Tag: Business Tax

Posted on Mar 27, 2017

If you own a profitable, unincorporated business with your spouse, you’re probably fed up with high self-employment (SE) tax bills.

Self-Employment Tax Basics

For 2016, the maximum 15.3% self-employment (SE) tax rate hits the first $118,500 of net SE income. For 2017, the 15.3% rate hits the first $127,200 of net SE income. It includes 12.4% for the Social Security tax component and 2.9% for the Medicare tax component.

Above the Social Security tax ceiling, the Social Security tax component goes away, but the Medicare tax component continues at a 2.9% rate before rising to 3.8% at higher income levels.

If you have an unincorporated small business in which both you and your spouse participate, you may have been treating it as a 50/50 spouse-owned partnership or as a spouse-owned LLC that’s treated as a 50/50 partnership for tax purposes. The more profitable your business is, the more you’re paying in SE tax bills. That’s because you and your spouse must separately calculate your respective SE tax bills. For 2017, that means you will 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.

An unincorporated business in which both spouses are active is typically treated as a partnership that’s owned 50/50 by the spouses — or a limited liability company (LLC) that’s treated as a partnership for tax purposes and owned 50/50 by the spouses. In either case, you and your spouse must separately calculate your respective SE tax bills.

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. (See “Self-Employment Tax Basics” at right.) Those bills can mount up if your business is profitable. Here are three ways spouse-owned businesses can lower their combined SE tax hit.

1. Establish that You Don’t Have a Spouse-Owned Partnership (or LLC)

To illustrate the adverse tax consequences of operating a spouse-owned partnership, suppose you expect your business to generate $250,000 of net SE income in 2017. You and your spouse must separately calculate SE tax. So each of you will owe $19,125 ($125,000 x 15.3%), for a combined total of $38,250. To make matters worse, your SE tax bill is likely to increase every year due to inflation adjustments to the Social Security tax ceiling and the growth of your business.

These adverse effects apply only if you have a business that is properly treated as a 50/50 spouse-owned partnership or a spouse-owned LLC that’s properly treated as a 50/50 partnership for federal tax purposes.

Several IRS publications attempt to create the impression that involvement by both spouses in an unincorporated business automatically creates a partnership for federal tax purposes. For example, the Tax Guide for Small Business says, “If you and your spouse jointly own and operate an unincorporated business and share in the profits and losses, you are partners in a partnership, whether or not you have a formal partnership agreement.”

However, in many cases, the IRS will have a tough time making the argument that a business is a 50/50 spouse-owned partnership (or LLC). Consider the following quote from an IRS private letter ruling: “Whether parties have formed a joint venture is a question of fact to be determined by reference to the same principles that govern the question of whether persons have formed a partnership which is to be accorded recognition for tax purposes. Therefore, while all circumstances are to be considered, the essential question is whether the parties intended to, and did, in fact, join together for the present conduct of an undertaking or enterprise.”

The IRS private letter ruling identifies these factors, none of which is conclusive, as evidence of this intent:

  • The agreement of the parties and their conduct in executing its terms,
  • The contributions, if any, that each party makes to the venture,
  • Control over the income and capital of the venture and the right to make withdrawals,
  • Whether the parties are co-proprietors who share in net profits and who have an obligation to share losses, and
  • Whether the business was conducted in the joint names of the parties and was represented to be a partnership.

In many situations where both spouses have some involvement in an activity that has been treated as a sole proprietorship or in an activity that has been operated as a single-member LLC (SMLLC) that has been treated as a sole proprietorship for tax purposes, only some of the factors listed in the private letter ruling are present. Therefore, the IRS may not necessarily succeed in arguing that the business is a spouse-owned partnership (or LLC).

That argument may be especially weak when:

    • The spouses have no discernible partnership agreement, and
    • The business hasn’t been represented as a partnership to third parties, such as banks and customers.

If your business can more properly be characterized as a sole proprietorship or as an SMLLC that is treated as a sole proprietorship for tax purposes, only the spouse who is considered the proprietor owes SE tax.

Let’s assume the same facts as in the previous example, except that you take a supportable position 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 would be $23,023 [($127,200 x 15.3%) + ($122,800 x 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 (or LLC)

Not all businesses are owned 50/50 by their owners. Say your business can more properly be characterized as a partnership (or LLC) that’s owned 80% by one spouse and 20% by the other spouse, because one spouse does much more work than the other.

This time, let’s assume the same facts as in the previous example, except that you take a supportable position that your business is an 80/20 spouse-owned partnership (or LLC). 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 would be $21,573 [($127,200 x 15.3%) + ($72,800 x 2.9%)], and the SE tax bill for the 20% spouse would be $7,650 ($50,000 x 15.3%). The combined total SE tax bill is $29,223 ($21,573 + $7,650), which is significantly lower than the total from the first example ($38,250).

3. Liquidate Spouse-Owned Partnership and Hire One Spouse as an Employee

This strategy is a little more complicated than the previous strategies. First, you’ll need to dissolve your existing spouse-owned partnership or spouse-owned LLC that’s treated as a partnership for federal tax purposes, and start running the operation as a sole proprietorship or SMLLC treated as a sole proprietorship for federal tax purposes. Even if the partnership (or LLC) owns assets and has liabilities, this step is generally a tax-free liquidation under the partnership tax rules.

The second step is to hire one spouse as an employee of the new proprietorship (SMLLC). Pay that spouse a modest cash salary, and withhold 7.65% from the salary checks to cover the employee-spouse’s share of Social Security and Medicare taxes. As the employer, the proprietorship must pay another 7.65% directly to the government to cover the employer’s half of Social Security and Medicare taxes. However, since the employee-spouse’s salary is modest, the Social Security and Medicare tax hits will also be modest.

The third step is to consider setting up a Section 105 medical expense reimbursement plan for the employee-spouse. Use the plan to cover your family’s out-of-pocket medical expenses, including health insurance premiums, by making reimbursement payments to the employee-spouse out of the proprietorship’s business checking account. Deduct the plan reimbursements as a business expense of the proprietorship. On the employee-spouse’s side of the deal, the plan reimbursements are free of federal income, Social Security and Medicare taxes because the plan is considered a tax-free fringe benefit.

The fourth step is to deduct, on the sole proprietorship’s (SMLLC’s) tax schedule, the medical expense plan reimbursements, the employee-spouse’s cash salary, and the employer’s share of Social Security and Medicare taxes. These deductions also reduce the proprietor’s net SE income and the SE tax bill for the business.

Finally, you’ll need to calculate the SE tax bill for the spouse who is treated as the proprietor. This minimizes the SE tax hit, because the maximum 15.3% SE tax rate applies to no more than $127,200 of SE income (for 2017), vs. up to $254,400 if you continue to treat your business as a 50/50 spouse-owned partnership (or LLC).

Important note: If you have employees other than the spouse, your business may have to cover them under a Section 105 medical expense reimbursement plan.

Consult a Tax Pro

SE taxes can quickly add up, but there are several strategies that spouse-owned businesses can use to reduce their combined total bill. Consult your tax advisor before using any of these strategies to avoid any potential pitfalls and make the optimal choice for your business.

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Posted on Dec 12, 2016

advisory services, business tax, business services, tax services, CPA in DallasBusiness tax credits are particularly beneficial for planning because they reduce tax liability dollar-for-dollar. The Protecting Americans from Tax Hikes (PATH) Act of 2015 has made permanent the research credit and extended but not made permanent other credits, including the Work Opportunity credit (through 2019). Let’s explore a few details of these business tax credits.

Research credit

Also known as the Research & Development (R&D) credit, it gives businesses an incentive to step up their investments in research and innovation. The PATH Act permanently extends the credit, allowing businesses to earn a credit for pursuing critical research into new products and technologies. Plus, in 2016 businesses with $50 million or less in gross receipts can claim the credit against AMT liability. Certain start-ups (in general, those with less than $5 million in gross receipts) that haven’t yet incurred any income tax liability can use the credit against their payroll tax. While the credit is complicated to compute, the tax savings can be worth the effort.

Work Opportunity credit

This credit is for employers that hire from a “target group.” It has been extended through 2019. Starting this year, target groups are extended to include individuals who’ve been unemployed for 27 weeks or more. The size of the tax credit depends on the hired person’s target group, the wages paid to that person and the number of hours that person worked during the first year of employment. The maximum tax credit that can be earned for each member of a target group is generally $2,400 per adult employee. But the credit can be higher for members of certain target groups, up to as much as $9,600 for certain veterans. Employers aren’t subject to a limit on the number of eligible individuals they can hire. That is, if there are 10 individuals that qualify, the credit can be 10 times the listed amount. Bear in mind that you must obtain certification that an employee is a target group member from the appropriate State Workforce Agency before you can claim the credit. The certification generally must be requested within 28 days after the employee begins work.

New Markets credit

This credit has been extended through 2019. It gives investors who make “qualified equity investments” in certain low-income communities a 39% tax credit over a seven-year period. Certified Community Development Entities (CDEs) determine which projects get funded — often construction or rehabilitation real estate projects in “distressed” communities, using data from the 2006–2010 American Community Survey. Flexible financing is provided to the developers and business owners.

Empowerment Zones

Empowerment Zones are certain urban and rural areas where employers and other taxpayers qualify for special tax incentives, including a 20% credit for “qualified zone wages” up to $15,000, for a maximum credit of $3,000. The tax incentive expired December 31, 2014, but it has been extended through December 31, 2016.

If you have questions about any of these potential deductions, employee benefits incentives or tax credits for the current or coming tax year, talk to the Tax Services Group at Cornwell Jackson. You may also download our newest Tax Planning Guide.

Gary Jackson, CPA, is the lead tax partner at Cornwell Jackson. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing tax advisory services to individuals and business leaders in the Dallas/Fort Worth area and across North Texas. 

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Posted on Nov 28, 2016

advisory services, business tax, business services, tax services, CPA in Dallas

Finding skilled talent is a high priority for almost any industry you read about in the US. Employee benefits like health insurance and paid time off are mainly done to attract and retain the best employees, but there are some tax savings incentives associated with this practice. Consider the following tax savings options through employee benefits:

Qualified deferred compensation plans

These plans include pension, profit-sharing and 401(k) plans, as well as SIMPLEs. You take a tax deduction for your contributions to employees’ accounts. Certain small employers may also be eligible for a credit when setting up a plan.

Retirement plan credit

Small employers (generally those with 100 or fewer employees) that create a new retirement plan may be eligible for a $500 credit per year for three years. The credit is limited to 50% of the first $1,000 in qualified plan startup costs. Employers must file IRS Form 8881 – Credit for Small Employer Pension Plan Startup Costs.

HSAs and FSAs

If your business provides employees with a qualified high deductible health plan (HDHP), you can offer them Health Savings Accounts to contribute dollars pre-tax for certain medical expenses. Regardless of the type of health insurance you provide, you can also offer Flexible Spending Accounts for health care. If you have employees who incur day care expenses, consider offering FSAs for child and dependent care.

Employees can also contribute to an FSA for unreimbursed business expenses such as parking. The money for HSAs and FSAs can be contributed pre-tax, helping employees reduce their taxable income for expenses they would pay for anyway. A certain amount of money from FSAs can be carried forward for non-health care related expenses.  HSAs can be a long-term investment vehicle if employees don’t need to use the funds for medical care.

HRAs

A Health Reimbursement Account reimburses an employee for medical expenses up to a maximum dollar amount. Unlike an HSA, no high deductible health plan (HDHP) is required. Unlike an FSA, any unused portion can be carried forward to the next year. But only the employer can contribute to an HRA. The employer sets the parameters for the HRA, and unused dollars remain with the employer rather than following the employee to new employment. Because the reimbursements occur pre-tax, employees and employers often save up to 50% in combined taxes on the cost of medical expenses.

Small-business health care credit

The maximum credit is 50% of group health coverage premiums paid by the employer, provided it contributes at least 50% of the total premium or of a benchmark premium. For 2016, the full credit is available for employers with 10 or fewer full-time equivalent employees (FTEs) and average annual wages of less than $25,900 per employee. Partial credits are available on a sliding scale to businesses with fewer than 25 FTEs and average annual wages of less than $51,800. To qualify, employers must generally be enrolled online in the Small Business Health Options Program (SHOP). The credit can be taken for only two years, and the years must be consecutive.

Fringe benefits

Some fringe benefits — such as employee discounts, group term-life insurance (up to $50,000 annually per person), parking (up to $255 per month), mass transit / van pooling (also up to $255 per month for 2016, because Congress has made parity permanent) and health insurance — aren’t included in employee income. Yet the employer can still receive a deduction for the portion, if any, of the benefit it pays and typically avoid payroll tax as well.

Play-or-pay penalty risk

Not all employee benefits are created equal in terms of tax advantage. The play-or-pay provision of the Affordable Care Act (ACA) does impose a penalty on “large” employers if just one full-time employee receives a premium tax credit. Premium tax credits are available to employees who enroll in a qualified health plan through a government-run Health Insurance Marketplace (e.g. exchanges) and meet certain income requirements — but only if: they don’t have access to “minimum essential coverage” from their employer, or the employer coverage offered is “unaffordable” or doesn’t provide “minimum value.” The IRS has issued detailed guidance on what these terms mean and how employers can determine whether they’re a “large” employer and, if so, whether they’re offering sufficient coverage to avoid the risk of penalties.

Review your company’s employee benefits with your tax advisor to determine which benefits may provide additional business tax savings. If you are planning to add new benefits, explore the advantages and tax implications first.

Continue Reading: Which tax credits apply to my business in 2016?

If you have questions about any of these potential deductions, employee benefits incentives or tax credits for the current or coming tax year, talk to the Tax Services Group at Cornwell Jackson. You may also download our newest Tax Planning Guide.

Gary Jackson, CPA, is the lead tax partner at Cornwell Jackson. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing tax advisory services to individuals and business leaders in the Dallas/Fort Worth area and across North Texas. 

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Posted on Nov 14, 2016

advisory services, business tax, business services, tax services, CPA in Dallas

Running a profitable business these days isn’t easy. You have to operate efficiently, market aggressively and respond swiftly to competitive and financial challenges. Even when you do all of that, taxes may drag down your bottom line more than they should.

Projecting your business’s income for this year and next can allow you to time income and deductions to your advantage. It’s generally — but not always — better to defer tax, so consider:

Deferring income to next year

If your business uses the cash method of accounting, you can defer billing for products or services at year-end. If you use the accrual method, you can delay shipping products or delivering services.

Accelerating deductible expenses into the current year

If you’re a cash-basis taxpayer, you may pay business expenses by December 31 so you can deduct them 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. You may also choose to take the opposite approach. If it’s likely you’ll be in a higher tax bracket next year, accelerating income and deferring deductible expenses may save you more tax over the two-year period.

Don’t forget about depreciation of larger assets as a way to reduce taxable income. For assets with a useful life of more than one year, you generally must depreciate the cost over a period of years. In most cases, the Modified Accelerated Cost Recovery System (MACRS) will be preferable to other methods because you’ll get larger deductions in the early years of an asset’s life. But if you made more than 40% of the year’s asset purchases in the last quarter of 2016, you could be subject to the typically less favorable midquarter convention. Careful planning can help you maximize depreciation deductions in 2017. Other depreciation-related breaks and strategies may still be available for 2016:

Section 179 expensing election

This election allows you to deduct (rather than depreciate over a number of years) the cost of purchasing eligible new or used assets, such as equipment and furniture. The expensing limit for 2015 had been $25,000 — and the break was to begin to phase out dollar-for-dollar when total asset acquisitions for the tax year exceeded $200,000 — but Congress revived the 2014 levels of $500,000 and $2 million, respectively, for 2015. These amounts are annually adjusted for inflation, with the election at $2.01 million and  $500,000 for 2016.

The new expensing election permanently includes off-the-shelf computer software as qualified property. Beginning in 2016, it adds air conditioning and heating units to the list. You can claim the election only to offset net income from a “trade or business,” not to reduce it below zero to create a loss.

The break allowing Section 179 expensing for qualified leasehold improvement, restaurant and retail-improvement property has also been made permanent. For 2015, a $250,000 limit applied, but for 2016 the full Sec. 179 expensing limit applies.

50% bonus depreciation

This additional first-year depreciation for qualified assets expired December 31, 2014, but it has now been extended through 2019. However, it will drop to 40% for 2018 and 30% for 2019. Qualified assets include new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), off-the-shelf computer software, water utility property and qualified leasehold improvement property. Beginning in 2016, the qualified improvement property doesn’t have to be leased.

Accelerated depreciation

The break allowing a shortened recovery period of 15 years — rather than 39 years — for qualified leasehold improvement, restaurant and retail-improvement property expired December 31, 2014. However, it has now been made permanent.

Tangible property repairs

A business that has made repairs to tangible property, such as buildings, machinery, equipment and vehicles, can expense those costs and take an immediate deduction. But costs incurred to acquire, produce or improve tangible property must be depreciated. Final IRS regulations released in late 2013 distinguish between repairs and improvements and include safe harbors for qualified businesses and routine maintenance. The final regulations are complex and are still being interpreted, so check with your CPA or tax services advisor on how it may apply to you.

Cost segregation study

If you’ve recently purchased or built a building or are remodeling existing business space, consider a cost segregation study. It identifies property components that can be depreciated much faster, increasing your current deductions. Typical assets that qualify include decorative fixtures, security equipment, parking lots and landscaping.

Hire Your Children

If your children don’t have earned income and you own a business, consider hiring them. As the business owner, you can deduct their pay. Other tax benefits may also apply. The children must be paid in line with what you would pay non-family employees for the same work.

Vehicle-related deductions

Business-related vehicle expenses can be deducted using the mileage-rate method (54 cents per mile driven in 2016) or the actual-cost method (total out-of-pocket expenses for fuel, insurance, repairs and other vehicle expenses, plus depreciation). Purchases of new or used vehicles may be eligible for Sec. 179 expensing. However, many rules and limits apply.

For autos placed in service in 2016, the first-year depreciation limit is $3,160. The amount that may be deducted under the combination of MACRS depreciation and Sec. 179 for the first year is limited under the luxury auto rules to $11,160. In addition, if a vehicle is used for business and personal purposes, the associated expenses, including depreciation, must be allocated between deductible business use and nondeductible personal use.

NOLs

A net operating loss occurs when a C corporation’s operating expenses and other deductions for the year exceed its revenues. Generally, an NOL may be carried back two years to generate a refund. Any loss not absorbed is carried forward up to 20 years to offset income. Carrying back an NOL may provide a needed influx of cash. But you can elect to forgo the carryback if carrying the entire loss forward may be more

beneficial. This might be the case if you expect your income to increase substantially compared to the prior two years…or for tax rates to go up in future years.

Section 199 deduction

The Section 199 deduction, also called the “manufacturers’ deduction” or “domestic production activities deduction,” (DPAD) is 9% of the lesser of qualified production activities income or taxable income. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts. The deduction is available to traditional manufacturers and to businesses engaged in activities such as construction, engineering, architecture, computer software production and agricultural processing. It isn’t allowed in determining net self-employment earnings and generally can’t reduce net income below zero. But it can be used against the Alternative Minimum Tax calculation.

Not all of these deductions will apply to your particular business, but knowing about them supports better business tax planning in 2017.

Continue Reading: Which employee benefits offer 2016 tax savings?

If you have questions about any of these potential deductions, employee benefits incentives or tax credits for the current or coming tax year, talk to the Tax Services Group at Cornwell Jackson. You may also download our newest Tax Planning Guide.

Gary Jackson, CPA, is the lead tax partner at Cornwell Jackson. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing tax advisory services to individuals and business leaders in the Dallas/Fort Worth area and across North Texas. 

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Posted on Aug 1, 2016
Tax forms 1065
Tax forms 1065

Unless you’ve extended the due date for filing last year’s individual federal income tax return to October 17, the filing deadline passed you by in April. What if you didn’t extend and you haven’t yet filed your Form 1040? And what if you can’t pay your tax bill? This article explains how to handle these situations.

“I Didn’t File but I Don’t Owe”

Let’s say you’re certain that you don’t owe any federal income tax for last year. Maybe you had negative taxable income or paid your fair share via withholding or estimated tax payments. But you didn’t file or extend the deadline because you were missing some records, were too busy, or had some other convincing reason (to you) for not meeting the deadline.

No problem, since you don’t owe — right? Wrong.

While it’s true there won’t be IRS interest or penalties (these are based on your unpaid liability, which you don’t have), blowing off filing is still a bad idea. For example:

You may be due a refund. Filing a return gets your money back. Without a return, there is no refund.
Until a return is filed, the three-year statute-of-limitations period for the commencement of an IRS audit never gets started. The IRS could then decide to audit your 2015 tax situation five years (or more) from now and hit you with a tax bill plus interest and penalties. By then, you may not be able to prove that you actually owed nothing. In contrast, when you do the smart thing and file a 2015 return showing zero tax due, the government must generally begin any audit within three years. Once the three-year window closes, your 2015 tax year is generally safe from audit, even if the return had problems.
If you had a tax loss in 2015, you may be able to carry it back as far as your 2013 tax year and claim refunds for taxes paid in 2013 and/or 2014. However, until you file a 2015 return, your tax loss doesn’t officially exist, and no loss carryback refund claims are possible.
There are other more esoteric reasons that apply to taxpayers in specific situations.

The bottom line is, you should file a 2015 return, even though you’ve missed the deadline and believe you don’t owe.

“I Owe but Don’t Have the Dough”

In this situation, there’s no excuse for not filing your 2015 return, especially if you obtained a filing extension to October 17.

If you did extend, filing your return by October 17 will avoid the 5%-per-month “failure-to-file” penalty. The only cost for failing to pay what you owe is an interest charge. The current rate is a relatively reasonable 0.83% per month, which amounts to a 10% annual rate. This rate can change quarterly, and you’ll continue to incur it until you pay up. If you still can’t pay when you file by the extended October 17 due date, relax. You can arrange for an installment arrangement (see below).

If you didn’t extend, you’ll continue to incur the 5%-per-month failure-to-file penalty until it cuts off:

Five months after the April 19 due date for filing your 2015 return or
When you file, whichever occurs sooner.
While the penalty can’t be assessed for more than five months, it can amount to up to 25% of your unpaid tax bill (5 times 5% per month equals 25%). So you can still save some money by filing your 2015 return as soon as possible to cut off the 5%-per-month penalty. Then you’ll continue to be charged only the IRS interest rate — currently 0.83% per month — until you pay.

If you still don’t file your 2015 return, the IRS will collect the resulting penalty and interest. You’ll be charged the failure-to-file penalty until it hits 25% of what you owe. For example, if your unpaid balance is $10,000, you’ll rack up monthly failure-to-file penalties of $500 until you max out at $2,500. After that, you’ll be charged interest until you settle your account (at the current monthly rate of 0.83%).

Save Money with an Installment Agreement

By now you understand why filing your 2015 return is crucial even if you don’t have the money to pay what you owe. But you may ask: When do I have to come up with the balance due? The answer: As soon as possible, if you want to halt the IRS interest charge. If you can borrow at a reasonable rate, you may want to do so and pay off the government, hopefully at the same time you file your return or even sooner if possible.

Alternatively, you can usually request permission from the IRS to pay off your bill in installments. This is done by filing a form with your 2015 return. On the form, you suggest your own terms. For example, if you owe $5,000, you might offer to pay $250 on the first of each month. You’re supposed to get an answer to your installment payment application within 31 days of filing the form, but it sometimes takes a bit longer. Upon approval, you’ll be charged a $120 setup fee or $52 if you agree to automatic withdrawals from your bank account.

As long as you have an unpaid balance, you’ll be charged interest (currently at 0.583% a month, which equates to a 7% annual rate), but this may be much lower than you could arrange with a commercial lender. Other details:

Approval of your installment payment request is automatic if you owe $10,000 or less (not counting interest or penalties), propose a repayment period of 36 months or less, haven’t entered into an earlier installment agreement within the preceding five years, and have filed returns and paid taxes for the preceding five tax years.
A streamlined installment payment approval process is available if you owe between $10,001 and $25,000 (including any assessed interest and penalties) and propose a repayment period of 72 months or less.
Another streamlined process is available if you owe between $25,001 and $50,000 and propose a repayment period of 72 months or less. However, you must agree to automatic bank withdrawals, and you may have to supply financial information.
If you owe $50,000 or less, you can apply for an installment payment arrangement online instead of filing an IRS form.
Finally, if you can pay what you owe within 120 days, you can arrange for an agreement with the IRS and avoid any setup fee.
Warning: When you enter into an installment agreement, you must pledge to stay current on your future taxes. The government is willing to help with your 2015 unpaid liability, but it won’t agree to defer payments for later years while you’re still paying the 2015 tab.

Pay With a Credit Card

You can also pay your federal tax bill with Visa, MasterCard, Discover or American Express. But before pursuing this option, ask about the one-time fee your credit card company will charge and the interest rate. You may find the IRS installment payment program is a better deal.

Act Soon

Filing a 2015 federal income return is important even if you believe you don’t owe anything or can’t pay right now. If you need assistance or want more information, contact your tax adviser.

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Posted on Apr 27, 2016

Alternative Minimum Tax

Congress originally devised the alternative minimum tax (AMT) rules to ensure that high-income individuals who take advantage of multiple tax breaks will owe something to Uncle Sam each year. In recent years, however, that concept has eroded. Now, even upper-middle-income taxpayers are likely to owe the AMT. Here’s an overview of how the AMT works and possible ways to minimize it.

Don’t Overlook the AMT Credit

If you owed the AMT last year, you may have earned an AMT credit that will reduce your regular federal income tax bill in the current tax year. Many taxpayers who pay the AMT fail (or forget) to claim their rightful AMT credits the following year.

There are two reasons you earn an AMT credit for a tax year:

1. If you owed the AMT from exercising in-the-money incentive stock options, or

2. If your AMT bill was caused by claiming accelerated depreciation write-offs.

The first situation is common, especially with employees of start-ups and high-tech firms. The second typically happens only if you own an interest in a business with significant investments in depreciable assets.

Ask your tax adviser if you earned an AMT credit. But, be advised that you can claim it only if your regular federal income tax liability exceeds your AMT liability for the tax year. That’s because you’re allowed to use the credit to reduce only regular federal income taxes (not the AMT). Put another way, you can’t claim the AMT credit on your current return if you owe the AMT again this year.

So, you still must calculate your AMT liability for the current year. The difference between your AMT liability and your regular federal income tax liability is the maximum amount of AMT credit you can claim on your current-year return. In other words, you can use the AMT credit to equalize your regular federal income tax and the AMT for the current year, but that’s it. After taking this limitation into account, any leftover AMT credit is carried forward to next year.

AMT Basics

Think of the AMT as an alternate set of tax rules that are similar to the regular federal income tax system. But there are key differences. For example, under the AMT rules, certain types of income that are tax-free under the regular federal income tax system are taxable. The AMT rules also disallow certain deductions and credits that are allowed under the regular federal income tax system. And the maximum AMT rate is only 28% compared to the 39.6% maximum rate that applies under the regular federal income tax system.

In addition, taxpayers are allowed a relatively large inflation-adjusted AMT exemption, which is deducted when you calculate AMT income. Unfortunately, the exemption is phased out when your AMT income surpasses certain levels.

If your AMT liability exceeds your regular federal income tax liability for the tax year, you must pay the higher AMT amount.

Why Upper-Middle-Income Taxpayers Get Hit

After repetitive tax law changes, the AMT often doesn’t apply to the wealthiest taxpayers in the highest tax bracket. That’s because many of their tax breaks are already cut back or eliminated under the regular federal income tax rules before getting to the AMT calculation.

For instance, the passive activity loss rules greatly restrict the tax benefits that can be reaped from “shelter” investments, including rental real estate and limited partnerships. And, if your income exceeds certain levels, phaseout rules are likely to reduce or eliminate various tax breaks, such as personal and dependent exemption deductions, itemized deductions, higher-education tax credits and deductions for college loan interest.

Moreover, individuals in the 35% or 39.6% tax brackets are less likely to be hit with the AMT, which has a maximum tax rate of 28%. Finally, the AMT exemption — which is deducted when you calculate AMT income — is phased out as income goes up. This phaseout has little or no impact on individuals with the highest incomes, but it increases the likelihood that upper-middle-income taxpayers will owe the AMT.

AMT Risk Indicators

Various inter-related factors make it hard to pinpoint who will be hit by the AMT. But taxpayers are generally more at risk if they have:

    • Substantial (but not necessarily huge) salary income (more than $250,000 per year).
    • Significant long-term capital gains and/or dividends.
    • Large deductions for state and local income and property taxes.
    • A spouse and several children (e.g., at least four) who provide personal and dependent exemption deductions for regular federal income tax purposes. (These deductions are disallowed under the AMT rules.)
    • Significant miscellaneous itemized deductions, such as investment expenses, fees for tax advice and unreimbursed employee business expenses.
    • Interest from private activity bonds. This income is tax-free for regular federal income tax purposes, but it’s taxable under the AMT rules.
  • Significant depreciation write-offs for personal property assets, such as machinery, equipment, computers, furniture, and fixtures from your own business or from investments in S corporations, LLCs or partnerships. These assets must be depreciated over longer periods under the AMT rules.

Another noteworthy factor that’s likely to trigger the AMT is exercising in-the-money incentive stock options (ISOs) during the tax year. The so-called “bargain element” — the difference between the market value of the shares on the exercise date and the exercise price — doesn’t count as income under regular federal income tax rules, but it counts as income under the AMT rules.

A significant spread between a stock’s current market value and an ISO’s exercise price can result in an unexpected AMT liability. Consult your tax professional before exercising your options. Depending on current and anticipated market conditions, it may be advantageous to exercise them over several years to minimize the adverse AMT effects.

Possible Ways to Minimize the AMT

Any strategy that reduces your adjusted gross income (AGI) might help to reduce or avoid the AMT. AGI includes all taxable income items and certain non-itemized deductions, such as moving expenses and alimony paid.

By lowering AGI, you may be able to claim a higher AMT exemption. Here are some considerations that may help reduce your AGI:

    • Contribute as much as you can to your tax-favored retirement plan, such as a 401(k) plan, profit-sharing plan or SEP.
    • Contribute to your cafeteria benefit plan at work. Contributions lower your taxable salary and AGI. Most cafeteria plans include healthcare and dependent care flexible spending account arrangements.
    • Harvest losses from investments held in taxable brokerage firm accounts. Then use the capital losses to offset any capital gains. Any leftover capital losses up to $3,000 are deductible against income from salary, interest, dividends, self-employment and other sources.
    • Defer the sale of appreciated investments held in taxable brokerage firm accounts until next year. Doing so will defer the resulting taxable gains.
  • Prepay deductible business expenses near year end if you run a business as a sole proprietorship, limited liability company, partnership or S corporation. The resulting business deductions will be “passed through” to you, thereby lowering AGI. Similarly, postpone the receipt of business income until next year to reduce your AGI in the current tax year.

Important note: Lowering AGI will also slash your state and local income taxes, which are disallowed for AMT purposes and, therefore, increase your AMT exposure. Likewise, if you’re likely to be hit with the AMT, the traditional tax year-end strategy of prepaying state and local income and property taxes that are due early next year won’t help you. Those taxes aren’t deductible under the AMT rules. So prepay them in a year when you have a chance of not being in the AMT mode.

Address the AMT Head-On

Taxpayers can’t automatically assume they’re exempt from the AMT. Most individuals in the higher tax brackets probably have some risk factors. The IRS has trained auditors to find unsuspecting folks who owe the AMT. If you’re not careful, you could owe back taxes, interest and potential penalties under the AMT rules.

Consult with your tax adviser about your specific situation. Cornwell Jackson’s tax team can identify whether you’re at risk and help find ways to reduce your exposure to the AMT that also factor in current market conditions and other personal investment goals.

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Posted on Jan 22, 2016

At the end of last year, the Protecting Americans from Tax Hikes Act of 2015 was signed into law. Known as the PATH Act, it does more than just extend expired and expiring tax provisions for another year. The new law makes many temporary tax breaks permanent.

This provides some stability in planning. When it comes to certain deductions and credits, taxpayers will no longer have to wait for Congress to pass a temporary tax extenders law — often at the end of the year — in order to plan tax-saving strategies.

Here’s an overview of how individuals and businesses can benefit from the latest tax package.

Tax Breaks for Individuals

American Opportunity education credit. Eligible taxpayers can take an annual credit of up to $2,500 for various tuition and related expenses for each of the first four years of postsecondary education. The credit phases out based on modified adjusted gross income (MAGI) beginning at $80,000 for single filers and $160,000 for joint filers, indexed for inflation. The new law makes this credit permanent.

Tuition and fees deduction. The new law extends through 2016 the above-the-line deduction for qualified tuition and related expenses for higher education. The deduction is capped at $4,000 for taxpayers whose adjusted gross income (AGI) doesn’t exceed $65,000 ($130,000 for joint filers) or, for those beyond those amounts, $2,000 for taxpayers whose AGI doesn’t exceed $80,000 ($160,000 for joint filers).

Small business stock gains exclusion. The PATH Act makes permanent the exclusion of 100% of the gain on the sale or exchange of qualified small business (QSB) stock acquired and held for more than five years. The 100% exclusion is available for QSB stock acquired after September 27, 2010.

A QSB is generally a domestic C corporation that has gross assets of no more than $50 million at any time (including when the stock is issued) and uses at least 80% of its assets in an active trade or business. The law also permanently extends the rule that eliminates QSB stock gain as a preference item for alternative minimum tax (AMT) purposes.

Charitable giving from IRAs. The PATH Act makes permanent the provision that allows taxpayers who are age 70½ or older to make direct contributions from their IRAs to qualified charitable organizations up to $100,000 per tax year. If you take advantage of this opportunity, you can’t claim a charitable or other deduction for the contributions, but the amounts aren’t considered taxable income and can be used to satisfy your required minimum distributions.

To qualify for the exclusion from income for IRA contributions for a tax year, you need to arrange a direct transfer by the IRA trustee to an eligible charity by December 31. Donor-advised funds and supporting organizations aren’t eligible recipients.

Transit benefits. Do you commute to work via a van pool or public transportation? The law makes permanent the requirement that limits on the amounts that can be excluded from an employee’s wages for income and payroll tax purposes be the same for parking benefits and van pooling / mass transit benefits.

For 2015, the monthly limit is $250. Before the PATH Act, the 2015 monthly limit was only $130 for van pooling / mass transit benefits. (The $250 limit increases to $255 for 2016.)

State and local sales tax deduction. Taxpayers can take an itemized deduction for state and local sales taxes, instead of for state and local income taxes. This tax break is now permanent. The deduction is especially valuable for individuals who live in states without income taxes and those who purchase major items, such as a car or boat.

Energy tax credit. The PATH Act extends through 2016 the credit for purchases of residential energy property. Examples include new high-efficiency heating and air conditioning systems, insulation, energy-efficient exterior windows and doors, high-efficiency water heaters and stoves that burn biomass fuel.

The provision allows a credit of 10% of expenditures for qualified energy improvements, up to a lifetime limit of $500.

Mortgage-related tax breaks. Under the new law, you can treat qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction through 2016. However, the deduction phases out for taxpayers with AGI of $100,000 to $110,000.

In addition, the PATH Act extends through 2016 the exclusion from gross income for mortgage loan forgiveness. It also modifies 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.

Educator expense deductions. Qualifying elementary and secondary school teachers can claim an above-the-line deduction for up to $250 per year of expenses paid or incurred for books, certain supplies, computer and other equipment, and supplementary materials used in the classroom. Under the new law, beginning in 2016, the deduction is indexed for inflation and includes professional development expenses.

Tax Breaks for Businesses

Section 179 deduction. Tax law allows businesses to elect to immediately deduct — or expense — the cost of certain tangible personal property acquired and placed in service during the tax year. The Section 179 deduction is in lieu of recovering the costs more slowly through depreciation deductions. Keep in mind the election can only offset net income — it can’t reduce it below $0 to create a net operating loss. There are also other restrictions.

The election is also subject to annual dollar limits. For 2014, businesses could expense up to $500,000 in qualified new or used assets, subject to a dollar-for-dollar phaseout once the cost of all qualifying property placed in service during the tax year exceeded $2 million. Without the PATH Act, the expensing limit and the phaseout amounts for 2015 would have sunk to $25,000 and $200,000, respectively.

The new law makes the higher limits permanent and indexes them for inflation beginning in 2016. It also makes permanent the ability to apply Sec. 179 expensing to qualified real property, reviving the 2014 limit of $250,000 on such property for 2015 but raising it to the full Sec. 179 limit beginning in 2016. Qualified real property includes qualified leasehold-improvement, restaurant and retail-improvement property.

Finally, the new law permanently includes off-the-shelf computer software on the list of qualified property. And, beginning in 2016, it adds air conditioning and heating units.

Bonus depreciation. Bonus depreciation allows businesses to recover the costs of depreciable property more quickly by claiming bonus first-year depreciation for qualified assets. It’s been extended, but only through 2019 and with declining benefits in the later years. For property placed in service during 2015, 2016 and 2017, the bonus depreciation percentage is 50%. It drops to 40% for 2018 and 30% for 2019.

The provision continues to allow businesses to claim unused AMT credits in lieu of bonus depreciation. Beginning in 2016, the amount of unused AMT credits that may be claimed increases.

Qualified assets include new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), off-the-shelf computer software, water utility property and qualified leasehold-improvement property. Beginning in 2016, qualified improvement property doesn’t have to be leased to be eligible for bonus depreciation.

Accelerated depreciation of qualified real property. The PATH Act permanently extends the 15-year straight-line cost recovery period for qualified leasehold improvements (building alterations to suit the needs of a tenant), qualified restaurant property and qualified retail-improvement property. These expenditures are now exempt from the normal 39-year depreciation period.

This is beneficial for restaurants and retailers because they tend to remodel periodically. If eligible, they may first apply Section 179 expensing and then enjoy this accelerated depreciation on qualified expenses in excess of the applicable Section 179 limit.

Research credit. This valuable credit provides an incentive for businesses to increase their investments in research. However, the temporary nature of the credit deterred some businesses from pursuing critical innovations.

The PATH Act permanently extends the credit. Additionally, beginning in 2016, businesses with $50 million or less in gross receipts can claim the credit against AMT liability, and certain start-ups (generally, those with less than $5 million in gross receipts) that haven’t yet incurred income tax liability can use the credit against their payroll tax.

Work Opportunity tax credit. Employers that hire individuals who are members of a “target group” can claim this credit, which has been extended through 2019. The new law also expands the credit beginning in 2016 to apply to employers that hire qualified individuals who have been unemployed for 27 weeks or more.

The credit amount varies depending on:

  • The target group of the individual hired;
  • Wages paid to the employee; and
  • Hours worked by the new hire during the first year of employment.

The maximum credit that can be earned for each qualified adult employee is generally $2,400. The credit can be as high as $9,600 per qualified veteran. Employers aren’t subject to a limit on the number of eligible individuals they can hire.

You must obtain certification that an employee is a member of a target group from the appropriate State Workforce Agency before claiming the credit. The certification must be requested within 28 days after the employee begins work. For 2015, the IRS may extend the deadline as it did for 2014, when legislation reviving the credit for that year wasn’t passed until late in the year — meaning that the 28-day period had already expired for many covered employees hired in 2014.

Food inventory donations. The PATH Act makes permanent the enhanced deduction for contributions of food inventory for non-corporate business taxpayers. Under the enhanced deduction (which is already permanently available to C corporations), the lesser of basis plus one-half of the item’s appreciation or two times basis can be deducted, rather than only the lesser of basis or fair market value. Beginning in 2016, the limit on deductible contributions of inventory increases from 10% to 15% of the business’s AGI per year.

S corporation recognition period for built-in gains tax. S corporation income generally is passed through to its shareholders, who pay tax on their pro-rata shares. If a C corporation elects to become an S corporation, the newly created S corporation is taxed at the highest corporate rate (currently 35%) on all gains that were built-in at the time of the election and recognized during the “recognition period.”

Generally, this period is 10 years. But, under the new law, it’s only five years, beginning on the first day of the first tax year for which the corporation was an S corporation.

Commuting benefits. The PATH Act makes permanent the provision that established equal limits for the amounts that can be excluded from an employee’s wages for income and payroll tax purposes for parking fringe benefits and van-pooling / mass transit benefits. The limits for both types of benefits are now $250 per month for 2015. Without the parity extension, the limit for van-pooling / mass transit would be only $130.

Tax Planning with More Certainty

Many of these tax breaks may seem familiar, because they’re continuations from previous years. Under the PATH Act, there are now significant tax planning opportunities for individuals and businesses. The permanent extensions of some valuable tax breaks will make it easier for taxpayers to plan ahead. Keep in mind that this article only touches on some of the new law’s provisions. There may be extensions and enhancements that can benefit you as an individual taxpayer and your company if you’re a business owner or executive.

 

Contact your Cornwell Jackson tax advisor to determine how you can make the most of this tax relief.

 

 

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