Projecting your business income and expenses for this year and next can allow you to time when you recognize income and incur deductible expenses to your tax advantage. Typically, it’s better to defer tax. This might end up being especially true this year, if tax reform legislation is signed into law.
Timing strategies for businesses
Here are two timing strategies that can help businesses defer taxes:
1. Defer income to next year. If your business uses the cash method of accounting, you can defer billing for your products or services. Or, if you use the accrual method, you can delay shipping products or delivering services.
2. Accelerate deductible expenses into the current year. If you’re a cash-basis taxpayer, you may make a state estimated tax payment before December 31, so you can deduct it this year rather than next. Both cash- and accrual-basis taxpayers can charge expenses on a credit card and deduct them in the year charged, regardless of when the credit card bill is paid.
Potential impact of tax reform
These deferral strategies could be particularly powerful if tax legislation is signed into law this year that reflects the nine-page “Unified Framework for Fixing Our Broken Tax Code” that President Trump and congressional Republicans released on September 27.
Among other things, the framework calls for reduced tax rates for corporations and flow-through entities as well as the elimination of many business deductions. If such changes were to go into effect in 2018, there could be a significant incentive for businesses to defer income to 2018 and accelerate deductible expenses into 2017.
But if you think you’ll be in a higher tax bracket next year (such as if your business is having a bad year in 2017 but the outlook is much brighter for 2018 and you don’t expect that tax rates will go down), consider taking the opposite approach instead — accelerating income and deferring deductible expenses. This will increase your tax bill this year but might save you tax over the two-year period.
Because of tax law uncertainty, in 2017 you may want to wait until closer to the end of the year to implement some of your year-end tax planning strategies. But you need to be ready to act quickly if tax legislation is signed into law. So keep an eye on developments in Washington and contact us to discuss the best strategies for you this year based on your particular situation.
A tried-and-true tax-saving strategy for investors is to sell assets at a loss to offset gains that have been realized during the year. So if you’ve cashed in some big gains this year, consider looking for unrealized losses in your portfolio and selling those investments before year end to offset your gains. This can reduce your 2017 tax liability.
But what if you expect an investment that would produce a loss if sold now to not only recover but thrive in the future? Or perhaps you simply want to minimize the impact on your asset allocation. You might think you can simply sell the investment at a loss and then immediately buy it back. Not so fast: You need to beware of the wash sale rule.
The rule up close
The wash sale rule prevents you from taking a loss on a security if you buy a substantially identical security (or an option to buy such a security) within 30 days before or after you sell the security that created the loss. You can recognize the loss only when you sell the replacement security.
Keep in mind that the rule applies even if you repurchase the security in a tax-advantaged retirement account, such as a traditional or Roth IRA.
Achieving your goals
Fortunately, there are ways to avoid the wash sale rule and still achieve your goals:
For more ideas on saving taxes on your investments, please contact us.
If you own a profitable, unincorporated business with your spouse, you probably find the high self-employment (SE) tax bills burdensome. An unincorporated business in which both spouses are active is typically treated by the IRS as a partnership owned 50/50 by the spouses. (For simplicity, when we refer to “partnerships,” we’ll include in our definition limited liability companies that are treated as partnerships for federal tax purposes.)
For 2017, that means you’ll each pay the maximum 15.3% SE tax rate on the first $127,200 of your respective shares of net SE income from the business. Those bills can mount up if your business is profitable. To illustrate: Suppose your business generates $250,000 of net SE income in 2017. Each of you will owe $19,125 ($125,000 × 15.3%), for a combined total of $38,250.
Fortunately, there are ways spouse-owned businesses can lower their combined SE tax hit. Here are two.
1. Establish that you don’t have a spouse-owned partnership
While the IRS creates the impression that involvement by both spouses in an unincorporated business automatically creates a partnership for federal tax purposes, in many cases, it will have a tough time making the argument — especially when:
Let’s assume the same facts as in the previous example, except that your business is a sole proprietorship operated by one spouse. Now you have to calculate SE tax for only that spouse. For 2017, the SE tax bill is $23,023 [($127,200 × 15.3%) + ($122,800 × 2.9%)]. That’s much less than the combined SE tax bill from the first example ($38,250).
2. Establish that you don’t have a 50/50 spouse-owned partnership
Even if you do have a spouse-owned partnership, it’s not a given that it’s a 50/50 one. Your business might more properly be characterized as owned, say, 80% by one spouse and 20% by the other spouse, because one spouse does much more work than the other.
Let’s assume the same facts as in the first example, except that your business is an 80/20 spouse-owned partnership. In this scenario, the 80% spouse has net SE income of $200,000, and the 20% spouse has net SE income of $50,000. For 2017, the SE tax bill for the 80% spouse is $21,573 [($127,200 × 15.3%) + ($72,800 × 2.9%)], and the SE tax bill for the 20% spouse is $7,650 ($50,000 × 15.3%). The combined total SE tax bill is only $29,223 ($21,573 + $7,650).
More-complicated strategies are also available. Contact us to learn more about how you can reduce your spouse-owned business’s SE taxes.
One important step to both reducing taxes and saving for retirement is to contribute to a tax-advantaged retirement plan. If your employer offers a 401(k) plan, contributing to that is likely your best first step.
If you’re not already contributing the maximum allowed, consider increasing your contribution rate between now and year end. Because of tax-deferred compounding (tax-free in the case of Roth accounts), boosting contributions sooner rather than later can have a significant impact on the size of your nest egg at retirement.
A traditional 401(k) offers many benefits:
For 2017, you can contribute up to $18,000. So if your current contribution rate will leave you short of the limit, try to increase your contribution rate through the end of the year to get as close to that limit as you can afford. Keep in mind that your paycheck will be reduced by less than the dollar amount of the contribution, because the contributions are pre-tax so income tax isn’t withheld.
If you’ll be age 50 or older by December 31, you can also make “catch-up” contributions (up to $6,000 for 2017). So if you didn’t contribute much when you were younger, this may allow you to partially make up for lost time. Even if you did make significant contributions before age 50, catch-up contributions can still be beneficial, allowing you to further leverage the power of tax-deferred compounding.
Employers can include a Roth option in their 401(k) plans. If your plan offers this, you can designate some or all of your contribution as Roth contributions. While such contributions don’t reduce your current MAGI, qualified distributions will be tax-free.
Roth 401(k) contributions may be especially beneficial for higher-income earners, because they don’t have the option to contribute to a Roth IRA. On the other hand, if you expect your tax rate to be lower in retirement, you may be better off sticking with traditional 401(k) contributions.
Finally, keep in mind that any employer matches to Roth 401(k) contributions will be pretax and go into your traditional 401(k) account.
How much and which type
Have questions about how much to contribute or the best mix between traditional and Roth contributions? Contact us. We’d be pleased to discuss the tax and retirement-saving considerations with you.
Updated travel per diem rates go into effect October 1. To simplify recordkeeping, they can be used for reimbursement of ordinary and normal business expenses incurred while employees travel away from home.
Per diem advantages
As long as employees properly account for their business-travel expenses, reimbursements are generally tax-free to the employees and deductible by the employer. But keeping track of actual costs can be a headache.
With the per diem rates, employees don’t have to keep receipts for covered travel expenses. They just need to document the time, place and business purpose of the travel. Assuming that the travel qualifies as a business expense, the employer simply pays the employee the per diem allowance designated for the specific travel destination and deducts the per diem paid.
Although the per diem rates are set by the General Services Administration (GSA) to cover travel by government employees, private employers may use them for tax purposes. The rates are updated annually for the following areas:
For October 1, 2017, through September 30, 2018, the per diem standard CONUS rate is $144, an increase of $2 over the prior year. This rate consists of $93 for lodging and $51 for M&IE. Also effective October 1, there are 332 NSAs. The following locations have moved from NSAs into the standard CONUS rate:
What’s right for you?
As noted earlier, the per diem changes go into effect on October 1, 2017. During the last three months of 2017, an employer may switch to the new rates or continue with the old rates. But an employer must select one set of rates for this quarter and stick with it; it can’t use the old rates for some employees and the new rates for others.
Because travel expenses often attract IRS attention, they require careful record-keeping. The per diem method can help, but it’s not the best solution for all employers. An even simpler “high-low” per diem method is also available. And, in some cases, a policy of reimbursing actual expenses could be beneficial, despite the record-keeping hassles. If you have questions regarding travel expense reimbursements, please contact us.
With kids back in school, it’s a good time for parents (and grandparents) to think about college funding. One option, which can be especially beneficial if the children in question still have many years until they’ll be starting their higher education, is a Section 529 plan.
529 plans are generally state-sponsored, and the savings-plan option offers the opportunity to potentially build up a significant college nest egg because of tax-deferred compounding. So these plans can be particularly powerful if contributions begin when the child is quite young. Although contributions aren’t deductible for federal purposes, plan assets can grow tax-deferred. In addition, some states offer tax incentives for contributing.
Distributions used to pay qualified expenses (such as tuition, mandatory fees, books, supplies, computer equipment, software, Internet service and, generally, room and board) are income-tax-free for federal purposes and typically for state purposes as well, thus making the tax deferral a permanent savings.
529 plans offer other benefits as well:
Finally, 529 plans provide estate planning benefits: A special break for 529 plans allows you to front-load five years’ worth of annual gift tax exclusions, which means you can make up to a $70,000 contribution (or $140,000 if you split the gift with your spouse) in 2017. In the case of grandparents, this also can avoid generation-skipping transfer taxes.
One negative of a 529 plan is that your investment options are limited. Another is that you can make changes to your options only twice a year or if you change the beneficiary.
But whenever you make a new contribution, you can choose a different option for that contribution, no matter how many times you contribute during the year. Also, you can make a tax-free rollover to another 529 plan for the same child every 12 months.
We’ve focused on 529 savings plans here; a prepaid tuition version of 529 plans is also available. If you’d like to learn more about either type of 529 plan, please contact us. We can also tell you about other tax-smart strategies for funding education expenses.
Charitable giving allows you to help an organization you care about and, in most cases, enjoy a valuable income tax deduction. If you’re considering a large gift, a noncash donation such as appreciated real estate can provide additional benefits. For example, if you’ve held the property for more than one year, you generally will be able to deduct its full fair market value and avoid any capital gains tax you’d owe if you sold the property. There are, however, potential tax pitfalls you must watch out for:
Donation to a private foundation. While real estate donations to a public charity generally can be deducted at the property’s fair market value, your deduction for such a donation to a private foundation is limited to the lower of fair market value or your cost basis in the property.
Property subject to a mortgage. In this case, you may recognize taxable income for all or a portion of the loan’s value. And charities might not accept mortgaged property because it may trigger unrelated business income tax. For these reasons, it’s a good idea to pay off the mortgage before you donate the property or ask the lender to accept another property as collateral for the loan.
Failure to properly substantiate your donation. This can result in loss of the deduction and overvaluation penalties. Generally, real estate donations require a qualified appraisal. You’ll also need to complete Form 8283, “Noncash Charitable Contributions,” have your appraiser sign it and file it with your federal tax return. If the property is valued at more than $500,000, you’ll generally need to include the appraisal report as well.
Sale of the property within three years. The charity must report the sale to the IRS, and if the price is substantially less than the amount you claimed as a tax deduction, the IRS may challenge your deduction. To avoid this result, be sure your initial appraisal is accurate and well documented.
Sale of the property to someone related to you. If the charity sells the property you donated to your relative (or to someone with whom you negotiated a potential sale), the IRS may argue that the sale was prearranged and tax you on any capital gain.
If you’re considering a real estate donation, plan carefully and contact us for help ensuring that you avoid these pitfalls.
If you acquire a company, your to-do list will be long, which means you can’t devote all of your time to the deal’s potential tax implications. However, if you neglect tax issues during the negotiation process, the negative consequences can be serious. To improve the odds of a successful acquisition, it’s important to devote resources to tax planning before your deal closes.
Complacency can be costly
During deal negotiations, you and the seller should discuss such issues as whether and how much each party can deduct their transaction costs and how much in local, state and federal tax obligations the parties will owe upon signing the deal. Often, deal structures (such as asset sales) that typically benefit buyers have negative tax consequences for sellers and vice versa. So it’s common for the parties to wrangle over taxes at this stage.
Just because you seem to have successfully resolved tax issues at the negotiation stage doesn’t mean you can become complacent. With adequate planning, you can spare your company from costly tax-related surprises after the transaction closes and you begin to integrate the acquired business. Tax management during integration can also help your company capture synergies more quickly and efficiently.
You may, for example, have based your purchase price on the assumption that you’ll achieve a certain percentage of cost reductions via postmerger synergies. However, if your taxation projections are flawed or you fail to follow through on earlier tax assumptions, you may not realize such synergies.
Merging accounting functions
One of the most important tax-related tasks is the integration of your seller’s and your own company’s accounting departments. There’s no time to waste: You generally must file federal and state income tax returns — either as a combined entity or as two separate sets — after the first full quarter following your transaction’s close. You also must account for any short-term tax obligations arising from your acquisition.
To ensure the two departments integrate quickly and are ready to prepare the required tax documents, decide well in advance of closing which accounting personnel you’ll retain. If you and your seller use different tax processing software or follow different accounting methods, choose between them as soon as feasible. Understand that, if your acquisition has been using a different accounting method, you’ll need to revise the company’s previous tax filings to align them with your own accounting system.
The tax consequences of M&A decisions may be costly and could haunt your company for years. We can help you ensure you plan properly and minimize any potentially negative tax consequences.
The extended deadline for filing 2016 individual federal income tax returns is October 16. If you extended your return and know you owe tax but can’t pay the bill, you may be wondering what to do next.
File by October 16
First and foremost, file your return by October 16. Filing by the extended deadline will allow you to avoid the 5%-per-month failure-to-file penalty.
The only cost for failing to pay what you owe is an interest charge. Because an extension of time to file isn’t an extension of time to pay, generally the interest will begin to accrue after the April 18 filing deadline even if you filed for an extension. If you still can’t pay when you file by the extended October 16 due date, interest will continue to accrue until you pay the tax.
Consider your payment options
So when must you pay the balance due? As soon as possible, if you want to halt the IRS interest charges. Here are a few options:
Pay with a credit card. You can pay your federal tax bill with American Express, Discover, MasterCard or Visa. But before pursuing this option, ask about the one-time fee your credit card company will charge (which might be deductible) and the interest rate.
Take out a loan. If you can borrow at a reasonable rate, this may be a good option.
Arrange an IRS installment agreement. You can request permission from the IRS to pay off your bill in installments. Approval of your installment payment request is automatic if you:
As long as you have an unpaid balance, you’ll be charged interest. But this may be at a much lower rate than what you’d pay on a credit card or could arrange with a commercial lender.
Be aware that, when you enter into an installment agreement, you must pledge to stay current on your future taxes.
Filing a 2016 federal income tax return is important even if you can’t pay the tax due right now. If you need assistance or would like more information, please contact us.
Converting a traditional IRA to a Roth IRA can provide tax-free growth and the ability to withdraw funds tax-free in retirement. But what if you convert a traditional IRA — subject to income taxes on all earnings and deductible contributions — and then discover that you would have been better off if you hadn’t converted it? Fortunately, it’s possible to undo a Roth IRA conversion, using a “recharacterization.”
Reasons to re-characterize
There are several possible reasons to undo a Roth IRA conversion. For example:
Generally, when you convert to a Roth IRA, if you extend your tax return, you have until October 15 of the following year to undo it. (For 2016 returns, the extended deadline is October 16 because the 15th falls on a weekend in 2017.)
In some cases it can make sense to undo a Roth IRA conversion and then redo it. If you want to redo the conversion, you must wait until the later of 1) the first day of the year following the year of the original conversion, or 2) the 31st day after the re-characterization.
Keep in mind that, if you reversed a conversion because your IRA’s value declined, there’s a risk that your investments will bounce back during the waiting period. This could cause you to reconvert at ahigher tax cost.
Re-characterization in action
Nick had a traditional IRA with a balance of $100,000. In 2016, he converted it to a Roth IRA, which, combined with his other income for the year, put him in the 33% tax bracket. So normally he’d have owed $33,000 in federal income taxes on the conversion in April 2017. However, Nick extended his return and, by September 2017, the value of his account drops to $80,000.
On October 1, Nick re-characterizes the account as a traditional IRA and files his return to exclude the $100,000 in income. On November 1, he reconverts the traditional IRA, whose value remains at $80,000, to a Roth IRA. He’ll report that amount on his 2017 tax return. This time, he’ll owe $26,400 — deferred for a year and resulting in a tax savings of $6,600. If the $20,000 difference in income keeps him in the 28% tax bracket or tax reform legislation is signed into law that reduces rates retroactively to January 1, 2017, he could save even more.
If you convert a traditional IRA to a Roth IRA, monitor your financial situation. If the advantages of the conversion diminish, we can help you assess your options.