If you’re married, you and your spouse must decide whether to use a joint trust or separate trusts. The right choice depends on your financial and family circumstances, applicable state law, and other factors.
If you’re comfortable with your spouse inheriting your combined assets (and vice versa), a joint trust can be less complex to set up and administer than separate trusts. Funding the trust is a simple matter of transferring assets into it and avoids the need to divide assets between two separate trusts.
In addition, during your lifetimes, you and your spouse have equal control over the trust’s assets, which can make it easier to manage and conduct transactions involving the assets. On the other hand, separate trusts may be the way to go for spouses who aren’t comfortable sharing control of their combined assets.
If shielding assets from creditors is a concern, separate trusts usually offer greater protection. With a joint trust, if a creditor obtains a judgment against one spouse, all trust assets may be at risk. A spouse’s trust is generally protected from the other spouse’s creditors.
Also, when one spouse dies, his or her trust becomes irrevocable, making it more difficult for creditors of either spouse to reach the trust assets. Keep in mind that the degree of asset protection a trust provides depends on the type of debt involved, applicable state law and the existence of a prenuptial agreement.
For most couples today, federal gift and estate taxes aren’t a concern. This is because they enjoy a combined gift and estate tax exemption of more than $27 million in 2024 and 2025.
However, if a couple’s wealth exceeds the exemption amount, or if they live in a state where an estate or inheritance tax kicks in at lower asset levels, separate trusts offer greater opportunities to avoid or minimize these taxes. For example, some states have exemption amounts as low as $1 million or $2 million. In these states, separate trusts can be used to make the most of each spouse’s exemption amount and minimize exposure to death taxes.
It’s also important to consider income tax. As previously mentioned, when one spouse dies, his or her trust becomes irrevocable. That means filing tax returns for the trust each year and, to the extent trust income is accumulated in the trust, paying tax at significantly higher trust tax rates.
A joint trust remains revocable after the first spouse’s death (it doesn’t become irrevocable until both spouses have passed). In this case, income is taxed to the surviving spouse at his or her individual tax rate.
Joint and separate trusts each have advantages and disadvantages. Contact us to determine which is right for you. We’d be pleased to review your circumstances and help you make a final decision.
© 2024
Tax planning is only a small component of estate planning — and usually not even the most important one for most people. The primary goal of estate planning is to protect your family, and saving taxes is just one of many strategies you can use to provide for your family’s financial security. Another equally important strategy is asset protection. And a spendthrift trust can be an invaluable tool for preserving wealth for your heirs.
A spendthrift trust prohibits a beneficiary from directly tapping its funds or transferring its rights to someone else. The trust can also deny access to creditors or a beneficiary’s ex-spouse.
Instead, the trust beneficiary relies on the trustee to provide payments based on the trust’s terms. These could be in the form of regular periodic payouts or on an “as needed” basis. The trust document will spell out the nature and frequency, if any, of the payments. Once a payment has been made to a beneficiary, the money becomes fair game to any creditors.
Be aware that a spendthrift trust isn’t designed primarily for tax-reduction purposes. Typically, this trust type is most beneficial when you want to leave money or property to a family member but worry that he or she may squander the inheritance.
For example, you might think that the beneficiary doesn’t handle money well based on experience, or that he or she could easily be defrauded, has had prior run-ins with creditors or suffers from an addiction that may result in a substantial loss of funds.
If any of these scenarios are possible, a spendthrift trust can provide asset protection. It enables the designated trustee to make funds available for the beneficiary without the risk of misuse or overspending. But that brings up another critical issue.
Depending on the trust’s terms, the trustee may be responsible for making scheduled payments or have wide discretion as to whether funds should be paid, how much and when. The trustee may even decide if there should be any payment at all.
Or perhaps someone will direct the trustee to pay a specified percentage of the trust’s assets depending on investment performance, so the payouts fluctuate. Similarly, the trustee may be authorized to withhold payment upon the occurrence of certain events (for example, if the beneficiary exceeds a debt threshold or declares bankruptcy).
The designation of the trustee can take on even greater significance if you expect to provide this person with broad discretion. Frequently, the trustee will be a CPA, attorney, financial planner or investment advisor, or someone else with the requisite experience and financial know-how. You should also name a successor trustee in the event the designated trustee passes away before the term ends or otherwise becomes incapable of handling the duties.
Be aware that the protection offered by a spendthrift trust isn’t absolute. Depending on applicable law, government agencies may be able to access the trust’s assets — for example, to satisfy a tax obligation.
It’s also essential to establish how and when the trust should terminate. It could be set up for a term of years or for termination to occur upon a stated event, such as a child reaching the age of majority.
Contact us if you have questions regarding a spendthrift trust.
© 2024
If you sell your home, you might be able to pocket up to a half million dollars in gain from the sale without owing any federal income tax. How? By claiming the home sale gain exclusion. But various rules and limits apply, so it’s important to understand the ins and outs of this tax break.
If you qualify, you can exclude up to $250,000 of gain — $500,000 if you’re married filing jointly — on the sale of your home from your income. The amount of gain is the difference between the sales price and your adjusted basis. Typically, adjusted basis is the amount paid for the home plus the cost of any home improvements. Therefore, it’s especially important to keep detailed records of improvements that could increase your basis.
To qualify for the exclusion, you must have owned and used the home as your principal residence for at least two of the five years prior to the sale. There’s no definitive definition of “principal residence” in the tax code. Generally, your principal residence is the place where you hang your hat most of the time and where you’ve established legal residency for other purposes.
The exclusion can’t be claimed for a second home. This may warrant a change in your living habits. For instance, if you spend seven months at a winter home in a warm climate and five months at a summer home, the winter home is considered to be your principal residence. So if you want to sell your summer home, you may first want to spend enough additional time there that it can qualify as your principal residence.
Here are some other key points about the home sale gain exclusion:
If the home has been used for business rental or use — including use of a home office for which you’ve claimed a tax deduction — you must recapture depreciation deductions attributable to the period after May 6, 1997. The recaptured income is taxable at a maximum rate of 25%.
Even if you don’t meet the two-out-of-five-year rule, you may be eligible for a partial exclusion if you sell the home due to certain unforeseen circumstances, such as:
If a specific exception doesn’t apply, the IRS will examine the facts and circumstances of the case. The partial exclusion is equal to the available exclusion amount ($250,000 or $500,000, depending on your filing status) multiplied by the percentage of time for which you met the requirements.
Maximizing The Benefits
The home sale gain exclusion is valuable enough that taking the steps necessary to ensure you meet the requirements can be well worth the effort. If you’re unsure whether your circumstances will qualify you for this tax break or what you can do to make the most of it, please contact us.
© 2024
Every business owner should have an exit strategy that helps recoup the maximum amount for his or her investment. Understanding the tax implications of a business sale will help you plan for — and, in some cases, reduce — the tax impact. One option is to sell your business to a third party. Here are some considerations to help ensure the transition is as smooth as possible.
Start by obtaining a professional valuation of your business to give you an idea of what the business is currently worth. The valuation process also will help you understand what factors drive the value of your business and identify any weaknesses that reduce its value.
Once you’ve received a valuation, you can make changes to enhance the business’s value and potentially increase the selling price. For example, if the valuator finds that the business relies too heavily on your management skills, bringing in new management talent may make the business more valuable to a prospective buyer.
A valuation can also reveal concentration risks. For instance, if a significant portion of your business is concentrated in a handful of customers or one geographical area, you could take steps to diversify your customer base.
Corporate sellers generally prefer selling stock rather than assets. That’s because the profit on a stock sale is generally taxable at more favorable long-term capital gains rates, while asset sales generate a combination of capital gains and ordinary income. For a business with large amounts of depreciated machinery and equipment, asset sales can generate significant ordinary income in the form of depreciation recapture. (Note: The tax rate on recaptured depreciation of certain real estate is capped at 25%.)
In addition, if your company is a C corporation, an asset sale can trigger double taxation: once at the corporate level and a second time when the proceeds are distributed to shareholders as a dividend. In a stock sale, the buyer acquires the stock directly from the shareholders, so there’s no corporate-level tax.
Buyers, on the other hand, almost always prefer to buy assets, especially for equipment-intensive businesses, such as manufacturers. Acquiring assets provides the buyer with a fresh tax basis in the assets for depreciation purposes and allows the buyer to avoid assuming the seller’s liabilities.
Given the significant advantages of buying assets, most buyers are reluctant to purchase stock. But even in an asset sale, there are strategies for a seller to employ to minimize the tax hit. One strategy is to negotiate a favorable allocation of the purchase price. Although tax rules require the purchase price allocation to be reasonable in light of the assets’ market values, the IRS will generally respect an allocation agreed on by unrelated parties.
As a seller, you’ll want to allocate as much of the price as possible to assets that generate capital gains, such as goodwill and certain other intangible assets. The buyer will prefer allocations to assets eligible for accelerated depreciation, such as machinery and equipment. However, depreciable assets are likely to generate ordinary income for the seller.
Allocating a portion of the purchase price to goodwill can be a good compromise between the parties’ conflicting interests. Sellers enjoy capital gains treatment while buyers can generally amortize goodwill over 15 years for tax purposes.
If your company is a C corporation, establishing that a portion of goodwill is attributable to personal goodwill — that is, goodwill associated with the reputations of the individual owners rather than the enterprise — can be particularly advantageous. That’s because payments for personal goodwill are made directly to the shareholders, avoiding double taxation.
You may need to take certain steps to transfer personal goodwill to the buyer. This may include executing an employment or consulting agreement that defines your responsibility for ensuring that the buyer enjoys the benefits of your ability to attract and retain customers. Buyers may want a noncompete agreement. These are common in private business sales and can help protect the buyer from competition from the seller after the deal closes.
Different strategies can help you enhance your business’s value and minimize taxes, but they may take some time to put into place. Whatever your exit strategy, the earlier you start planning, the better.
An employee stock ownership plan (ESOP) might be a viable exit strategy if your business is organized as a corporation and you’re not interested in leaving it to your family or selling to an outsider. An ESOP creates a market for your stock, allowing you to cash out of the business and transfer control to the next generation of owners gradually.
An ESOP is a qualified retirement plan that invests in the company’s stock. Benefits to business owners include the ability to:
ESOPs also provide significant tax benefits to the company, including tax deductions for contributions to the ESOP to cover stock purchases and (in the case of a leveraged ESOP) loan payments. S corporations may avoid taxes on income passed through to shares held by the ESOP.
But there are some downsides, too. For example, ESOPs are subject to many of the same rules and restrictions as 401(k) and other employer-sponsored plans. And they can involve significant administrative costs, including annual appraisals of the company’s stock. Contact your tax advisor to discuss if an ESOP is right for your business.
© 2023
The Silent Generation and Baby Boomers are incredibly fortunate generations—and so might be their heirs. Cerulli’s U.S. High-Net-Worth and Ultra-High-Net-Worth Markets 2021 report predicts these generations will transfer $72.6 trillion in assets to heirs and $11.9 trillion to charities through 2045.
That’s a lot of money, and it presents a unique opportunity for Gen Xers and Millennials to secure their financial futures. But it’s important to remember that this wealth won’t just magically appear. It will take planning and communication between the generations to transfer it smoothly.
Managing expectations is one of the biggest challenges heirs face when inheriting wealth from their parents or grandparents. Many Gen Xers and Millennials believe they will inherit a large sum of money, but this may not be the case.
Older generations are living longer and may spend a large percentage of their estate before it can be passed on. Others might give away too much money now and need financial support from their adult children later.
The first step in any estate planning discussion is getting honest about what heirs hope to receive and what the older generation can afford to give.
Older generations can find it difficult to talk about their death. They may feel like they are losing control over their life and finances. Or they may be afraid that their heirs won’t be able to handle the responsibility of inheriting wealth.
However, it’s essential for members of different generations to have open communication about estate planning. That way, everyone is on the same page when the time comes to hand over the reins.
Involving a third party—a CPA, financial advisor, or attorney—in these conversations can help. These professionals do more than ensure the estate planning documents are in order and help navigate tax issues. They can also help facilitate difficult conversations between family members and negotiate any conflicts that might arise during the process. By working with these professionals, families can avoid costly legal disputes and ensure that their wealth is transferred seamlessly from one generation to the next.
Even if the younger generation has a good idea of how much they’ll inherit, there may be some surprises. For example, they may inherit assets that must be managed carefully, such as a business or real estate. Or they may be expected to take over their parent or grandparents’ philanthropic activities.
Members of the younger generation who were kept in the dark about these decisions often struggle to live up to expectations.
If you plan on leaving a legacy for your heirs, start educating them about your intentions. Make sure they understand the role you expect them to play in managing and using the wealth you leave behind.
Every estate plan is unique, but with a long runway and proper planning, most estate tax is avoidable. The key is to start right away—as soon as it’s clear that are assets you want to transfer.
Some simple strategies you can start implementing now include:
When transferring wealth from one generation to the next, specific strategies will vary depending on whether you own a business, have philanthropic inclinations, and who your heirs are. However, what doesn’t change from one estate plan to the next is the need for communication.
For any generational wealth transfer to be successful, heirs need to understand why the wealth is being transferred, how it will be managed, and their role in the process.
Failure to communicate effectively can lead to many problems, including family feuds and lost money. So, families need to have open discussions about generational wealth transfer early on—before any decisions are made. Managing expectations and having honest conversations can help your family avoid misunderstandings and ensure the transition goes as smoothly as possible.
Estate planning usually starts with a Last Will and Testament, a legal document that spells out how you want your assets to be distributed and other affairs handled after you die. A will is a good first step in estate planning, but it’s not necessarily the best option in every situation.
For California residents, trusts can be especially beneficial. In this article, we’ll discuss why you might want to consider setting up a trust or updating your existing trust if you haven’t looked at it in a while.
While there are many different kinds of trusts, a living trust is one of the most popular types for estate planning.
A living trust is a legal entity that distributes your property to people and organizations after you pass away. Once you establish a living trust, you fund it by putting your assets in the trust’s name. You can put all kinds of assets into a living trust, including real estate, investments, stock from closely held corporations, certificates of deposit (CDs), life insurance, personal property, collectibles, and more.
Living trusts may be revocable or irrevocable. Revocable trusts are more popular for estate planning, as they’re flexible and can be changed any time during your lifetime (as long as you are competent). Irrevocable trusts typically can’t be changed without a court order or approval of the trust’s beneficiaries.
Revocable living trusts are particularly beneficial for California residents for two main reasons.
Currently, probate is generally required for all estates in California valued at more than $184,500 unless all the assets are in a trust. (For deaths prior to April 1, 2022, the maximum value of an estate was $166,250.) There are a few exceptions. For example, property owned jointly automatically transfers to the surviving owner, and life insurance policies and retirement accounts go to the beneficiaries, as long as they are correctly designated.
Other assets must go through probate, including real estate, personal property, and bank and investment accounts. In California, anyone can view probate records, so setting up a trust can help you and your loved ones maintain privacy.
Probate attorney fees are set by statute in California, and they’re based on a percentage of the value of assets that go through probate.
Currently, those rates are:
For value above $25 million, the court determines a “reasonable amount.”
California real estate is expensive so going through probate can be costly based on the value of a residence alone.
For example, say you own a home valued at $1,000,000—roughly the median home price in San Diego. Based on the value of your residence alone, your estate’s probate fees would be:
The attorney’s statutory fee would be $23,000, even if they just file paperwork.
This fee applies even if the home is fully mortgaged since it’s based on the gross amount of probate assets.
If you already have a trust but haven’t looked at it in a while, now is a good time to review it with your attorney.
Many life events can impact how you want to distribute your estate, so it’s essential to ensure your trust and other estate planning documents are up to date.
In general, we recommend reviewing your trust every three to five years or after any of the following life events:
We also recommend working with an estate planning attorney to draft or revise a trust. Many clients think they can save money by using a trust form found on the internet, but estate planning is complex, and trusts are governed by state law. The short-term savings from a DIY approach aren’t worth the expensive problems it can create down the road.
If you’d like a referral to an estate planning attorney, would like us to review your trust documents for tax consequences, or need help with a trust tax return, reach out to a Hamilton Tharp advisor.
Although merger and acquisition activity has been down in 2022, according to various reports, there are still companies being bought and sold. If your business is considering merging with or acquiring another business, it’s important to understand how the transaction will be taxed under current law.
Stocks vs. assets
From a tax standpoint, a transaction can basically be structured in two ways:
1. Stock (or ownership interest). A buyer can directly purchase a seller’s ownership interest if the target business is operated as a C or S corporation, a partnership, or a limited liability company (LLC) that’s treated as a partnership for tax purposes.
The current 21% corporate federal income tax rate makes buying the stock of a C corporation somewhat more attractive. Reasons: The corporation will pay less tax and generate more after-tax income than it would have years ago. Plus, any built-in gains from appreciated corporate assets will be taxed at a lower rate when they’re eventually sold.
Under current law, individual federal tax rates are reduced from years ago and may also make ownership interests in S corporations, partnerships, and LLCs more attractive. Reason: The passed-through income from these entities also will be taxed at lower rates on a buyer’s personal tax return. However, individual rate cuts are scheduled to expire at the end of 2025, and, depending on future changes in Washington, they could be eliminated earlier or extended.
2. Assets. A buyer can also purchase the assets of a business. This may happen if a buyer only wants specific assets or product lines. And it’s the only option if the target business is a sole proprietorship or a single-member LLC that’s treated as a sole proprietorship for tax purposes.
Note: In some circumstances, a corporate stock purchase can be treated as an asset purchase by making a “Section 338 election.” Ask your tax advisor for details.
What buyers and sellers want
For several reasons, buyers usually prefer to purchase assets rather than ownership interests. Generally, a buyer’s main objective is to generate enough cash flow from an acquired business to pay any acquisition debt and provide an acceptable return on the investment. Therefore, buyers are concerned about limiting exposure to undisclosed and unknown liabilities and minimizing taxes after the deal closes.
A buyer can step up (increase) the tax basis of purchased assets to reflect the purchase price. Stepped-up basis lowers taxable gains when certain assets, such as receivables and inventory, are sold or converted into cash. It also increases depreciation and amortization deductions for qualifying assets.
Meanwhile, sellers generally prefer stock sales for tax and nontax reasons. One of their main objectives is to minimize the tax bill from a sale. That can usually be achieved by selling their ownership interests in a business (corporate stock or partnership or LLC interests) as opposed to selling business assets.
With a sale of stock or other ownership interest, liabilities generally transfer to the buyer, and any gain on sale is generally treated as lower-taxed long-term capital gain (assuming the ownership interest has been held for more than one year).
Keep in mind that other issues, such as employee benefits, can also cause unexpected tax issues when merging with, or acquiring, a business.
Get professional advice
Buying or selling a business may be the most important transaction you make during your lifetime, so it’s important to seek professional tax advice as you negotiate. After a deal is done, it may be too late to get the best tax results. Contact us for the best way to proceed in your situation.
© 2022
Becoming a partner at a law firm is a goal many lawyers spend their careers striving to reach. Once you’re there, however, you must re-evaluate your personal financial and tax strategies as you shift from employee to owner. If you recently were promoted to partner and have reviewed your personal financial strategy, keep reading.
Personal financial considerations for new partners
Many of the personal financial decisions partners need to make depend on two things: the partnership agreement and whether you became an equity (owner) or non-equity partner. The partnership agreement will detail a lot of information about compensation and benefit structures, as well as equity structures and required capital contributions. Factors include:
Tax considerations for partners
Switching from an employee to an owner of a law firm also provides additional tax considerations. You’ll most likely see a change from a Form W-2 employee to a Form K-1 owner when it comes time to file your taxes. Keep the following in mind:
Once you’ve thoroughly reviewed your new partnership agreement, meeting with your tax planner and financial advisor can help you outline a new plan for managing your finances moving forward. Contact us today to get started!
Are you planning to launch a business or thinking about changing your business entity? If so, you need to determine which entity will work best for you — a C corporation or a pass-through entity such as a sole-proprietorship, partnership, limited liability company (LLC) or S corporation. There are many factors to consider and proposed federal tax law changes being considered by Congress may affect your decision.
The corporate federal income tax is currently imposed at a flat 21% rate, while the current individual federal income tax rates begin at 10% and go up to 37%. The difference in rates can be mitigated by the qualified business income (QBI) deduction that’s available to eligible pass-through entity owners that are individuals, estates and trusts.
Note that noncorporate taxpayers with modified adjusted gross income above certain levels are subject to an additional 3.8% tax on net investment income.
Organizing a business as a C corporation instead of as a pass-through entity can reduce the current federal income tax on the business’s income. The corporation can still pay reasonable compensation to the shareholders and pay interest on loans from the shareholders. That income will be taxed at higher individual rates, but the overall rate on the corporation’s income can be lower than if the business was operated as a pass-through entity.
Other considerations
Other tax-related factors should also be considered. For example:
These are only some of the many factors involved in operating a business as a certain type of legal entity. For details about how to proceed in your situation, consult with us.
© 2021
Managing cash flow is essential to business management. Revenue can fluctuate, and expenses need to be paid on time to maintain a positive working relationship with vendors, utility companies, and employees.
Thankfully, there’s a way to know what your cash flow could look like down the road so you can plan appropriately, and forecasting can provide these insights for business leaders.
What is forecasting?
Forecasting is the practice of using existing business data to create a model for what your business looks like now, as well as weeks, months, and even years down the road. This essential reporting is what allows business leaders to make real-time decisions based on the health of the business.
While there are different types of forecasting, rolling forecasting provides more information about the future by using existing data to predict performance in a certain time period. Whichever method you choose, building accurate models using complete data is essential.
Tips for accurate forecasting
As a business leader, you can make decisions on the direction of your business all day. If the data you’re using to make those decisions is not accurate, you could end up with less than stellar results or unexpected cash flow issues. Here are some tips to ensure you have the right numbers to base your decisions on.
What to include in forecasting
When creating your forecasts, you should include certain elements to ensure sure you’re getting the most accurate outlook possible. This includes:
While it’s important to create a budget and stick to it, forecasting is an equally important business function that can help direct the future of your company. Forecasts will allow you to foresee upcoming roadblocks or cash flow concerns so you can plan for and adjust around them.
Our firm is available to help you with regular forecasting data, setting up a system for you to create forecasts, audit your current system, and provide outsourced CFO services. Reach out to us to discuss how we can help you today!
Low interest rates and other factors have caused global merger and acquisition (M&A) activity to reach new highs in 2021, according to Refinitiv, a provider of financial data. It reports that 2021 is set to be the biggest in M&A history, with the United States accounting for $2.14 trillion worth of transactions already this year. If you’re considering buying or selling a business — or you’re in the process of an M&A transaction — it’s important that both parties report it to the IRS and state agencies in the same way. Otherwise, you may increase your chances of being audited.
If a sale involves business assets (as opposed to stock or ownership interests), the buyer and the seller must generally report to the IRS the purchase price allocations that both use. This is done by attaching IRS Form 8594, “Asset Acquisition Statement,” to each of their respective federal income tax returns for the tax year that includes the transaction.
Here’s what must be reported
If you buy business assets in an M&A transaction, you must allocate the total purchase price to the specific assets that are acquired. The amount allocated to each asset then becomes its initial tax basis. For depreciable and amortizable assets, the initial tax basis of each asset determines the depreciation and amortization deductions for that asset after the acquisition. Depreciable and amortizable assets include:
In addition to reporting the items above, you must also disclose on Form 8594 whether the parties entered into a noncompete agreement, management contract or similar agreement, as well as the monetary consideration paid under it.
What the IRS might examine
The IRS may inspect the forms that are filed to see if the buyer and the seller use different allocations. If the tax agency finds that different allocations are used, auditors may dig deeper and the examination could expand beyond the transaction. So, it’s best to ensure that both parties use the same allocations. Consider including this requirement in your asset purchase agreement at the time of the sale.
The tax implications of buying or selling a business are complex. Price allocations are important because they affect future tax benefits. Both the buyer and the seller need to report them to the IRS in an identical way to avoid unwanted attention. To lock in the best results after an acquisition, consult with us before finalizing any transaction.
© 2021
If you’re a business owner and you’re getting a divorce, tax issues can complicate matters. Your business ownership interest is one of your biggest personal assets and in many cases, your marital property will include all or part of it.
Tax-free property transfers
You can generally divide most assets, including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).
Let’s say that under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding periods for the home and the stock would carry over to the person who receives them.
Tax-free transfers can occur before a divorce or at the time it becomes final. Tax-free treatment also applies to post-divorce transfers as long as they’re made “incident to divorce.” This means transfers that occur within:
More tax issues
Later on, there will be tax implications for assets received tax-free in a divorce settlement. The ex-spouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies).
What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.
Note that the person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement.
In addition, the beneficial tax-free transfer rule is now extended to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in a divorce, these types of ordinary-income assets can also be transferred tax-free. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.
Plan ahead to avoid surprises
Like many major life events, divorce can have major tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher. We can help you minimize the adverse tax consequences of settling your divorce.
© 2021
The last few years have afforded quite a few changes in how the IRS allows businesses to handle meal and entertainment costs in relation to their taxes. The 2018 Tax Cuts and Jobs Act (TCJA) eliminated deductions for most business-related entertainment expenses. Since the pandemic, the IRS has temporarily changed the tax-deductible amount allowed for some business meals to encourage increased sales at restaurants. With the easing of restrictions, businesses may be considering company picnics for employee appreciation or starting up business lunches with clients again.
With all of these changes, putting a system in place to accurately track business food and entertainment expenses becomes essential. Best practices should include requesting detailed receipts and separately tracking which costs fall under the 50 percent deduction, 100 percent deduction, or not deductible categories.
In addition to keeping excellent records, below are some additional things to keep in mind about the business meal and entertainment deduction rules, including a helpful chart highlighting the deduction category particular meal and entertainment expenses fall under.
Meal and entertainment expense changes
Under the TCJA, the IRS no longer allows businesses to deduct most entertainment expenses even if they were a cost of doing business. Food and beverage related to entertainment venues are only covered with detailed receipts separately stating the cost of the meal.
Another change from the TCJA is that spouse or guest meals are not covered from travel unless the business employs the person. So, if your spouse accompanies you on a work trip, their meals are not deductible for the business.
The Consolidated Appropriations Act of 2021 (CAA) has temporarily increased the deduction for business meals provided by restaurants to 100 percent for tax years 2021 and 2022. Not all meals are created equal, however. The 100 percent deduction is only available for meals provided by restaurants, which the IRS defines as: “A business that prepares and sells food or beverages to retail customers for immediate consumption, regardless of whether the food or beverages are consumed on the business’s premises.” Prepackaged food from a grocery, specialty, or convenience store is not eligible for the 100% deduction and would be limited to a 50% deduction.
Also, note that the expenses must be considered ordinary (common and accepted for your business) or necessary (helpful and appropriate) and cannot be considered lavish or extravagant. An employee of the business or the taxpayer must be present during the meal, as well.
A quick guide to business meal deductions
Expense Category | Deductible Amount | Tax Code Reference |
Company social events and facilities for employees (e.g., holiday parties, team-building events) | 100% | IRC Secs. 274(e)(4) and 274(n)(2)(A) |
Meals and entertainment included in employee or non-employee compensation | 100% | IRC Secs. 274(e)(2) and (9) |
Reimbursed expenses under an accountable plan | 100% | IRC Sec. 274(e)(3) |
Meals and entertainment made available to the public | 100% | IRC Sec. 274(e)(7) |
Meals and entertainment sold to customers | 100% | IRC Sec. 274(e)(8) |
Business travel meals | 50%
100% (1/1/2021 to 12/31/2022)* |
IRC Secs. 274(e)(3) and 274(e)(9)
|
Client/customer business meals | 50%
100% (1/1/2021 to 12/31/2022)* |
Notice 2018-76 |
Business meeting meals | 50%
100% (1/1/2021 to 12/31/2022)* |
IRC Secs 274(e)(5), 274(k)(1), and 274(e)(6) |
De minimis food and beverages provided in the workplace (e.g., bottled water, coffee, snacks) | 50%
|
IRC Sec 274(e)(1) |
Meals provided for the convenience of the employer | 50% (through 12/31/2025)
0% (on or after 1/1/2026) |
IRC Sec. 274(n) and 274(o) |
Employer-operated eating facilities | 50% (through 12/31/2025)
0% (on or after 1/1/2026) |
IRC Sec. 274(n) and 274(o) |
Meals/beverages associated with entertainment activities when not separated stated on the receipt | 0% | Notice 2018-76 |
Personal, lavish, or extravagant meals/beverages in relation to the activity | 0% | IRC Secs. 274(k)(1) and 274(k)(2) |
Entertainment without exception | 0% | IRC Secs. 274(a)(1) and 274(e) |
*Meals are only deductible in the 2021 and 2022 tax years if provided by a restaurant, as defined by the IRS in the above article.
If you need help establishing a system to better track expenses or seek clarification on whether certain expenses are tax-deductible, give our team of CPAs a call today.
Do you know what will happen to your business when you retire? By necessity, many busy small business owners spend all of their time thinking about the here and now, with little opportunity to focus on the future. But your company’s long-term survival -— and your own retirement security -— may depend on establishing a realistic and workable exit strategy.
Set a retirement date
Here is your first question: When do you plan to quit working? You may have a general idea of the age range when you would like to retire, but now is the time to set a precise date. That gives you a timeline to work with, which will make all your other planning easier.
Consider your options
The next essential question: Who do you expect will take over your business? Many companies make one of two choices: either someone buys the company from you or a family member or employee takes over as chief executive when you retire. It is important to consider which one is the most realistic option so that you can ensure a smooth transition down the road. Depending on your plans, there are different steps you should take now to ensure a smooth transition.
If you plan to sell
If you are going to sell your company to another business or individual, you will need an accurate idea of what it is worth. You should get a business appraisal when you are ready to sell; but it may be a good idea to get one now, even if there are many years until your planned retirement. An appraisal can help to spot your company’s strengths and weaknesses so you can analyze how those attributes impact its overall worth.
The information in the appraisal can be used to make changes that improve operations, sales and revenues and make you a more competitive player in the marketplace. Those steps will help increase your company’s value and its appeal to potential buyers at the time you decide to sell.
If you plan to promote from within
It is always a good idea to have a current idea of your company’s worth, but there are also other necessary factors to consider if you are hoping that someone within your company will one day take over the reins of leadership. The first question, of course, is who will that person be? Is there a very talented younger employee who you believe could one day take over? If so, begin grooming him or her now. This includes introducing the employee to key clients, increasing his or her level of responsibility and including the person in decision making whenever possible.
Even if you expect to sell your business, it is a good idea to have a promising future leader ready to take over the reins. In most cases, a potential buyer will be happy to see that there is someone in place to carry on.
There are many possible exit strategies available to small business owners. No matter which you choose, it will be a good idea to have an accurate sense of the company’s worth and to have a strong management team in place. Our firm’s professionals can help you develop a strategy to suit your business. Call us today.