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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.

Facts of the case

In the case, the taxpayer ran a notary and paralegal business. She deducted business meals and vehicle expenses that she allegedly incurred in connection with her business.

The deductions were denied by the IRS and the court. Tax law “establishes higher substantiation requirements” for these and certain other expenses, the court noted. No deduction is generally allowed “unless the taxpayer substantiates the amount, time and place, business purpose, and business relationship to the taxpayer of the person receiving the benefit” for each expense with adequate records or sufficient evidence.

The taxpayer in this case didn’t provide adequate records or other sufficient evidence to prove the business purpose of her meal expenses. She gave vague testimony that she deducted expenses for meals where she “talked strategies” with people who “wanted her to do some work.” The court found this was insufficient to show the connection between the meals and her business.

When it came to the taxpayer’s vehicle expense deductions, she failed to offer credible evidence showing where she drove her vehicle, the purpose of each trip and her business relationship to the places visited. She also conceded that she used her car for both business and personal activities. (TC Memo 2021-50)

Best practices for business expenses

This case is an example of why it’s critical to maintain meticulous records to support business expenses for meals and vehicle 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. Meal and auto expenses are a magnet for attention. Be prepared for a challenge.

With organization and guidance from us, your tax records can stand up to scrutiny 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 (“the Cohan rule”), if your records are lost due to a fire, theft, flood or other disaster.

© 2021

In 2020, there was record-breaking new business growth in the United States. The sheer number of new businesses was 24 percent higher than the prior year, with new employee identification number (EIN) applications breaking records in Quarter 3. This all took place despite the pandemic that has swept around the world. In the 1930s, an Austrian economist described this phenomenon of new business growth in times of uncertainty as “creative destruction.” In short, this creative destruction happens as people come up with new ways to overcome challenges – like the inability to shop in person due to lockdowns or health concerns. 

However exciting or successful your new business may be at marketing and sales, it’s hard to know what you don’t know about the finance functions and find the time to manage the books and your other priorities. Brushing important accounting and record-keeping tasks to the side can hurt your bottom line and create stress when tax payments are due. So how do you tackle this problem? Keep reading to find out. 

Your business will thrive when the finance functions are in working order. Business owners quickly realize they will either need to carve out the necessary time to manage their organization’s finances or hire someone else to do it.  

Hiring a CFO is one option. However, most new businesses do not have forty hours of work for a qualified individual. This is when outsourcing CFO services can be a practical solution.  

The benefits of working with an outsourced CFO:  

Outsourcing services from your organization can help you operate more effectively.  With our requisite knowledge of different organizational structures, we can help you create innovative changes in your organization.  If you would like to learn more, please call our office to speak with one of our professionals and learn how our outsourced CFO services can help enhance the success of your business. 

Most industries came to a halt last year when the pandemic shut down businesses around the world. When manufacturers adjusted operations, taking necessary precautions to protect employees, it created a ripple effect of shortages in other areas,  including lumbar, tile, and other supplies used to build houses. Amidst all the uncertainty, it may seem easier to ignore performance metrics. In this climate, however, they are more important than ever before.  

Tracking key performance indicators (KPIs) can help business owners keep their operations running smoothly. KPIs are essentially prioritized metrics that owners and managers need regular access to make decisions. When determining which KPIs are important to track, know that it varies by industry. Keep reading to discover some key metrics to help leaders in the construction industry understand your firm’s performance.  

Here are a few KPIs to consider:  

In addition to these more traditional KPIs, the following also impact profitability.  

While there are many other KPIs that construction firms can choose from, we find that these are often the top indicators of financial health and areas of opportunity. If you would like a second look at your KPIs or help establish some, give our team of professionals a call today. 

The last few years have afforded quite a few changes in how the IRS allows businesses to handle meal and entertainment costs in relation to their taxes. The 2018 Tax Cuts and Jobs Act (TCJA) eliminated deductions for most business-related entertainment expenses. Since the pandemic, the IRS has temporarily changed the tax-deductible amount allowed for some business meals to encourage increased sales at restaurants. With the easing of restrictions, businesses may be considering company picnics for employee appreciation or starting up business lunches with clients again.  

With all of these changes, putting a system in place to accurately track business food and entertainment expenses becomes essential. Best practices should include requesting detailed receipts and separately tracking which costs fall under the 50 percent deduction, 100 percent deduction, or not deductible categories. 

In addition to keeping excellent records, below are some additional things to keep in mind about the business meal and entertainment deduction rules, including a helpful chart highlighting the deduction category particular meal and entertainment expenses fall under. 

Meal and entertainment expense changes 

Under the TCJA, the IRS no longer allows businesses to deduct most entertainment expenses even if they were a cost of doing business. Food and beverage related to entertainment venues are only covered with detailed receipts separately stating the cost of the meal. 

Another change from the TCJA is that spouse or guest meals are not covered from travel unless the business employs the person. So, if your spouse accompanies you on a work trip, their meals are not deductible for the business. 

The Consolidated Appropriations Act of 2021 (CAA) has temporarily increased the deduction for business meals provided by restaurants to 100 percent for tax years 2021 and 2022. Not all meals are created equal, however. The 100 percent deduction is only available for meals provided by restaurants, which the IRS defines as: “A business that prepares and sells food or beverages to retail customers for immediate consumption, regardless of whether the food or beverages are consumed on the business’s premises.” Prepackaged food from a grocery, specialty, or convenience store is not eligible for the 100% deduction and would be limited to a 50% deduction. 

Also, note that the expenses must be considered ordinary (common and accepted for your business) or necessary (helpful and appropriate) and cannot be considered lavish or extravagant. An employee of the business or the taxpayer must be present during the meal, as well. 

A quick guide to business meal deductions 

Expense Category  Deductible Amount  Tax Code Reference 
Company social events and facilities for employees (e.g., holiday parties, team-building events)  100%  IRC Secs. 274(e)(4) and 274(n)(2)(A) 
Meals and entertainment included in employee or non-employee compensation  100%  IRC Secs. 274(e)(2) and (9) 
Reimbursed expenses under an accountable plan  100%  IRC Sec. 274(e)(3) 
Meals and entertainment made available to the public  100%  IRC Sec. 274(e)(7) 
Meals and entertainment sold to customers  100%  IRC Sec. 274(e)(8)  
Business travel meals  50% 

100% (1/1/2021 to 12/31/2022)* 

IRC Secs. 274(e)(3) and 274(e)(9) 

 

Client/customer business meals  50% 

100% (1/1/2021 to 12/31/2022)* 

Notice 2018-76 
Business meeting meals  50% 

100% (1/1/2021 to 12/31/2022)* 

IRC Secs 274(e)(5), 274(k)(1), and 274(e)(6) 
De minimis food and beverages provided in the workplace (e.g., bottled water, coffee, snacks)  50% 

 

IRC Sec 274(e)(1) 
Meals provided for the convenience of the employer   50% (through 12/31/2025) 

0% (on or after 1/1/2026) 

IRC Sec. 274(n) and 274(o) 
Employer-operated eating facilities  50% (through 12/31/2025) 

0% (on or after 1/1/2026) 

IRC Sec. 274(n) and 274(o) 
Meals/beverages associated with entertainment activities when not separated stated on the receipt  0%  Notice 2018-76 
Personal, lavish, or extravagant meals/beverages in relation to the activity  0%  IRC Secs. 274(k)(1) and 274(k)(2) 
Entertainment without exception  0%  IRC Secs. 274(a)(1) and 274(e) 

*Meals are only deductible in the 2021 and 2022 tax years if provided by a restaurant, as defined by the IRS in the above article.   

If you need help establishing a system to better track expenses or seek clarification on whether certain expenses are tax-deductible, give our team of CPAs a call today. 

 

If your business is organized as a sole proprietorship or as a wholly owned limited liability company (LLC), you’re subject to both income tax and self-employment tax. There may be a way to cut your tax bill by conducting business as an S corporation.

Fundamentals of self-employment tax

The self-employment tax is imposed on 92.35% of self-employment income at a 12.4% rate for Social Security up to a certain maximum ($142,800 for 2021) and at a 2.9% rate for Medicare. No maximum tax limit applies to the Medicare tax. An additional 0.9% Medicare tax is imposed on income exceeding $250,000 for married couples ($125,000 for married persons filing separately) and $200,000 in all other cases.

What if you conduct your business as a partnership in which you’re a general partner? In that case, in addition to income tax, you’re subject to the self-employment tax on your distributive share of the partnership’s income. On the other hand, if you conduct your business as an S corporation, you’ll be subject to income tax, but not self-employment tax, on your share of the S corporation’s income.

An S corporation isn’t subject to tax at the corporate level. Instead, the corporation’s items of income, gain, loss and deduction are passed through to the shareholders. However, the income passed through to the shareholder isn’t treated as self-employment income. Thus, by using an S corporation, you may be able to avoid self-employment income tax.

Keep your salary “reasonable”

Be aware that the IRS requires that the S corporation pay you reasonable compensation for your services to the business. The compensation is treated as wages subject to employment tax (split evenly between the corporation and the employee), which is equivalent to the self-employment tax. If the S corporation doesn’t pay you reasonable compensation for your services, the IRS may treat a portion of the S corporation’s distributions to you as wages and impose Social Security taxes on the amount it considers wages.

There’s no simple formula regarding what’s considered reasonable compensation. Presumably, reasonable compensation is the amount that unrelated employers would pay for comparable services under similar circumstances. There are many factors that should be taken into account in making this determination.

Converting from a C corporation

There may be complications if you convert a C corporation to an S corporation. A “built-in gains tax” may apply when you dispose of appreciated assets held by the C corporation at the time of the conversion. However, there may be ways to minimize its impact.

Many factors to consider

Contact us if you’d like to discuss the factors involved in conducting your business as an S corporation, and how much the business should pay you as compensation.

© 2021

As a business owner, increasing sales can be a great mood lifter. But what happens if you get a large order and have no way to pay for the supplies? Sales don’t always equal immediate cash in hand, which can put a strain on your business accounts and your ability to deliver on time.

Below, we’ll share what the difference between revenue (sales) and cash flow is, and how it can affect your business.

More revenue, more problems

While the thought of increased revenue causing more problems for a business owner can seem counterintuitive, there are challenges that increased sales can bring forth. But first, let’s talk about what revenue is.

Revenue is the total income generated by business’s sales before expenses are deducted. This is also known as cash inflow. Most often, this is income from your primary operations. Your business may also have non-operating income, which is generated from interest bearing accounts and investments.

When you have sales come in on credit, or terms, it can be weeks or months before you receive the full payment for the order. Additionally, credit card processors can take up to three days to deposit monies from sales, depending on your merchant services provider. Meanwhile, your business still must cover any expenses like building materials, new inventory, or payroll.

That’s where managing your cash flow comes in.

The ins and outs of cash flow

Cash flow is simply how money moves in and out of a business or bank account. Just like you have to budget your paychecks, bills, and expenses in your personal accounts, you have to manage the cash flow for your business.

As stated above, cash inflow is your revenue and your non-operating income. Cash outflow, then, is comprised of anything your business has to pay for (i.e., rent, inventory, supplies, payroll, refunds, and merchant chargebacks).

Creating a forecast for expected expenses and payments, plus when they’re expected to take place, can help you see where any shortages could be expected throughout the month. Keep in mind, the forecast can be affected by delayed sales payments and unexpected expenses.

To create a buffer and give yourself some breathing room in your cash flow, consider:

Managing your cash flow is an essential part of business ownership and can keep your company moving forward while minimizing growing pains. Our team can help you review your cash flow system and identify areas of strength or for improvement; or we can assist you in setting up your cash flow system from scratch. Give us a call to get started today.

If you are in possession of business or investment property, or looking to exchange real property for others, you might want to get acquainted with “like-kind exchanges,” also known as a 1031 exchange. As with all tax code, changes are consistently made to clarify previous unclear areas or adjust the language based on new policy. In 2020, there were some larger changes noted to section 1031 of the tax code, which deals with like-kind exchanges of real property.

Here are some of the bigger changes.

1. Defining “Real Property.” In the past, the definition of real property held more ambiguity, and there was little deference to the state and local definitions. The new language allows real property to be defined by local and state guidelines in addition to the list included in the final regulations, and property that passes a facts and circumstances test. The final regulations include categories such as “land and improvements to land, unsevered natural products of land, and water and airspace superjacent to land.” Note that property previously excluded prior to the 2017 TCJA is still excluded.

2. Inherently Permanent. The “purpose or use test” that was previously required to determine whether the property contributed to unrelated income is no longer applicable. Instead, the final rules state that if the tangible property is both permanently affixed and will remain affixed to the real property indefinitely, it’s considered inherently permanent and a part of the real property. Note, this does not automatically include installed appliances, sheds, carports, Wi-Fi systems, and trade fixtures. In addition, if interconnected assets serve an inherently permanent structure together, they are now analyzed as one distinct asset. (e.g., a gas line powering a heating unit would qualify as part of the heating unit. However, if the gas line solely powered a stove or oven, it would not qualify).

3. Facts and Circumstances Test. For fixtures and assets not automatically included by the Inherently Permanent rule, use the facts and circumstances test to determine if it’s eligible to be considered a part of the real property. For each fixture, ask:

While there is still some room for improvement, the facts and circumstances test are a vast improvement, as the previous rule may have led to costly and inefficient cost segregation studies.

4. Incidental Property. In the past, non-real property that could be transferred as part of an exchange could potentially violate the escrow rules allowing for a Qualified Intermediary to facilitate an exchange not made in real-time (a third-party exchange). The new regulations now allow some leeway, defining that if the fixtures or non-real property is deemed as typical for the type of property transfer, or if the aggravate value does not exceed 15 percent of the fair market value of the real property, it is considered incidental and will not be in violation of the escrow rules. Keep in mind, the real property is still considered a separate transaction and not included in the gains deferment of the exchanged real property.

5. Qualified Intermediaries. The new regulations maintain the transaction must be structured as an exchange and that the seller cannot receive funds from the sale before taking ownership of the new property. Qualified intermediaries can hold the properties or funds in an escrow within the time limit, so that the transaction looks like an exchange.

Most of the time, the sale of any investment property, which is property not considered your primary residence, can result in capital gains tax. Using a 1031 like-kind exchange can help defer that tax until later and possibly result in a lower tax liability down the road.

On April 28, 2021, President Biden introduced a new economic plan that would impact 1031 exchanges. The Biden proposal would abolish 1031 exchanges on real-estate profits of more than $500,000. As we move further into 2021, we will continue to monitor the impact.

If you would like to discuss tax strategies in business or investment properties, give us a call. Our team can help you understand if the decision you are making falls in line with applicable tax laws and if it’s the best strategy for your real property investments.

Many businesses provide education fringe benefits so their employees can improve their skills and gain additional knowledge. An employee can receive, on a tax-free basis, up to $5,250 each year from his or her employer for educational assistance under a “qualified educational assistance program.”

For this purpose, “education” means any form of instruction or training that improves or develops an individual’s capabilities. It doesn’t matter if it’s job-related or part of a degree program. This includes employer-provided education assistance for graduate-level courses, including those normally taken by an individual pursuing a program leading to a business, medical, law or other advanced academic or professional degree.

Additional requirements

The educational assistance must be provided under a separate written plan that’s publicized to your employees, and must meet a number of conditions, including nondiscrimination requirements. In other words, it can’t discriminate in favor of highly compensated employees. In addition, not more than 5% of the amounts paid or incurred by the employer for educational assistance during the year may be provided for individuals who (including their spouses or dependents) who own 5% or more of the business.

No deduction or credit can be taken by the employee for any amount excluded from the employee’s income as an education assistance benefit.

Job-related education

If you pay more than $5,250 for educational benefits for an employee during the year, he or she must generally pay tax on the amount over $5,250. Your business should include the amount in income in the employee’s wages. However, in addition to, or instead of applying, the $5,250 exclusion, an employer can satisfy an employee’s educational expenses, on a nontaxable basis, if the educational assistance is job-related. To qualify as job-related, the educational assistance must:

“Job-related” employer educational assistance isn’t subject to a dollar limit. To be job-related, the education can’t qualify the employee to meet the minimum educational requirements for qualification in his or her employment or other trade or business.

Educational assistance meeting the above “job-related” rules is excludable from an employee’s income as a working condition fringe benefit.

Student loans

In addition to education assistance, some employers offer student loan repayment assistance as a recruitment and retention tool. Recent COVID-19 relief laws may provide your employees with tax-free benefits. Contact us to learn more about setting up an education assistance or student loan repayment plan at your business.

© 2021

Are you wondering whether alternative energy technologies can help you manage energy costs in your business? If so, there’s a valuable federal income tax benefit (the business energy credit) that applies to the acquisition of many types of alternative energy property.

The credit is intended primarily for business users of alternative energy (other energy tax breaks apply if you use alternative energy in your home or produce energy for sale).

Eligible property

The business energy credit equals 30% of the basis of the following:

The credit equals 10% of the basis of the following:

Pluses and minuses

However, there are several restrictions. For example, the credit isn’t available for property acquired with certain non-recourse financing. Additionally, if the credit is allowable for property, the “basis” is reduced by 50% of the allowable credit.

On the other hand, a favorable aspect is that, for the same property, the credit can sometimes be used in combination with other benefits — for example, federal income tax expensing, state tax credits or utility rebates.

There are business considerations unrelated to the tax and non-tax benefits that may influence your decision to use alternative energy. And even if you choose to use it, you might do so without owning the equipment, which would mean forgoing the business energy credit.

As you can see, there are many issues to consider. We can help you address these alternative energy considerations.

© 2021

Owners of incorporated businesses know that there’s a tax advantage to taking money out of a C corporation as compensation rather than as dividends. The reason: A corporation can deduct the salaries and bonuses that it pays executives, but not dividend payments. Thus, if funds are paid as dividends, they’re taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is only taxed once — to the employee who receives it.

However, there are limits to how much money you can take out of the corporation this way. Under tax law, compensation can be deducted only to the extent that it’s reasonable. Any unreasonable portion isn’t deductible and, if paid to a shareholder, may be taxed as if it were a dividend. Keep in mind that the IRS is generally more interested in unreasonable compensation payments made to someone “related” to a corporation, such as a shareholder-employee or a member of a shareholder’s family.

Determining reasonable compensation

There’s no easy way to determine what’s reasonable. In an audit, the IRS examines the amount that similar companies would pay for comparable services under similar circumstances. Factors that are taken into account include the employee’s duties and the amount of time spent on those duties, as well as the employee’s skills, expertise and compensation history. Other factors that may be reviewed are the complexities of the business and its gross and net income.

There are some steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation. For example, you can:

You can avoid problems and challenges by planning ahead. If you have questions or concerns about your situation, contact us.