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.
Benefits abound 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. Tax impact 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. © 2017
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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. © 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. © 2017 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. © 2017 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. Tax impact 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. © 2017 According to IRS Publication 5137, Fringe Benefit Guide, a fringe benefit is “a form of pay (including property, services, cash or cash equivalent), in addition to stated pay, for the performance of services.” But the tax treatment of a fringe benefit can vary dramatically based on the type of benefit.
Generally, the IRS takes one of four tax approaches to fringe benefits: 1. Taxable/includable. The value of benefits in this category are taxable because they must be included in employees’ gross income as wages and reported on Form W-2. They’re usually also subject to federal income tax withholding, Social Security tax (unless the employee has already reached the current year Social Security wage base limit) and Medicare tax. Typical examples include cash bonuses and the personal use of a company vehicle. 2. Nontaxable/excludable. Benefits in this category are considered nontaxable because you may exclude them from employees’ wages under a specific section of the Internal Revenue Code. Examples include:
3. Partially taxable. In some cases, the value of a fringe benefit will be excluded under an IRC section up to a certain dollar limit with the remainder taxable. A public transportation subsidy under Section 132 is one example. 4. Tax-deferred. This designation applies to fringe benefits that aren’t taxable when received but that will be subject to tax later. A common example is employer contributions to a defined contribution plan, such as a 401(k) plan. Are you applying the proper tax treatment to each fringe benefit you provide? If not, you could face unexpected tax liabilities or other undesirable consequences. Please contact us with any questions you have about the proper tax treatment of a particular benefit you currently offer or are considering offering. © 2017 It’s common for a business to own not only typical business assets, such as equipment, inventory and furnishings, but also the building where the business operates — and possibly other real estate as well. There can, however, be negative consequences when a business’s real estate is included in its general corporate assets. By holding real estate in a separate entity, owners can save tax and enjoy other benefits, too.
Capturing tax savings Many businesses operate as C corporations so they can buy and hold real estate just as they do equipment, inventory and other assets. The expenses of owning the property are treated as ordinary expenses on the company’s income statement. However, if the real estate is sold, any profit is subject to double taxation: first at the corporate level and then at the owner’s individual level when a distribution is made. As a result, putting real estate in a C corporation can be a costly mistake. If the real estate is held instead by the business owner(s) or in a pass-through entity, such as a limited liability company (LLC) or limited partnership, and then leased to the corporation, the profit on a sale of the property is taxed only once — at the individual level. LLC: The entity of choice The most straightforward and seemingly least expensive way for an owner to maximize the tax benefits is to buy the real estate outright. However, this could transfer liabilities related to the property (such as for injuries suffered on the property) directly to the owner, putting other assets — including the business — at risk. In essence, it would negate part of the rationale for organizing the business as a corporation in the first place. So, it’s generally best to put real estate in its own limited liability entity. The LLC is most often the vehicle of choice for this. Limited partnerships can accomplish the same ends if there are multiple owners, but the disadvantage is that you’ll incur more expense by having to set up two entities: the partnership itself and typically a corporation to serve as the general partner. We can help you create a plan of ownership for real estate that best suits your situation. © 2017 Donating to charity is more than good business citizenship; it can also save tax. Here are three lesser-known federal income tax breaks for charitable donations by businesses.
1. Food donations Charitable write-offs for donated food (such as by restaurants and grocery stores) are normally limited to the lower of the taxpayer’s basis in the food (generally cost) or fair market value (FMV), but an enhanced deduction equals the lesser of:
To qualify, the food must be apparently wholesome at the time it’s donated. Your total charitable write-off for food donations under the enhanced deduction provision can’t exceed:
2. Qualified conservation contributions Qualified conservation contributions are charitable donations of real property interests, including remainder interests and easements that restrict the use of real property. For qualified C corporation farming and ranching operations, the maximum write-off for qualified conservation contributions is increased from the normal 10% of adjusted taxable income to 100% of adjusted taxable income. Qualified conservation contributions in excess of what can be written off in the year of the donation can be carried forward for 15 years. 3. S corporation appreciated property donations A favorable tax basis rule is available to shareholders of S corporations that make charitable donations of appreciated property. For such donations, each shareholder’s basis in the S corporation stock is reduced by only the shareholder’s pro-rata percentage of the company’s tax basis in the donated asset. Without this provision, a shareholder’s basis reduction would equal the passed-through write-off for the donation (a larger amount than the shareholder’s pro-rata percentage of the company’s basis in the donated asset). This provision is generally beneficial to shareholders, because it leaves them with higher tax basis in their S corporation shares. If you believe you may be eligible to claim one or more of these tax breaks, contact us. We can help you determine eligibility, prepare the required documentation and plan for charitable donations in future years. © 2017 Here are some of the key tax-related deadlines affecting businesses and other employers during the second quarter of 2017. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
July 31
August 10
September 15
© 2017 It’s common for closely held businesses to transfer money into and out of the company, often in the form of a loan. However, the IRS looks closely at such transactions: Are they truly loans, or actually compensation, distributions or contributions to equity?
Loans to owners When an owner withdraws funds from the company, the transaction can be characterized as compensation, a distribution or a loan. Loans aren’t taxable, but compensation is and distributions may be. If the company is a C corporation and the transaction is considered a distribution, it can trigger double taxation. If a transaction is considered compensation, it’s deductible by the corporation, so it doesn’t result in double taxation — but it will be taxable to the owner and subject to payroll taxes. If the company is an S corporation or other pass-through entity and the transaction is considered a distribution, there’s no entity-level tax, so double taxation won’t be an issue. But distributions reduce an owner’s tax basis, which makes it harder to deduct business losses. If the transaction is considered compensation, as with a C corporation, it will be taxable to the owner and subject to payroll taxes. Loans to the business There are also benefits to treating transfers of money from owners to the business as loans. If such advances are treated as contributions to equity, for example, any reimbursements by the company may be taxed as distributions. Loan payments, on the other hand, aren’t taxable, apart from the interest, which is deductible by the company. A loan may also give the owner an advantage in the event of the company’s bankruptcy, because debt obligations are paid before equity is returned. Is it a loan or not? To enjoy the tax advantages of a loan, it’s important to establish that a transaction is truly a loan. Simply calling a withdrawal or advance a “loan” doesn’t make it so. Whether a transaction is a loan is a matter of intent. It’s a loan if the borrower has an unconditional intent to repay the amount received and the lender has an unconditional intent to obtain repayment. Because the IRS and the courts aren’t mind readers, it’s critical to document loans and treat them like other arm’s-length transactions. This includes:
If you’re considering a loan to or from your business, contact us for more details on how to help ensure it will be considered a loan by the IRS. © 2017 |
AuthorAdam Carr, MBA, EA Archives
January 2024
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