If you’ve reached age 70½, you can make cash donations directly from your IRA to IRS-approved charities. These qualified charitable distributions (QCDs) may help you gain tax advantages.
QCDs can be made from your traditional IRA(s) free of federal income tax. In contrast, other traditional IRA distributions are wholly or partially taxable, depending on whether you’ve made nondeductible contributions over the years.
Unlike regular charitable donations, you can’t claim itemized deductions for QCDs. That’s OK because the tax-free treatment of QCDs equates to a 100% deduction.
To be a QCD, an IRA distribution must meet the following requirements:
Under the SECURE 2.0 Act, the annual QCD limit is now adjusted for inflation. In 2024, the limit is $105,000, up from $100,000 last year. In 2025, it will jump again to $108,000.
If both you and your spouse have IRAs set up in your respective names, each of you is entitled to a separate QCD limit. If you inherited an IRA from the deceased original account owner, you can make a QCD with the inherited account if you’ve reached age 70½.
QCDs have at least five tax-saving advantages:
The QCD strategy is a tax-smart opportunity for many people. It’s especially beneficial for seniors with charitable inclinations and more IRA money than they need for retirement. Contact us if you have questions or want assistance with QCDs.
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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.
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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
When start-ups launch, their focus is often on tightly controlling expenses. Most need to establish a brand and some semblance of stability before funding anything other than essential operating activities.
For companies that make it past that tenuous initial stage, there comes a time when they must loosen up the purse strings and start investing in, among other things, their employees. One way to do so is to sponsor a retirement plan. Offering this fringe benefit lets staff know the business cares about them and their financial futures.
Has your company reached this point? Or is it almost there? If so, let’s review three of the most popular plan types that growing businesses should consider.
These are available to any employer with one or more employees. Under the plan, participants are given accounts that they own. This means their contributions are immediately vested, and they retain ownership even if they leave their jobs. Participants typically contribute via pretax payroll deductions, which reduce their taxable income. Distributions, however, are taxable.
For 2025, 401(k) participants can contribute up to $23,500 (up from $23,000 in 2024). Those age 50 or older by the end of the year can make additional “catch-up” contributions of $7,500 (the same amount as in 2024). Your business may also opt to contribute to participants’ accounts under a vesting schedule of your choosing. In 2025, the total combined limit for employee and employer contributions is $70,000. Within limits, your company can deduct contributions made on behalf of eligible employees.
Many companies’ plans now have Roth 401(k) features. This means participants can choose to make some contributions with compensation that’s already been taxed. The upside is that qualified distributions are tax-free.
Establishing a 401(k) plan typically requires, among other steps, adopting a written plan and arranging a trust fund for plan assets. Annually, employers must file Form 5500 and perform discrimination testing to ensure the plan doesn’t favor highly compensated employees. However, with a “safe harbor” 401(k), the plan isn’t subject to discrimination testing. There are also several other 401(k) variations worth considering.
If choosing a 401(k) plan and administering it seems a bit overwhelming, there are simpler options. Case in point: Simplified Employee Pension Individual Retirement Accounts (SEP-IRAs). Businesses of any size can establish a plan to offer these accounts by completing Form 5305-SEP, “Simplified Employee Pension — Individual Retirement Accounts Contribution Agreement.” But there’s no annual filing requirement.
From there, you set up and wholly fund a SEP-IRA for each participant. Employer contributions immediately vest with participants, who own their respective accounts. What’s nice is you can decide each year whether and how much to contribute. In 2025, contribution limits will be 25% of an employee’s compensation, up to $70,000 (up from $69,000 in 2024).
Another less complex approach is sponsoring Savings Incentive Match Plan for Employees (SIMPLE) IRAs. However, only businesses with 100 or fewer employees can offer them.
Like SEP-IRAs, these are accounts you set up for each participant. They may choose to contribute to their SIMPLE IRAs but don’t have to. Employer contributions are required, but you can opt to either:
Participants are immediately 100% vested in contributions, whether those funds come from you or their own paychecks. The contribution limit in 2025 will be $16,500 (up from $16,000 in 2024).
To be clear, these are but three options among many different retirement plan types that growing businesses can sponsor for their employees. Our firm can help you weigh the pros and cons of all of them, including forecasting the costs involved and understanding the tax implications.
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If you’re charitably inclined and itemize deductions, you may be entitled to deduct charitable donations. The key word is “may” because there are requirements you must meet. One such requirement is the need to substantiate charitable gifts with proper documentation that will satisfy the IRS. Indeed, a charitable gift may be legitimate, but if the taxpayer fails to substantiate it properly, the deduction may be lost.
Cash donations, regardless of the amount, must be substantiated with one of the following:
Bank records. These can include bank statements, electronic fund transfer receipts, canceled checks (including scanned images of both sides of a check from the bank’s website) or credit card statements.
Written communication. This can be in the form of a letter or email from the charitable organization, showing the donee’s name, the contribution date and the amount. A blank pledge card furnished by the donee isn’t sufficient.
In addition to the above, cash donations of $250 or more require a contemporaneous written acknowledgment (CWA) from the donee that details the following:
You can use a single document to meet both the written communication and CWA requirements. For the CWA to be “contemporaneous,” you must obtain it by the earlier of 1) the extended due date of your tax return for the year the donation is made, or 2) the date you file your return.
You must substantiate noncash donations of less than $250 with a receipt from the donee showing the donee’s name and address, the date of the contribution, and a detailed description of the property. For noncash donations of $250 or more, there are additional substantiation requirements depending on the size of the donation:
Additional rules may apply to certain types of property, such as vehicles, clothing, household items or securities.
The regulations on substantiating charitable donations are complex, and one mistake can cause you to lose valuable tax deductions. When in doubt, contact us to ensure you follow all the rules correctly.
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One of the golden rules of estate planning is to revisit your plan after a significant life event. Such an event may be getting married, having a child, going through a divorce or getting remarried.
If you’re taking a second trip down the aisle, you may have different expectations than when you married the first time, especially when it comes to estate planning. For example, if you have children from a previous marriage, your priority may be to provide for them. You may feel your new spouse should have more limited rights to your assets than your spouse in your first marriage.
Unfortunately, your state’s law may not see it that way. Indeed, in nearly every state, a person’s spouse has certain property rights that apply regardless of the terms of the estate plan. And these rights are the same whether it’s your first marriage or your second or third.
Spousal property rights are creatures of state law, so it’s critical to familiarize yourself with the laws in your state to achieve your planning objectives. Many states provide a surviving spouse with an “elective share” of the deceased spouse’s estate, regardless of the terms of his or her will or certain other documents.
Generally, a surviving spouse’s elective share ranges from 30% to 50%, though some states start lower and provide for progressively larger shares as the duration of the marriage increases. Perhaps the most significant variable, with respect to planning, is the definition of assets subject to the surviving spouse’s elective share rights.
In some states, the elective share applies only to the “probate estate” — generally, assets held in the deceased spouse’s name alone that don’t have a beneficiary designation. In other states, it applies to the “augmented estate,” which is the probate estate plus certain nonprobate assets. By understanding how elective share laws apply in your state, you can identify potential strategies for bypassing them.
Elective shares are designed to protect surviving spouses from being disinherited. But there may be good reasons for limiting the amount of property that goes to your spouse when you die. For one thing, your spouse may possess substantial wealth in his or her own name. And you may want most of your estate to go to your children from a previous marriage. Or perhaps the bulk of your wealth is tied up in a family business that you want to keep in the family.
Strategies for minimizing the impact of your spouse’s elective share on your estate plan include transferring assets to a revocable trust. In most (but not all) probate-only states, transferring assets to a revocable trust is sufficient to shield them from your spouse’s elective share. In augmented estate jurisdictions, the elective share generally applies to revocable trusts. However, the laws of some states provide that the augmented estate only includes assets transferred to a revocable trust during marriage. In that case, it may be possible to protect assets from the elective share by transferring them to a revocable trust before remarrying.
State elective share laws are complex and can vary dramatically from state to state. If you’re remarrying, we can evaluate their impact on your estate plan and explore strategies for protecting your assets.
© 2024
Hiring household help, whether you employ a nanny, housekeeper or gardener, can significantly ease the burden of childcare and daily chores. However, as a household employer, it’s critical to understand your tax obligations, commonly called the “nanny tax.” If you hire a household employee who isn’t an independent contractor, you may be liable for federal income tax and other taxes (including state tax obligations).
If you employ a household worker, you aren’t required to withhold federal income taxes from pay. But you can choose to withhold if the worker requests it. In that case, ask the worker to fill out a Form W-4. However, you may be required to withhold Social Security and Medicare (FICA) taxes and to pay federal unemployment (FUTA) tax.
In 2024, you must withhold and pay FICA taxes if your household worker earns cash wages of $2,700 or more (excluding the value of food and lodging). The Social Security Administration recently announced that this amount will increase to $2,800 in 2025. If you reach the threshold, all the wages (not just the excess) are subject to FICA.
However, if a nanny is under age 18 and childcare isn’t his or her principal occupation, you don’t have to withhold FICA taxes. So, if you have a part-time student babysitter, there’s no FICA tax liability.
Both an employer and a household worker may have FICA tax obligations. As an employer, you’re responsible for withholding your worker’s FICA share. In addition, you must pay a matching amount. FICA tax is divided between Social Security and Medicare. The Social Security tax rate is 6.2% for the employer and 6.2% for the worker (12.4% total). Medicare tax is 1.45% each for the employer and the worker (2.9% total).
If you want, you can pay your worker’s share of Social Security and Medicare taxes. If you do, your payments aren’t counted as additional cash wages for Social Security and Medicare purposes. However, your payments are treated as additional income to the worker for federal tax purposes, so you must include them as wages on the W-2 form that you must provide.
You also must pay FUTA tax if you pay $1,000 or more in cash wages (excluding food and lodging) to your worker in any calendar quarter. FUTA tax applies to the first $7,000 of wages paid and is only paid by the employer.
You pay household worker obligations by increasing your quarterly estimated tax payments or increasing withholding from wages, rather than making an annual lump-sum payment.
As an employer of a household worker, you don’t have to file employment tax returns, even if you’re required to withhold or pay tax (unless you own your own business). Instead, employment taxes are reported on your tax return on Schedule H.
When you report the taxes on your return, include your employer identification number (EIN), which is not the same as your Social Security number. You must file Form SS-4 to get one.
However, if you own a business as a sole proprietor, you include the taxes for a household worker on the FUTA and FICA forms (940 and 941) you file for the business. And you use your sole proprietorship EIN to report the taxes.
Keep related tax records for at least four years from the later of the due date of the return or the date the tax was paid. Records should include the worker’s name, address, Social Security number, employment dates, amount of wages paid, taxes withheld and copies of forms filed.
Contact us for assistance or if you have questions about how to comply with these requirements.
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If you hold an interest in a business that’s closely held or family owned, a buy-sell agreement should be a component of your estate plan. The agreement provides for the orderly disposition of each owner’s interest after a “triggering event,” such as death, disability, divorce, termination of employment or withdrawal from the business.
A buy-sell agreement accomplishes this by permitting or requiring the company or the remaining owners to purchase the departing owner’s interest. Often, life insurance is used to fund the buyout. And because circumstances frequently change, reviewing your buy-sell agreement periodically is important to ensure that it continues to meet your needs.
It’s essential to revisit the agreement’s valuation provision — the mechanism for setting the purchase price for an owner’s interest — to ensure that it reflects the business’s current value. A pressing reason to do this sooner rather than later is because, absent congressional action, the federal gift and estate tax exemption is scheduled to be halved beginning in 2026.
As you review your agreement, pay close attention to the valuation provision. Generally, a valuation provision follows one of three approaches when a triggering event occurs:
Independent appraisals almost always produce the most accurate valuations. Formulas tend to become less reliable over time as circumstances change and may lead to over- or underpayments if earnings have fluctuated substantially since the valuation date.
A negotiated price can be a good approach in theory, but expecting owners to reach an agreement under stressful, potentially adversarial conditions is asking a lot. One potential solution is to use a negotiated price but provide for an independent appraisal in the event the parties fail to agree on a price within a specified period.
The type of buy-sell agreement you use can have significant tax and estate planning implications. Generally, the choices are structured either as “redemption” or “cross-purchase” agreements. A redemption agreement permits or requires the company to purchase a departing owner’s interest, while a cross-purchase agreement permits or requires the remaining owners to make the purchase.
A disadvantage of cross-purchase agreements is that they can be cumbersome, especially if there are many owners. For example, if life insurance is used to fund the purchase of a departing owner’s shares, each owner will have to purchase an insurance policy on the lives of each of the other owners. Note that redemption agreements may trigger a variety of unwelcome tax consequences.
A buy-sell agreement can provide several significant benefits, including keeping ownership and control within your family, creating a market for otherwise unmarketable interests, and providing liquidity to pay estate tax and other expenses. In some cases, a buy-sell agreement can even establish the value of an ownership interest for estate tax purposes. We can work with you to design a buy-sell agreement that helps preserve the value of your business for your family.
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As the end of the year approaches, many people start to think about their finances and tax strategies. One effective way to reduce potential estate taxes and show generosity to loved ones is by giving cash gifts before December 31. Under tax law, you can gift a certain amount each year without incurring gift taxes or requiring a gift tax return. Taking advantage of this rule can help you reduce the size of your taxable estate while benefiting your family and friends.
Taxpayers can transfer substantial amounts, free of gift taxes, to their children or other recipients each year through the proper use of the annual exclusion. The exclusion amount is adjusted for inflation annually, and in 2024 is $18,000. It covers gifts that an individual makes to each recipient each year. So a taxpayer with three children can transfer $54,000 ($18,000 × 3) to the children this year, free of federal gift taxes. If the only gifts during a year are made this way, there’s no need to file a federal gift tax return. If annual gifts exceed $18,000 per recipient, the exclusion covers the first $18,000 and only the excess is taxable.
Note: This discussion isn’t relevant to gifts made to a spouse because they’re gift-tax-free under separate marital deduction rules.
If you’re married, gifts made during a year can be treated as split between the spouses, even if the cash or asset is given to an individual by only one of you. Therefore, by gift splitting, up to $36,000 a year can be transferred to each recipient by a married couple because two exclusions are available. For example, a married couple with three married children can transfer $216,000 ($36,000 × 6) each year to their children and the children’s spouses.
If gift splitting is involved, both spouses must consent to it. This is indicated on the gift tax return (or returns) that the spouses file. (If more than $18,000 is being transferred by a spouse, a gift tax return must be filed, even if the $36,000 exclusion covers the total gifts.)
Even gifts that aren’t covered by the exclusion may not result in a tax liability. That’s because a tax credit wipes out the federal gift tax liability on the first taxable gifts you make in your lifetime, up to $13.61 million in 2024. However, to the extent you use this credit against a gift tax liability, it reduces or eliminates the credit available for use against the federal estate tax at your death.
For a gift to qualify for the annual exclusion, it must be a “present interest” gift, meaning you can’t postpone the recipient’s enjoyment of the gift to the future. Other rules may apply. Contact us with questions. We can also prepare a gift tax return for you if you give more than $18,000 (or $36,000 if married) to a single person this year or make a split gift.
© 2024
Time is running out to take advantage of the current federal gift and estate tax exemption ($13.61 million for 2024). Absent action from Congress, the amount will drop to an inflation-adjusted $5 million in 2026. One way to make the most of the current record-high exemption amount is to give substantial gifts to your loved ones, thus reducing the size of your taxable estate.
However, making certain hard-to-value gifts, such as interests in a closely held business or family limited partnership (FLP), can raise the concern of the IRS. Indeed, if the IRS determines that a gift was undervalued, you may be liable for gift tax (plus interest and possibly penalties). To help avoid an unexpected outcome, consider making a defined-value gift.
A defined-value gift is a gift of assets that are valued at a specific dollar amount rather than a certain number of stock shares or FLP units or a specified percentage of a business entity. A properly structured defined-value gift ensures that it won’t trigger a gift tax assessment later.
The key is to ensure that the defined-value language in the transfer document is drafted as a “formula” clause rather than an invalid “savings” clause. A formula clause transfers a fixed dollar amount, subject to adjustment in the number of shares necessary to equal that amount (based on a final determination of the value of those shares for federal gift and estate tax purposes). A savings clause, in contrast, provides for a portion of the gift to be returned to the donor if that portion is ultimately determined to be taxable.
For a defined-value gift to be effective, use precise language in the transfer documents. In one case, the U.S. Tax Court rejected an intended defined-value gift of FLP interests and upheld the IRS’s gift tax assessment based on percentage interests. The documents called for transferring FLP interests with a defined fair market value “as determined by a qualified appraiser” within a specified time after the transfer.
The court found that the transfer documents failed to achieve a defined-value gift because a qualified appraiser determined the fair market value. The documents didn’t provide for an adjustment in the number of FLP units if their value “is finally determined for federal gift tax purposes to exceed the amount described.”
The bottom line: Before taking action, contact us to help ensure that your defined-value gift’s transfer documents are worded in a way to pass muster with the IRS. We’d be pleased to help.
© 2024
Few estate planning subjects are as misunderstood as probate. Its biggest downside, and the one that grabs the most attention, is the fact that probate is public. Indeed, anyone who’s interested can find out what assets you owned and how they’re being distributed after your death.
And because of its public nature, the probate process can draw unwanted attention from disgruntled family members who may challenge the disposition of your assets, as well as from other unscrupulous parties.
Probate is predicated on state law, so the exact process varies from state to state. This has led to numerous misconceptions about the length of probate. On average, the process takes no more than six to nine months, but it can run longer for complex situations in certain states. Also, some states exempt small estates or provide a simplified process for surviving spouses.
In basic terms, probate is the process of settling an estate and passing legal title of ownership of assets to heirs. If the deceased person has a valid will, probate begins when the executor named in the will presents the document in the county courthouse. If there’s no will — the deceased has died “intestate” in legal parlance — the court will appoint someone to administer the estate. After that, this person becomes the estate’s legal representative.
With that in mind, here’s how the process generally works, covering four basic steps.
First, a petition is filed with the probate court, providing notice to the beneficiaries of the deceased under the will. Typically, such notice is published in a local newspaper for the general public’s benefit. If someone wants to object to the petition, they can do so in court.
Second, the executor takes an inventory of the deceased’s property, including securities, real estate and business interests. In some states, an appraisal of value may be required. Then the executor must provide notice to all known creditors. Generally, a creditor must stake a claim within a limited time specified under state law.
Third, the executor determines which creditor claims are legitimate and then meets those obligations. He or she also pays any taxes and other debts that are owed by the estate. In some cases, state law may require the executor to sell assets to provide proceeds sufficient to settle the estate.
Fourth, ownership of assets is transferred to beneficiaries named in the will, following the waiting period allowed for creditors to file claims. If the deceased died intestate, state law governs the disposition of those assets. However, before any transfers take place, the executor must petition the court to distribute the assets as provided by will or state intestacy law.
For some estate plans, the will provides for the creation of a testamentary trust to benefit heirs. For instance, a trust may be established to benefit minor children who aren’t yet capable of managing funds. In this case, control over the trust assets is transferred to the named trustee. Finally, the petition should include an accounting of the inventory of assets unless this is properly waived under state law.
A revocable living trust may be used to avoid probate and protect privacy. The assets are typically transferred to the trust during your lifetime and managed by a trustee that you designate. You may even choose to act as a trustee during your lifetime. Upon your death, the assets will continue to be managed by a trustee or, should you prefer, the assets will be distributed outright to your designated beneficiaries.
Contact us with any questions regarding the probate process.
© 2024
If you have a child or grandchild planning to attend college, you’ve probably heard about qualified tuition programs, also known as 529 plans. These plans, named for the Internal Revenue Code section that provides for them, allow prepayment of higher education costs on a tax-favored basis.
There are two types of programs:
You don’t get a federal income tax deduction for 529 plan contributions, but the account earnings aren’t taxed while the funds are in the program. (Contributors are eligible for state tax deductions in some states.) You can change the beneficiary, or roll over the funds in the program to another plan for the same or a different beneficiary, without income tax consequences.
Distributions from the program are tax-free up to the amount of the student’s “qualified higher education expenses.” These include tuition (up to $10,000 for an elementary or secondary public, private or religious school), fees, books, supplies and required equipment. Reasonable room and board are also qualified expenses if the student is enrolled at least half time.
Tax-free distributions from a 529 plan can also be used to pay the principal or interest on a loan for qualified higher education expenses of the beneficiary or a sibling of the beneficiary.
What about distributions in excess of qualified expenses? They’re taxed to the beneficiary to the extent that they represent earnings on the account. The IRS will also impose a 10% penalty tax.
Your contributions to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the gift tax exclusion ($18,000 in 2024, adjusted annually for inflation). Suppose your contributions in a year exceed the exclusion amount. In that case, you can elect to take the contributions into account ratably over five years starting with the year of the contributions. Thus, assuming you make no other gifts to that beneficiary, you could contribute up to $90,000 per beneficiary in 2024 without gift tax. (In that case, any additional contributions during the next four years would be subject to gift tax, except to the extent that the exclusion amount increases.) You and your spouse together could contribute $180,000 per beneficiary for 2024, subject to any contribution limits imposed by the plan.
Eligible schools include colleges, universities, vocational schools or other postsecondary schools eligible to participate in a student aid program of the U.S. Department of Education. This includes nearly all accredited public, nonprofit and for-profit postsecondary institutions.
However, “qualified higher education expenses” also include expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private or religious school. A school should be able to tell you whether it qualifies.
A distribution from a qualified tuition program isn’t subject to gift tax, but a change in beneficiary or rollover to the account of a new beneficiary may be. Contact us with questions about tax-saving ways to save and pay for college.
© 2024
For many people, two common estate planning goals are contributing to a favorite charity and leaving significant assets to your family under favorable tax terms. A charitable remainder trust (CRT) can help you achieve both goals.
Typically, you set up one of two CRT types (described below) and fund it with assets such as cash and securities. The trust then pays out income to the designated beneficiary or beneficiaries — perhaps yourself or your spouse — for life or a term of 20 years or less. The CRT then distributes the remaining assets to one or more charities.
When using a CRT, you may be eligible for a current tax deduction based on several factors. They include the value of the assets at the time of the transfer, the ages of the income beneficiaries and the government’s Section 7520 rate. Generally, the greater the payout to you (and consequently, the lower the amount that ultimately goes to charity), the lower the deduction.
There are two types of CRTs, each with its own pros and cons:
CRATs offer the advantage of uniform payouts, regardless of fluctuations in the trust’s value. CRUTs, on the other hand, allow payouts to keep pace with inflation because they increase as the trust’s value increases. And, as noted, CRUTs allow you to make additional contributions. One potential disadvantage of a CRUT is that payouts shrink if the trust’s value declines.
When setting up a CRT, appoint a trustee to manage the trust’s assets. The trustee should be someone with the requisite financial knowledge and a familiarity with your personal situation. Thus, it could be a professional or an entity, a family member, or a close friend.
Because of the potentially significant dollars at stake, many trust creators opt for a professional who specializes in managing trust assets. If you’re leaning in this direction, interview several candidates and choose the best one for your situation, considering factors such as experience, investment performance and the level of services provided.
Know that a trustee must adhere to the terms of the trust and follow your instructions. Thus, you still maintain some control if someone else handles these duties. For instance, you may retain the right to change the trustee if you become dissatisfied or designate a different charity to receive the remainder assets.
Finally, be aware that a CRT is irrevocable. In other words, you can’t undo it once it’s executed. So, you must be fully committed to this approach before taking the plunge. Contact us to learn whether a CRT might be a good fit to achieve your estate planning goals.
© 2024
A key decision you must make when drafting your estate plan is who to appoint as the executor. In a nutshell, an executor (called a “personal representative” in some states) is the person who will carry out your wishes after your death. Let’s take a look at the specific duties and how to choose the right person for the job.
Typically, your executor shepherds your will through the probate process, takes steps to protect your estate’s assets, distributes property to beneficiaries according to the will, and pays the estate’s debts and taxes.
Most assets must pass through probate before they can be distributed to beneficiaries. (Note, however, that assets transferred to a living trust are exempt from probate.) When the will is offered for probate, the executor also obtains “letters testamentary” from the court, authorizing him or her to act on the estate’s behalf.
It’s the executor’s responsibility to locate, manage and disburse your estate’s assets. In addition, he or she must determine the value of property. Depending on the finances, assets may have to be liquidated to pay debts of the estate.
Also, your executor can use estate funds to pay for funeral and burial expenses if you didn’t make other arrangements to cover those costs. In addition, your executor will obtain copies of your death certificate. The death certificate will be needed for several purposes, including closing financial accounts, canceling certain benefit payments and filing the final tax return.
So, whom should you choose as the executor of your estate? Your first inclination may be to name a family member or a trusted friend. But this can cause complications.
For starters, the person may be too grief-stricken to function effectively. And, if the executor stands to gain from the will, there may be conflicts of interest that can trigger contests of your will or other disputes by disgruntled family members. Furthermore, the executor may need more financial acumen for this position. Frequently, a professional advisor you know and trust is a good alternative.
An executor can renounce the right to this position by filing a written declaration with the probate court. This further accentuates the need to name a backup executor.
Without a named successor in the executor role, the probate court will appoint one for the estate. If you have additional questions regarding the role of an executor, please contact us.
© 2024
With the arrival of fall, it’s an ideal time to begin implementing strategies that could reduce your tax burden for both this year and next.
One of the first planning steps is to ascertain whether you’ll take the standard deduction or itemize deductions for 2024. You may not itemize because of the high 2024 standard deduction amounts ($29,200 for joint filers, $14,600 for singles and married couples filing separately, and $21,900 for heads of household). Also, many itemized deductions have been reduced or suspended under current law.
If you do itemize, you can deduct medical expenses that exceed 7.5% of adjusted gross income (AGI), state and local taxes up to $10,000, charitable contributions, and mortgage interest on a restricted amount of debt, but these deductions won’t save taxes unless they’re more than your standard deduction.
You may be able to work around these deduction restrictions by applying a “bunching” strategy to pull or push discretionary medical expenses and charitable contributions into the year where they’ll do some tax good. For example, if you can itemize deductions for this year but not next, you may want to make two years’ worth of charitable contributions this year.
Here are some other ideas to consider:
These are just some of the year-end strategies that may help reduce your taxes. Reach out to us to tailor a plan that works best for you.
© 2024
Legendary singer Aretha Franklin died more than six years ago. However, it wasn’t until last year that a Michigan judge ruled a handwritten document discovered under her couch cushions was a valid will. This case illustrates the dangers of a so-called “holographic” will. It’s one where the entire document is handwritten and signed without the presence of a lawyer or witnesses.
Initially, Franklin’s family thought she had no will. In that situation, her estate would have been divided equally among her four sons under the laws of intestate succession. A few months after she died, however, the family discovered two handwritten “wills” in her home.
The first, dated 2010 and found in a locked cabinet, was signed on each page and notarized. The second, dated 2014, was found in a spiral notebook under her couch cushions and was signed only on the last page. The two documents had conflicting provisions regarding the distribution of her homes, cars, bank accounts, music royalties and other assets, leading to a fight in court among her heirs. Ultimately, a jury found that the 2014 handwritten document should serve as her will.
Michigan, like many states, permits holographic wills. These wills, which don’t need to be witnessed like formal wills, must be signed and dated by the testator and the material portions must be in the testator’s handwriting. In addition, there must be evidence (from the language of the document itself or from elsewhere) that the testator intended the document to be his or her last will and testament.
Holographic wills can be quick, cheap and easy, but they can come at a cost. Absent the advice of counsel and the formalities of traditional wills, handwritten wills tend to invite challenges and interfamily conflict. In addition, because an attorney doesn’t prepare them, holographic wills tend to be less thorough and often contain ambiguous language.
If you need a will, contact your estate planning attorney for help. Having your will drafted by a professional can give you peace of mind knowing that your assets will be divided as you intended.
© 2024
Business owners, executives and employees are hitting the road, rails and skies at levels that haven’t been seen since before the pandemic. The extent to which business travel expenses can be deducted depends on a variety of factors.
Self-employed people may deduct business travel expenses on Schedule C. But through 2025, employees aren’t permitted to deduct unreimbursed business expenses, including travel expenses. This is due to the Tax Cuts and Jobs Act (TCJA) suspension of miscellaneous itemized deductions subject to the 2% of adjusted gross income floor.
Businesses may deduct employees’ travel expenses to the extent that they provide advances or reimbursements to employees or pay the expenses directly. Advances or reimbursements are excluded from the employees’ wages (and, therefore, aren’t subject to income or payroll taxes) if they’re made according to an “accountable plan,” which must comply with a variety of rules.
Another requirement for the business travel deduction is that the travel must be away from the person’s “tax home.” This isn’t necessarily the place where someone maintains a family home. Rather, it refers to the city or general area where the person’s main place of business is located.
Generally, someone is considered to be traveling away from home if his or her duties require being away for substantially longer than an ordinary day’s work and the person needs to get sleep or rest to meet work demands while away. This includes temporary work assignments. However, travel expenses in connection with an indefinite work assignment (that is, more than a year) or one that’s realistically expected to last more than a year can’t be deducted.
When the other applicable requirements are met, ordinary and necessary expenses of business-related travel are deductible. “Ordinary” means common and accepted in the business’s industry. “Necessary” means helpful and appropriate for the business. Expenses aren’t deductible if they’re for personal purposes, or if they’re lavish or extravagant (unless the expense was reasonable under the circumstances).
Commonly deductible travel expenses include (but aren’t limited to):
Tips paid in relation to these expenses are also generally deductible.
To be deductible, travel expenses also must be properly substantiated — typically with receipts, canceled checks or bills that show the amount, date, place and nature of each expense. Receipts aren’t required for nonlodging expenses less than $75, though these expenses must still be documented in an expense report.
For lodging and meal and incidental expenses (M&IE) — such as small fees or tips — employers can use the alternative per-diem method to simplify expense tracking. Self-employed individuals can use this method for M&IE, but not for lodging.
Under this method, taxpayers use the federal lodging and M&IE per-diem rates for the travel destination to determine reimbursement or deduction amounts. This avoids the need to keep receipts to substantiate the actual cost. However, it’s still necessary to document the time, place and nature of the expense.
To make things even simpler, the optional high-low substantiation method allows a taxpayer to use two per-diem rates for all business travel: One for designated high-cost localities and a lower rate for all other localities.
It’s Complicated
As you can see, the rules surrounding deductions for business travel are complex. There are also special rules for international travel and travel that includes a spouse or other family members, as well as for travel that mixes business with pleasure. Don’t hesitate to contact us with any questions you may have about the tax treatment of business travel expenses.
© 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
Do you own your principal residence? If so, you’re likely aware that you can benefit from the home’s build-up in equity, realize current tax breaks and pocket a sizable tax-exempt gain when you sell it.
And from an estate planning perspective, it may be beneficial to transfer ownership of your home to a qualified personal residence trust (QPRT). Using a QPRT, you can continue to live in the home for the duration of the trust’s term. When the term ends, the remainder interest passes to designated beneficiaries.
When you transfer a home to a QPRT, it’s removed from your taxable estate. The transfer of the remainder interest is subject to gift tax, but tax resulting from this future gift is generally reasonable. The IRS uses the Section 7520 rate, which is updated monthly, to calculate the tax. For September 2024, the rate is 4.8%, down from the year’s high thus far of 5.6% in June.
You must appoint a trustee to manage the QPRT. Frequently, the grantor will act as the trustee. Alternatively, it can be another family member, friend or professional advisor.
Typically, the home being transferred to the QPRT is your principal residence. However, a QPRT may also be used for a second home, such as a vacation house.
What happens if you die before the end of the trust’s term? Then the home is included in your taxable estate. Although this defeats the intentions of the trust, your family is no worse off than it was before you created the QPRT.
There’s no definitive period of time for the trust term, but the longer the term, the smaller the value of the remainder interest for tax purposes. Avoid choosing a term longer than your life expectancy. Doing so will reduce the chance that the home will be included in your estate should you die before the end of the term. If you sell the home during the term, you must reinvest the proceeds in another home that will be owned by the QPRT and subject to the same trust provisions.
So long as you live in the residence, you must continue to pay the monthly bills, including property taxes, maintenance and repair costs, and insurance. Because the QPRT is a grantor trust, you’re entitled to deduct qualified expenses on your tax return, within the usual limits.
When a QPRT’s term ends, the trust’s beneficiaries become owners of the home, at which point you’ll need to pay them a fair market rental rate if you want to continue to live there. Despite the fact that it may feel strange to have to pay rent to live in “your” home, at that point, it’s no longer your home. Further, paying rent generally coincides with the objective of shifting more assets to younger loved ones.
Note, also, that a QPRT is an irrevocable trust. In other words, you can’t revise the trust or back out of the deal. The worst that can happen is you pay rent to your beneficiaries if you outlive the trust’s term, or the home reverts to your estate if you don’t. Also, the beneficiaries will owe income tax on any rental income.
Contact us to determine if a QPRT is right for your estate plan.
© 2024
Planning for retirement is a crucial aspect of managing a small business. Unlike traditional employees who may have access to employer-sponsored benefits, business owners must proactively manage their retirement savings. This involves navigating fluctuating incomes and variable cash flows while balancing the demands of running a business. Tax-deferred retirement plans offer a valuable solution, providing significant tax benefits while helping to secure your financial future.
One of the most accessible retirement plans for small business owners is the SEP-IRA. This plan allows employers to contribute to their employees’ retirement accounts and their own. For 2024, contributions can be up to 25% of each eligible employee’s compensation, capped at $69,000. Contributions are tax-deductible, and the funds grow tax-deferred until withdrawal.
SEP-IRAs are attractive due to their simplicity and flexibility. They have low administrative costs and do not require annual funding commitments, allowing contributions to vary based on business performance. However, it’s important to note that employees cannot contribute directly to SEP-IRAs; only employers can contribute. Early withdrawals from SEP-IRAs, like traditional IRAs, incur a 10% penalty if taken before age 59½ and are subject to income taxes.
A SIMPLE IRA is another retirement option for businesses with fewer than 100 employees. It operates similarly to a traditional IRA but includes mandatory employer contributions. Employees can contribute up to $15,500 annually (as of 2024), with an additional $3,500 catch-up contribution for those over 50. Employers must match employee contributions up to 3% of their compensation or make a fixed contribution of 2% of each eligible employee’s compensation.
SIMPLE IRAs offer tax-deferred growth, reducing taxable income in the contribution year. They are relatively easy to set up and maintain, though they have lower contribution limits than 401(k) plans. Importantly, a business may face penalties if it fails to make the required employer contributions.
The Solo 401(k) provides an excellent retirement savings vehicle for sole proprietors or business owners with no employees. It allows for employer and employee contributions, significantly increasing the potential savings. For 2024, total contributions can reach up to $69,000, with an additional $7,500 catch-up contribution for those over 50.
As the sole employee, you can contribute up to $23,000 or 100% of your compensation, whichever is less. Additionally, as the employer, you can make a profit-sharing contribution of up to 25% of your net self-employment income. The Solo 401(k) also offers the flexibility to choose between traditional (pre-tax) and Roth (post-tax) contributions, depending on your tax strategy.
The Solo 401(k) is advantageous due to its high contribution limits and flexibility. However, it requires more administrative effort than SEP-IRAs and SIMPLE IRAs, including annual filings with the IRS once assets exceed $250,000.
Tax-deferred retirement plans are invaluable for business owners as they offer significant tax savings while ensuring financial security for the future. Contributions reduce taxable income in the year they are made, allowing more money to be invested and grow over time. This tax deferral can result in substantial retirement savings, particularly when leveraging compound interest.
Furthermore, having a mix of retirement accounts, such as SEP-IRAs, SIMPLE IRAs, and Solo 401(k)s, can provide flexibility in managing tax liabilities. For example, Roth accounts provide tax-free withdrawals in retirement, while traditional accounts offer tax deductions now, potentially lowering your current tax bracket.
Navigating the complexities of retirement planning can be challenging, especially with the varying tax implications of different accounts. Developing a strategy that aligns with your business’s financial situation and future goals is essential. Consulting with a CPA or financial advisor can provide personalized advice, ensuring you make informed decisions that maximize your retirement savings and minimize tax liabilities.
Tax-deferred retirement plans like SEP-IRAs, SIMPLE IRAs, and Solo 401(k)s can significantly benefit business owners by reducing current tax liabilities and securing a comfortable retirement. Understanding the options available and seeking professional guidance allows you to create a robust retirement strategy tailored to your unique needs.
Always contact your CPA or financial advisor for more detailed advice tailored to your specific situation. They can provide the expertise needed to navigate the complexities of retirement planning and ensure you make the most of your financial future.
A common question, and one where many taxpayers often make mistakes, is whether it is better to receive a home as a gift or as an inheritance. Generally, from a tax perspective, it is more advantageous to inherit a home rather than receive it as a gift before the owner’s death. This article will delve into the tax aspects of gifting a home, including gift tax implications, basis considerations for the recipient, and potential capital gains tax implications. Here are the key reasons why inheriting a home is often the better option.
Let’s first explore the tax ramifications of receiving a home as a gift. Gifting a home is a generous act with significant implications for both the donor and the recipient, particularly regarding taxes. Most gifts of this nature occur between parents and children, making it essential to understand the tax consequences.
When a homeowner gifts their home, the primary tax consideration is the federal gift tax. The Internal Revenue Service (IRS) requires individuals to file a gift tax return if the gift exceeds the annual exclusion amount of $18,000 per recipient for 2024. This amount is adjusted for inflation annually. Since a home’s value typically exceeds this amount, filing a Form 709 gift tax return is often necessary.
While a gift tax return may be required, actual gift tax may not be due because of the lifetime gift and estate tax exemption. For 2024, this exemption is $13.61 million per individual, meaning a person can gift up to this amount over their lifetime without incurring gift tax. The value of the home will count against this lifetime exemption.
The basis of the gifted property is a critical concept for the recipient. The recipient’s basis in the property is the same as the donor’s basis, known as “carryover” or “transferred” basis. For example, if a parent purchased a home for $200,000 and later gifts it to their child when its fair market value (FMV) is $500,000, the child’s basis in the home would be $200,000. If the parent made $50,000 in improvements, the adjusted basis would be $250,000, which would be the child’s starting basis.
This carryover basis can significantly impact the recipient if they sell the home. The capital gains tax will be calculated based on the difference between the sale price and the recipient’s basis. If the home has appreciated significantly, the recipient could face a substantial capital gains tax bill.
Homeowners who sell their homes may qualify for a $250,000 ($500,000 for married couples) home gain exclusion if they owned and used the residence for 2 of the prior 5 years. However, this gain qualification does not automatically pass on to the gift recipient. To qualify, the recipient must meet the 2 of the prior 5 years qualification. Thus, it may be tax-wise for the donor to sell the home, take the gain exclusion, and gift the cash proceeds.
The capital gains tax implications for the recipient of a gifted home are directly tied to the property’s basis and the donor’s holding period. If the recipient sells the home, they will owe capital gains tax on the difference between the sale price and their basis in the home. Given the carryover basis rule, this could result in a significant tax liability if the property has appreciated.
Sometimes, a homeowner may transfer the title but retain the right to live in it for their lifetime, establishing a de facto life estate. In such situations, the home’s value is included in the decedent’s estate upon their death, and the beneficiary’s basis would be the FMV at the date of death, potentially offering a step-up in basis and reducing capital gains tax implications.
There are significant differences between receiving a property as a gift and as an inheritance.
When you inherit a home, your basis in the property is generally “stepped up” to the FMV at the date of the decedent’s death. For example, if a home were purchased for $100,000 and is worth $300,000 at the time of the owner’s death, the inheritor’s basis would be $300,000. If sold for $300,000, there would be no capital gains tax on the sale.
The holding period for inherited property is always long-term, meaning gains are taxed at more favorable long-term capital gains rates.
The accumulated depreciation is reset for inherited property used for business or rental purposes, allowing the new owner to start depreciation afresh. This is not the case with gifted property, where the recipient takes over the giver’s depreciation schedule.
While each situation is unique and other factors might influence the decision, from a tax perspective, inheriting a property is often more beneficial than receiving it as a gift. Considering the overall estate planning strategy and potential non-tax implications is crucial. Consulting with a tax professional can provide personalized advice based on specific circumstances.
With school out, you might be hiring your child to work at your company. In addition to giving your son or daughter some business knowledge, you and your child could reap some tax advantages.
There are special tax breaks for hiring your offspring if you operate your business as one of the following:
These entities can hire an owner’s under-age-18 children as full- or part-time employees. The children’s wages then will be exempt from the following federal payroll taxes:
In addition, your dependent employee-child’s standard deduction can shelter from federal income tax up to $14,600 of 2024 wages from your business.
When hiring your child, you get a business tax deduction for employee wage expense. The deduction reduces your federal income tax bill, your self-employment tax bill and your state income tax bill, if applicable.
Note: There are different rules for corporations. If you operate as a C or S corporation, your child’s wages are subject to Social Security, Medicare and FUTA taxes, like any other employee’s. However, you can deduct your child’s wages as a business expense on your corporation’s tax return, and your child can shelter the wages from federal income tax with the $14,600 standard deduction for single filers.
No matter what type of business you operate, your child can contribute to an IRA or Roth IRA. With a Roth IRA, contributions are made with after-tax dollars. So, taxes are paid on the front end. After age 59½, the contributions and earnings that have accumulated in the account can be withdrawn free from federal income tax if the account has been open for more than five years.
In contrast, contributions to a traditional IRA are deductible, subject to income limits. So, unlike Roth contributions, deductible contributions to a traditional IRA lower the employee-child’s taxable income.
However, contributing to a Roth IRA is usually a much better idea for a young person than contributing to a traditional IRA for several reasons. Notably, your child probably won’t get any meaningful write-offs from contributing to a traditional IRA because the child’s standard deduction will shelter up to $14,600 of 2024 earned income. Any additional income will likely be taxed at very low rates.
In addition, your child can withdraw all or part of the annual Roth contributions — without any federal income tax or penalty — to pay for college or for any other reason. Of course, even though your child can withdraw Roth contributions without adverse tax consequences, the best strategy is to leave as much of the Roth balance as possible untouched until retirement to accumulate a larger tax-free sum.
The only tax law requirement for your child when making an annual Roth IRA contribution is having earned income for the year that at least equals what’s contributed for that year. There’s no age restriction. For the 2024 tax year, your child can contribute to an IRA or Roth IRA the lesser of:
Making modest Roth contributions can add up over time. For example, suppose your child contributes $1,000 to a Roth IRA each year for four years. The Roth account would be worth about $32,000 in 45 years when he or she is ready to retire, assuming a 5% annual rate of return. If you assume an 8% return, the account would be worth more than three times that amount.
Hiring your child can be a tax-smart idea. However, your child’s wages must be reasonable for the work performed. Be sure to maintain the same records as you would for other employees to substantiate the hours worked and duties performed. These include timesheets, job descriptions and W-2 forms. Contact us with any questions you have about employing your child at your small business.
© 2024
If your business doesn’t already have a retirement plan, it might be a good time to take the plunge. Current retirement plan rules allow for significant tax-deductible contributions.
For example, if you’re self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $69,000 for 2024 (up from $66,000 for 2023). If you’re employed by your own corporation, up to 25% of your salary can be contributed to your account, with a maximum contribution of $69,000. If you’re in the 32% federal income tax bracket, making a maximum contribution could cut what you owe Uncle Sam for 2024 by a whopping $22,080 (32% × $69,000).
There are more small business retirement plan options, including:
Depending on your situation, these plans may allow bigger or smaller deductible contributions than a SEP-IRA. For example, for 2024, a participant can contribute $23,000 to a 401(k) plan, plus a $7,500 “catch-up” contribution for those age 50 or older.
Thanks to a change made by the 2019 SECURE Act, tax-favored qualified employee retirement plans, except for SIMPLE-IRA plans, can now be adopted by the due date (including any extension) of the employer’s federal income tax return for the adoption year. The plan can then receive deductible employer contributions that are made by the due date (including any extension), and the employer can deduct those contributions on the return for the adoption year.
Important: This provision didn’t change the deadline to establish a SIMPLE-IRA plan. It remains October 1 of the year for which the plan is to take effect. Also, the SECURE Act change doesn’t override rules that require certain plan provisions to be in effect during the plan year, such as the provisions that cover employee elective deferral contributions (salary-reduction contributions) under a 401(k) plan. The plan must be in existence before such employee elective deferral contributions can be made.
For example, the deadline for the 2023 tax year for setting up a SEP-IRA for a sole proprietorship business that uses the calendar year for tax purposes is October 15, 2024, if you extend your 2023 tax return. The deadline for making a contribution for the 2023 tax year is also October 15, 2024. For the 2024 tax year, the deadline for setting up a SEP and making a contribution is October 15, 2025, if you extend your 2024 tax return. However, to make a SIMPLE-IRA contribution for the 2023 tax year, you must have set up the plan by October 1, 2023. So, it’s too late to set up a plan for last year.
While you can delay until next year establishing a tax-favored retirement plan for this year (except for a SIMPLE-IRA plan), why wait? Get it done this year as part of your tax planning, and start saving for retirement. We can provide more information on small business retirement plan options. Be aware that if your business has employees, you may have to make contributions for them, too.
© 2024
If you operate a business, or you’re starting a new one, you know records of income and expenses need to be kept. Specifically, you should carefully record expenses to claim all the tax deductions to which you’re entitled. And you want to make sure you can defend the amounts reported on your tax returns in case you’re ever audited by the IRS.
Be aware that there’s no one way to keep business records. On its website, the IRS states: “You can choose any recordkeeping system suited to your business that clearly shows your income and expenses.” But there are strict rules when it comes to deducting legitimate expenses for tax purposes. And certain types of expenses, such as automobile, travel, meal and home office costs, require extra attention because they’re subject to special recordkeeping requirements or limitations on deductibility.
A business expense can be deducted if a taxpayer establishes that the primary objective of the activity is making a profit. To be deductible, a business expense must be “ordinary and necessary.” In one recent case, a married couple claimed business deductions that the IRS and the U.S. Tax Court mostly disallowed. The reasons: The expenses were found to be personal in nature and the taxpayers didn’t have adequate records for them.
In the case, the husband was a salaried executive. With his wife, he started a separate business as an S corporation. His sideline business identified new markets for chemical producers and connected them with potential customers. The couple’s two sons began working for the business when they were in high school.
The couple then formed a separate C corporation that engaged in marketing. For some of the years in question, the taxpayers reported the income and expenses of the businesses on their joint tax returns. The businesses conducted meetings at properties the family owned (and resided in) and paid the couple rent for the meetings.
The IRS selected the couple’s returns for audit. Among the deductions the IRS and the Tax Court disallowed:
The couple did prevail on deductions for contributions to 401(k) accounts for their sons. The IRS contended that the sons weren’t employees during one year in which contributions were made for them. However, the court found that 401(k) plan documents did mention the sons working in the business and the father “credibly recounted assigning them research tasks and overseeing their work while they were in school.” Thus, the court ruled the taxpayers were entitled to the retirement plan deductions. (TC Memo 2023-140)
As this case illustrates, a business can’t deduct personal expenses, and scrupulous records are critical. Make sure to use your business bank account for business purposes only. In addition, maintain meticulous records to help prepare your tax returns and prove deductible business expenses in the event of an IRS audit.
Contact us if you have questions about retaining adequate business records.
© 2024
Here are some of the key tax-related deadlines that apply to businesses and other employers during the second quarter of 2024. 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.
© 2024
In the landscape of financial planning and tax optimization, Qualified Charitable Distributions (QCDs) stand out as a powerful mechanism for individuals looking to enhance their philanthropic impact while optimizing their tax situation. This article delves into the core of QCDs, providing insights into how they can serve as a strategic tool in your charitable giving and financial planning.
Qualified Charitable Distributions allow individuals aged 70½ or older to directly donate up to $100,000 from their Individual Retirement Accounts (IRAs) to a qualified charity, tax-free. This unique provision supports your philanthropic endeavors and offers a tax-efficient way to meet Required Minimum Distributions (RMDs), particularly for those aged 73 and above. QCDs differ from regular IRA distributions, which is typically taxable, by excluding these donations from your taxable income, thus achieving the dual objective of aiding charitable causes and reducing your tax liability.
QCDs embody the essence of strategic giving, allowing you to see the impact of your generosity firsthand. This proactive approach to philanthropy provides a more immediate and gratifying experience compared to traditional legacy giving. With the onset of charity-focused events early in the year, it’s an opportune time to consider QCDs as a key element of your giving strategy.
Effective tax planning is a crucial element of sound financial management. Utilizing QCDs can significantly improve the tax efficiency of your charitable contributions. By transferring funds directly from your IRA to a charity, the donation does not count as taxable income, therefore not only advancing your charitable objectives but also potentially reducing your overall tax burden. This can be especially beneficial in light of increased standard deductions, which may diminish the tax advantages of itemized deductions for many taxpayers.
To fully benefit from QCDs, accurately navigating associated regulations is essential. You must be at least 70½ years old at the time of the distribution and the donation must go directly to a qualifying charity, excluding private foundations and donor-advised funds. The annual limit for QCDs is $100,000 per individual, with recent updates allowing for inflation adjustments. Ensuring that your IRA trustee correctly processes the QCD is required for it to qualify for tax-free treatment.
Opting to donate your RMD through a QCD enables you to embody your philanthropic values, creating a legacy of support and impact. This strategy provides the satisfaction of contributing to worthy causes and smartly aligns with your tax planning, potentially influencing various tax considerations such as Social Security taxation and Medicare premiums.
Leveraging Qualified Charitable Distributions within your philanthropic and financial strategy can offer substantial rewards. QCDs enable impactful contributions to the community and present an intelligent way to manage your tax obligations. Consulting with your financial advisor and tax professional is advised to ensure that your charitable giving initiatives are well integrated with your overall financial objectives. By incorporating QCDs into your planning, you can achieve a fulfilling balance between meaningful giving and prudent financial management.
To ensure that this strategy aligns with your overall financial goals and tax situation, it is crucial to seek the advice of your CPA or certified financial planner. They can provide personalized guidance to determine if QCDs are the right choice for you.
The newly approved Tax Relief for American Families and Workers Act of 2024, symbolizing a legislative victory for taxpayers, especially small business owners and professionals, deserves a detailed look due to its retroactive provisions and potential to affect the upcoming tax season.
The Child Tax Credit (CTC) sees a notable expansion for individuals. This credit calculates the refundable portion per child once the taxpayer’s earned income exceeds $2,500 by 15%. For tax years 2023 through 2025, the credit increases to $1,800, $1,900, and $2,000, respectively, offering substantial savings for families. Additionally, for the tax years 2024 and 2025, taxpayers can calculate their CTC based on the previous year’s earned income, providing flexibility in fluctuating income.
Several key provisions have been introduced to support business growth and adaptability:
The bill delays the onset of a five-year amortization rule for domestic research and experimental costs to tax years beginning after December 31, 2025, providing an incentive for innovation.
For tax years starting after 2023 and before 2026, businesses can compute adjusted taxable income (ATI) for interest limitation with reinstated depreciation, amortization, and depletion deductions, enhancing cash flow.
The Act extends the 100% bonus depreciation for qualifying property placed in service before January 1, 2026. This extension allows businesses to deduct the full cost of eligible property in the year of service, promoting investment in new assets.
The deduction limit under Section 179 is increased for tax years starting after 2023, allowing businesses to expense up to $1.29 million and phase out thresholds starting at $3.22 million, indexed for inflation thereafter.
The Act introduces stringent measures to curb fraudulent claims, specifically targeting the misuse of the Employee Retention Tax Credit (ERTC). It shortens the claim period for the ERTC to January 31, 2024, and amplifies penalties for incorrect or fraudulent claims.
In a significant move, the bill extends tax treaty-like benefits to Taiwan to avoid double taxation, which may impact businesses with operations or interests in Taiwan.
Disaster relief provisions from the Taxpayer Certainty and Disaster Tax Relief Act of 2020 are extended. This includes benefits for those affected by federally declared disasters between January 1, 2020, and 60 days post-enactment of the new bill.
The reporting threshold for Form 1099-NEC and 1099-MISC increases from $600 to $1,000 for payments made after December 31, 2023, easing the administrative load for small businesses.
The bill boosts the 9% low-income housing tax credit ceiling by 12.5% for calendar years 2023 through 2025 and reduces the bond financing threshold to 30% for projects financed by bonds issued before 2026.
This Act presents a mosaic of opportunities and considerations. Small business owners and professionals must promptly assess how these changes impact their operations and tax strategies. As the provisions have retroactive effects, it’s crucial to consult with tax professionals to maximize benefits and navigate the complexities of the new law.
As the end of the tax year approaches, it’s essential to consider strategies to minimize your 2023 federal tax liability. The current landscape presents challenges with market volatility, persistent high-interest rates, and notable adjustments to retirement planning regulations. Despite this uncertainty, there is still an opportunity to implement year-end tax planning techniques to reduce your tax bill. Whether you are contemplating investment decisions, charitable contributions, or estate planning, there are practical strategies to optimize your tax plan.
With a standard deduction of $13,850 for single filers, $27,700 for married couples filing jointly, and $20,800 for heads of households in 2023, assessing your itemized deductions is crucial. Consider strategically timing your itemized deduction items by “bunching” them to exceed the standard deduction every other year. This approach can help lower your tax bill this year, and in the following year, you can take advantage of the increased standard deduction to account for inflation.
Potential candidates for itemized deductions include:
It’s worth noting the possibility of future changes to the value of itemized deductions, emphasizing the importance of maximizing these deductions while current regulations permit.
Effectively managing your investment portfolio can influence your tax liability. Consider the strategic sale of appreciated securities held for over 12 months in 2023, leveraging the favorable 15% federal income tax rate on long-term capital gains. It’s crucial to remember that this rate can increase to 20% for individuals with higher income levels. Equally important is evaluating stocks valued below your initial investment (tax basis). Realizing capital losses this year could offset various gains, including short-term capital gains taxed at ordinary income rates. Always be aware of the wash sale rules before reacquiring recently sold or purchased stocks. This approach allows you to navigate the complexities of the market while optimizing your tax position.
Embrace unique avenues for philanthropy tailored to your preferences:
Safeguard a portion or all of your retirement savings from potential tax rate increases by converting traditional IRAs into Roth accounts. While you’ll incur taxes on the conversion as if it were a traditional IRA distribution, this approach is most beneficial when anticipating remaining in the same or higher tax bracket during retirement. Notably, the current tax impact from conversion may be a small price to pay for evading potentially higher future tax rates on post-conversion earnings. Additionally, the flexibility exists to convert varying amounts over several years, allowing you to tailor the strategy to your circumstances.
If concerns arise about a potentially taxable estate, leverage the annual gift tax exclusion as an effortless method to reduce your taxable estate. In 2023, seize the opportunity to make annual exclusion gifts up to $17,000 per donee, with no limitations on the number of donees. The joint annual exclusion gift limit for couples reaches $34,000 per donee. These tax-free gifts don’t impact your lifetime gifting exemption, providing an effective means to manage your estate’s tax implications.
Homeowners investing in energy-efficient improvements can claim an Energy Efficient Home Improvement Credit, covering up to 30% of qualified expenses, capped at $1,200 annually for energy property costs and an additional $2,000 for qualified heat pumps. Ensure compliance with energy.gov guidelines to include expenses related to doors, windows, air conditioning, and insulation materials. Additionally, explore Residential Clean Energy Credits for qualifying expenses related to solar and alternative energy sources, offering potential tax advantages for environmentally conscious choices.
Given the $10,000 limitation on state and local tax deductions for individuals, assess the advantages of participating in the Pass-Through Entity (PTE) tax regime. Many states allow pass-through entities to pay and deduct the full state taxes on behalf of partners/shareholders. If you receive substantial income from a partnership or S corporation, consider engaging in the PTE tax regime when recommended by the entity representative. Alternatively, if you hold a significant stake in a pass-through entity not currently electing this option, it’s worthwhile to explore whether participating makes sense for your overall tax strategy.
Strengthen your financial foundation and simultaneously impact your tax liabilities by directing funds into your 401(k) or IRA. Capitalize on valuable tax advantages, including tax-deferred growth and potential deductions. For the tax year 2023, individuals can contribute up to $22,500 to their 401(k), with an additional $7,500 catch-up contribution for those aged 50 or older. Traditional IRA contributions are capped at $6,500, with a $1,000 catch-up provision for individuals over 50. Remember to make contributions by April 15, 2024, to qualify for the 2023 tax year. This proactive approach allows you to fortify your financial future while making a meaningful impact on your tax obligations.
Taking a proactive approach to tax planning can yield significant benefits for your next tax bill. Strategically assessing your financial landscape and implementing these practical tips can help you navigate the complexities of the 2023 tax year.
Life insurance can provide peace of mind, but if your estate will be large enough that estate taxes will be a concern, it’s important to not own the policy at death. The policy’s proceeds will be included in your taxable estate and may be subject to estate tax. To avoid this result, a common estate planning strategy is to draft an irrevocable life insurance trust (ILIT) to hold the policy.
Generally, the proceeds of a life insurance policy aren’t included in your taxable estate if you don’t own the policy. However, life insurance proceeds will be included if you possess any “incidents of ownership” over the policy. This goes beyond mere ownership. If you have the right to amend the policy — say, by changing the beneficiaries — or you can borrow against the cash value, it’s treated as an incident of ownership.
Avoiding incidents of ownership can be important because the top estate tax rate is currently 40%. Fortunately, with your gift and estate tax exemption, you can shelter up to $12.92 million (for 2023) of assets from federal gift and estate tax. But be aware that, without congressional action, after 2025 the exemption is scheduled to revert to $5 million (indexed for inflation).
Furthermore, you may have to contend with estate or inheritance tax at the state level. In any event, the estate tax treatment of life insurance policies is a prime consideration in estate planning, especially for wealthier individuals.
A common method for avoiding these estate tax complications is to use an ILIT. This may be accomplished by setting up a trust as the owner of the life insurance policy when the coverage is purchased or by transferring an existing policy to the trust.
The trust must be “irrevocable,” as the name states. In other words, you must relinquish any control over the ILIT, such as the right to revise beneficiaries or revoke the trust. Similarly, acting as the trustee of the ILIT will be treated as an incident of ownership that invalidates the trust.
You’ll designate the ILIT as the primary beneficiary of the life insurance policy. On your death, the proceeds are deposited into the ILIT and held for distribution to the trust’s beneficiaries, such as your spouse, children, grandchildren or other family members.
Naming your surviving spouse as the sole beneficiary can be problematic, however. It may merely delay estate tax liability until your spouse dies.
There are several pitfalls to watch for when transferring an insurance policy to an ILIT. Significantly, if you transfer an existing policy to the ILIT and die within three years of the transfer, the proceeds will be included in your taxable estate. One way to avoid this is to have the ILIT purchase the policy on your life and then fund the trust with enough money over time to pay the premiums.
Also bear in mind that the transfer of an existing policy to an ILIT is considered a taxable gift. Further, subsequent transfers to the trust would also be treated as gifts. The gifts can be sheltered from tax by your available gift and estate tax exemption.
Life insurance is a powerful estate planning tool. It creates an instant source of wealth and liquidity to meet your family’s financial needs after you’re gone. To shield proceeds from estate tax, consider creating an ILIT to hold your policy. Contact your estate planning advisor to determine if an ILIT is right for your estate plan.
© 2023
If leaving a charitable legacy is important to you, you may be thinking about establishing a private foundation or other vehicle for managing your philanthropic activities. Private foundations can be highly effective, but they’re expensive to set up and operate. Donor-advised funds (DAFs) are popular alternatives, but they also have potential drawbacks.
Why use a foundation or DAF? Can’t you just write checks to your charities of choice? Of course, but contributing funds to a private foundation or DAF allows you to enjoy immediate charitable tax deductions without needing to identify specific beneficiaries or make contributions right away. It gives you more time to research potential recipients or change the organizations you support from year to year.
These vehicles also allow you to involve your family in your charitable endeavors. You can name family members to the board of a private foundation or even hire loved ones to manage it. Many DAFs allow you to designate a successor advisor.
A private foundation is a charitable organization, typically structured as a trust or corporation and designed to accept donations from a small group of people, such as you and your family. Private foundations usually make grants to other charitable organizations rather than provide charitable services themselves.
A DAF is an investment account, controlled by a sponsoring organization — usually, a public charity or community foundation — and often managed by an investment firm. The fund accepts tax-deductible contributions from investors, who advise the fund on how their charitable dollars should be spent.
DAFs generally can be set up in a matter of days — or even hours. Setting up a private foundation, however, takes time, since it involves establishing a legal entity. Another advantage of DAFs is that they’re inexpensive (or free) to create, and minimum initial contributions can be as low as $5,000. In contrast, starting a private foundation involves significant legal and accounting fees. Foundations also require much larger initial contributions — typically hundreds of thousands or even millions of dollars — to justify their start-up and ongoing administrative expenses.
Here are other ways the two vehicles compare:
Operating expenses. DAFs typically charge management and investment fees of around 1% to 2% of your account balance. Managing a private foundation is much more expensive since you’ll need to appoint a board, hold periodic meetings, keep minutes, file separate tax returns, and incur ongoing legal and accounting costs, in addition to paying investment fees. You’ll also need to hire a staff or engage a third-party administrator, and pay an excise tax on net investment income (currently 1.39%).
Distribution requirements. DAFs aren’t subject to required minimum distributions, so investments can grow tax-free indefinitely (subject to any rules of the sponsoring organization). But private foundations must distribute at least 5% of their net market value each year.
Charitable recipients. Distributions from DAFs must be made to public charities. Private foundations can make grants to a wider range of charitable recipients, including individuals (subject to certain restrictions).
Tax deductibility. Cash contributions to DAFs are tax deductible up to 50% of the donor’s adjusted gross income (AGI), while noncash contributions are generally deductible up to 30% of AGI. For private foundations, the deduction limits are 30% and 20%, respectively. Typically, you can deduct the market value of appreciated assets donated to a DAF. Deductions for donations to foundations are limited to your cost basis (except for publicly traded stock).
Privacy. DAFs are permitted to accept donations privately, so it’s possible for contributors to remain anonymous. Private foundations must publicly disclose the names of donors who give more than $5,000.
Control. This is an area where private foundations have a clear advantage. You and other board members retain full control over the foundation’s investments and distributions. DAF contributions become the sponsor’s property and your role in managing investments and distributions is strictly advisory. Practically speaking, however, sponsors almost always follow contributors’ advice.
The right charitable giving vehicle for you depends on many factors, including your financial resources, the charities you wish to support and the level of control you desire. Talk to your advisors about designing a philanthropic strategy that meets your needs.
© 2023
Do you use an automobile in your trade or business? If so, you may question how depreciation tax deductions are determined. The rules are complicated, and special limitations that apply to vehicles classified as passenger autos (which include many pickups and SUVs) can result in it taking longer than expected to fully depreciate a vehicle.
First, be aware that separate depreciation calculations for a passenger auto only come into play if you choose to use the actual expense method to calculate deductions. If, instead, you use the standard mileage rate (65.5 cents per business mile driven for 2023), a depreciation allowance is built into the rate.
If you use the actual expense method to determine your allowable deductions for a passenger auto, you must make a separate depreciation calculation for each year until the vehicle is fully depreciated. According to the general rule, you calculate depreciation over a six-year span as follows: Year 1, 20% of the cost; Year 2, 32%; Year 3, 19.2%; Years 4 and 5, 11.52%; and Year 6, 5.76%. If a vehicle is used 50% or less for business purposes, you must use the straight-line method to calculate depreciation deductions instead of the percentages listed above.
For a passenger auto that costs more than the applicable amount for the year the vehicle is placed in service, you’re limited to specified annual depreciation ceilings. These are indexed for inflation and may change annually. For example, for a passenger auto placed in service in 2023 that cost more than a certain amount, the Year 1 depreciation ceiling is $20,200 if you choose to deduct first-year bonus depreciation. The annual ceilings for later years are: Year 2, $19,500; Year 3, $11,700; and for all later years, $6,960 until the vehicle is fully depreciated.
These ceilings are proportionately reduced for any nonbusiness use. And if a vehicle is used 50% or less for business purposes, you must use the straight-line method to calculate depreciation deductions.
Reminder: Under the Tax Cuts and Jobs Act, bonus depreciation is being phased down to zero in 2027, unless Congress acts to extend it. For 2023, the deduction is 80% of eligible property and for 2024, it’s scheduled to go down to 60%.
Much more favorable depreciation rules apply to heavy SUVs, pickups, and vans used over 50% for business, because they’re treated as transportation equipment for depreciation purposes. This means a vehicle with a gross vehicle weight rating (GVWR) above 6,000 pounds. Quite a few SUVs and pickups pass this test. You can usually find the GVWR on a label on the inside edge of the driver-side door.
What’s the impact of these depreciation limits on your business vehicle decisions? They change the after-tax cost of passenger autos used for business. That is, the true cost of a business asset is reduced by the tax savings from related depreciation deductions. To the extent depreciation deductions are reduced, and thereby deferred to future years, the value of the related tax savings is also reduced due to time-value-of-money considerations, and the true cost of the asset is therefore that much higher.
The rules are different if you lease an expensive passenger auto used for business. Contact us if you have questions or want more information.
© 2023
In an era of growing environmental awareness and the push for sustainable living, homeowners are more interested than ever in upgrading their living spaces to be energy-efficient. However, it’s not just about saving the planet—it’s also about saving money. The U.S. government, recognizing the importance of these measures, has provided an enticing incentive: The Energy-Efficient Home Improvement Credit. Here’s everything you need to know about this tax relief opportunity.
The Energy-Efficient Home Improvement Credit is an initiative by the IRS designed to encourage homeowners to make eco-friendly home upgrades. If you have made any qualifying energy-efficient improvements to your home since January 1, 2023, you may be eligible for this credit, where the savings could be substantial.
The first step in determining eligibility is determining what improvements qualify. The following energy-efficient improvements, when in line with requirements set on energy.gov, can make you eligible for the credit:
Once you have determined which improvements qualify, you might wonder what the savings could be if you claimed the credit. The potential savings can be significant. Here’s a breakdown:
The silver lining? There is no lifetime dollar limit on this credit. If you make eligible improvements annually, you can claim the maximum amount every year until 2033.
If you use your home for business, there are special considerations where you could be eligible to claim a percentage of the credit, even 100%.
If this applies to you, it is best to talk with an accountant about the most beneficial use of this credit.
Here are some essential pointers to keep in mind:
While making your home more energy-efficient is a commendable step toward sustainability, it also offers financial benefits. The Energy-Efficient Home Improvement Credit is an avenue worth exploring for homeowners. By staying informed and making timely upgrades, you can contribute to a greener planet and enjoy tangible tax savings.
Are you wondering if your energy-efficient choices will qualify for this tax credit? Hamilton Tharp is here to help. Reach out to us, and let’s map out a greener, cost-efficient future for your home.
For more details and regular updates, keep an eye on Hamilton Tharp’s insights on tax savings and financial strategies.
Here are some of the key tax-related deadlines affecting businesses and other employers during the third quarter of 2023. 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.
July 31
August 10
September 15
© 2023
The IRS recently released guidance providing the 2024 inflation-adjusted amounts for Health Savings Accounts (HSAs).
An HSA is a trust created or organized exclusively for the purpose of paying the “qualified medical expenses” of an “account beneficiary.” An HSA can only be established for the benefit of an “eligible individual” who is covered under a “high-deductible health plan.” In addition, a participant can’t be enrolled in Medicare or have other health coverage (exceptions include dental, vision, long-term care, accident and specific disease insurance).
Within specified dollar limits, an above-the-line tax deduction is allowed for an individual’s contributions to an HSA. This annual contribution limitation and the annual deductible and out-of-pocket expenses under the tax code are adjusted annually for inflation.
In Revenue Procedure 2023-23, the IRS released the 2024 inflation-adjusted figures for contributions to HSAs, which are as follows:
Annual contribution limitation. For calendar year 2024, the annual contribution limitation for an individual with self-only coverage under an HDHP will be $4,150. For an individual with family coverage, the amount will be $8,300. This is up from $3,850 and $7,750, respectively, in 2023.
There is an additional $1,000 “catch-up” contribution amount for those age 55 and older in 2024 (and 2023).
High-deductible health plan defined. For calendar year 2024, an HDHP will be a health plan with an annual deductible that isn’t less than $1,600 for self-only coverage or $3,200 for family coverage (up from $1,500 and $3,000, respectively, in 2023). In addition, annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) won’t be able to exceed $8,050 for self-only coverage or $16,100 for family coverage (up from $7,500 and $15,000, respectively, in 2023).
There are a variety of benefits to HSAs. Contributions to the accounts are made on a pre-tax basis. The money can accumulate tax-free year after year and can be withdrawn tax-free to pay for a variety of medical expenses such as doctor visits, prescriptions, chiropractic care and premiums for long-term care insurance. In addition, an HSA is “portable.” It stays with an account holder if he or she changes employers or leaves the workforce. Contact your employee benefits and tax advisors if you have questions about HSAs at your business.
© 2023
Many businesses use independent contractors to help keep their costs down — especially in these times of staff shortages and inflationary pressures. If you’re among them, be careful that these workers are properly classified for federal tax purposes. If the IRS reclassifies them as employees, it can be an expensive mistake.
The question of whether a worker is an independent contractor or an employee for federal income and employment tax purposes is a complex one. If a worker is an employee, your company must withhold federal income and payroll taxes and pay the employer’s share of FICA taxes on the wages, plus FUTA tax. A business may also provide the worker with fringe benefits if it makes them available to other employees. In addition, there may be state tax obligations.
On the other hand, if a worker is an independent contractor, these obligations don’t apply. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if it’s $600 or more).
Who’s an “employee?” Unfortunately, there’s no uniform definition of the term.
The IRS and courts have generally ruled that individuals are employees if the organization they work for has the right to control and direct them in the jobs they’re performing. Otherwise, the individuals are generally independent contractors. But other factors are also taken into account including who provides tools and who pays expenses.
Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Section 530. This protection generally applies only if an employer meets certain requirements. For example, the employer must file all federal returns consistent with its treatment of a worker as a contractor and it must treat all similarly situated workers as contractors.
Note: Section 530 doesn’t apply to certain types of workers.
Be aware that you can ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, you should also be aware that the IRS has a history of classifying workers as employees rather than independent contractors.
Businesses should consult with us before filing Form SS-8 because it may alert the IRS that your business has worker classification issues — and it may unintentionally trigger an employment tax audit.
It may be better to properly set up a relationship with workers to treat them as independent contractors so that your business complies with the tax rules.
Workers who want an official determination of their status can also file Form SS-8. Dissatisfied independent contractors may do so because they feel entitled to employee benefits and want to eliminate their self-employment tax liabilities.
If a worker files Form SS-8, the IRS will notify the business with a letter. It identifies the worker and includes a blank Form SS-8. The business is asked to complete and return the form to the IRS, which will render a classification decision.
These are the basic tax rules. Contact us if you’d like to discuss how to classify workers at your business. We can help make sure that your workers are properly classified.
© 2023
Fraud. Scam. Phishing. Regardless of what you call these illicit activities, it’s important to protect yourself against the bad players that take advantage of weaknesses for their gain. Not only is it inconvenient, but there’s often a financial cost when you’re a victim of fraud.
The IRS releases an annual ‘Dirty Dozen’ list featuring the top taxpayer scams for the coming year. The list is certainly not exhaustive of every potential pitfall out there, but it is an excellent place to start educating yourself (and your team if you’re a business owner). Here’s a summary of the 2023 IRS Dirty Dozen.
Employer Retention Credit Promoters: Businesses have been targeted by companies claiming to help them submit tax returns and adjustments to take maximum advantage of the Employee Retention Credit (ERC). These promoters collect a fee for preparation services, which is often tied to the value of the proposed credit. Usually, the targeted businesses don’t qualify for the credit, so when the adjustment claim is either rejected by the IRS or found to be incorrect during an audit, the business is out the funds paid to the promoter, as well as any monies received from the ERC they were not eligible for and potential IRS fees.
Phishing and Smishing Scams: Emails, texts, phone calls. These are all popular channels for scammers trying to obtain sensitive information from taxpayers by lying and saying they work for the IRS. Please remember that the IRS will always initiate contact with taxpayers by mail.
Online Account Assistance: The IRS Online Account tool provides helpful information to taxpayers. Scammers are using this as an opportunity to learn social security numbers and other sensitive information by calling and offering to help taxpayer set up their online accounts. This can lead to identity theft and a big headache for taxpayers trying to sort everything out.
Fuel Tax Credit Promoters: Like the Employee Retention Credit promotors, Fuel Tax Credit promoters claim that the taxpayer is qualified for the credit when they may not be. These scammers usually charge a big fee to assist the taxpayer in submitting these claims.
Fake Charity Scams: Major disasters like hurricanes, floods, and wildfires can lead to an increase in counterfeit charities to dupe taxpayers. When these disasters occur, people want to help those affected. Scammers take advantage of this generosity by using fake charities as a front for stealing money and private information. Be sure to take the time to thoroughly research any organization before donating.
Shady Tax Preparers: Common warning signs of a shady tax preparer include charging a fee based on the size of the refund or refusing to sign the form as a preparer as required by law. Make sure you’re using a trusted and knowledgeable tax preparer.
Social Media Trends: While this may seem unsurprising to most, it bears repeating – you can’t always trust what you hear on the internet. Social media can circulate misinformation quickly, including ‘hacks’ for getting a bigger tax refund. These trends usually involve lying on tax forms or creating false income. The IRS reminds taxpayers that falsifying tax documents is illegal and penalties are involved.
Spearphishing Email Scams: Bad players have been sending email requests to tax preparers, and payroll and human resources teams to try and gain sensitive client and employee data like W-2 information. These requests can look like they’re from a potential new client, and the scammers then use the data they collect to submit a series of false tax refund filings and collect on the tax returns. Businesses can protect themselves with these cybersecurity tips.
Offer in Compromise Mills: Promoters target taxpayers that owe the IRS money by offering to settle their debts with the IRS at a steep discount for a fee. Many times, the targeted taxpayers don’t meet the technical requirements to obtain an offer, meaning they still owe the IRS the same amount and are paying excessive fees to these companies. Taxpayers can check their eligibility for an Offer in Compromise using this free IRS tool.
Charitable Remainder Annuity Trust Schemes: Promoters can misuse Charitable Remainder Annuity Trusts and monetized installment sales by misapplying the rules, leaving filers vulnerable. These types of schemes are often targeted at wealthy taxpayers.
Tax Avoidance Schemes: The IRS warns taxpayers to be wary of anyone claiming to reduce their taxes owed drastically or even to nothing. This could include micro-captive insurance arrangements, international accounts, and syndicated conservation easements.
Be diligent with your information, teach your employees how to recognize scams, and be sure to discuss any changes in tax strategy with your trusted tax professional. If anyone contacts you with a claim that seems too good to be true, it probably is.
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.
If you have money invested in the stock market, you’re well aware of potential volatility. Needless to say, this volatility can affect your net worth, thus affecting your lifestyle. Something you might not think about is the potential effect on your estate tax liability. Specifically, if the value of stocks or other assets drops precipitously soon after your death, estate tax could be owed on value that has disappeared. One strategy to ease estate tax liability in this situation is for the estate’s executor to elect to use an alternate valuation date.
Typically, assets owned by the deceased are included in his or her taxable estate based on their value on the date of death. For instance, if an individual owned stocks valued at $1 million on the day when he or she died, the stocks would be included in the estate at a value of $1 million.
Despite today’s favorable rules that allow a federal gift and estate tax exemption of $12.06 million, a small percentage of families still must contend with the federal estate tax. However, the tax law provides some relief to estates that are negatively affected by fluctuating market conditions. Instead of using the value of assets on the date of death for estate tax purposes, the executor may elect an “alternate valuation” date of six months after the date of death. This election could effectively lower a federal estate tax bill.
The election is permissible only if the total value of the gross estate is lower on the alternate valuation date than it was on the date of death. Of course, the election generally wouldn’t be made otherwise. If assets are sold after death, the date of the disposition controls. The value doesn’t automatically revert to the date of death.
Furthermore, the ensuing estate tax must be lower by using the alternate valuation date than it would have been using the date-of-death valuation. This would also seem to be obvious, but that’s not necessarily true for estates passing under the unlimited marital deduction or for other times when the estate tax equals zero on the date of death.
Note that the election to use the alternate valuation date generally must be made with the estate tax return. There is, however, a provision that allows for a late-filed election.
The alternate valuation date election can save estate tax, but there’s one potential drawback: The election must be made for the entire estate. In other words, the executor can’t cherry-pick stocks to be valued six months after the date of death and retain the original valuation date for other stocks or assets. It’s all or nothing.
This could be a key consideration if an estate has, for example, sizable real estate holdings in addition to securities. If the real estate has been appreciating in value, making the election may not be the best approach. The executor must conduct a thorough inventory and accounting of the value of all assets.
If your estate includes assets that can fluctuate in value, such as stocks, be sure your executor knows about the option of choosing an alternate valuation date. This option allows flexibility to reduce the chances of estate tax liability. Contact your estate planning advisor for additional information.
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How much can you and your employees contribute to your 401(k)s next year — or other retirement plans? In Notice 2022-55, the IRS recently announced cost-of-living adjustments that apply to the dollar limitations for pensions, as well as other qualified retirement plans for 2023. The amounts increased more than they have in recent years due to inflation.
The 2023 contribution limit for employees who participate in 401(k) plans will increase to $22,500 (up from $20,500 in 2022). This contribution amount also applies to 403(b) plans, most 457 plans and the federal government’s Thrift Savings Plan.
The catch-up contribution limit for employees age 50 and over who participate in 401(k) plans and the other plans mentioned above will increase to $7,500 (up from $6,500 in 2022). Therefore, participants in 401(k) plans (and the others listed above) who are 50 and older can contribute up to $30,000 in 2023.
The limitation for defined contribution plans, including a Simplified Employee Pension (SEP) plan, will increase from $61,000 to $66,000. To participate in a SEP, an eligible employee must receive at least a certain amount of compensation for the year. That amount will increase in 2023 to $750 (from $650 for 2022).
Deferrals to a SIMPLE plan will increase to $15,500 in 2023 (up from $14,000 in 2022). The catch-up contribution limit for employees age 50 and over who participate in SIMPLE plans will increase to $3,500 in 2023, up from $3,000.
The IRS also announced that in 2023:
The 2023 limit on annual contributions to an individual IRA will increase to $6,500 (up from $6,000 for 2022). The IRA catch-up contribution limit for individuals age 50 and older isn’t subject to an annual cost-of-living adjustment and will remain $1,000.
Current high inflation rates will make it easier for you and your employees to save much more in your retirement plans in 2023. The contribution amounts will be a great deal higher next year than they’ve been in recent years. Contact us if you have questions about your tax-advantaged retirement plan or if you want to explore other retirement plan options.
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What makes Roth IRAs so appealing? Primarily, it’s the ability to withdraw money from them tax-free. But to enjoy this benefit, there are a few rules you must follow, including the widely misunderstood five-year rule.
To understand the five-year rule, you first need to understand the three types of funds that may be withdrawn from a Roth IRA:
Contributed principal. This is your after-tax contributions to the account.
Converted principal. This consists of funds that had been in a traditional IRA but that you converted to a Roth IRA (paying tax on the conversion).
Earnings. This includes the (untaxed) returns generated from the contributed or converted principal.
Generally, you can withdraw contributed principal at any time without taxes or early withdrawal penalties, regardless of your age or how long the funds have been held in the Roth IRA. But to avoid taxes and penalties on withdrawals of earnings, you must meet two requirements:
The withdrawal must not be made before you turn 59½, die, become disabled or qualify for an exception to early withdrawal penalties (such as withdrawals for qualified first-time homebuyer expenses), and
You must satisfy the five-year rule.
Withdrawals of converted principal aren’t taxable because you were taxed at the time of the conversion. But they’re subject to early withdrawal penalties if you fail to satisfy the five-year rule.
As the name suggests, the five-year rule requires you to satisfy a five-year holding period before you can withdraw Roth IRA earnings tax-free or converted principal penalty-free. But the rule works differently depending on the type of funds you’re withdrawing.
If you’re withdrawing earnings, the five-year period begins on January 1 of the tax year for which you made your first contribution to any Roth IRA. For example, if you opened your first Roth IRA on April 1, 2018, and treated your initial contribution as one for the 2017 tax year, then the five-year period started on January 1, 2017. That means you were able to withdraw earnings from any Roth IRA tax- and penalty-free beginning on January 1, 2022 (assuming you were at least 59½ or otherwise exempt from early withdrawal penalties).
Note: If you’re not subject to early withdrawal penalties (because, for example, you’re 59½ or older), failure to satisfy the five-year rule won’t trigger a penalty, but earnings will be taxable.
If you’re withdrawing converted principal, the five-year holding period begins on January 1 of the tax year in which you do the conversion. For instance, if you converted a traditional IRA into a Roth IRA at any time during 2017, the five-year period began January 1, 2017, and ended December 31, 2021.
Unlike earnings, however, each Roth IRA conversion is subject to a separate five-year holding period. If you do several conversions over the years, you’ll need to track each five-year period carefully to avoid triggering unexpected penalties.
Keep in mind that the five-year rule only comes into play if you’re otherwise subject to early withdrawal penalties. If you’ve reached age 59½, or a penalty exception applies, then you can withdraw converted principal penalty-free even if the five-year period hasn’t expired.
You may be wondering why the five-year rule applies to withdrawals of funds that have already been taxed. The reason is that the tax benefits of Roth and traditional IRAs are intended to promote long-term saving for retirement. Without the five-year rule, a traditional IRA owner could circumvent the penalty for early withdrawals simply by converting it to a Roth IRA, paying the tax, and immediately withdrawing it penalty-free.
Note, however, that while the five-year rule prevents this, it’s still possible to use a conversion to withdraw funds penalty-free before age 59½. For example, you could convert a traditional IRA to a Roth IRA at age 45, pay the tax, wait five years and then withdraw the converted principal penalty-free.
Generally, one who inherits a Roth IRA may withdraw the funds immediately without fear of taxes or penalties, with one exception: The five-year rule may still apply to withdrawals of earnings if the original owner of the Roth IRA hadn’t satisfied the five-year rule at the time of his or her death.
For instance, suppose you inherited a Roth IRA from your grandfather on July 1, 2021. If he made his first Roth IRA contribution on December 1, 2018, you’ll have to wait until January 1, 2023, before you can withdraw earnings tax-free.
Many people are accustomed to withdrawing retirement savings freely once they reach age 59½. But care must be taken when withdrawing funds from a Roth IRA to avoid running afoul of the five-year rule and inadvertently triggering unexpected taxes or penalties. The rule is complex — so when in doubt, consult a tax professional before making a withdrawal.
The consequences of violating the five-year rule can be costly, but fortunately, there are ordering rules that help you avoid inadvertent mistakes. Under these rules, withdrawals from a Roth IRA are presumed to come from after-tax contributions first, converted principal second, and earnings third.
So, if contributions are large enough to cover the amount you wish to withdraw, you will avoid taxes and penalties even if the five-year rule hasn’t been satisfied for converted principal or earnings. Of course, if you withdraw the entire account balance, the ordering rules won’t help you.
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On October 21, 2022, the Internal Revenue Service (IRS) announced the updated contribution limits to retirement plans in Notice 2022-55. The new limits are valid beginning in tax year 2023. These limits are important, as they cap the tax benefits that can be realized from retirement plan savings contributions each year and are adjusted to account for annual inflation.
There are several options available under the ‘Employer Contribution Plans’ category. These plans are typically funded through an employer and may or may not have contributions paid for by the employer. For 401(k), 403(b), the federal government’s Thrift Savings Plan, and most 457 plans, the contribution limit will increase from $20,500 in 2022 to $22,500 in 2023.
Individuals aged 50 years and above can contribute additional funds, called ‘Catch Up Contributions.’ The catch-up contribution limit or the employer-sponsored plans mentioned above will increase from $6,500 in 2022 to $7,500 in 2023. This means those with a qualifying employer-sponsored plan who are 50 or older can contribute up to $30,000 to tax-beneficial retirement plans.
Depending on income, the IRS provides tax benefits to non-employer-sponsored retirement accounts called Individual Retirement Arrangements (IRAs). The traditional IRA offers a deduction for the income in the tax year the contribution is made, while a Roth IRA offers tax benefits when the funds are withdrawn after the qualifying retirement age.
The IRS has increased the contribution limit to these types of accounts to $6,500 in 2023 from $6,000 in 2022. For individuals eligible for a catch-up contribution, the additional contribution amount remains at $1,000.
Keep in mind that there is an income limit on both Traditional IRA and Roth IRA accounts before the tax benefits start to phase out. These limits are:
Traditional IRA |
|
| Single Filers/Heads of Household | $73,000 to $83,000* |
| Married Filing Jointly (spouse contributing covered by employer plan) | $116,000 to $136,000* |
| Married Filing Jointly (contributor not covered by employer plan, but spouse is) | $218,000 to $228,000* |
| Married Filing Separate (contributor covered by an employer plan) | $0 to $10,000* |
Roth IRA |
|
| Single Filers/Heads of Household | $138,000 to $153,000* |
| Married Filing Jointly | $218,000 to $228,000* |
| Married Filing Separate | $0 to $10,000* |
Retirement Savings Contributions Credit |
|
| Single Filers/Married Filing Separate | $36,500 |
| Married Filing Jointly | $73,000 |
| Heads of Household | $54,750 |
*Note: Contribution limits to Traditional IRA and Roth IRA accounts phase out over the noted income range.
Need assistance understanding the tax benefits and contribution limits attached to the different tax-beneficial retirement accounts? Our team of knowledgeable professionals is here to help. Give us a call to discuss your tax strategy for retirement savings today.
If you’re thinking about selling your home, it’s important to determine whether you qualify for the home sale gain exclusion. The exclusion is one of the most generous tax breaks in the tax code, so be sure to review its requirements before you sell.
Ordinarily, when you sell real estate or other capital assets that you’ve owned for more than one year, your profit is taxable at long-term capital gains rates of 15% or 20%, depending on your tax bracket. High-income taxpayers may also be subject to an additional 3.8% net investment income (NII) tax. If you’re selling your principal residence, however, the home sale gain exclusion may allow you to avoid tax on up to $250,000 in profit for single filers and up to $500,000 for married couples filing jointly.
Don’t assume that you’re eligible for this tax break just because you’re selling your principal residence. If you’re a single filer, to qualify for the exclusion, you must have owned and used the home as your principal residence for at least 24 months of the five-year period ending on the sale date.
If you’re married filing jointly, then both you and your spouse must have lived in the home as your principal residence for 24 months of the preceding five years and at least one of you must have owned it for 24 months of the preceding five years. Special eligibility rules apply to people who become unable to care for themselves, couples who divorce or separate, military personnel, and widowed taxpayers.
You can’t use the exclusion more than once in a two-year period, even if you otherwise meet the requirements. Also, if you convert an ineligible residence into a principal residence and live in it for 24 months or more, only a portion of your gain will qualify for the exclusion.
For example, John is single and has owned a home for five years, using it as a vacation home for the first three years and as his principal residence for the last two. If he sells the home for a $300,000 gain, only 40% of his gain ($120,000) qualifies for the exclusion, and the remaining $180,000 is taxable. (Note: Nonqualified use prior to 2009 doesn’t reduce the exclusion).
What if you sell your home before you meet the 24-month threshold due to a work- or health-related move, or certain other unforeseen circumstances? You may qualify for a partial exclusion.
For example, Paul and Linda bought a home in California for $1 million. One year later, Paul’s employer transferred him to its New York office, so the couple sold the home for $1.2 million. Paul and Linda didn’t meet the 24-month threshold but, because they sold the home due to a work-related move, they qualified for a partial exclusion of 12 months/24 months, or 50%.
Note that the 50% reduction applied to the exclusion, not to the couple’s gain. Thus, their exclusion was reduced to 50% of $500,000, or $250,000, which shielded their entire $200,000 gain from tax.
Before you sell your principal residence, determine the amount of your home sale gain exclusion and your expected gain (selling price less adjusted cost basis). Keep in mind that your cost basis is increased by the cost of certain improvements and other expenses, which in turn reduces your gain. Also, be aware that capital gains attributable to depreciation deductions (for a home office, for example) will be taxable regardless of the home sale gain exclusion.
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IRS audit rates are historically low, according to a recent Government Accountability Office (GAO) report, but that’s little consolation if your return is among those selected to be examined. Plus, the IRS recently received additional funding in the Inflation Reduction Act to improve customer service, upgrade technology and increase audits of high-income taxpayers. But with proper preparation and planning, you should fare well.
From tax years 2010 to 2019, audit rates of individual tax returns decreased for all income levels, according to the GAO. On average, the audit rate for all returns decreased from 0.9% to 0.25%. IRS officials attribute this to reduced staffing as a result of decreased funding. Businesses, large corporations, and high-income individuals are more likely to be audited, but overall, all types of audits are being conducted less frequently than they were a decade ago.
There’s no 100% guarantee that you won’t be picked for an audit because some tax returns are chosen randomly. However, the best way to survive an IRS audit is to prepare in advance. On an ongoing basis, you should systematically maintain documentation — invoices, bills, canceled checks, receipts, or other proof — for all items to be reported on your tax returns. Keep all records in one place.
It also helps to know what might catch the attention of the IRS. Certain types of tax-return entries are known to involve inaccuracies, so they may lead to an audit. Here are a few examples:
Certain types of deductions may be questioned by the IRS because there are strict recordkeeping requirements for them — for example, auto and travel expense deductions. In addition, an owner-employee’s salary that’s much higher or lower than those at similar companies in his or her location may 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 doesn’t make initial contact by phone. But if there’s no response to the letter, the agency may follow up with a call.
Many audits simply request that you mail in documentation to support certain deductions you’ve claimed. Only the strictest version, the field audit, requires meeting with one or more IRS auditors. (Note: Ignore unsolicited emails or text messages about an audit. The IRS doesn’t contact people in this manner. These are scams.)
The tax agency doesn’t demand an immediate response to a mailed notice. You’ll be informed of the discrepancies in question and given time to prepare. Collect and organize all relevant income and expense records. If anything is missing, you’ll have to reconstruct the information as accurately as possible based on other documentation.
If you’re audited, our firm can help you:
The IRS normally has three years within which to conduct an audit, and an audit probably won’t begin until a year or more after you file a return. Don’t panic if the IRS contacts you. Many audits are routine. By taking a meticulous, proactive approach to tracking, documenting and filing your company’s tax-related information, you’ll make an audit less painful and even decrease the chances you’ll be chosen in the first place.
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Does your business need real estate to conduct operations? Or does it otherwise hold property and put the title in the name of the business? You may want to rethink this approach. Any short-term benefits may be outweighed by the tax, liability, and estate planning advantages of separating real estate ownership from the business.
Businesses that are formed as C corporations treat real estate assets as they do equipment, inventory and other business assets. Any expenses related to owning the assets appear as ordinary expenses on their income statements and are generally tax deductible in the year they’re incurred.
However, when the business sells the real estate, the profits are taxed twice — at the corporate level and at the owner’s individual level when a distribution is made. Double taxation is avoidable, though. If ownership of the real estate were transferred to a pass-through entity instead, the profit upon sale would be taxed only at the individual level.
Separating your business ownership from its real estate also provides an effective way to protect it from creditors and other claimants. For example, if your business is sued and found liable, a plaintiff may go after all of its assets, including real estate held in its name. But plaintiffs can’t touch property owned by another entity.
The strategy also can pay off if your business is forced to file for bankruptcy. Creditors generally can’t recover real estate owned separately unless it’s been pledged as collateral for credit taken out by the business.
Separating real estate from a business may give you some estate planning options, too. For example, if the company is a family business but some members of the next generation aren’t interested in actively participating, separating property gives you an extra asset to distribute. You could bequest the business to one heir and the real estate to another family member who doesn’t work in the business.
The business simply transfers ownership of the real estate and the transferee leases it back to the company. Who should own the real estate? One option: The business owner could purchase the real estate from the business and hold title in his or her name. One concern is that it’s not only the property that’ll transfer to the owner, but also any liabilities related to it.
Moreover, any liability related to the property itself could inadvertently put the business at risk. If, for example, a client suffers an injury on the property and a lawsuit ensues, the property owner’s other assets (including the interest in the business) could be in jeopardy.
An alternative is to transfer the property to a separate legal entity formed to hold the title, typically a limited liability company (LLC) or limited liability partnership (LLP). With a pass-through structure, any expenses related to the real estate will flow through to your individual tax return and offset the rental income.
An LLC is more commonly used to transfer real estate. It’s simple to set up and requires only one member. LLPs require at least two partners and aren’t permitted in every state. Some states restrict them to certain types of businesses and impose other restrictions.
Separating the ownership of a business’s real estate isn’t always advisable. If it’s worthwhile, the right approach will depend on your individual circumstances. Contact us to help determine the best approach to minimize your transfer costs and capital gains taxes while maximizing other potential benefits.
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