Archives for July 2023

A Tax-Smart Way To Develop And Sell Appreciated Land

Ken Botwinick, CPA | 07/28/2023

Let’s say you own highly appreciated land that’s now ripe for development. If you subdivide it, develop the resulting parcels and sell them off for a hefty profit, it could trigger a large tax bill.

In this scenario, the tax rules generally treat you as a real estate dealer. That means your entire profit — including the portion from pre-development appreciation in the value of the land — will be treated as high-taxed ordinary income subject to a federal rate of up to 37%. You may also owe the 3.8% net investment income tax (NIIT) for a combined federal rate of up to 40.8%. And you may owe state income tax too.

It would be better if you could arrange to pay lower long-term capital gain (LTCG) tax rates on at least part of the profit. The current maximum federal income tax rate on LTCGs is 20% or 23.8% if you owe the NIIT.

Potential tax-saving solution

Thankfully, there’s a strategy that allows favorable LTCG tax treatment for all pre-development appreciation in the land value. You must have held the land for more than one year for investment (as opposed to holding it as a real estate dealer).

The portion of your profit attributable to subsequent subdividing, development and marketing activities will still be considered high-taxed ordinary income, because you’ll be considered a real estate dealer for that part of the process.

But if you can manage to pay a 20% or 23.8% federal income tax rate on a big chunk of your profit (the pre-development appreciation part), that’s something to celebrate.

Three-step strategy

Here’s the three-step strategy that could result in paying a smaller tax bill on your real estate development profits.

1. Establish an S corporation

If you individually own the appreciated land, you can establish an S corporation owned solely by you to function as the developer. If you own the land via a partnership, or via an LLC treated as a partnership for federal tax purposes, you and the other partners (LLC members) can form the S corp and receive corporate stock in proportion to your percentage partnership (LLC) interests.

2. Sell the land to the S corp

Sell the appreciated land to the S corp for a price equal to the land’s pre-development fair market value. If necessary, you can arrange a sale that involves only a little cash and a big installment note the S corp owes you. The business will pay off the note with cash generated by selling off parcels after development. The sale to the S corp will trigger a LTCG eligible for the 20% or 23.8% rate as long as you held the land for investment and owned it for over one year.

3. Develop the property and sell it off

The S corp will subdivide and develop the property, market it and sell it off. The profit from these activities will be higher-taxed ordinary income passed through to you as an S corp shareholder. If the profit is big, you’ll probably pay the maximum 37% federal rate (or 40.8% percent with the NIIT. However, the average tax rate on your total profit will be much lower, because a big part will be lower-taxed LTCG from pre-development appreciation.

Favorable treatment

Thanks to the tax treatment created by this S corp developer strategy, you can lock in favorable treatment for the land’s pre-development appreciation. That’s a huge tax-saving advantage if the land has gone up in value. Consult with us if you have questions or want more information.

Use An S Corporation To Mitigate Federal Employment Tax Bills

Ken Botwinick, CPA | 07/28/2023

If you own an unincorporated small business, you probably don’t like the size of your self-employment (SE) tax bills. No wonder!

For 2023, the SE tax is imposed at the painfully high rate of 15.3% on the first $160,200 of net SE income. This includes 12.4% for Social Security tax and 2.9% for Medicare tax. The $160,200 Social Security tax ceiling is up from the $147,000 ceiling for 2022, and it’s only going to get worse in future years, thanks to inflation. Above the Social Security tax ceiling, the Medicare tax component of the SE tax continues at a 2.9% rate before increasing to 3.8% at higher levels of net SE income thanks to the 0.9% additional Medicare tax, on all income.

The S corp advantage

For wages paid in 2023 to an S corporation employee, including an employee who also happens to be a shareholder, the FICA tax wage withholding rate is 7.65% on the first $160,200 of wages: 6.2% for Social Security tax and 1.45% for Medicare tax. Above $160,200, the FICA tax wage withholding rate drops to 1.45% because the Social Security tax component is no longer imposed. But the 1.45% Medicare tax wage withholding hits compensation no matter how much you earn, and the rate increases to 2.35% at higher compensation levels thanks to the 0.9% additional Medicare tax.

An S corporation employer makes matching payments except for the 0.9% Additional Medicare tax, which only falls on the employee. Therefore, the combined employee and employer FICA tax rate for the Social Security tax is 12.4%, and the combined rate for the Medicare tax is 2.9%, increasing to 3.8% at higher compensation levels — same as the corresponding SE tax rates.

Note: In this article, we’ll refer to the Social Security and Medicare taxes collectively as federal employment taxes whether paid as SE tax for self-employed folks or FICA tax for employees.

Strategy: Become an S corporation

While wages paid to an S corporation shareholder-employee get hit with federal employment taxes, any remaining S corp taxable income that’s passed through to the employee-shareholder is exempt from federal employment taxes. The same is true for cash distributions paid out to a shareholder-employee. Since passed-through S corporation taxable income increases the tax basis of a shareholder-employee’s stock, distributions of corporate cash flow are usually free from federal income tax.

In appropriate circumstances, an S corp can follow the tax-saving strategy of paying modest, but justifiable, salaries to shareholder-employees. At the same time, it can pay out most or all of the remaining corporate cash flow in the form of federal-employment-tax-free shareholder distributions. In contrast, an owner’s share of net taxable income from a sole proprietorship, partnership and LLC (treated as a partnership for tax purposes) is generally subject to the full ravages of the SE tax.

Potential negative side effect

Running your business as an S corporation and paying modest salaries to the shareholder-employee(s) may mean reduced capacity to make deductible contributions to tax-favored retirement accounts. For example, if an S corporation maintains a SEP, the maximum annual deductible contribution for a shareholder-employee is limited to 25% of salary. So the lower the salary, the lower the maximum contribution. However, if the S corp sets up a 401(k) plan, paying modest salaries generally won’t preclude generous contributions.

Other implications

Converting an unincorporated business into an S corporation has other legal and tax implications. It’s a big decision. We can explain all the issues.

FAQs

What is the process for becoming an S corporation?

To become an S corporation, you must first form a regular corporation by filing the necessary documents with your state’s Secretary of State or similar agency. Once the corporation is formed, you can elect S corporation status by filing Form 2553 with the IRS. This form must be filed within a certain timeframe after the corporation is formed or at the beginning of the tax year in which you want S corporation status to take effect.

Are there any specific eligibility requirements for businesses to qualify as an S corporation?

There are a number of general requirements that must be met to qualify as an S corporation. These include being a domestic corporation, having only allowable shareholders (which generally means individuals, estates, certain trusts, and tax-exempt organizations), having no more than 100 shareholders, and having only one class of stock. Additionally, shareholders must be U.S. citizens or residents and the corporation cannot be an ineligible corporation (such as certain financial institutions or insurance companies).

Starting A Business? How Expenses Will Be Treated On Your Tax Return

Ken Botwinick, CPA | 07/12/2023

Government officials saw a large increase in the number of new businesses launched during the COVID-19 pandemic. And the U.S. Census Bureau reports that business applications are still increasing slightly (up 0.4% from April 2023 to May 2023). The Bureau measures this by tracking the number of businesses applying for Employer Identification Numbers.

If you’re one of the entrepreneurs, you may not know that many of the expenses incurred by start-ups can’t be currently deducted on your tax return. You should be aware that the way you handle some of your initial expenses can make a large difference in your federal tax bill.

Handling expenses

Here’s the three-step strategy that could result in paying a smaller tax bill on your real estate development profits.

1. Start-up costs include those incurred or paid while creating an active trade or business — or investigating the creation or acquisition of one.

2. Under the tax code, taxpayers can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the business begins. As you know, $5,000 doesn’t go very far these days! And the $5,000 deduction is reduced dollar-for-dollar by the amount by which your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis.

3. No deductions or amortization deductions are allowed until the year when “active conduct” of your new business begins. Generally, that means the year when the business has all the pieces in place to start earning revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask questions such as: Did the taxpayer undertake the activity intending to earn a profit? Was the taxpayer regularly and actively involved? Did the activity actually begin?

Rules to qualify

In general, start-up expenses are those you incur to:

Investigate the creation or acquisition of a business,
Create a business, or
Engage in a for-profit activity in anticipation of that activity becoming an active business.

To qualify for the election, an expense also must be one that would be deductible if it were incurred after a business began. One example is money you spend analyzing potential markets for a new product or service.

To be eligible as an “organization expense,” an expense must be related to establishing a corporation or partnership. Some examples of organization expenses are legal and accounting fees for services related to organizing a new business and filing fees paid to the state of incorporation.

Decision to be made

If you have start-up expenses that you’d like to deduct this year, you need to decide whether to take the election described above. Recordkeeping is critical. Contact us about your start-up plans. We can help with the tax and other aspects of your new business.

FAQs

Are there any tax benefits or credits available for new businesses or startups?

Yes, there are several tax benefits and credits available for new businesses or startups. New businesses can deduct certain expenses, such as office supplies, equipment purchases, and business-related travel. Startups that engage in qualified research activities may also be eligible for a tax credit to offset their R&D expenses. Additionally, hiring certain employees, such as veterans or individuals from targeted groups, may qualify your business for tax credits. Many states and local jurisdictions also offer specific tax incentives to attract new businesses or encourage local economic development. It’s important to consult with a tax professional or accountant to ensure you are aware of all the available benefits and credits that apply to your specific situation.

What is one important piece of advice regarding handling start-up costs and expenses when starting a business?

It’s important to maintain accurate and detailed records of all your business expenses. This includes keeping receipts, invoices, and other relevant documents. Good record-keeping will not only help you identify deductible expenses but also provide evidence in case of an audit.

Experience The Benefits Of Working With A Dental CPA

Ken Botwinick, CPA | 07/03/2023

By Kenneth Botwinick, CPA

Having real-time guidance from a certified public accountant (CPA) who specializes in the dental industry is extremely valuable. If you approach your local CPA and inquire about making a significant purchase like acquiring a CBCT or a new Panorex, they might respond with confusion, asking, “what’s a CBCT?” Similarly, if you ask a non-specialized CPA about the appropriate time to consider dropping a PPO insurance plan, they may reply with uncertainty, saying “what’s a PPO?” or “How would I know?”

When presenting yourself as a professional in the field of accounting, it is crucial to have a deep understanding of the specific industry you cater to. At Botwinick & Company LLC, we are experts in dental practice accounting and have been for nearly thirty years. We successfully guided our dental clients through the worst of COVID times. Through skillful guidance and real-time open communication, we assisted and steered our clients through the PPP programs, the EIDL loans, the HRSA/HHS grants and their reporting requirements, and the employee retention credits (“ERCs”). For each of these programs, they learned about it from us first and then relied on our team to make sure their practice received all the stimulus grants they were lawfully entitled to.

However, beyond the special needs of the last several years, we as dental-specific accountants have been relied upon to provide business counsel relevant to the dental industry. It is knowledge that has been attained and refined through decades of working in the industry, attending relevant dental practice management training programs, and helping our clients from their first days of practice owners until their passing of the office keys on to the new practice owner.

If you are beginning to realize that your current CPA does not understand your business or industry, we encourage you to reach out for a no-obligation, complimentary consultation with one of our dental-specific accountants. This is the perfect opportunity to experience the advantages of working with “New Jersey’s most reliable Dental CPAs.”

How can a dental-industry-specific CPA help with tax planning and preparation?

There are a number of unique tax considerations for dental practices involving depreciation of equipment, qualified business income (QBI) deductions, employee benefits, sales tax on ancillary dental products, and self-employment taxes depending on the practice’s organizational structure. It’s always a good idea to consult with a tax professional who is familiar with the specific tax considerations for dental practices to ensure compliance and optimize your tax strategy.

What are some specific financial challenges that dental practices face, and how can a dental-specific accountant help address them?

Dental practices face several specific financial challenges, including managing cash flow, handling insurance reimbursements, tracking expenses and revenue, and understanding tax implications. A dental-specific accountant can help address these challenges by providing expertise in dental industry accounting practices and regulations. They can assist with financial planning, budgeting, and forecasting to ensure the practice is financially stable. They can also help with optimizing insurance billing processes, identifying opportunities for cost savings and efficiency improvements, ensuring tax compliance, and designing financial strategies that are aligned with the dental practice’s unique needs.

About the author: Kenneth Botwinick, CPA, is a partner with Botwinick & Company, LLC and has been with the firm for more than 25 years. Ken specializes in providing accounting, tax, and business consulting services to dental and medical practices. He established the firm’s dental-focused accounting practice and is a sought-after lecturer at dental continuing education programs. Ken has his “finger on the pulse of the dental industry,” and with comprehensive experience in ownership transitions, he assists clients in the healthcare industry to reach their professional and financial aspirations and goals.

A Tax-Smart Way To Develop And Sell Appreciated Land

Use An S Corporation To Mitigate Federal Employment Tax Bills

FAQs

Starting A Business? How Expenses Will Be Treated On Your Tax Return

FAQs

Experience The Benefits Of Working With A Dental CPA

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