If your business offers health insurance benefits to employees, there’s a good chance you’ve seen a climb in premium costs in recent years — perhaps a dramatic one. To meet the challenge of rising costs, some employers are opting for a creative alternative to traditional health insurance known as “captive insurance.” A captive insurance company generally is wholly owned and controlled by the employer. So it’s essentially like forming your own insurance company. And it provides tax advantages, too.
Potential benefits of forming a captive insurance company include:
You can customize your coverage package and charge premiums that more accurately reflect your business’s true loss exposure.
Another big benefit is that you can participate in the captive’s underwriting profits and investment income. When you pay commercial health insurance premiums, a big chunk of your payment goes toward the insurer’s underwriting profit. But when you form a captive, you retain this profit through the captive.
Also, your business can enjoy investment and cash flow benefits by investing premiums yourself instead of paying them to a commercial insurer.
A captive insurance company may also save you tax dollars. For example, premiums paid to a captive are tax-deductible and the captive can deduct most of its loss reserves. To qualify for federal income tax purposes, a captive must meet several criteria. These include properly priced premiums based on actuarial and underwriting considerations and a sufficient level of risk distribution as determined by the IRS.
Recent U.S. Tax Court rulings have determined that risk distribution exists if there’s a large enough pool of unrelated risks — or, in other words, if risk is spread over a sufficient number of employees. This is true regardless of how many entities are involved.
Additional tax benefits may be available if your captive qualifies as a “microcaptive” (a captive with $2.2 million or less in premiums that meets certain additional tests): You may elect to exclude premiums from income and pay taxes only on net investment income. Be aware, however, that you’ll lose certain deductions with this election.
Also keep in mind that there are some potential drawbacks to forming a captive insurance company. Contact us to learn more about the tax treatment and other pros and cons of captive insurance. We can help you determine whether this alternative may be right for your business.
Among the taxes that are being considered for repeal as part of tax reform legislation is the estate tax. This tax applies to transfers of wealth at death, hence why it’s commonly referred to as the “death tax.” Its sibling, the gift tax — also being considered for repeal — applies to transfers during life. Yet most taxpayers won’t face these taxes even if the taxes remain in place.
Exclusions and exemptions
For 2017, the lifetime gift and estate tax exemption is $5.49 million per taxpayer. (The exemption is annually indexed for inflation.) If your estate doesn’t exceed your available exemption at your death, then no federal estate tax will be due.
Any gift tax exemption you use during life does reduce the amount of estate tax exemption available at your death. But every gift you make won’t use up part of your lifetime exemption. For example:
What’s your estate tax exposure?
Here’s a simplified way to project your estate tax exposure. Take the value of your estate, net of any debts. Also subtract any assets that will pass to charity on your death.
Then, if you’re married and your spouse is a U.S. citizen, subtract any assets you’ll pass to him or her. (But keep in mind that there could be estate tax exposure on your surviving spouse’s death, depending on the size of his or her estate.) The net number represents your taxable estate.
You can then apply the exemption amount you expect to have available at death. Remember, any gift tax exemption amount you use during your life must be subtracted. But if your spouse predeceases you, then his or her unused estate tax exemption, if any, may be added to yours (provided the applicable requirements are met).
If your taxable estate is equal to or less than your available estate tax exemption, no federal estate tax will be due at your death. But if your taxable estate exceeds this amount, the excess will be subject to federal estate tax.
Be aware that many states impose estate tax at a lower threshold than the federal government does. So you could have state estate tax exposure even if you don’t need to worry about federal estate tax.
If you’re not sure whether you’re at risk for the estate tax or if you’d like to learn about gift and estate planning strategies to reduce your potential liability, please contact us. We also can keep you up to date on any estate tax law changes.
It’s a safe bet that state tax authorities will let you know if you haven’t paid enough sales and use taxes, but what are the odds that you’ll be notified if you’ve paid too much? The chances are slim — so slim that many businesses use reverse audits to find over-payments so they can seek refunds.
Take all of your exemptions
In most states, businesses are exempt from sales tax on equipment used in manufacturing or recycling, and many states don’t require them to pay taxes on the utilities and chemicals used in these processes, either. In some states, custom software, computers and peripherals are exempt if they’re used for research and development projects.
This is just a sampling of sales and use tax exemptions that might be available. Unless you’re diligent about claiming exemptions, you may be missing out on some to which you’re entitled.
Many businesses have sales and use tax compliance systems to guard against paying too much, but if you haven’t reviewed yours recently, it may not be functioning properly. Employee turnover, business expansion or downsizing, and simple mistakes all can take their toll.
Look back and broadly
The audit should extend across your business, going back as far as the statute of limitations on state tax reviews. If your state auditors can review all records for the four years preceding the audit, for example, your reverse audit should encompass the same time-frame.
What types of payments should be reviewed? You may have made over-payments on components of manufactured products as well as on the equipment you use to make the products. Other areas where over-payments may occur, depending on state laws, include:
Save now and later
Reverse audits can be time consuming and complicated, but a little pain can bring significant gain. Use your reverse audit not only to reap tax refund rewards now but also to update your compliance systems to help ensure you don’t overpay taxes in the future.
Rules and regulations surrounding state sales and use tax refunds are complicated. We can help you understand them and ensure your refund claims are properly prepared before you submit them.
Most of the talk about possible tax legislation this year has focused on either wide-sweeping tax reform or taxes that are part of the Affordable Care Act. But there are a few other potential tax developments for individuals to keep an eye on.
Back in December of 2015, Congress passed the PATH Act, which made a multitude of tax breaks permanent. However, there were a few valuable breaks for individuals that it extended only through 2016. The question now is whether Congress will extend them for 2017.
An education break
One break the PATH Act extended through 2016 was the above-the-line deduction for qualified tuition and related expenses for higher education. The deduction was capped at $4,000 for taxpayers whose adjusted gross income (AGI) didn’t exceed $65,000 ($130,000 for joint filers) or, for those beyond those amounts, $2,000 for taxpayers whose AGI didn’t exceed $80,000 ($160,000 for joint filers).
You couldn’t take the American Opportunity credit, its cousin the Lifetime Learning credit and the tuition deduction in the same year for the same student. If you were eligible for all three breaks, the American Opportunity credit would typically be the most valuable in terms of tax savings.
But in some situations, the AGI reduction from the tuition deduction might prove more beneficial than taking the Lifetime Learning credit. For example, a lower AGI might help avoid having other tax breaks reduced or eliminated due to AGI-based phaseouts.
Mortgage-related tax breaks
Under the PATH Act, through 2016 you could treat qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction. The deduction phased out for taxpayers with AGI of $100,000 to $110,000.
The PATH Act likewise extended through 2016 the exclusion from gross income for mortgage loan forgiveness. It also modified the exclusion to apply to mortgage forgiveness that occurs in 2017 as long as it’s granted pursuant to a written agreement entered into in 2016. So even if this break isn’t extended, you might still be able to benefit from it on your 2017 income tax return.
Please check back with us for the latest information. In the meantime, keep in mind that, if you qualify and you haven’t filed your 2016 income tax return yet, you can take advantage of these breaks on that tax return. The deadline for individual extended returns is October 16, 2017.
If your business is a limited liability company (LLC) or a limited liability partnership (LLP), you know that these structures offer liability protection and flexibility as well as tax advantages. But they once also had a significant tax disadvantage: The IRS used to treat all LLC and LLP owners as limited partners for purposes of the passive activity loss (PAL) rules, which can result in negative tax consequences. Fortunately, these days LLC and LLP owners can be treated as general partners, which means they can meet any one of seven “material participation” tests to avoid passive treatment.
The PAL rules
The PAL rules prohibit taxpayers from offsetting losses from passive business activities (such as limited partnerships or rental properties) against nonpassive income (such as wages, interest, dividends and capital gains). Disallowed losses may be carried forward to future years and deducted from passive income or recovered when the passive business interest is sold.
There are two types of passive activities: 1) trade or business activities in which you don’t materially participate during the year, and 2) rental activities, even if you do materially participate (unless you qualify as a “real estate professional” for federal tax purposes).
The 7 tests
Material participation in this context means participation on a “regular, continuous and substantial” basis. Unless you’re a limited partner, you’re deemed to materially participate in a business activity if you meet just one of seven tests:
In many cases, meeting one of the material participation tests will require diligently tracking every hour spent on your activities associated with that business. Questions about the material participation tests? Contact us.
Now that Affordable Care Act (ACA) repeal and replacement efforts appear to have collapsed, at least for the time being, it’s a good time for a refresher on the tax penalty the ACA imposes on individuals who fail to have “minimum essential” health insurance coverage for any month of the year. This requirement is commonly called the “individual mandate.”
Before we review how the penalty is calculated, let’s take a quick look at exceptions to the penalty. Taxpayers may be exempt if they fit into one of these categories for 2017:
Calculating the tax
So how much can the penalty cost? That’s a tricky question. If you owe the penalty, the tentativeamount equals the greater of the following two prongs:
In terms of the dollar-amount prong of the penalty, the applicable dollar amount for each uninsured household member is $695 for 2017. For a household member who’s under age 18, the applicable dollar amounts are cut by 50%, to $347.50. The maximum penalty under this prong for 2017 is $2,085 (300% of $695).
The final penalty amount per person can’t exceed the national average cost of “bronze coverage” (the cheapest category of ACA-compliant coverage) for your household. The important thing to know is that a high-income person or household could owe more than 300% of the applicable dollar amount but not more than the cost of bronze coverage.
If you have minimum essential coverage for only part of the year, the final penalty is calculated on a monthly basis using prorated annual figures.
Also be aware that the extent to which the penalty will continue to be enforced isn’t certain. The IRS has been accepting 2016 tax returns even if a taxpayer hasn’t completed the line indicating health coverage status. That said, the ACA is still the law, so compliance is highly recommended. For more information about this and other ACA-imposed taxes, contact us.
Unemployment tax rates for employers vary from state to state. Your unemployment tax bill may be influenced by the number of former employees who’ve filed unemployment claims with the state, your current number of employees and your business’s age. Typically, the more claims made against a business, the higher the unemployment tax bill.
Here are six ways to control your unemployment tax costs:
1. Buy down your unemployment tax rate if your state permits it. Some states allow employers to annually buy down their rate. If you’re eligible, this could save you substantial dollars in unemployment taxes.
2. Hire new staff conservatively. Remember, your unemployment payments are based partly on the number of employees who file unemployment claims. You don’t want to hire employees to fill a need now, only to have to lay them off if business slows. A temporary staffing agency can help you meet short-term needs without permanently adding staff, so you can avoid layoffs. This is also a good way to try out a candidate.
3. Assess candidates before hiring them. Often it’s worth a small financial investment to have job candidates undergo prehiring assessments to see if they’re the right match for your business and the position available. Hiring carefully will increase the likelihood that new employees will work out.
4. Train for success. Many unemployment insurance claimants are awarded benefits despite employer assertions that the employee failed to perform adequately. Often this is because the hearing officer concluded the employer hadn’t provided the employee with enough training to succeed in the position.
5. Handle terminations thoughtfully. If you must terminate an employee, consider giving him or her severance as well as offering outplacement benefits. Severance pay may reduce or delay the start of unemployment insurance benefits. Effective outplacement services may hasten the end of unemployment insurance benefits, because the claimant has found a new job.
6. Leverage an acquisition. If you’ve recently acquired another company, it may have a lower established tax rate that you can use instead of the tax rate that’s been set for your existing business. You also may be able to request the transfer of the previous company’s unemployment reserve fund balance.
If you have questions about unemployment taxes and how you can reduce them, contact our firm. We’d be pleased to help.
With an employee stock ownership plan (ESOP), employee participants take part ownership of the business through a retirement savings arrangement. Meanwhile, the business and its existing owner(s) can benefit from some potential tax breaks, an extra-motivated workforce and potentially a smoother path for succession planning.
How ESOPs work
To implement an ESOP, you establish a trust fund and either:
The shares in the trust are allocated to individual employees’ accounts, often using a formula based on their respective compensation. The business has to formally adopt the plan and submit plan documents to the IRS, along with certain forms.
Among the biggest benefits of an ESOP is that contributions to qualified retirement plans such as ESOPs typically are tax-deductible for employers. However, employer contributions to all defined contribution plans, including ESOPs, are generally limited to 25% of covered payroll. In addition, C corporations with leveraged ESOPs can deduct contributions used to pay interest on the loan. That is, the interest isn’t counted toward the 25% limit.
Dividends paid on ESOP stock passed through to employees or used to repay an ESOP loan, so long as they’re reasonable, may be tax-deductible for C corporations. Dividends voluntarily reinvested by employees in company stock in the ESOP also are usually deductible by the business. (Employees, however, should review the tax implications of dividends.)
In another potential benefit, shareholders in some closely held C corporations can sell stock to the ESOP and defer federal income taxes on any gains from the sale, with several stipulations. One is that the ESOP must own at least 30% of the company’s stock immediately after the sale. In addition, the sellers must reinvest the proceeds (or an equivalent amount) in qualified replacement property securities of domestic operation corporations within a set period of time.
Finally, when a business owner is ready to retire or otherwise depart the company, the business can make tax-deductible contributions to the ESOP to buy out the departing owner’s shares or have the ESOP borrow money to buy the shares.
More tax considerations
There are tax benefits for employees, too. Employees don’t pay tax on stock allocated to their ESOP accounts until they receive distributions. But, as with most retirement plans, if they take a distribution before they turn 59½ (or 55, if they’ve terminated employment), they may have to pay taxes and penalties — unless they roll the proceeds into an IRA or another qualified retirement plan.
Also be aware that an ESOP’s tax impact for entity types other than C corporations varies somewhat from what we’ve discussed here. And while an ESOP offers many potential benefits, it also presents risks. For help determining whether an ESOP makes sense for your business, contact us.
Your compensation may take several forms, including salary, fringe benefits and bonuses. If you work for a corporation, you might also receive stock-based compensation, such as stock options. These come in two varieties: nonqualified (NQSOs) and incentive (ISOs). With both NQSOs and ISOs, if the stock appreciates beyond your exercise price, you can buy shares at a price below what they’re trading for.
The tax consequences of these types of compensation can be complex. So smart tax planning is critical. Let’s take a closer look at the tax treatment of NQSOs, and how it differs from that of the perhaps better known ISOs.
NQSOs create compensation income — taxed at ordinary-income rates — on the “bargain element” (the difference between the stock’s fair market value and the exercise price) when exercised. This is regardless of whether the stock is held or sold immediately.
ISOs, on the other hand, generally don’t create compensation income taxed at ordinary rates unless you sell the stock from the exercise without holding it for more than a year, in a “disqualified disposition.” If the stock from an ISO exercise is held more than one year, then generally your lower long-term capital gains tax rate applies when you sell the stock.
Also, NQSO exercises don’t create an alternative minimum tax (AMT) preference item that can trigger AMT liability. ISO exercises can trigger AMT unless the stock is sold in a disqualified disposition (though it’s possible the AMT could be repealed under tax reform legislation).
More tax consequences to consider
When you exercise NQSOs, you may need to make estimated tax payments or increase withholding to fully cover the tax. Otherwise you might face underpayment penalties.
Also keep in mind that an exercise could trigger or increase exposure to top tax rates, the additional 0.9% Medicare tax and the 3.8% net investment income tax (NIIT). These two taxes might be repealed or reduced as part of Affordable Care Act repeal and replace legislation or tax reform legislation, possibly retroactive to January 1 of this year. But that’s still uncertain.
Have tax questions about NQSOs or other stock-based compensation? Let us know — we’d be happy to answer them.
Tax reform has been a major topic of discussion in Washington, but it’s still unclear exactly what such legislation will include and whether it will be signed into law this year. However, the last major tax legislation that was signed into law — back in December of 2015 — still has a significant impact on tax planning for businesses. Let’s look at three midyear tax strategies inspired by the Protecting Americans from Tax Hikes (PATH) Act:
1. Buy equipment. The PATH Act preserved both the generous limits for the Section 179 expensing election and the availability of bonus depreciation. These breaks generally apply to qualified fixed assets, including equipment or machinery, placed in service during the year. For 2017, the maximum Sec. 179 deduction is $510,000, subject to a $2,030,000 phaseout threshold. Without the PATH Act, the 2017 limits would have been $25,000 and $200,000, respectively. Higher limits are now permanent and subject to inflation indexing.
Additionally, for 2017, your business may be able to claim 50% bonus depreciation for qualified costs in excess of what you expense under Sec. 179. Bonus depreciation is scheduled to be reduced to 40% in 2018 and 30% in 2019 before it’s set to expire on December 31, 2019.
2. Ramp up research. After years of uncertainty, the PATH Act made the research credit permanent. For qualified research expenses, the credit is generally equal to 20% of expenses over a base amount that’s essentially determined using a historical average of research expenses as a percentage of revenues. There’s also an alternative computation for companies that haven’t increased their research expenses substantially over their historical base amounts.
In addition, a small business with $50 million or less in gross receipts may claim the credit against its alternative minimum tax (AMT) liability. And, a start-up company with less than $5 million in gross receipts may claim the credit against up to $250,000 in employer Federal Insurance Contributions Act (FICA) taxes.
3. Hire workers from “target groups.” Your business may claim the Work Opportunity credit for hiring a worker from one of several “target groups,” such as food stamp recipients and certain veterans. The PATH Act extended the credit through 2019. It also added a new target group: long-term unemployment recipients.
Generally, the maximum Work Opportunity credit is $2,400 per worker. But it’s higher for workers from certain target groups, such as disabled veterans.
One last thing to keep in mind is that, in terms of tax breaks, “permanent” only means that there’s no scheduled expiration date. Congress could still pass legislation that changes or eliminates “permanent” breaks. But it’s unlikely any of the breaks discussed here would be eliminated or reduced for 2017. To keep up to date on tax law changes and get a jump start on your 2017 tax planning, contact us.
Adam Carr, MBA, EA