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.
Does your small business engage in qualified research activities? If so, you may be eligible for a research tax credit that you can use to offset your federal payroll tax bill.
This relatively new privilege allows the research credit to benefit small businesses that may not generate enough taxable income to use the credit to offset their federal income tax bills, such as those that are still in the unprofitable start-up phase where they owe little or no federal income tax.
Under the Protecting Americans from Tax Hikes Act of 2015, a qualified small business (QSB) can elect to use up to $250,000 of its research credit to reduce the Social Security tax portion of its federal payroll tax bills. Under the old rules, businesses could use the credit to offset only their federal income tax bills. However, many small businesses owe little or no federal income tax, especially small start-ups that tend to incur significant research expenses.
For the purposes of the research credit, a QSB is generally defined as a business with:
The allowable payroll tax reduction credit can’t exceed the employer portion of the Social Security tax liability imposed for any calendar quarter. Any excess credit can be carried forward to the next calendar quarter, subject to the Social Security tax limitation for that quarter.
Research activities that qualify
To be eligible for the research credit, a business must have engaged in “qualified” research activities. To be considered “qualified,” activities must meet the following four-factor test:
Expenses that qualify for the credit include wages for time spent engaging in supporting, supervising or performing qualified research, supplies consumed in the process of experimentation, and 65% of any contracted outside research expenses.
The ability to use the research credit to reduce payroll tax is a welcome change for eligible small businesses, but the rules are complex and we’ve only touched on the basics here. We can help you determine whether you qualify and, if you do, assist you with making the election for your business and filing payroll tax returns to take advantage of the new privilege.
Adam Carr, MBA, EA