If you’re claiming deductions for business meals or auto expenses, expect the IRS to closely review them. In some cases, taxpayers have incomplete documentation or try to create records months (or years) later. In doing so, they fail to meet the strict substantiation requirements set forth under tax law. Tax auditors are adept at rooting out inconsistencies, omissions and errors in taxpayers’ records, as illustrated by one recent U.S. Tax Court case.
In the case, a married couple claimed $13,596 in car and truck expenses, supported only by mileage logs that weren’t kept contemporaneously and were made using estimates rather than odometer readings. The court disallowed the entire deduction, stating that “subsequently prepared mileage records do not have the same high degree of credibility as those made at or near the time the vehicle was used and supported by documentary evidence.”
The court noted that it appeared the taxpayers attempted to deduct their commuting costs. However, it stated that “expenses a taxpayer incurs traveling between his or her home and place of business generally constitute commuting expenses, which … are nondeductible.”
A taxpayer isn’t relieved of the obligation to substantiate business mileage, even if he or she opts to use the standard mileage rate (65.5 cents per business mile in 2023), rather than keep track of actual expenses.
The court also ruled the couple wasn’t entitled to deduct $5,233 of travel, meal and entertainment expenses because they didn’t meet the strict substantiation requirements of the tax code. (TC Memo 2022-113)
This case is an example of why it’s critical to maintain meticulous records to support business expenses for vehicle and meal deductions. Here’s a list of “DOs and DON’Ts” to help meet the strict IRS and tax law substantiation requirements for these items:
DO keep detailed, accurate records. For each expense, record the amount, the time and place, the business purpose, and the business relationship of any person to whom you provided a meal. If you have employees who you reimburse for meals and auto expenses, make sure they’re complying with all the rules.
DON’T reconstruct expense logs at year end or wait until you receive a notice from the IRS. Take a moment to record the details in a log or diary or on a receipt at the time of the event or soon after. Require employees to submit monthly expense reports.
DO respect the fine line between personal and business expenses. Be careful about combining business and pleasure. Your business checking account shouldn’t be used for personal expenses.
DON’T be surprised if the IRS asks you to prove your deductions. Vehicle and meal expenses are a magnet for attention. Be prepared for a challenge.
With organization and guidance from us, your tax records can stand up to inspection from the IRS. There may be ways to substantiate your deductions that you haven’t thought of, and there may be a way to estimate certain deductions (called “the Cohan rule”), if your records are lost due to a fire, theft, flood or other disaster.
As we approach the halfway point of 2023, it’s the perfect opportunity to evaluate your business tax planning and determine ways to decrease your tax burden. Employing the right strategies can reduce your taxes, optimize your cash flow, and enhance your long-term financial success.
In this article, we’ll introduce three tax strategies for 2023: Roth IRA conversions, tax loss harvesting, and year-round charitable giving. By familiarizing yourself with these tactics and how they can benefit your enterprise, you can make well-informed decisions and capitalize on available tax savings. Let’s dive into these tax-saving concepts and explore the options available for your business.
Roth IRA conversions effectively transform a portion of your traditional IRA into a tax-free asset that can provide you with cash distributions in your retirement years. Converting a portion of your traditional IRA can save you taxes at a potentially lower marginal tax rate and create a tax-free asset that can serve as a mechanism for tax redistribution during retirement. Even better, consider using this strategy as a future legacy asset for your beneficiaries.
By converting to a Roth IRA, you can ensure your desired assets are passed onto your loved ones.
Tax loss harvesting is a strategy that involves taking advantage of market volatility to generate a tax asset using captured capital losses. These losses can be used to offset future capital gains, and any remaining losses can be used to offset gains in subsequent years. Another effective strategy involves pairing these losses with qualified opportunity zones, which can further reduce your tax liabilities.
Investors who suffered losses due to the steep decline of the cryptocurrency and stock markets can benefit from this approach. The recent market downturn could also lead more investors to opportunity zone funds, presenting an excellent opportunity to maximize tax benefits.
End-of-year charitable donations have long been a go-to for taxpayers seeking tax deductions. However, there are benefits to giving year-round, especially when combined with investments.
For example, investors with appreciated securities in a taxable account can use these securities to fulfill their philanthropic goals. This strategy allows for a fair market value deduction without having to pay taxes on the capital gain. It’s a practical way to donate without sacrificing your end-of-the-year cash or check donation.
Charitable remainder trusts offer another means of donating to worthwhile causes and taking advantage of tax breaks. Although the lower interest rates over the last few years have cooled investor interest in these trusts, the benefits of using these trusts become increasingly clear as rates rise.
Don’t wait until the end of the year to give back. Consider these charitable giving strategies to boost your philanthropic impact and build a better future.
Remember, it’s essential to review your tax planning regularly to take advantage of available opportunities and ensure you’re putting your assets to their best use. With these actionable takeaways, you can start making informed decisions today and set your business up for long-term financial success.
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.
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.
Whether you’re operating a new company or an established business, losses can happen. The federal tax code may help soften the blow by allowing businesses to apply losses to offset taxable income in future years, subject to certain limitations.
The net operating loss (NOL) deduction addresses the tax inequities that can exist between businesses with stable income and those with fluctuating income. It essentially lets the latter average out their income and losses over the years and pay tax accordingly.
You may be eligible for the NOL deduction if your deductions for the tax year are greater than your income. The loss generally must be caused by deductions related to your:
The following generally aren’t allowed when determining your NOL:
Individuals and C corporations are eligible to claim the NOL deduction. Partnerships and S corporations generally aren’t eligible, but partners and shareholders can use their separate shares of the business’s income and deductions to calculate individual NOLs.
The Tax Cuts and Jobs Act (TCJA) made significant changes to the NOL rules. Previously, taxpayers could carry back NOLs for two years, and carry forward the losses 20 years. They also could apply NOLs against 100% of their taxable income.
The TCJA limits the NOL deduction to 80% of taxable income for the year and eliminates the carryback of NOLs (except for certain farming losses). However, it does allow NOLs to be carried forward indefinitely.
A COVID-19 relief law temporarily loosened the TCJA restrictions. It allowed NOLs arising in 2018, 2019 or 2020 to be carried back five years and removed the taxable income limitation for years beginning before 2021. As a result, NOLs could completely offset income. However, these provisions have expired.
If your NOL carryforward is more than your taxable income for the year to which you carry it, you may have an NOL carryover. The carryover will be the excess of the NOL deduction over your modified taxable income for the carryforward year. If your NOL deduction includes multiple NOLs, you must apply them against your modified taxable income in the same order you incurred them, beginning with the earliest.
The TCJA established an “excess business loss” limitation, which took effect in 2021. For partnerships or S corporations, this limitation is applied at the partner or shareholder level, after the outside basis, at-risk and passive activity loss limitations have been applied.
Under the rule, noncorporate taxpayers’ business losses can offset only business-related income or gain, plus an inflation-adjusted threshold. For 2023, that threshold is $289,000 ($578,000 if married filing jointly). Remaining losses are treated as an NOL carryforward to the next tax year. In other words, you can’t fully deduct them because they become subject to the 80% income limitation on NOLs, reducing their tax value.
Important: Under the Inflation Reduction Act, the excess business loss limitation applies to tax years beginning before January 1, 2029. Under the TCJA, it had been scheduled to expire after December 31, 2026.
The tax rules regarding business losses are complex, especially when accounting for how NOLs can interact with other potential tax breaks. We can help you chart the best course forward.
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.
If your business occupies substantial space and needs to increase or move from that space in the future, you should keep the rehabilitation tax credit in mind. This is especially true if you favor historic buildings.
The credit is equal to 20% of the qualified rehabilitation expenditures (QREs) for a qualified rehabilitated building that’s also a certified historic structure. A qualified rehabilitated building is a depreciable building that has been placed in service before the beginning of the rehabilitation and is used, after rehabilitation, in business or for the production of income (and not held primarily for sale). Additionally, the building must be “substantially” rehabilitated, which generally requires that the QREs for the rehabilitation exceed the greater of $5,000 or the adjusted basis of the existing building.
A QRE is any amount chargeable to capital and incurred in connection with the rehabilitation (including reconstruction) of a qualified rehabilitated building. QREs must be for real property (but not land) and can’t include building enlargement or acquisition costs.
The 20% credit is allocated ratably to each year in the five-year period beginning in the tax year in which the qualified rehabilitated building is placed in service. Thus, the credit allowed in each year of the five-year period is 4% (20% divided by 5) of the QREs with respect to the building. The credit is allowed against both regular federal income tax and alternative minimum tax.
The Tax Cuts and Jobs Act, which was signed at the end of 2017, made some changes to the credit. Specifically, the law:
Contact us to discuss the technical aspects of the rehabilitation credit. There may also be other federal tax benefits available for the space you’re contemplating. For example, various tax benefits might be available depending on your preferences as to how a building’s energy needs will be met and where the building is located. In addition, there may be state or local tax and non-tax subsidies available.
Getting beyond these preliminary considerations, we can work with you and construction professionals to determine whether a specific available “old” building can be the subject of a rehabilitation that’s both tax-credit-compliant and practical to use. And, if you do find a building that you decide you’ll buy (or lease) and rehabilitate, we can help you monitor project costs and substantiate the compliance of the project with the requirements of the credit and any other tax benefits.
California taxpayers should note the changes made to these tax laws over the last several months. Here’s an overview of what you may have missed:
California law requires holders of unclaimed property to attempt to notify owners of the property regularly, to keep records of the property and to turn over the property to the State Controller’s Office after the appropriate dormancy period. Unclaimed property could be:
Under California Assembly Bill 466, the dormancy period has been set to one year for payroll accounts and three years for Securities, Accounts Receivable and Payable, and Disbursements. The law also requires businesses to review their books and records annually to determine if they have any unclaimed property to report. Keep in mind, businesses must also complete the following reporting requirements:
In addition, the State of California identifies the following filling and reporting deadlines:
Personal property owners in California will receive annual assessments and tax bills for the personal property based on their county or local jurisdiction laws. In order to stay in compliance with tax laws, keep these points in mind:
The Tax Cuts and Jobs Act limited the state tax deduction for personal income in pass-through entities to $10,000. In California, pass-through entities pay tax, and the PTE owns remain taxable on the distributive shares of income. However, the owners receive a tax credit for a share of the PTE tax. The nonrefundable tax credit can be carried forward for up to 5 years.
In order to qualify as a pass-through entity, the election must be made annually and consented to by each owner to the pass-through entity. Payments of more than $1,000 or 50% of the prior year PTE tax are due by June 15 of the current tax year, with the remaining due on March 15 of the following year. This is effective for tax years beginning January 1, 2021 or later and before January 1, 2026.
The following are business taxes that business owners should be aware of for San Francisco and Los Angeles.
In late 2022 and early 2023, California issued qualified taxpayers a total of $9.2 billion in refunds of tax overpayments, called the Middle Class Tax Refund. The State of California noted these payments are not liable for state taxes previously. In February, the IRS determined that it will not challenge the tax treatment of these payments on 2022 tax filings, citing their general welfare and disaster relief exception.
Due to historically high rain, snow, and flooding in much of California, the IRS is offering disaster relief assistance in the form of due date extensions on required tax filings and payments. The new deadline for tax payments due from January through October is October 16, 2023. This includes:
For more information on the counties qualified for tax relief and what payments have been extended, please visit the IRS press release or call our team.
If you’re thinking about setting up a retirement plan for yourself and your employees, but you’re worried about the financial commitment and administrative burdens involved, there are a couple of options to consider. Let’s take a look at a “simplified employee pension” (SEP) or a “savings incentive match plan for employees” (SIMPLE).
SEPs are intended as an attractive alternative to “qualified” retirement plans, particularly for small businesses. The features that are appealing include the relative ease of administration and the discretion that you, as the employer, are permitted in deciding whether or not to make annual contributions.
If you don’t already have a qualified retirement plan, you can set up a SEP simply by using the IRS model SEP, Form 5305-SEP. By adopting and implementing this model SEP, which doesn’t have to be filed with the IRS, you’ll have satisfied the SEP requirements. This means that as the employer, you’ll get a current income tax deduction for contributions you make on behalf of your employees. Your employees won’t be taxed when the contributions are made but will be taxed later when distributions are made, usually at retirement. Depending on your needs, an individually-designed SEP — instead of the model SEP — may be appropriate for you.
When you set up a SEP for yourself and your employees, you’ll make deductible contributions to each employee’s IRA, called a SEP-IRA, which must be IRS-approved. The maximum amount of deductible contributions that you can make to an employee’s SEP-IRA, and that he or she can exclude from income, is the lesser of: 25% of compensation and $66,000 for 2023. The deduction for your contributions to employees’ SEP-IRAs isn’t limited by the deduction ceiling applicable to an individual’s own contribution to a regular IRA. Your employees control their individual IRAs and IRA investments, the earnings on which are tax-free.
There are other requirements you’ll have to meet to be eligible to set up a SEP. Essentially, all regular employees must elect to participate in the program, and contributions can’t discriminate in favor of the highly compensated employees. But these requirements are minor compared to the bookkeeping and other administrative burdens connected with traditional qualified pension and profit-sharing plans.
The detailed records that traditional plans must maintain to comply with the complex nondiscrimination regulations aren’t required for SEPs. And employers aren’t required to file annual reports with IRS, which, for a pension plan, could require the services of an actuary. The required recordkeeping can be done by a trustee of the SEP-IRAs — usually a bank or mutual fund.
Another option for a business with 100 or fewer employees is a “savings incentive match plan for employees” (SIMPLE). Under these plans, a “SIMPLE IRA” is established for each eligible employee, with the employer making matching contributions based on contributions elected by participating employees under a qualified salary reduction arrangement. The SIMPLE plan is also subject to much less stringent requirements than traditional qualified retirement plans. Or, an employer can adopt a “simple” 401(k) plan, with similar features to a SIMPLE plan, and automatic passage of the otherwise complex nondiscrimination test for 401(k) plans.
For 2023, SIMPLE deferrals are up to $15,500 plus an additional $3,500 catch-up contributions for employees ages 50 and older.
Contact us for more information or to discuss any other aspect of your retirement planning.
Summer is around the corner so you may be thinking about hiring young people at your small business. At the same time, you may have children looking to earn extra spending money. You can save family income and payroll taxes by putting your child on the payroll. It’s a win-win!
Here are four tax advantages.
You can turn some of your high-taxed income into tax-free or low-taxed income by shifting some business earnings to a child as wages for services performed. In order for your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child’s salary must be reasonable.
For example, suppose you’re a sole proprietor in the 37% tax bracket. You hire your 16-year-old son to help with office work full-time in the summer and part-time in the fall. He earns $10,000 during the year (and doesn’t have other earnings). You can save $3,700 (37% of $10,000) in income taxes at no tax cost to your son, who can use his $13,850 standard deduction for 2023 to shelter his earnings.
Family taxes are cut even if your son’s earnings exceed his standard deduction. That’s because the unsheltered earnings will be taxed to him beginning at a 10% rate, instead of being taxed at your higher rate.
Your business likely will have to withhold federal income taxes on your child’s wages. Usually, an employee can claim exempt status if he or she had no federal income tax liability for last year and expects to have none this year.
However, exemption from withholding can’t be claimed if: 1) the employee’s income exceeds $1,250 for 2023 (and includes more than $400 of unearned income), and 2) the employee can be claimed as a dependent on someone else’s return.
Keep in mind that your child probably will get a refund for part or all of the withheld tax when filing a return for the year.
If your business isn’t incorporated, you can also save some Social Security tax by shifting some of your earnings to your child. That’s because services performed by a child under age 18 while employed by a parent aren’t considered employment for FICA tax purposes.
A similar but more liberal exemption applies for FUTA (unemployment) tax, which exempts earnings paid to a child under age 21 employed by a parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting only of his or her parents.
Note: There’s no FICA or FUTA exemption for employing a child if your business is incorporated or is a partnership that includes non-parent partners. However, there’s no extra cost to your business if you’re paying a child for work you’d pay someone else to do.
Your business also may be able to provide your child with retirement savings, depending on your plan and how it defines qualifying employees. For example, if you have a SEP plan, a contribution can be made for the child up to 25% of his or her earnings (not to exceed $66,000 for 2023).
Contact us if you have any questions about these rules in your situation. Keep in mind that some of the rules about employing children may change from year to year and may require your income-shifting strategies to change too.
It’s been years since the Tax Cuts and Jobs Act (TCJA) of 2017 was signed into law, but it’s still having an impact. Several provisions in the law have expired or will expire in the next few years. One provision that took effect last year was the end of current deductibility for research and experimental (R&E) expenses.
The TCJA has affected many businesses, including manufacturers, that have significant R&E costs. Starting in 2022, Internal Revenue Code Section 174 R&E expenditures must be capitalized and amortized over five years (15 years for research conducted outside the United States). Previously, businesses had the option of deducting these costs immediately as current expenses.
The TCJA also expanded the types of activities that are considered R&E for purposes of IRC Sec. 174. For example, software development costs are now considered R&E expenses subject to the amortization requirement.
Businesses should consider the following strategies for minimizing the impact of these changes:
For 2022 tax returns, the IRS recently released guidance for taxpayers to change the treatment of R&E expenses (Revenue Procedure 2023-11). The guidance provides a way to obtain automatic consent under the tax code to change methods of accounting for specified research or experimental expenditures under Sec. 174, as amended by the TCJA. This is important because unless there’s an exception provided under tax law, a taxpayer must secure the consent of the IRS before changing a method of accounting for federal income tax purposes.
The recent revenue procedure also provides a transition rule for taxpayers who filed a tax return on or before January 17, 2023.
We can advise you how to proceed. There have also been proposals in Congress that would eliminate the amortization requirements. However, so far, they’ve been unsuccessful. We’re monitoring legislative developments and can help adjust your tax strategies if there’s a change in the law.
Under tax law, businesses can generally deduct advertising and marketing expenses that help keep existing customers and bring in new ones. This valuable tax deduction can help businesses cut their taxes.
However, in order to be deductible, advertising and marketing expenses must be “ordinary and necessary.” As one taxpayer recently learned in U.S. Tax Court, not all expenses are eligible. An ordinary expense is one that’s common and accepted in the industry. And a necessary expense is one that’s helpful and appropriate for the business.
According to the IRS, here are some advertising expenses that are usually deductible:
An attorney deducted his car-racing expenses and claimed they were advertising for his personal injury law practice. He contended that his racing expenses, totaling over $303,000 for six tax years, were deductible as advertising because the car he raced was sponsored by his law firm.
The IRS denied the deductions and argued that the attorney’s car racing wasn’t an ordinary and necessary expense paid or incurred while carrying on his business of practicing law. The Tax Court agreed with the IRS.
When making an ordinary and necessary determination for an expense, most courts look to the taxpayer’s primary motive for incurring the expense and whether there’s a “proximate” relationship between the expense and the taxpayer’s occupation. In this case, the taxpayer’s car-racing expenses were neither necessary nor common for a law practice, so there was no “proximate” relationship between the expense and the taxpayer’s occupation. And, while the taxpayer said his primary motive for incurring the expense was to advertise his law business, he never raced in the state where his primary law practice was located, and he never actually got any legal business from his car-racing activity.
The court noted that the car “sat in his garage” after he returned to the area where his law practice was located. The court added that even if the taxpayer raced in that area, “we would not find his expenses to be legitimate advertising expenses. His name and a decal for his law firm appeared in relatively small print” on his car.
This form of “signage,” the court stated, “is at the opposite end of the spectrum from (say) a billboard or a newspaper ad. Indeed, every driver’s name typically appeared on his or her racing car.” (TC Memo 2023-18)
There are no deductions allowed for personal expenses or hobbies. But as explained above, you can deduct ordinary and necessary advertising and marketing expenses in a bona fide business. The key to protecting your deductions is to keep meticulous records to substantiate them. Contact us with questions about your situation.
If you’re buying or replacing a vehicle that you’ll use in your business, be aware that a heavy SUV may provide a more generous tax break this year than you’d get from a smaller vehicle. The reason has to do with how smaller business cars are depreciated for tax purposes.
Business cars are subject to more restrictive tax depreciation rules than those that apply to other depreciable assets. Under the so-called “luxury auto” rules, depreciation deductions are artificially “capped.” Those caps also extend to the alternative deduction that a taxpayer can claim if it elects to use Section 179 expensing for all or part of the cost of a business car. (It allows you to write-off an asset in the year it’s placed in service.)
These rules include smaller trucks or vans built on truck chassis that are treated as cars. For most cars that are subject to the caps and that are first placed in service in calendar year 2023, the maximum depreciation and/or expensing deductions are:
Generally, the effect is to extend the number of years it takes to fully depreciate the vehicle.
Because of the restrictions for cars, you may be better off from a tax timing perspective if you replace your business car with a heavy SUV instead of another car. That’s because the caps on annual depreciation and expensing deductions for passenger automobiles don’t apply to trucks or vans that are rated at more than 6,000 pounds gross (loaded) vehicle weight. This includes large SUVs, many of which are priced over $50,000.
The result is that in most cases, you’ll be able to write-off a majority of the cost of a new SUV used entirely for business purposes by utilizing bonus and regular depreciation in the year you place it into service. For 2023, bonus depreciation is available at 80%, but is being phased down to zero over the next few years.
If you consider electing Section 179 expensing for all or part of the cost of an SUV, you need to know that an inflation-adjusted limit, separate from the general caps described above, applies ($28,900 for an SUV placed in service in tax years beginning in 2023, up from $27,000 for an SUV placed in service in tax years beginning in 2022). There’s also an aggregate dollar limit for all assets elected to be expensed in the year that would apply. Following the expensing election, you would then depreciate the remainder of the cost under the usual rules without regard to general annual caps.
Please note that the tax benefits described above are all subject to adjustment for non-business use. Also, if business use of an SUV doesn’t exceed 50% of total use, the SUV won’t be eligible for the expensing election, and would have to be depreciated on a straight-line method over a six-tax-year period.
Contact us for more details about this opportunity to get hefty tax write-offs if you buy a heavy SUV for business.
Many people began working from home during the COVID-19 pandemic — and many still work from their home offices either all the time or on a hybrid basis. If you’re self-employed and run your business from home or perform certain functions there, you might be able to claim deductions for home office expenses against your business income. There are two methods for claiming this tax break: the actual expense method and the simplified method.
In general, you qualify for home office deductions if part of your home is used “regularly and exclusively” as your principal place of business.
If your home isn’t your principal place of business, you may still be able to deduct home office expenses if:
Many eligible taxpayers deduct actual expenses when they claim home office deductions. Deductible home office expenses may include:
But keeping track of actual expenses can take time and it requires organized recordkeeping.
Fortunately, there’s a simplified method: You can deduct $5 for each square foot of home office space, up to a maximum of $1,500.
The cap can make the simplified method less valuable for larger home office spaces. Even for small spaces, taxpayers may qualify for bigger deductions using the actual expense method. So, tracking your actual expenses can be worth it.
When claiming home office deductions, you’re not stuck with a particular method. For instance, you might choose the actual expense method on your 2022 return, use the simplified method when you file your 2023 return next year and then switch back to the actual expense method for 2024. The choice is yours.
If you sell — at a profit — a home on which you claimed home office deductions, there may be tax implications. We can explain them to you.
Also be aware that the amount of your home office deductions is subject to limitations based on the income attributable to your use of the office. Other rules and limitations may apply. But any home office expenses that can’t be deducted because of these limitations can be carried over and deducted in later years.
Unfortunately, the Tax Cuts and Jobs Act suspended the business use of home office deductions from 2018 through 2025 for employees. Those who receive paychecks or Form W-2s aren’t eligible for deductions, even if they’re currently working from home because their employers closed their offices due to COVID-19.
We can help you determine if you’re eligible for home office deductions and how to proceed in your situation.
The IRS has released the updated tax brackets, deductions, and credits for the 2023 tax year. While tax filing for this year won’t happen until early 2024, it’s important to pay attention to your tax rate. Strategizing now can help minimize your tax liability and maximize your income potential. Here are the updated numbers for 2023.
The tax brackets for the 2023 tax year (filing in the spring of 2024) are as follows:
|Tax Rate||Single Filers, Married Filing Separately*||Heads of Household||Married Filing Jointly|
|10%||< $11,000||<$15,700||< $22,000|
In addition to the tax brackets for 2023, taxpayers should be aware of these credits, deductions, and phase-outs.
To discuss how these updates may affect your unique tax situation or to create a tax plan for the year, please reach out to one of our knowledgeable professionals today!
Many businesses in certain industries employ individuals who receive tips as part of their compensation. These businesses include restaurants, hotels, and salons.
Tips are optional payments that customers make to employees who perform services. They can be cash or noncash. Cash tips include those received directly from customers, electronically paid tips distributed to employees by employers, and tips received from other employees under tip-sharing arrangements. Generally, workers must report cash tips to their employers. Noncash tips are items of value other than cash. They may include tickets, passes, or other items that customers give employees. Workers don’t have to report noncash tips to employers.
For tax purposes, four factors determine whether a payment qualifies as a tip:
Tips can also be direct or indirect. A direct tip occurs when an employee receives it directly from a customer, even as part of a tip pool. Directly tipped employees include wait staff, bartenders and hairstylists. An indirect tip occurs when an employee who normally doesn’t receive tips receives one. Indirectly tipped employees include bussers, service bartenders, cooks and salon shampooers.
Tipped workers must keep daily records of the cash tips they receive. To keep track of them, they can use Form 4070A, Employee’s Daily Record of Tips. It is found in IRS Publication 1244.
Workers should also keep records of the dates and value of noncash tips. Although the IRS doesn’t require workers to report noncash tips to employers, they must report them on their tax returns.
Employees must report tips to employers by the 10th of the month following the month they were received. The IRS doesn’t require workers to use a particular form to report tips. However, a worker’s tip report generally should include:
Note: Employees whose monthly tips are less than $20 don’t need to report them to their employers but must include them as income on their tax returns.
Employers should send each employee a Form W-2 that includes reported tips. Employers also must:
In addition, “large” food or beverage establishments must file an annual report disclosing receipts and tips on Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips.
If you’re an employer with tipped workers providing food and beverages, you may qualify for a federal tax credit involving the Social Security and Medicare taxes that you pay on employees’ tip income. The tip tax credit may be valuable to you. If you have any questions about the tax implications of tips, don’t hesitate to contact us.
An array of tax-related limits that affect businesses are indexed annually, and due to high inflation, many have increased more than usual for 2023. Here are some that may be important to you and your business.
The amount of employees’ earnings that are subject to Social Security tax is capped for 2023 at $160,200 (up from $147,000 for 2022).
These are only some of the tax limits and deductions that may affect your business and additional rules may apply. Contact us if you have questions.
With the 2023 filing season deadline drawing near, be aware that the deadline for businesses to file information returns for hired workers is even closer. By January 31, 2023, employers must file these forms:
Form W-2, Wage and Tax Statement. W-2 forms show the wages paid and taxes withheld for the year for each employee. They must be provided to employees and filed with the Social Security Administration (SSA). The IRS notes that “because employees’ Social Security and Medicare benefits are computed based on information on Form W-2, it’s very important to prepare Form W-2 correctly and timely.”
Form W-3, Transmittal of Wage and Tax Statements. Anyone required to file Form W-2 must also file Form W-3 to transmit Copy A of Form W-2 to the SSA. The totals for amounts reported on related employment tax forms (Form 941, Form 943, Form 944 or Schedule H for the year) should agree with the amounts reported on Form W-3.
Failing to timely file or include the correct information on either the information return or statement may result in penalties.
The January 31 deadline also applies to Form 1099-NEC, Nonemployee Compensation. These forms are provided to recipients and filed with the IRS to report non-employee compensation to independent contractors.
Payers must complete Form 1099-NEC to report any payment of $600 or more to a recipient.
If the following four conditions are met, you must generally report payments as nonemployee compensation:
Your business may also have to file a Form 1099-MISC for each person to whom you made certain payments for rent, medical expenses, prizes and awards, attorney’s services and more.
If you have questions about filing Form W-2, Form 1099-NEC or any tax forms, contact us. We can assist you in staying in compliance with all rules.
If your small business has a retirement plan, and even if it doesn’t, you may see changes and benefits from a new law. The Setting Every Community Up for Retirement Enhancement 2.0 Act (SECURE 2.0) was recently signed into law. Provisions in the law will kick in over several years.
SECURE 2.0 is meant to build on the original SECURE Act, which was signed into law in 2019. Here are some provisions that may affect your business.
Retirement plan automatic enrollment. Under the new law, 401(k) plans will be required to automatically enroll employees when they become eligible, beginning with plan years after December 31, 2024. Employees will be permitted to opt out. The initial automatic enrollment amount would be at least 3% but not more than 10%. Then, the amount would be increased by 1% each year thereafter until it reaches at least 10%, but not more than 15%. All current 401(k) plans are grandfathered. Certain small businesses would be exempt.
Part-time worker coverage. The first SECURE Act requires employers to allow long-term, part-time workers to participate in their 401(k) plans with a dual eligibility requirement (one year of service and at least 1,000 hours worked or three consecutive years of service with at least 500 hours worked). The new law will reduce the three-year rule to two years, beginning after December 31, 2024. This provision would also extend the long-term part-time coverage rules to 403(b) plans that are subject to ERISA.
Employees with student loan debt. The new law will allow an employer to make matching contributions to 401(k) and certain other retirement plans with respect to “qualified student loan payments.” This means that employees who can’t afford to save money for retirement because they’re repaying student loan debt can still receive matching contributions from their employers into retirement plans. This will take effect beginning after December 31, 2023.
“Starter” 401(k) plans. The new law will allow an employer that doesn’t sponsor a retirement plan to offer a starter 401(k) plan (or safe harbor 403(b) plan) that would require all employees to be default enrolled in the plan at a 3% to 15% of compensation deferral rate. The limit on annual deferrals would be the same as the IRA contribution limit with an additional $1,000 in catch-up contributions beginning at age 50. This provision takes effect beginning after December 31, 2023.
Tax credit for small employer pension plan start-up costs. The new law increases and makes several changes to the small employer pension plan start-up cost credit to incentivize businesses to establish retirement plans. This took effect for plan years after December 31, 2022.
Higher catch-up contributions for some participants. Currently, participants in certain retirement plans can make additional catch-up contributions if they’re age 50 or older. The catch-up contribution limit for 401(k) plans is $7,500 for 2023. SECURE 2.0 will increase the 401(k) catch-up contribution limit to the greater of $10,000 or 150% of the regular catch-up amount for individuals ages 60 through 63. The increased amounts will be indexed for inflation after December 31, 2025. This provision will take effect for taxable years beginning after December 31, 2024. (There will also be increased catch-up amounts for SIMPLE plans.)
Retirement savings for military spouses. SECURE 2.0 creates a new tax credit for eligible small employers for each military spouse that begins participating in their eligible defined contribution plan. This became effective in 2023.
These are only some of the provisions in SECURE 2.0. Contact us if you have any questions about your situation.
The Employee Retention Credit (ERC) was a valuable tax credit that helped employers that kept workers on staff during the height of the COVID-19 pandemic. While the credit is no longer available, eligible employers that haven’t yet claimed it might still be able to do so by filing amended payroll returns for tax years 2020 and 2021.
However, the IRS is warning employers to beware of third parties that may be advising them to claim the ERC when they don’t qualify. Some third-party “ERC mills” are promising that they can get businesses a refund without knowing anything about the employers’ situations. They’re sending emails, letters and voice mails as well as advertising on television. When businesses respond, these ERC mills are claiming many improper write-offs related to taxpayer eligibility for — and computation of — the credit.
These third parties often charge large upfront fees or a fee that’s contingent on the amount of the refund. They may not inform taxpayers that wage deductions claimed on the companies’ federal income tax returns must be reduced by the amount of the credit.
According to the IRS, if a business filed an income tax return deducting qualified wages before it filed an employment tax return claiming the credit, the business should file an amended income tax return to correct any overstated wage deduction. Your tax advisor can assist with this.
Businesses are encouraged to be cautious of advertised schemes and direct solicitations promising tax savings that are too good to be true. Taxpayers are always responsible for the information reported on their tax returns. Improperly claiming the ERC could result in taxpayers being required to repay the credit along with penalties and interest.
The ERC is a refundable tax credit designed for businesses that:
Eligible taxpayers could have claimed the ERC on an original employment tax return or they can claim it on an amended return.
To be eligible for the ERC, employers must have:
As a reminder, only recovery startup businesses are eligible for the ERC in the fourth quarter of 2021. Additionally, for any quarter, eligible employers cannot claim the ERC on wages that were reported as payroll costs in obtaining Paycheck Protection Program (PPP) loan forgiveness or that were used to claim certain other tax credits.
If you didn’t claim the ERC, and believe you’re eligible, contact us. We can advise you on how to proceed.
The new Secure Act 2.0 legislation expands upon the Secure Act of 2019 with updates to retirement savings plans across the country. Here’s what you need to know.
Plan sponsors of 401(k) and 403(b) plans will be required to automatically enroll eligible employees with a starting contribution of 3% of their salary beginning in 2025. This amount will increase annually by 1% until the deferral amount reaches 10% of their earnings. Employees can opt-out if they do not wish to enroll in the sponsored retirement plan. This goes into effect for all existing defined-contribution plans if the employer has more than 10 employees and has existed for more than three years. Government and churches are excluded.
In addition, unenrolled participant notification requirements have been eliminated except for an annual reminder of plan requirements and their opportunity to participate.
Over the next 10 years, the age when required minimum distributions go into effect will increase. Here are the highlights:
For those who failed to make their required minimum contribution, the Act reduces the penalty from 50% to 25%.
Certain hardships are eligible for penalty-free early withdrawals from retirement accounts, where retirement account owners are only responsible for applicable taxes instead of the early withdrawal fee. Eligible hardships have been expanded to include victims of domestic violence, terminally ill patients, and certain personal financial emergencies. In addition, victims of qualified federal disasters who have experienced significant financial impact may take an early withdrawal without penalty within 180 days of the disaster.
Currently, taxpayers aged 50 or older can make catch-up contributions to eligible retirement plans, like a 401(k) or IRA. Beginning in 2025, The Secure Act 2.0 increases limits to the greater of $10,000 or 50% more than the original catch-up amount for those aged 60, 61, 62, or 63. In addition, IRA catch-up limits will no longer be set to $1,000 per year but will increase with inflation. In 2024, catch-up contributions will also be subject to after-tax (ROTH) rules.
The Secure Act 2.0 permits qualified 403(b) and governmental 457(b) plans to allow employees to designate employer matching, nonelective contributions, and student loan matching contributions as pre- or post-tax contributions. Take note that Roth-designated employer contributions must be 100% vested.
If a part-time worker has worked for an employer for at least three consecutive years and worked a minimum of 500 hours per year for those three years, the plan sponsor must allow them to contribute to qualified 401(k) plans. Effective for 401(k) and 403 (b) plans beginning after December 31, 2024, the three-year requirement has been reduced to two years.
Beginning in 2023, businesses with 50 employees or fewer can take a credit of up to 100% of the startup costs for workplace retirement plans, up to the annual cap of $5,000. This is an increase from the 50% credit previously offered.
To review how your tax strategy is affected by the Secure Act 2.0, reach out to our team of knowledgeable professionals.
If you’re considering converting your C corporation to an S corporation, be aware that there may be tax implications if you’ve been using the last in, first out (LIFO) inventory method. That’s because of the LIFO recapture income that will be triggered by converting to S corporation status. We can meet to compute what the tax on this recapture would be and to see what planning steps might be taken to minimize it.
As you’re aware, your corporation has been reporting a lower amount of taxable income under LIFO than it would have under the first in, first out (FIFO) method. The reason: The inventory taken into account in calculating the cost of goods sold under LIFO reflects current costs, which are usually higher.
This benefit of LIFO over FIFO is equal to the difference between the LIFO value of inventory and the higher value it would have had if the FIFO method had been used. In effect, the tax law treats this difference as though it were profit earned while the corporation was a C corporation. To make sure there’s a corporate-level tax on this amount, it must be “recaptured” into income when the corporation converts from a C corporation to an S corporation. Also, the recapture amount will increase the corporation’s earnings and profits, which can have adverse tax consequences down the road.
There are a couple of rules that soften the blow of this recapture tax to some degree.
We can help you gauge your exposure to the LIFO recapture tax and can suggest strategies for reducing it. Contact us to discuss these issues in detail.
Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2023. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. If you have questions about filing requirements, contact us. We can ensure you’re meeting all applicable deadlines.
Give annual information statements to recipients of certain payments you made during 2022. You can use the appropriate version of Form 1099 or other information return. Form 1099 can be issued electronically with the consent of the recipient. This due date applies only to the following types of payments:
If you own a business, you may wonder if you’re eligible to take the qualified business income (QBI) deduction. Sometimes this is referred to as the pass-through deduction or the Section 199A deduction.
The QBI deduction is:
Taxpayers other than corporations may be entitled to a deduction of up to 20% of their QBI. For 2022, if taxable income exceeds $170,050 for single taxpayers, or $340,100 for a married couple filing jointly, the QBI deduction may be limited based on different scenarios. For 2023, these amounts are $182,100 and $364,200, respectively.
The situations in which the QBI deduction may be limited include whether the taxpayer is engaged in a service-type of trade or business (such as law, accounting, health or consulting), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business. The limitations are phased in.
Some taxpayers may be able to achieve significant savings with respect to this deduction (or be subject to a smaller phaseout of the deduction), by deferring income or accelerating deductions at year-end so that they come under the dollar thresholds for 2022. Depending on your business model, you also may be able to increase the deduction by increasing W-2 wages before year-end. The rules are quite complex, so contact us with questions and consult with us before taking the next steps.
These days, most businesses have some intangible assets. The tax treatment of these assets can be complex.
IRS regulations require the capitalization of costs to:
Capitalized costs can’t be deducted in the year paid or incurred. If they’re deductible at all, they must be ratably deducted over the life of the asset (or, for some assets, over periods specified by the tax code or under regulations). However, capitalization generally isn’t required for costs not exceeding $5,000 and for amounts paid to create or facilitate the creation of any right or benefit that doesn’t extend beyond the earlier of 1) 12 months after the first date on which the taxpayer realizes the right or benefit or 2) the end of the tax year following the tax year in which the payment is made.
The term “intangibles” covers many items. It may not always be simple to determine whether an intangible asset or benefit has been acquired or created. Intangibles include debt instruments, prepaid expenses, non-functional currencies, financial derivatives (including, but not limited to options, forward or futures contracts, and foreign currency contracts), leases, licenses, memberships, patents, copyrights, franchises, trademarks, trade names, goodwill, annuity contracts, insurance contracts, endowment contracts, customer lists, ownership interests in any business entity (for example, corporations, partnerships, LLCs, trusts, and estates) and other rights, assets, instruments and agreements.
Here are just a few examples of expenses to acquire or create intangibles that are subject to the capitalization rules:
The IRS regulations generally characterize an amount as paid to “facilitate” the acquisition or creation of an intangible if it is paid in the process of investigating or pursuing a transaction. The facilitation rules can affect any type of business, and many ordinary business transactions. Examples of costs that facilitate acquisition or creation of an intangible include payments to:
Like most tax rules, these capitalization rules have exceptions. There are also certain elections taxpayers can make to capitalize items that aren’t ordinarily required to be capitalized. The above examples aren’t all-inclusive, and given the length and complexity of the regulations, any transaction involving intangibles and related costs should be analyzed to determine the tax implications.
Contact us to discuss the capitalization rules to see if any costs you’ve paid or incurred must be capitalized or whether your business has entered into transactions that may trigger these rules. You can also contact us if you have any questions.
These days, most businesses buy or lease computer software to use in their operations. Or perhaps your business develops computer software to use in your products or services or sells or leases software to others. In any of these situations, you should be aware of the complex rules that determine the tax treatment of the expenses of buying, leasing or developing computer software.
Some software costs are deemed to be costs of “purchased” software, meaning it’s either:
The entire cost of purchased software can be deducted in the year that it’s placed into service. The cases in which the costs are ineligible for this immediate write-off are the few instances in which 100% bonus depreciation or Section 179 small business expensing isn’t allowed, or when a taxpayer has elected out of 100% bonus depreciation and hasn’t made the election to apply Sec. 179 expensing. In those cases, the costs are amortized over the three-year period beginning with the month in which the software is placed in service. Note that the bonus depreciation rate will begin to be phased down for property placed in service after calendar year 2022.
If you buy the software as part of a hardware purchase in which the price of the software isn’t separately stated, you must treat the software cost as part of the hardware cost. Therefore, you must depreciate the software under the same method and over the same period of years that you depreciate the hardware. Additionally, if you buy the software as part of your purchase of all or a substantial part of a business, the software must generally be amortized over 15 years.
You must deduct amounts you pay to rent leased software in the tax year they’re paid, if you’re a cash-method taxpayer, or the tax year for which the rentals are accrued, if you’re an accrual-method taxpayer. However, deductions aren’t generally permitted before the years to which the rentals are allocable. Also, if a lease involves total rentals of more than $250,000, special rules may apply.
Some software is deemed to be “developed” (designed in-house or by a contractor who isn’t at risk if the software doesn’t perform). For tax years beginning before calendar year 2022, bonus depreciation applies to developed software to the extent described above. If bonus depreciation doesn’t apply, the taxpayer can either deduct the development costs in the year paid or incurred, or choose one of several alternative amortization periods over which to deduct the costs. For tax years beginning after calendar year 2021, generally the only allowable treatment is to amortize the costs over the five-year period beginning with the midpoint of the tax year in which the expenditures are paid or incurred.
If following any of the above rules requires you to change your treatment of software costs, it will usually be necessary for you to obtain IRS consent to the change.
Contact us with questions or for assistance in applying the tax rules for treating computer software costs in the way that is most advantageous for you.
Many companies are eligible for tax write-offs for certain equipment purchases and building improvements. These write-offs can do wonders for a business’s cash flow, but whether to claim them isn’t always an easy decision. In some cases, there are advantages to following the regular depreciation rules. So it’s critical to look at the big picture and develop a strategy that aligns with your company’s overall tax-planning objectives.
Taxpayers can elect to claim 100% bonus depreciation or Section 179 expensing to deduct the full cost of eligible property up front in the year it’s placed in service. Alternatively, they may spread depreciation deductions over several years or decades, depending on how the tax code classifies the property.
Under the Tax Cuts and Jobs Act (TCJA), 100% bonus depreciation is available for property placed in service through 2022. Without further legislation, bonus depreciation will be phased down to 80% for property placed in service in 2023, 60% in 2024, 40% in 2025, and 20% in 2026; then, after 2026, bonus depreciation will no longer be available. (For certain property with longer production periods, these reductions are delayed by one year. For example, 80% bonus depreciation will apply to long-production-period property placed in service in 2024.)
In March 2020, a technical correction made by the CARES Act expanded the availability of bonus depreciation. Under the correction, qualified improvement property (QIP), which includes many interior improvements to commercial buildings, is eligible for 100% bonus depreciation not only following the phaseout schedule through 2026 but also retroactively to 2018. So, taxpayers that placed QIP in service in 2018 and 2019 may have an opportunity to claim bonus depreciation by amending their returns for those years. If bonus depreciation isn’t claimed, QIP is generally depreciable on a straight-line basis over 15 years.
Sec. 179 also allows taxpayers to fully deduct the cost of eligible property, but the maximum deduction in a given year is $1 million (adjusted for inflation to $1.08 million for 2022), and the deduction is gradually phased out once a taxpayer’s qualifying expenditures exceed $2.5 million (adjusted for inflation to $2.7 million for 2022).
While 100% first-year bonus depreciation or Sec. 179 expensing can significantly lower your company’s taxable income, it’s not always a smart move. Here are three examples of situations where it may be preferable to forgo bonus depreciation or Sec. 179 expensing:
You’re planning to sell QIP. If you’ve invested heavily in building improvements that are eligible for bonus depreciation as QIP and you plan to sell the building in the near future, you may be stepping into a tax trap by claiming the QIP write-off. That’s because your gain on the sale — up to the amount of bonus depreciation or Sec. 179 deductions you’ve claimed — will be treated as “recaptured” depreciation that’s taxable at ordinary-income tax rates as high as 37%. On the other hand, if you deduct the cost of QIP under regular depreciation rules (generally, over 15 years), any long-term gain attributable to those deductions will be taxable at a top rate of 25% upon the building’s sale.
You’re eligible for the Sec. 199A “pass-through” deduction. This deduction allows eligible business owners to deduct up to 20% of their qualified business income (QBI) from certain pass-through entities, such as partnerships, limited liability companies and S corporations, as well as sole proprietorships. The deduction, which is available through 2025 under the TCJA, can’t exceed 20% of an owner’s taxable income, excluding net capital gains. (Several other restrictions apply.)
Claiming bonus depreciation or Sec. 179 deductions reduces your QBI, which may deprive you of an opportunity to maximize the 199A deduction. And since the 199A deduction is scheduled to expire in 2025, it makes sense to take advantage of it while you can.
Your depreciation deductions may be more valuable in the future. The value of a deduction is based on its ability to reduce your tax bill. If you think your tax rate will go up in the coming years, either because you believe Congress will increase rates or you expect to be in a higher bracket, depreciation write-offs may be worth more in future years than they are now.
Keep in mind that forgoing bonus depreciation or Sec. 179 deductions only affects the timing of those deductions. You’ll still have an opportunity to write off the full cost of eligible assets; it will just be over a longer time period. Your tax advisor can analyze how these write-offs interact with other tax benefits and help you determine the optimal strategy for your situation.
If you need to hire, be aware of a valuable tax credit for employers hiring individuals from one or more targeted groups. The Work Opportunity Tax Credit (WOTC) is generally worth $2,400 for each eligible employee but can be worth more — in some cases, much more.
Generally, an employer is eligible for the credit only for qualified wages paid to members of a targeted group. These groups are:
Employers of all sizes are eligible to claim the WOTC. This includes both taxable and certain tax-exempt employers located in the United States and in some U.S. territories. Taxable employers can claim the WOTC against income taxes. However, eligible tax-exempt employers can claim the WOTC only against payroll taxes and only for wages paid to members of the qualified veteran targeted group.
Many additional conditions must be fulfilled before employers can qualify for the credit. Each employee must have completed a minimum of 120 hours of service for the employer. Also, the credit isn’t available for employees who are related to the employer or who previously worked for the employer.
WOTC amounts differ for specific employees. The maximum credit available for the first year’s wages generally is $2,400 for each employee, or $4,000 for a recipient of long-term family assistance. In addition, for those receiving long-term family assistance, there’s a 50% credit for up to $10,000 of second-year wages. The maximum credit available over two years for these employees is $9,000 ($4,000 for Year 1 and $5,000 for Year 2).
For some veterans, the maximum WOTC is higher: $4,800 for certain disabled veterans, $5,600 for certain unemployed veterans, and $9,600 for certain veterans who are both disabled and unemployed.
For summer youth employees, the wages must be paid for services performed during any 90-day period between May 1 and September 15. The maximum WOTC credit available for summer youth is $1,200 per employee.
Additional rules and requirements apply. For example, you must obtain certification that an employee is a target group member from the appropriate State Workforce Agency before you can claim the credit. The certification generally must be requested within 28 days after the employee begins work. And in limited circumstances, the rules may prohibit the credit or require an allocation of it.
Nevertheless, for most employers that hire from targeted groups, the credit can be valuable. Contact your tax advisor with questions or for more information about your situation.
The Social Security Administration recently announced that the wage base for computing Social Security tax will increase to $160,200 for 2023 (up from $147,000 for 2022). Wages and self-employment income above this threshold aren’t subject to Social Security tax.
The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees, and self-employed workers. One is for the Old Age, Survivors, and Disability Insurance program, which is commonly known as Social Security. The other is for the Hospital Insurance program, which is commonly known as Medicare.
There’s a maximum amount of compensation subject to the Social Security tax, but no maximum for Medicare tax. For 2023, the FICA tax rate for employers is 7.65% — 6.2% for Social Security and 1.45% for Medicare (the same as in 2022).
For 2023, an employee will pay:
For 2023, the self-employment tax imposed on self-employed people is:
What happens if one of your employees works for your business and has a second job? That employee would have taxes withheld from two different employers. Can the employee ask you to stop withholding Social Security tax once he or she reaches the wage base threshold? Unfortunately, no. Each employer must withhold Social Security taxes from the individual’s wages, even if the combined withholding exceeds the maximum amount that can be imposed for the year. Fortunately, the employee will get a credit on his or her tax return for any excess withheld.
Contact us if you have questions about 2023 payroll tax filing or payments. We can help ensure you stay in compliance.
Throughout the year, the Federal Emergency Management Agency (FEMA) will designate incidents that adversely affect residents in the affected areas as disasters. This FEMA designation puts relief efforts in motion, both short and long-term.
While immediate needs like food, water, and shelter are at the top of the list, long-term efforts, like relief options through the IRS, aim to help those affected get back on their feet.
In the past, the Senate was required to vote every time the IRS wanted to grant disaster relief provisions to FEMA-designated disaster areas. Now, the IRS can give disaster relief by extending deadlines for “certain time-sensitive acts.” This includes filing returns and paying taxes during the disaster period. For example, affected taxpayers usually receive a tax refund more quickly by “claiming losses related to the disaster on the tax return for the previous year.”
While in some areas of the country, disaster preparedness feels more like a what-if scenario, other parts of the country are all-too-familiar with preparing for floods, wildfires, and tornados. The IRS recommends:
Suppose you or your business have gone through a natural disaster, and you cannot access your original tax documents. In that case, the IRS recommends the following resources for obtaining important financial information when you are ready:
The IRS keeps a list of current and past disaster relief offered on its website. Some of the more recent disaster-related tax relief programs include:
We recommend talking with your tax advisor and visiting the IRS Disaster Relief Website for a comprehensive list.
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.
Do you own commercial or investment real estate that has substantially increased in value? If you sell the property, you may be hit with a huge capital gain tax liability. Possible solution: Consider a Section 1031 exchange (also known as a like-kind exchange) in which you swap qualifying properties while paying zero or little current tax.
Recent legislation has narrowed the availability of Sec. 1031 exchanges, but you can still use this technique for qualified real estate transactions. However, keep in mind that a repeal or modification of the rules has been discussed. So, if you’re interested in an exchange, you may want to act soon.
Under Sec. 1031 of the Internal Revenue Code, you can defer tax on the exchange of like-kind real estate properties if specific requirements are met. Previously, this tax break was available for various types of property, such as trade-ins of business vehicles. But as of 2018, the Tax Cuts and Jobs Act strictly limits the Sec. 1031 rules to real estate transactions.
Note that the properties — both the one you relinquish and the one you receive — must be business or investment properties. You can’t avoid current tax if you swap personal residences, but you may be able to exchange a vacation home that is treated as a rental property. (There may be other complications, so consult with your tax advisor.)
Normally, a sale of appreciated real estate would result in capital gains tax. For individual property owners, the maximum tax rate is 20% if the property has been owned for longer than one year. Otherwise, the gain for individuals is taxed at ordinary income tax rates currently topping out at 37%.
If you meet the requirements under Sec. 1031, there’s no current tax due on the exchange — except to the extent that you receive “boot” as part of the deal. Boot includes cash needed to “even things out” or other concessions of value (such as a reduction of mortgage debt). In some cases, cash may be combined with a valued benefit.
If you receive boot, you owe current tax on the amount equal to the lesser of:
On the other hand, if you’re the one paying boot, you won’t realize any taxable gain.
For these purposes, “like-kind” refers to the property’s nature or character. The prevailing tax regulations provide a liberal interpretation of what constitutes like-kind properties. For instance, you can exchange improved real estate for raw land, a strip mall for an apartment building or a marina for a golf course. It doesn’t have to be the exact same type of property (for example, a warehouse for a warehouse).
Timing is everything. The following two deadlines must be met for a like-kind exchange to qualify for tax-free treatment:
The 180-day period begins to run on the date of the transfer of legal ownership of the relinquished property. If that period straddles two tax years, it might be shortened by the tax return due date. So, if you give up title to the property in November or December this year, the due date for 2022 returns (April 18, 2023) would arrive before 180 days are up. Keep this in mind as the end of the year approaches.
Also, in the real world, it’s unlikely that you’ll own property that another person wants to acquire while he or she also owns property that you desire. These one-for-one exchanges are rare. The vast majority of Sec. 1031 real estate exchanges involve multiple parties. (See the sidebar, “Multiple-party exchanges.”)
Unless you’re an expert in the field, a Sec. 1031 exchange is not a do-it-yourself proposition. Enlist the services of professionals, including your CPA, who can provide the assistance you need.
Depending on your situation, you might use a “qualified intermediary” to cement a Section 1031 exchange. Essentially, the qualified intermediary is a third party that helps facilitate the deal. The parties create an agreement whereby the qualified intermediary:
Note that the agreement must limit the taxpayer’s rights to receive, pledge, borrow or otherwise obtain benefits of cash or other property held by the intermediary. In addition, specific IRS reporting requirements must be met. Typically, the intermediary charges a fee based on the value of the properties.
Businesses can provide benefits to employees that don’t cost them much or anything at all. However, in some cases, employees may have to pay tax on the value of these benefits.
Here are examples of two types of benefits which employees generally can exclude from income:
However, many fringe benefits are taxable, meaning they’re included in the employees’ wages and reported on Form W-2. Unless an exception applies, these benefits are subject to federal income tax withholding, Social Security (unless the employee has already reached the year’s wage base limit) and Medicare.
The line between taxable and nontaxable fringe benefits may not be clear. As illustrated in one recent case, some taxpayers get into trouble if they cross too far over the line.
A retired airline pilot received free stand-by airline tickets from his former employer for himself, his spouse, his daughter, and two other adult relatives. The value of the tickets provided to the adult relatives was valued $5,478. The airline reported this amount as income paid to the retired pilot on Form 1099-MISC, which it filed with the IRS. The taxpayer and his spouse filed a joint tax return for the year in question but didn’t include the value of the free tickets in gross income.
The IRS determined that the couple was required to include the value of the airline tickets provided to their adult relatives in their gross income. The retired pilot argued the value of the tickets should be excluded as a de minimis fringe.
The U.S. Tax Court agreed with the IRS that the taxpayers were required to include in gross income the value of airline tickets provided to their adult relatives. The value, the court stated, didn’t qualify for exclusion as a no-additional-cost service because the adult relatives weren’t the taxpayers’ dependent children. In addition, the value wasn’t excludable under the tax code as a de minimis fringe benefit “because the tickets had a value high enough that accounting for their provision was not unreasonable or administratively impracticable.” (TC Memo 2022-36)
You may be able to exclude from wages the value of certain fringe benefits that your business provides to employees. But the requirements are strict. If you have questions about the tax implications of fringe benefits, contact us.
You and your small business are likely to incur a variety of local transportation costs each year. There are various tax implications for these expenses.
First, what is “local transportation?” It refers to travel in which you aren’t away from your tax home (the city or general area in which your main place of business is located) long enough to require sleep or rest. Different rules apply if you’re away from your tax home for significantly more than an ordinary workday and you need sleep or rest in order to do your work.
The most important feature of the local transportation rules is that your commuting costs aren’t deductible. In other words, the fare you pay or the miles you drive simply to get to work and home again are personal and not business miles. Therefore, no deduction is available. This is the case even if you work during the commute (for example, via a cell phone, or by performing business-related tasks while on the subway).
An exception applies for commuting to a temporary work location that’s outside of the metropolitan area in which you live and normally work. “Temporary,” for this purpose, means a location where your work is realistically expected to last (and does in fact last) for no more than a year.
On the other hand, once you get to the work location, the cost of any local trips you take for business purposes is a deductible business expense. So, for example, the cost of travel from your office to visit a customer or pick up supplies is deductible. Similarly, if you have two business locations, the costs of traveling between them is deductible.
If your deductible trip is by taxi or public transportation, save a receipt if possible or make a notation of the expense in a logbook. Record the date, amount spent, destination, and business purpose. If you use your own car, note miles driven instead of the amount spent. Note also any tolls paid or parking fees and keep receipts.
You’ll need to allocate your automobile expenses between business and personal use based on miles driven during the year. Proper recordkeeping is crucial in the event the IRS challenges you.
Your deduction can be computed using:
From 2018 – 2025, employees, may not deduct unreimbursed local transportation costs. That’s because “miscellaneous itemized deductions” — a category that includes employee business expenses — are suspended (not allowed) for 2018 through 2025. However, self-employed taxpayers can deduct the expenses discussed in this article. But beginning with 2026, business expenses (including unreimbursed employee auto expenses) of employees are scheduled to be deductible again, as long as the employee’s total miscellaneous itemized deductions exceed 2% of adjusted gross income.
Contact us with any questions or to discuss the matter further.
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.
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.