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2024 business taxes

Why Every Business with Co-Owners Needs a Buy-Sell Agreement

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Are you considering purchasing a business that will have one or more co-owners? Or do you currently own such a business? If so, implementing a buy-sell agreement is a crucial step. A well-drafted agreement can offer the following benefits:

  • Transform your business ownership interest into a more liquid asset
  • Prevent unwanted ownership changes
  • Avoid complications with the IRS

Agreement Basics

There are two primary types of buy-sell agreements: cross-purchase agreements and redemption agreements (sometimes referred to as liquidation agreements).

Cross-purchase agreements are contracts between you and the other co-owners. Under this agreement, if a triggering event such as death or disability occurs, the withdrawing co-owner’s ownership interest must be purchased by the remaining co-owners.

Redemption agreements are contracts between the business entity and its co-owners. In this arrangement, the business entity is obligated to purchase the withdrawing co-owner’s ownership interest if a triggering event occurs.

Triggering Events

You and your co-owners can specify which triggering events to include in your agreement. Common events to consider are death, disability, and retirement at a specified age. Other events, such as divorce, can also be included based on your preferences.

Valuation and Payment Terms

Your buy-sell agreement should clearly outline the method for valuing business ownership interests. Common valuation methods include a fixed per-share price, an appraised fair market value, or a formula based on earnings or cash flow multiples.

Additionally, the agreement should specify how payments will be made to withdrawing co-owners or their heirs under various triggering events.

Life Insurance to Fund the Agreement

The death of a co-owner is often the most significant and catastrophic triggering event. Life insurance policies can serve as the financial foundation for your buy-sell agreement.

In a simple cross-purchase agreement between two co-owners, each co-owner purchases a life insurance policy on the other. If one co-owner dies, the surviving co-owner collects the insurance proceeds and uses them to buy out the deceased co-owner’s interest from the estate, surviving spouse, or other heirs. The insurance proceeds are generally free from federal income tax, provided the surviving co-owner is the original policy purchaser.

For arrangements involving more than two co-owners, the process can become complex, as each co-owner must buy life insurance policies on all the others. In such cases, using a trust or partnership to buy and maintain one policy on each co-owner can simplify the process. Upon the death of a co-owner, the trust or partnership collects the insurance proceeds tax-free and distributes the cash to the remaining co-owners, who then fulfill their buyout obligations under the cross-purchase agreement.

For redemption buy-sell agreements, the business entity purchases policies on the lives of all co-owners and uses the insurance proceeds to buy out deceased co-owners.

Ensure your agreement specifies that any buyout not funded by insurance proceeds will be paid through a multi-year installment plan. This provides the remaining co-owners with the necessary time to generate the required funds.

Certainty for Heirs

For many business co-owners, the value of their business share constitutes a significant portion of their estate. A buy-sell agreement guarantees that your ownership interest can be sold by your heirs under terms you approved. Furthermore, the price set by a well-drafted agreement establishes the value of your ownership interest for federal estate tax purposes, thereby preventing potential IRS disputes.

As a co-owner of a valuable business, having a comprehensive buy-sell agreement in place is essential. It offers financial protection for you, your heirs, and your co-owners, while also minimizing IRS complications regarding estate taxes.

Buy-sell agreements are complex and should not be handled as DIY projects. Contact us to assist you in setting up a robust buy-sell agreement.

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Borrowing from Your Closely Held Corporation: Essential Considerations

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If you own a closely held corporation, borrowing funds from your business at lower interest rates than those charged by banks can be advantageous. However, it is crucial to navigate certain risks and ensure the interest rate charged is adequate.

Strategy Basics

With the recent increase in interest rates, shareholders might prefer borrowing from their corporations instead of paying higher bank loan rates. Generally, the IRS expects closely held corporations to charge interest on related-party loans, including loans to shareholders, at least equal to the applicable federal rates (AFRs). Failure to comply with this can lead to adverse tax consequences. Fortunately, AFRs are typically lower than commercial lending rates.

Borrowing from your closely held corporation can be beneficial for covering personal expenses, such as college tuition, home improvements, a new car, or high-interest credit card debt. However, you must avoid two key risks:

Key Risks

  1. Not Establishing a Legitimate Loan: Establishing a bona fide borrower-lender relationship is crucial. If not, the IRS might reclassify the loan proceeds as additional compensation, resulting in an income tax bill for you and payroll tax liabilities for both you and your corporation. The business would be allowed to deduct the amount treated as compensation and the corporation’s share of related payroll taxes.

    Alternatively, if your company is a C corporation, the IRS might treat the loan as a taxable dividend, leading to taxable income for you without an offsetting deduction for your business.

    To avoid these issues, draft a formal written loan agreement that establishes your unconditional promise to repay a fixed amount under an installment repayment schedule or on demand by the corporation. Document the loan terms in your corporate minutes as well.

  2. Not Charging Adequate Interest: To avoid the unfavorable “below-market loan rules,” your business must charge at least the IRS-approved AFR. (An exception exists if the aggregate loans from the corporation to a shareholder are $10,000 or less.)

Current AFRs

The IRS publishes AFRs monthly based on market conditions. For loans made in July 2024, the AFRs are:

  • 4.95% for short-term loans of up to three years,
  • 4.40% for mid-term loans of more than three years but not more than nine years, and
  • 4.52% for long-term loans of over nine years.

These annual rates assume monthly compounding of interest. The applicable AFR depends on whether the loan is a demand or term loan. A demand loan is payable in full at any time upon notice and demand by the corporation, while a term loan has a fixed repayment schedule. The AFR for a term loan applies for its entire duration.

Example

Suppose you borrow $100,000 from your corporation, with the principal to be repaid in installments over 10 years. This term loan, being over nine years, would have an AFR of 4.52% compounded monthly for 10 years. The corporation must report the loan interest as taxable income.

Conversely, if the loan agreement allows the corporation to demand full repayment at any time, it is a demand loan. The AFR is then based on a blended average of monthly short-term AFRs for the year. If interest rates rise, you must pay more interest to comply with the below-market loan rules. If rates fall, you pay a lower interest rate.

Long-term loans of more than nine years are generally more tax-efficient than short-term or demand loans as they lock in current AFRs. If interest rates drop, a high-rate term loan can be repaid early, and a new loan agreement can be made at a lower rate.

Avoid Adverse Consequences

Shareholder loans can be complex, particularly if the interest charged is below the AFR, the shareholder ceases payments, or the corporation has multiple shareholders. Contact us for professional guidance tailored to your situation.

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Key Tax-Related Deadlines for Businesses and Employers in the Third Quarter of 2024

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As we move through the third quarter of 2024, it’s important for businesses and employers to be aware of key tax-related deadlines. Please note that this list is not exhaustive, and there may be additional deadlines applicable to your specific situation. Contact us to ensure you are meeting all relevant deadlines and to learn more about the filing requirements.

July 15

  • Monthly Deposit Rule: Employers should deposit Social Security, Medicare, and withheld income taxes for June if the monthly deposit rule applies.
  • Nonpayroll Withheld Income Tax: Employers should also deposit nonpayroll withheld income tax for June if the monthly deposit rule applies.

July 31

  • Form 941: Report income tax withholding and FICA taxes for the second quarter of 2024 and pay any tax due. (See the exception below under “August 12.”)
  • Form 5500 or Form 5500-EZ: File a 2023 calendar-year retirement plan report or request an extension.

August 12

  • Form 941: Report income tax withholding and FICA taxes for the second quarter of 2024, if you deposited on time and in full all the associated taxes due.

September 16

  • Estimated Income Taxes: Calendar-year C corporations should pay the third installment of 2024 estimated income taxes.
  • Income Tax Return: Calendar-year S corporations or partnerships that filed an automatic six-month extension should file their 2023 income tax return (Form 1120-S, Form 1065, or Form 1065-B) and pay any tax, interest, and penalties due.
  • Retirement Plan Contributions: Make contributions for 2023 to certain employer-sponsored retirement plans.
  • Monthly Deposit Rule: Employers should deposit Social Security, Medicare, and withheld income taxes for August if the monthly deposit rule applies.
  • Nonpayroll Withheld Income Tax: Employers should also deposit nonpayroll withheld income tax for August if the monthly deposit rule applies.

Staying compliant with tax deadlines is crucial for avoiding penalties and interest. For a comprehensive understanding of all applicable deadlines and filing requirements, please contact us. We are here to assist you in ensuring that all your tax obligations are met in a timely manner.

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Structuring Asset Purchases in Business Acquisitions: Key Tax Considerations

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After experiencing a downturn in 2023, merger and acquisition activity in several sectors is rebounding in 2024. If you are considering buying a business, optimizing the structure of your purchase for the best post-tax results is crucial. You can potentially structure the purchase in two ways:
  1. Buy the assets of the business
  2. Buy the seller’s entity ownership interest if the target business is operated as a corporation, partnership, or LLC.

This article focuses on the asset purchase approach.

Tax Basics of Asset Purchases

When purchasing assets, the total purchase price must be allocated to the specific assets acquired. The amount allocated to each asset becomes its initial tax basis.

For depreciable and amortizable assets—such as furniture, fixtures, equipment, buildings, software, and intangibles like customer lists and goodwill—the initial tax basis determines the depreciation and amortization deductions post-acquisition.

When you eventually sell a purchased asset, you will have a taxable gain if the sale price exceeds the asset’s tax basis (initial purchase price allocation plus any post-acquisition improvements minus any post-acquisition depreciation or amortization).

Asset Purchase Results with a Pass-Through Entity

If you operate the newly acquired business as a sole proprietorship, single-member LLC treated as a sole proprietorship, partnership, multi-member LLC treated as a partnership, or S corporation, post-acquisition gains, losses, and income are passed through to you and reported on your personal tax return. Various federal income tax rates can apply to income and gains, depending on the type of asset and how long it is held before being sold.

Asset Purchase Results with a C Corporation

If you operate the newly acquired business as a C corporation, the corporation pays the taxes on post-acquisition operations and asset sales. All types of taxable income and gains recognized by a C corporation are taxed at the same federal income tax rate, which is currently 21%.

Optimizing Purchase Price Allocation

A key tax planning opportunity in an asset purchase deal lies in how you allocate the purchase price to the acquired assets. To the extent permitted, you should aim to allocate more of the purchase price to:

  • Assets that generate higher-taxed ordinary income when converted into cash (such as inventory and receivables)
  • Assets that can be depreciated relatively quickly (such as furniture and equipment)
  • Intangible assets (such as customer lists and goodwill) that can be amortized over 15 years

Conversely, you should allocate less to assets that must be depreciated over long periods (such as buildings) and to land, which cannot be depreciated.

Obtaining appraised fair market values for the purchased assets can help allocate the total purchase price to specific assets. As noted, you will generally want to allocate more of the price to certain assets and less to others for optimal tax results. Since the appraisal process can be subjective, multiple legitimate appraisals may exist for the same group of assets. The tax results from one appraisal may be more favorable for you than another.

Nothing in the tax rules prevents buyers and sellers from agreeing to use legitimate appraisals that result in acceptable tax outcomes for both parties. Agreeing on appraised values is part of the purchase/sale negotiation process. However, the final agreed-upon appraisal must be reasonable.

Plan Ahead

When buying the assets of a business, remember that the total purchase price must be allocated to the acquired assets. This allocation process can significantly impact your post-acquisition tax results. Engage your advisor early in the negotiation phase to ensure the best tax outcomes. We are here to help you achieve favorable tax results. Contact us for guidance.

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Financial and Legal Considerations When Adding a New Partner to a Partnership

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Adding a new partner to a partnership involves several financial and legal implications that require careful planning to avoid various tax complications. Let’s consider an example: You and your partners are planning to admit a new partner, who will acquire a one-third interest in the partnership by making a cash contribution. Assume your basis in your partnership interests is sufficient, so the decrease in your portions of the partnership’s liabilities due to the new partner’s entry won’t reduce your basis to zero.

Complexity of Adding a New Partner

While admitting a new partner may seem straightforward, it is crucial to plan the entry meticulously to avoid potential tax issues. Here are two key considerations:

  1. Unrealized Receivables and Substantially Appreciated Inventory Items: Changes in partners’ interests in unrealized receivables and substantially appreciated inventory items are treated as a sale of those items, causing current partners to recognize gain. Unrealized receivables include accounts receivable, depreciation recapture, and certain other ordinary income items. To prevent gain recognition, these items must be allocated to the current partners even after the new partner joins.
  2. Built-In Gain or Loss: The tax code mandates that the “built-in gain or loss” on assets held by the partnership before the new partner’s admission be allocated to the current partners. Built-in gain or loss is the difference between the fair market value and the basis of the partnership property at the time the new partner is admitted. Consequently, the new partner must be allocated a portion of the depreciation equal to their share of the depreciable property based on current fair market value. This allocation reduces the amount of depreciation available to current partners. Additionally, built-in gain or loss on partnership assets must be allocated to the current partners when the assets are sold. These rules are complex and may necessitate special accounting procedures.

Monitoring Partner Basis

When adding a partner or making other changes, a partner’s basis in their interest may frequently adjust. Properly tracking basis is essential as it affects:

  • Gain or Loss on the Sale of Interest: Accurate basis tracking ensures correct calculation of gain or loss when selling your partnership interest.
  • Taxation of Partnership Distributions: Your basis determines how partnership distributions to you are taxed.
  • Deductible Partnership Losses: Basis also affects the maximum amount of partnership loss you can deduct.

We Can Assist

Contact us for assistance with these issues or any other concerns related to your partnership. We can help ensure that the process of adding a new partner is managed effectively, minimizing tax complications and ensuring compliance with relevant regulations.

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Alternative Tax Strategies: When Businesses Should Consider Opposite Approaches to Income and Deductions

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Businesses typically seek to delay recognizing taxable income into future years and accelerate deductions into the current year to minimize their current tax liabilities. However, there are instances where the opposite strategy may be advisable, particularly in anticipation of tax law changes that could increase tax rates.

One such scenario is the proposed increase in corporate federal income tax rates by the Biden administration, potentially raising the flat rate from 21% to 28%. Similarly, discussions about raising individual federal income tax rates could affect noncorporate pass-through entities, where income is taxed on personal returns.

If there’s a belief that income could be subject to higher tax rates in the future, accelerating income recognition into the current tax year can capitalize on the current lower rates. Conversely, postponing deductions to a later tax year, when rates are expected to be higher, can maximize their tax-saving impact.

To accelerate income recognition:

  • Consider selling appreciated assets with capital gains in the current year instead of waiting.
  • Review depreciable assets and sell fully depreciated ones to trigger taxable gains now.
  • Elect out of installment sale treatment for gains to be recognized in the year of sale.
  • Opt for taxable transactions instead of tax-deferred exchanges like Section 1031 for real property.

To postpone deductions:

  • Delay purchasing capital equipment and fixed assets that would lead to depreciation deductions.
  • Avoid claiming large first-year Section 179 or bonus depreciation deductions and spread out asset depreciation over time.
  • Capitalize professional fees and salaries associated with long-term projects to spread out costs.
  • Purchase bonds at a discount to increase interest income in future years.
  • Delay inventory shrinkage write-downs and other deductions to years with higher tax rates.

These strategies can be complex and tailored to your specific business circumstances. It’s recommended to consult with a tax advisor to determine the best approach for optimizing your tax planning amidst potential tax rate changes.

© 2024

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Effective Recordkeeping and Valid Business Expenses: Mitigating Challenges in IRS Audits

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Operating a business, whether established or newly launched, necessitates diligent record-keeping of income and expenses. It is crucial to accurately record expenses to maximize eligible tax deductions and to effectively substantiate reported amounts in the event of an IRS audit.

The IRS offers flexibility in choosing a recordkeeping system that best suits your business needs, emphasizing clarity in documenting income and expenses. However, strict guidelines govern the deduction of legitimate expenses for tax purposes. Certain expenses, such as those related to automobiles, travel, meals, and home offices, require meticulous recordkeeping due to specific requirements or limitations on deductibility.

Key to deductibility is establishing that a business expense is both “ordinary and necessary” for profit generation. A recent case serves as a poignant example where a married couple faced disallowed deductions primarily due to expenses being deemed personal and lacking sufficient documentation.

In this instance, the husband, a salaried executive, and his wife established separate businesses as S and C corporations, respectively. While conducting business meetings at properties they owned, the couple charged rent to their businesses. However, during an IRS audit, deductions for travel expenses were disallowed due to reconstructed rather than contemporaneous travel logs. Similarly, payments from the S corporation to the C corporation were disallowed as they were used for personal family expenses rather than marketing purposes. The rent payments for business use of their homes were also deemed excessive and not reflective of fair market rates.

Despite these challenges, the couple successfully defended deductions for contributions to their sons’ 401(k) accounts. Documentation proving the sons’ involvement in business operations played a crucial role in upholding these deductions.

Lessons drawn from this case emphasize the importance of segregating personal and business expenses and maintaining meticulous records. It is advisable to conduct all business transactions through dedicated business accounts and to retain comprehensive documentation to support tax returns and substantiate deductible business expenses during potential IRS audits.

For further guidance on effective business recordkeeping practices or inquiries regarding tax compliance, please feel free to contact us.

© 2024

Q&A

What defines an “ordinary and necessary” business expense?

An expense is deemed “ordinary and necessary” if it is customary in your industry and essential for your business operations. It should be reasonable in amount and directly contribute to generating income or facilitating business operations. Essentially, such expenses are typical within your trade and vital for your business’s effective functioning.

Why is maintaining good records of business expenses important?

Maintaining accurate records of business expenses is crucial, particularly during IRS audits. Comprehensive documentation substantiates claimed deductions, validating the legitimacy of business expenses. This practice significantly reduces the risk of penalties or fines due to inaccuracies or non-compliance. Furthermore, well-kept records streamline the audit process, enabling prompt and effective responses to IRS inquiries.

What are the implications if the IRS disallows business expenses during an audit?

When the IRS disallows business expenses during an audit, it signifies that certain expenses claimed on your tax return are not recognized as deductible. Consequently, you may face additional taxes, penalties, and interest related to the disallowed expenses. It is essential to carefully review the audit findings, consider appealing the decision, or furnish supplementary documentation to support your claimed expenses. In some instances, consulting with a tax professional may be necessary to navigate discussions and negotiations with the IRS.

These measures aim to resolve discrepancies and ensure compliance with tax regulations, safeguarding your business against potential financial repercussions.

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2024 Second Quarter Tax Calendar: Important Deadlines for Businesses and Employers

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Below are some of the key tax-related deadlines applicable to businesses and employers in the second quarter of 2024. Please note that this list is not exhaustive, so there may be additional deadlines specific to your situation. We recommend contacting us to ensure compliance with all relevant deadlines and to understand specific filing requirements.

April 15

  • Calendar-year corporations must either file their 2023 income tax return (Form 1120) or request an automatic six-month extension (Form 7004) and make any tax payments due.
  • Corporations should also pay the first installment of their estimated 2024 income taxes and retain Form 1120-W for record-keeping purposes.
  • Individuals should file their 2023 income tax return (Form 1040 or Form 1040-SR) or request an automatic six-month extension (Form 4868) and pay any taxes owed.
  • Individuals making estimated tax payments for 2024 (Form 1040-ES) should also pay their first installment if they do not pay income tax through withholding.

April 30

  • Employers must report income tax withholding and FICA taxes for the first quarter of 2024 using Form 941 and pay any taxes owed.

May 10

  • Employers should report income tax withholding and FICA taxes for the first quarter of 2024 using Form 941, provided they deposited all associated taxes due on time and in full.

May 15

  • Employers subject to the monthly deposit rule must deposit Social Security, Medicare, and withheld income taxes for April.

June 17

  • Corporations are required to make their second installment payment of estimated 2024 income taxes.

For comprehensive guidance tailored to your specific tax obligations and to ensure timely compliance, please do not hesitate to contact us.

© 2024

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Strategic Coordination of Sec. 179 Tax Deductions and Bonus Depreciation

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To optimize tax savings, businesses should prioritize maximizing depreciation write-offs for newly acquired assets within the current tax year. Two key federal tax incentives facilitate this strategy: first-year Section 179 depreciation deductions and first-year bonus depreciation deductions. These provisions enable businesses to potentially deduct a significant portion or all of their qualifying asset costs in the first year of use. However, these deductions are subject to annual inflation adjustments and evolving tax laws that may phase out bonus depreciation.

Here’s how to strategically coordinate these deductions for optimal tax-saving outcomes:

Section 179 deduction overview:
Most tangible depreciable business assets qualify, including equipment, computer hardware, vehicles (with limitations), furniture, most software, and fixtures.
Depreciable real property generally does not qualify unless it meets the criteria for qualified improvement property (QIP).
For tax year 2024, the maximum Section 179 deduction is $1.22 million, with a phase-out beginning at $3.05 million in qualified asset additions.

Bonus depreciation overview:
Most tangible depreciable business assets, as well as software and QIP, generally qualify.
Used assets must be new to the taxpayer to be eligible.
For assets placed in service in 2024, the first-year bonus depreciation rate is 60%, reduced from 80% in 2023.

Comparison of Section 179 vs. bonus depreciation:
Section 179 deductions have generous rules but are subject to limitations such as phase-out thresholds, business taxable income constraints, and specific rules for certain types of assets and ownership structures.
First-year bonus depreciation deductions are not subject to complex limitations but are subject to declining percentage rates, with 60% applicable for assets placed in service in 2024.

Tax-saving strategy:
Maximize Section 179 deductions up to allowable limits.
Utilize first-year bonus depreciation for any remaining qualifying asset costs.
Example scenario:
In 2024, a calendar-tax-year C corporation places $500,000 of qualifying assets in service. Due to taxable income limitations, the corporation’s Section 179 deduction is capped at $300,000. The corporation can deduct $300,000 on its 2024 federal income tax return. Additionally, it can deduct 60% of the remaining $200,000 ($500,000 – $300,000) through first-year bonus depreciation, totaling a $420,000 deduction for the year.

Managing tax incentives:
Effective coordination of Section 179 and bonus depreciation deductions is crucial for maximizing tax benefits. We can provide detailed guidance on these strategies and address any specific queries you may have regarding tax rules and implications.

© 2024

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Bartering Is A Taxable Transaction Even If No Cash Is Exchanged

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If your small business is seeking to conserve cash or reduce expenses, engaging in barter or trade for goods and services can be advantageous. While bartering dates back to ancient times, modern technology, particularly the internet, has facilitated easier exchanges between businesses.

Tax Considerations

  • Bartering transactions involve taxable income based on the fair market value of goods or services received. Exchanging services with another business also results in taxable income for both parties.

Fair Market Value Examples

  • A computer consultant provides tech support to an advertising agency in exchange for free advertising.
  • An electrical contractor performs repairs for a dentist in exchange for dental services.
  • Both parties are taxed on the fair market value of the services exchanged, typically the amount they would charge for the same services.
  • If services are exchanged for property:
    • A construction firm doing work for a retail business in exchange for unsold inventory realizes income equal to the inventory’s fair market value.
    • An architectural firm performing services for a corporation in exchange for shares incurs income based on the fair market value of the received stock.

Joining Barter Clubs

  • Many businesses join barter clubs that utilize “credit units” awarded to members providing goods and services. These credits can be redeemed within the club’s network.
  • Taxation of bartering occurs in the year of transaction. If participating in a club, taxation may apply when credits are credited to your account, regardless of redemption timing.
  • Provide your Social Security number or Employer Identification Number and certify non-existence of backup withholding when joining a club; otherwise, a 24% tax rate will be applied to bartering income.

Tax Reporting

  • Barter clubs issue Form 1099-B by January 31 annually, summarizing cash, property, services, and credit values received during the prior year for IRS reporting.

Exchanging Without Currency

  • Bartering enables businesses to trade excess inventory or provide services during slow periods, conserving cash flow. It also offers solutions when customers lack immediate funds for transactions.
  • Understanding federal and state tax implications is crucial for optimizing benefits from bartering transactions.

For further guidance or detailed information on navigating tax implications related to bartering, feel free to contact us.

© 2024

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Optimize Your QBI Deduction Before Its Expiration

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The qualified business income (QBI) deduction offers significant tax advantages to eligible businesses until its scheduled expiration in 2025. Therefore, it’s crucial for eligible businesses to capitalize on this deduction while it remains in effect, as it can lead to substantial tax savings.

Key Points:

  • Overview of the QBI Deduction: The QBI deduction allows owners to deduct up to 20% of qualified business income from sole proprietorships, single-member LLCs treated as sole proprietorships, partnerships, LLCs treated as partnerships, or S corporations.
  • Definition of QBI: Qualified income and gains from eligible businesses are considered QBI, adjusted for specific deductions such as contributions to self-employed retirement plans, self-employment tax deductions, and self-employed health insurance premiums.
  • Limitations: Higher income levels trigger limitations on the QBI deduction. For 2024, these limitations begin to apply when taxable income exceeds $191,950 ($383,900 for married joint filers) and are fully phased in at $241,950 or $483,900, respectively.
  • Calculation of Limitations: If taxable income exceeds the fully-phased-in threshold, the QBI deduction is limited to the greater of 1) 50% of W-2 wages allocated to QBI or 2) a combination of wages and 2.5% of the unadjusted basis immediately upon acquisition (UBIA) of qualified property.
  • Qualified Property Consideration: The UBIA of qualified property, which includes depreciable tangible property used to generate QBI, generally equals its original cost when placed in service.
  • Impact on SSTBs: Specified service trade or businesses (SSTBs) face stricter rules, with phaseouts beginning at lower income thresholds and complete phaseouts at higher thresholds, potentially disqualifying income from SSTBs from the QBI deduction.
  • Additional Considerations: Aggregating multiple businesses for the deduction may optimize benefits, particularly for businesses approaching the income limitations. Furthermore, decisions regarding depreciation deductions, such as Section 179 and bonus depreciation, can affect QBI and overall taxable income.
  • Use It or Lose It: With the QBI deduction set to expire after 2025, businesses are advised to maximize utilization of this tax benefit for the 2024 and 2025 tax years to benefit from potential tax savings.

For expert guidance on navigating the complexities of the QBI deduction and strategizing for optimal tax outcomes, please reach out to us. We are here to assist you in maximizing your QBI deduction and achieving your tax planning goals.

© 2024

Q&A:

What is qualified business income (QBI)?

Qualified business income refers to income generated by an eligible business, which is then reduced by specific deductions. These deductions include contributions to a self-employed retirement plan, 50% of self-employment tax, and self-employed health insurance premiums.

What are some qualified business income (QBI) limitations?

Qualified business income limitations encompass several factors:

  • Specified Service Trade or Business (SSTB) Limitation: Certain professional services (e.g., health, law, accounting, consulting) may face restrictions on QBI deductions based on income thresholds.
  • W-2 Wage and Capital Limitations: Businesses with higher incomes may have their QBI deduction limited by the W-2 wages paid by the business and the unadjusted basis of qualified property held by the business.
  • Overall QBI Deduction Limitation: The QBI deduction is subject to an overall limitation based on taxable income levels and can be further restricted for certain SSTBs once income thresholds are exceeded.

Why should I maximize my qualified business income (QBI) deductions now rather than later?

The QBI deduction is currently set to expire after 2025. While there is a possibility of extension by Congress, this is uncertain. Therefore, maximizing your QBI deductions now allows you to take advantage of potential tax savings before the deduction is scheduled to disappear.

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Better Tax Break When Applying The Research Credit Against Payroll Taxes

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The credit for increasing research activities, often referred to as the research and development (R&D) credit, is a valuable tax break available to certain eligible small businesses.

But in addition to the credit itself, be aware that there are two additional features that are especially favorable to small businesses:

  • Eligible small businesses ($50 million or less in gross receipts for the three prior tax years) may claim the credit against alternative minimum tax (AMT) liability.
  • The credit can be used by certain smaller startup businesses against their Social Security payroll and Medicare tax liability.

Let’s take a look at the second feature. The Inflation Reduction Act (IRA) has doubled the amount of the payroll tax credit election for qualified businesses and made a change to the eligible types of payroll taxes it can be applied to, making it better than it was before the law changes kicked in.

Election basics

Subject to limits, your business can elect to apply all or some of any research tax credit that you earn against your payroll taxes instead of your income tax. This payroll tax election may influence you to undertake or increase your research activities. On the other hand, if you’re engaged in — or are planning to undertake — research activities without regard to tax consequences, you could receive some tax relief.

Many new businesses, even if they have some cash flow, or even net positive cash flow and/or a book profit, pay no income taxes and won’t for some time. Thus, there’s no amount against which business credits, including the research credit, can be applied. On the other hand, any wage-paying business, even a new one, has payroll tax liabilities. Therefore, the payroll tax election is an opportunity to get immediate use out of the research credits that you earn. Because every dollar of credit-eligible expenditure can result in as much as a 10-cent tax credit, that’s a big help in the start-up phase of a business — the time when help is most needed.

Eligible businesses

To qualify for the election a taxpayer must:

  • Have gross receipts for the election year of less than $5 million, and
  • Be no more than five years past the period for which it had no receipts (the start-up period).

In making these determinations, the only gross receipts that an individual taxpayer considers are from the individual’s businesses. An individual’s salary, investment income or other income aren’t taken into account. Also, note that an entity or individual can’t make the election for more than six years in a row.

Limits on the election

The research credit for which the taxpayer makes the payroll tax election can be applied against the employer portion of Social Security and Medicare. It can’t be used to lower the FICA taxes that an employer withholds and remits to the government on behalf of employees. Before a provision in the IRA became effective for 2023 and later years, taxpayers were only allowed to use the payroll tax offset against Social Security, not Medicare.

The amount of research credit for which the election can be made can’t annually exceed $500,000. Prior to the IRA, the maximum credit amount allowed to offset payroll tax before 2023 was only $250,000. Note, too, that an individual or C corporation can make the election only for those research credits which, in the absence of an election, would have to be carried forward. In other words, a C corporation can’t make the election for the research credit to reduce current or past income tax liabilities.

These are just the basics of the payroll tax election. Keep in mind that identifying and substantiating expenses eligible for the research credit itself is a complex task. Contact us about whether you can benefit from the payroll tax election and the research tax credit.

© 2024

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Tax-Wise Ways To Take Cash From Your Corporation While Avoiding Dividend Treatment

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If you want to withdraw cash from your closely held corporation at a low tax cost, the easiest way is to distribute cash as a dividend. However, a dividend distribution isn’t tax efficient since it’s taxable to you to the extent of your corporation’s “earnings and profits,” but it’s not deductible by the corporation.

5 different approaches

Thankfully, there are some alternative methods that may allow you to withdraw cash from a corporation while avoiding dividend treatment. Here are five possible options:

1. Salary. Reasonable compensation that you, or family members, receive for services rendered to the corporation is deductible by the business. However, it’s also taxable to the recipient(s). The same rule applies to any compensation (in the form of rent) that you receive from the corporation for the use of property. In either case, the amount of compensation must be reasonable in relation to the services rendered or the value of the property provided. If it’s excessive, the excess will be nondeductible and treated as a corporate distribution.

2. Fringe benefits. Consider obtaining the equivalent of a cash withdrawal in fringe benefits that are deductible by the corporation and not taxable to you. Examples are life insurance, certain medical benefits, disability insurance and dependent care. Most of these benefits are tax-free only if provided on a nondiscriminatory basis to other employees of the corporation. You can also establish a salary reduction plan that allows you (and other employees) to take a portion of your compensation as nontaxable benefits, rather than as taxable compensation.

3. Capital repayments. To the extent that you’ve capitalized the corporation with debt, including amounts that you’ve advanced to the business, the corporation can repay the debt without the repayment being treated as a dividend. Additionally, interest paid on the debt can be deducted by the corporation. This assumes that the debt has been properly documented with terms that characterize debt and that the corporation doesn’t have an excessively high debt-to-equity ratio. If not, the “debt” repayment may be taxed as a dividend. If you make cash contributions to the corporation in the future, consider structuring them as debt to facilitate later withdrawals on a tax-advantaged basis.

4. Loans. You may withdraw cash from the corporation tax-free by borrowing money from it. However, to avoid having the loan characterized as a corporate distribution, it should be properly documented in a loan agreement or a note and be made on terms that are comparable to those on which an unrelated third party would lend money to you. This should include a provision for interest and principal. All interest and principal payments should be made when required under the loan terms. Also, consider the effect of the corporation’s receipt of interest income.

5. Property sales. You can withdraw cash from the corporation by selling property to it. However, certain sales should be avoided. For example, you shouldn’t sell property to a more than 50% owned corporation at a loss, since the loss will be disallowed. And you shouldn’t sell depreciable property to a more than 50% owned corporation at a gain, since the gain will be treated as ordinary income, rather than capital gain. A sale should be on terms that are comparable to those on which an unrelated third party would purchase the property. You may need to obtain an independent appraisal to establish the property’s value.

Minimize taxes

If you’re interested in discussing any of these ideas, contact us. We can help you get the maximum out of your corporation at the minimum tax cost.

© 2024

Q&A

How can I withdraw cash from my corporation without it being treated as a dividend?

Some alternative methods that can allow you to withdraw cash from your corporation while avoiding dividend treatment include paying yourself a reasonable salary, obtaining the equivalent of a cash withdrawal in fringe benefits, structuring cash contributions to the corporation as debt so that the subsequent repayment to you from the corporation can be treated as debt repayment rather than a dividend, withdrawing cash as a loan, and selling property to the corporation.

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Taking Your Spouse On A Business Trip? Can You Write Off The Costs?

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A recent report shows that post-pandemic global business travel is going strong. The market reached $665.3 billion in 2022 and is estimated to hit $928.4 billion by 2030, according to a report from Research and Markets. If you own your own company and travel for business, you may wonder whether you can deduct the costs of having your spouse accompany you on trips.

Is your spouse an employee?

The rules for deducting a spouse’s travel costs are very restrictive. First of all, to qualify for the deduction, your spouse must be your employee. This means you can’t deduct the travel costs of a spouse, even if his or her presence has a bona fide business purpose, unless the spouse is an employee of your business. This requirement prevents tax deductibility in most cases.

If your spouse is your employee, you can deduct his or her travel costs if his or her presence on the trip serves a bona fide business purpose. Merely having your spouse perform some incidental business service, such as typing up notes from a meeting, isn’t enough to establish a business purpose. In general, it isn’t enough for his or her presence to be “helpful” to your business pursuits — it must be necessary.

In most cases, a spouse’s participation in social functions, for example as a host or hostess, isn’t enough to establish a business purpose. That is, if his or her purpose is to establish general goodwill for customers or associates, this is usually insufficient. Further, if there’s a vacation element to the trip (for example, if your spouse spends time sightseeing), it will be more difficult to establish a business purpose for his or her presence on the trip. On the other hand, a bona fide business purpose exists if your spouse’s presence is necessary to care for a serious medical condition that you have.

If your spouse’s travel satisfies these requirements, the normal deductions for business travel away from home can be claimed. These include the costs of transportation, meals, lodging, and incidental costs such as dry cleaning, phone calls, etc.

What if your spouse isn’t an employee?

Even if your spouse’s travel doesn’t satisfy the requirements, however, you may still be able to deduct a substantial portion of the trip’s costs. This is because the rules don’t require you to allocate 50% of your travel costs to your spouse. You need only allocate any additional costs you incur for him or her. For example, in many hotels the cost of a single room isn’t that much lower than the cost of a double. If a single would cost you $150 a night and a double would cost you and your spouse $200, the disallowed portion of the cost allocable to your spouse would only be $50. In other words, you can write off the cost of what you would have paid traveling alone. To prove your deduction, ask the hotel for a room rate schedule showing single rates for the days you’re staying.

And if you drive your own car or rent one, the whole cost will be fully deductible even if your spouse is along. Of course, if public transportation is used, and for meals, any separate costs incurred by your spouse aren’t deductible.

Have questions?

You want to maximize all the tax breaks you can claim for your small business. Contact us if you have questions or need assistance with this or other tax-related issues.

© 2024

 

Q&A below:

How do I know if my spouse qualifies for business travel cost deductions when accompanying me on a business trip?

If your spouse accompanies you on a business trip, you generally cannot deduct their expenses unless they are also an employee of the company and their presence on the trip is necessary for business purposes. If your spouse is your employee, you can deduct his or her travel costs if his or her presence on the trip serves a bona fide business purpose. Your spouse’s presence must be necessary (i.e. caring for a medical condition that you have in order to enable you to travel for business)–not simply “helpful” (i.e. typing up notes from a meeting)–in order for his or her travel costs to be deductible.

If my spouse accompanies me on a business trip but does not meet the requirements for business travel deductions, can I still deduct costs from the trip?

Even if your spouse’s travel doesn’t satisfy the requirements, you may still be able to deduct a substantial portion of the trip’s costs. This is because the rules don’t require you to allocate 50% of your travel costs to your spouse. You need only allocate any additional costs you incur for him or her. For example, in many hotels the cost of a single room isn’t that much lower than the cost of a double. If a single would cost you $150 a night and a double would cost you and your spouse $200, the disallowed portion of the cost allocable to your spouse would only be $50. In other words, you can write off the cost of what you would have paid traveling alone. Additionally, if you drive your own car or rent one, the whole cost will be fully deductible even if your spouse is along. Of course, if public transportation is used, and for meals, any separate costs incurred by your spouse aren’t deductible.

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What’s The Best Accounting Method Route For Business Tax Purposes?

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Businesses basically have two accounting methods to figure their taxable income: cash and accrual. Many businesses have a choice of which method to use for tax purposes. The cash method often provides significant tax benefits for eligible businesses, though some may be better off using the accrual method. Thus, it may be prudent for your business to evaluate its method to ensure that it’s the most advantageous approach.

Eligibility to use the cash method

“Small businesses,” as defined by the tax code, are generally eligible to use either cash or accrual accounting for tax purposes. (Some businesses may also be eligible to use various hybrid approaches.) Before the Tax Cuts and Jobs Act (TCJA) took effect, the gross receipts threshold for classification as a small business varied from $1 million to $10 million depending on how a business was structured, its industry and factors involving inventory.

The TCJA simplified the small business definition by establishing a single gross receipts threshold. It also increased the threshold to $25 million (adjusted for inflation), expanding the benefits of small business status to more companies. For 2024, a small business is one whose average annual gross receipts for the three-year period ending before the 2024 tax year are $30 million or less (up from $29 million for 2023).

In addition to eligibility for the cash accounting method, small businesses can benefit from advantages including:

  • Simplified inventory accounting,
  • An exemption from the uniform capitalization rules, and
  • An exemption from the business interest deduction limit.

Note: Some businesses are eligible for cash accounting even if their gross receipts are above the threshold, including S corporations, partnerships without C corporation partners, farming businesses and certain personal service corporations. Tax shelters are ineligible for the cash method, regardless of size.

Difference between the methods

For most businesses, the cash method provides significant tax advantages. Because cash-basis businesses recognize income when received and deduct expenses when they’re paid, they have greater control over the timing of income and deductions. For example, toward the end of the year, they can defer income by delaying invoices until the following tax year or shift deductions into the current year by accelerating the payment of expenses.

In contrast, accrual-basis businesses recognize income when earned and deduct expenses when incurred, without regard to the timing of cash receipts or payments. Therefore, they have little flexibility to time the recognition of income or expenses for tax purposes.

The cash method also provides cash flow benefits. Because income is taxed in the year received, it helps ensure that a business has the funds needed to pay its tax bill.

However, for some businesses, the accrual method may be preferable. For instance, if a company’s accrued income tends to be lower than its accrued expenses, the accrual method may result in lower tax liability. Other potential advantages of the accrual method include the ability to deduct year-end bonuses paid within the first 2½ months of the following tax year and the option to defer taxes on certain advance payments.

Switching methods

Even if your business would benefit by switching from the accrual method to the cash method, or vice versa, it’s important to consider the administrative costs involved in a change. For example, if your business prepares its financial statements in accordance with U.S. Generally Accepted Accounting Principles, it’s required to use the accrual method for financial reporting purposes. That doesn’t mean it can’t use the cash method for tax purposes, but it would require maintaining two sets of books.

Changing accounting methods for tax purposes also may require IRS approval. Contact us to learn more about each method.

© 2024

Q&As

What are the main differences between the cash and accrual accounting methods?

The main differences between the cash and accrual accounting methods lie in how income and expenses are recorded and recognized. Under the cash accounting method, revenue is recognized when cash is received from customers, and expenses are recognized when cash is paid to suppliers or other parties. This method focuses on actual cash inflows and outflows. On the other hand, the accrual accounting method records revenue when it is earned, regardless of when payment is received, and expenses are recorded when they are incurred, regardless of when payment is made. This method matches revenues with their associated expenses, providing a more accurate picture of a company’s financial performance.

 

Which accounting method—cash or accrual basis—provides better tax advantages for businesses?

For most businesses, the cash method provides significant tax advantages. Because cash-basis businesses recognize income when received and deduct expenses when they’re paid, they have greater control over the timing of income and deductions. The cash method also provides cash flow benefits. Because income is taxed in the year received, it helps ensure that a business has the funds needed to pay its tax bill. However, for some businesses, the accrual method may be preferable. For instance, if a company’s accrued income tends to be lower than its accrued expenses, the accrual method may result in lower tax liability. Other potential advantages of the accrual method include the ability to deduct year-end bonuses paid within the first 2½ months of the following tax year and the option to defer taxes on certain advance payments.

 

What types of businesses are eligible to use the cash method for tax purposes?

Generally, businesses with average annual gross receipts of $30 million or less for the three-year period ending before the 2024 tax year are eligible to use the cash method. Some businesses are eligible for cash accounting even if their gross receipts are above the threshold, including S corporations, partnerships without C corporation partners, farming businesses and certain personal service corporations.

 

Can my business switch between the cash and accrual method?

Yes, businesses can switch between the cash and accrual method of accounting. However, it is important to note that once a business chooses a method for tax purposes, it generally must obtain permission from the IRS to change methods. The IRS has specific rules and procedures for changing accounting methods, and businesses should consult with a tax professional or accountant to ensure compliance with these regulations. Additionally, switching between methods may have implications for financial reporting and may require adjustments to be made to prior period financial statements. It is recommended to carefully consider the benefits and drawbacks of each method before making a decision to switch.

 

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Does Your Business Have Employees Who Get Tips? You May Qualify For a Tax Credit

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If you’re an employer with a business where tipping is routine when providing food and beverages, you may qualify for a federal tax credit involving the Social Security and Medicare (FICA) taxes that you pay on your employees’ tip income.

Credit fundamentals

The FICA credit applies to tips that your staff members receive from customers when they buy food and beverages. It doesn’t matter if the food and beverages are consumed on or off the premises. Although tips are paid by customers, for FICA purposes, they’re treated as if you paid them to your employees.

As you know, your employees are required to report their tips to you. You must:

  • Withhold and remit the employee’s share of FICA taxes, and
  • Pay the employer’s share of those taxes.

How the credit is claimed

You claim the credit as part of the general business credit. It’s equal to the employer’s share of FICA taxes paid on tip income in excess of what’s needed to bring your employee’s wages up to $5.15 per hour. In other words, no credit is available to the extent the tip income just brings the employee up to the $5.15-per-hour level, calculated monthly. If you pay each employee at least $5.15 an hour (excluding tips), you don’t have to be concerned with this calculation.

Note: A 2007 tax law froze the per-hour amount at $5.15, which was the amount of the federal minimum wage at that time. The minimum wage is now $7.25 per hour but the amount for credit computation purposes remains $5.15.

Let’s look at an example

Let’s say a server works at your restaurant. She is paid $2.13 an hour plus tips. During the month, she works 160 hours for $340.80 and receives $2,000 in cash tips which she reports to you.

The server’s $2.13-an-hour rate is below the $5.15 rate by $3.02 an hour. Thus, for the 160 hours worked, she is below the $5.15 rate by $483.20 (160 times $3.02). For the server, therefore, the first $483.20 of tip income just brings her up to the minimum rate. The rest of the tip income is $1,516.80 ($2,000 minus $483.20). As the server’s employer, you pay FICA taxes at the rate of 7.65% for her. Therefore, your employer credit is $116.03 for the month: $1,516.80 times 7.65%.

While the employer’s share of FICA taxes is generally deductible, the FICA taxes paid with respect to tip income used to determine the credit can’t be deducted, because that would amount to a double benefit. However, you can elect not to take the credit, in which case you can claim the deduction.

Get the credit you deserve

If your business pays FICA taxes on tip income paid to your employees, the tip tax credit may be valuable to you. Other rules may apply. Contact us if you have any questions.

© 2024

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Defer A Current Tax Bill With A Like-Kind Exchange

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If you’re interested in selling commercial or investment real estate that has appreciated significantly, one way to defer a tax bill on the gain is with a Section 1031 “like-kind” exchange. With this transaction, you exchange the property rather than sell it. Although the real estate market has been tough recently in some locations, there are still profitable opportunities (with high resulting tax bills) when the like-kind exchange strategy may be attractive.

A like-kind exchange is any exchange of real property held for investment or for productive use in your trade or business (relinquished property) for like-kind investment, trade or business real property (replacement property).

For these purposes, like-kind is broadly defined, and most real property is considered to be like-kind with other real property. However, neither the relinquished property nor the replacement property can be real property held primarily for sale.

Asset-for-asset or boot

Under the Tax Cuts and Jobs Act, tax-deferred Section 1031 treatment is no longer allowed for exchanges of personal property — such as equipment and certain personal property building components — that are completed after December 31, 2017.

If you’re unsure if the property involved in your exchange is eligible for like-kind treatment, please contact us to discuss the matter.

Assuming the exchange qualifies, here’s how the tax rules work. If it’s a straight asset-for-asset exchange, you won’t have to recognize any gain from the exchange. You’ll take the same “basis” (your cost for tax purposes) in the replacement property that you had in the relinquished property. Even if you don’t have to recognize any gain on the exchange, you still must report it on Form 8824, “Like-Kind Exchanges.”

However, in many cases, the properties aren’t equal in value, so some cash or other property is added to the deal. This cash or other property is known as “boot.” If boot is involved, you’ll have to recognize your gain, but only up to the amount of boot you receive in the exchange. In these situations, the basis you get in the like-kind replacement property you receive is equal to the basis you had in the relinquished property reduced by the amount of boot you received but increased by the amount of any gain recognized.

How it works

For example, let’s say you exchange business property with a basis of $100,000 for a building valued at $120,000, plus $15,000 in cash. Your realized gain on the exchange is $35,000: You received $135,000 in value for an asset with a basis of $100,000. However, since it’s a like-kind exchange, you only have to recognize $15,000 of your gain. That’s the amount of cash (boot) you received. Your basis in the new building (the replacement property) will be $100,000: your original basis in the relinquished property ($100,000) plus the $15,000 gain recognized, minus the $15,000 boot received.

Note that no matter how much boot is received, you’ll never recognize more than your actual (“realized”) gain on the exchange.

If the property you’re exchanging is subject to debt from which you’re being relieved, the amount of the debt is treated as boot. The reason is that if someone takes over your debt, it’s equivalent to the person giving you cash. Of course, if the replacement property is also subject to debt, then you’re only treated as receiving boot to the extent of your “net debt relief” (the amount by which the debt you become free of exceeds the debt you pick up).

Unload one property and replace it with another

Like-kind exchanges can be a great tax-deferred way to dispose of investment, trade or business real property. But you have to make sure to meet all the requirements. Contact us if you have questions or would like to discuss the strategy further.

© 2024

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The Standard Business Mileage Rate Will Be Going Up Slightly In 2024

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The optional standard mileage rate used to calculate the deductible cost of operating an automobile for business will be going up by 1.5 cents per mile in 2024. The IRS recently announced that the cents-per-mile rate for the business use of a car, van, pickup or panel truck will be 67 cents (up from 65.5 cents for 2023).

The increased tax deduction partly reflects the price of gasoline, which is about the same as it was a year ago. On December 21, 2023, the national average price of a gallon of regular gas was $3.12, compared with $3.10 a year earlier, according to AAA Gas Prices.

Standard rate vs. tracking expenses

Businesses can generally deduct the actual expenses attributable to business use of vehicles. These include gas, tires, oil, repairs, insurance, licenses and vehicle registration fees. In addition, you can claim a depreciation allowance for the vehicle. However, in many cases, certain limits apply to depreciation write-offs on vehicles that don’t apply to other types of business assets.

The cents-per-mile rate is helpful if you don’t want to keep track of actual vehicle-related expenses. However, you still must record certain information, such as the mileage for each business trip, the date and the destination.

The standard rate is also used by businesses that reimburse employees for business use of their personal vehicles. These reimbursements can help attract and retain employees who drive their personal vehicles for business purposes. Why? Under current law, employees can’t deduct unreimbursed employee business expenses, such as business mileage, on their own income tax returns.

If you use the cents-per-mile rate, keep in mind that you must comply with various rules. If you don’t comply, reimbursements to employees could be considered taxable wages to them.

Rate calculation

The business cents-per-mile rate is adjusted annually. It’s based on an annual study commissioned by the IRS about the fixed and variable costs of operating a vehicle, such as gas, maintenance, repairs and depreciation. Occasionally, if there’s a substantial change in average gas prices, the IRS will change the rate midyear.

Not always allowed

There are cases when you can’t use the cents-per-mile rate. In some situations, it depends on how you’ve claimed deductions for the same vehicle in the past. In other situations, it hinges on if the vehicle is new to your business this year or whether you want to take advantage of certain first-year depreciation tax breaks on it.

As you can see, there are many factors to consider in deciding whether to use the standard mileage rate to deduct business vehicle expenses. We can help if you have questions about tracking and claiming such expenses in 2024 — or claiming 2023 expenses on your 2023 tax return.

© 2023

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2024 Q1 Tax Calendar: Key Deadlines For Businesses And Other Employers

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Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2024. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. If you have questions about filing requirements, contact us. We can ensure you’re meeting all applicable deadlines.

January 16 (The usual deadline of January 15 is a federal holiday)

  • Pay the final installment of 2023 estimated tax.
  • Farmers and fishermen: Pay estimated tax for 2023. If you don’t pay your estimated tax by January 16, you must file your 2023 return and pay all tax due by March 1, 2024, to avoid an estimated tax penalty.

January 31

  • File 2023 Forms W-2, “Wage and Tax Statement,” with the Social Security Administration and provide copies to your employees.
  • Provide copies of 2023 Forms 1099-NEC, “Nonemployee Compensation,” to recipients of income from your business, where required, and file them with the IRS.
  • Provide copies of 2023 Forms 1099-MISC, “Miscellaneous Information,” reporting certain types of payments to recipients.
  • File Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” for 2023. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it’s more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 12 to file the return.
  • File Form 941, “Employer’s Quarterly Federal Tax Return,” to report Medicare, Social Security and income taxes withheld in the fourth quarter of 2023. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until February 12 to file the return. (Employers that have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944, “Employer’s Annual Federal Tax Return.”)
  • File Form 945, “Annual Return of Withheld Federal Income Tax,” for 2023 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on accounts such as pensions, annuities and IRAs. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 12 to file the return.

February 15

  • Give annual information statements to recipients of certain payments you made during 2023. You can use the appropriate version of Form 1099 or other information return. Form 1099 can be issued electronically with the consent of the recipient. This due date applies only to the following types of payments:
    • All payments reported on Form 1099-B.
    • All payments reported on Form 1099-S.
    • Substitute payments reported in box 8 or gross proceeds paid to an attorney reported in box 10 of Form 1099-MISC.

February 28

  • File 2023 Forms 1099-MISC with the IRS if you’re filing paper copies. (Otherwise, the filing deadline is April 1.)

March 15

  • If a calendar-year partnership or S corporation, file or extend your 2023 tax return and pay any tax due. If the return isn’t extended, this is also the last day to make 2023 contributions to pension and profit-sharing plans.

© 2023

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A Company Car Is A Valuable Perk But Don’t Forget About Taxes

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One of the most appreciated fringe benefits for owners and employees of small businesses is the use of a company car. This perk results in tax deductions for the employer as well as tax breaks for the owners and employees driving the cars. (And of course, they enjoy the nontax benefit of using a company car.) Even better, current federal tax rules make the benefit more valuable than it was in the past.

Rolling out the rules

Let’s take a look at how the rules work in a typical situation. For example, a corporation decides to supply the owner-employee with a company car. The owner-employee needs the car to visit customers and satellite offices, check on suppliers and meet with vendors. He or she expects to drive the car 8,500 miles a year for business and also anticipates using the car for about 7,000 miles of personal driving. This includes commuting, running errands and taking weekend trips. Therefore, the usage of the vehicle will be approximately 55% for business and 45% for personal purposes. Naturally, the owner-employee wants an attractive car that reflects positively on the business, so the corporation buys a new $57,000 luxury sedan.

The cost for personal use of the vehicle is equal to the tax the owner-employee pays on the fringe benefit value of the 45% personal mileage. In contrast, if the owner-employee bought the car to drive the personal miles, he or she would pay out-of-pocket for the entire purchase cost of the car.

Personal use is treated as fringe benefit income. For tax purposes, the corporation treats the car much the same way it would any other business asset, subject to depreciation deduction restrictions if the auto is purchased. Out-of-pocket expenses related to the car (including insurance, gas, oil and maintenance) are deductible, including the portion that relates to personal use. If the corporation finances the car, the interest it pays on the loan is deductible as a business expense (unless the business is subject to the business interest expense deduction limitation under the tax code).

On the other hand, if the owner-employee buys the auto, he or she isn’t entitled to any deductions. Outlays for the business-related portion of driving are unreimbursed employee business expenses, which are nondeductible from 2018 to 2025 due to the suspension of miscellaneous itemized deductions under the Tax Cuts and Jobs Act. And if the owner-employee finances the car personally, the interest payments are nondeductible.

One other implication: The purchase of the car by the corporation has no effect on the owner-employee’s credit rating.

Careful recordkeeping is essential

Supplying a vehicle for an owner’s or key employee’s business and personal use comes with complications and paperwork. Personal use needs to be tracked and valued under the fringe benefit tax rules and treated as income. This article only explains the basics.

Despite the necessary valuation and paperwork, a company-provided car is still a valuable fringe benefit for business owners and key employees. It can provide them with the use of a vehicle at a low tax cost while generating tax deductions for their businesses. (You may even be able to transfer the vehicle to the employee when you’re ready to dispose of it, but that involves other tax implications.) We can help you stay in compliance with the rules and explain more about this fringe benefit.

© 2023

Q&A below:

What are some employer and employee tax benefits associated with using a company car?

For employers, some tax benefits associated with using a company car include tax deductions for expenses related to the company car (such as fuel, maintenance, and insurance) and depreciation deductions for the value of the company car over time. For employees, some tax benefits associated with using a company car include tax-free fringe benefits if the company car is used primarily for business purposes and potential tax deductions for business-related expenses incurred while using the company car (such as parking fees or tolls).

What are some important rules and details regarding tax treatment of company cars?

It is important to distinguish between personal and business use. If the employer buys the car for the employee, the cost for personal use of the vehicle is equal to the tax the employee pays on the fringe benefit value of the car’s personal-use mileage portion. In contrast, if the owner-employee buys the car to drive the personal miles, he or she would pay out-of-pocket for the entire purchase cost of the car. Assuming the employer buys the car, personal use is treated as fringe benefit income. For tax purposes, the employer treats the car much the same way it would any other business asset, subject to depreciation deduction restrictions if the auto is purchased. Out-of-pocket expenses related to the car are deductible, including the portion that relates to personal use. If the employer finances the car, the interest it pays on the loan is deductible as a business expense (unless the business is subject to the business interest expense deduction limitation under the tax code). On the other hand, if the employee buys the auto, he or she isn’t entitled to any deductions. In this case, outlays for the business-related portion of driving are unreimbursed employee business expenses, which are nondeductible from 2018 to 2025 due to the suspension of miscellaneous itemized deductions under the Tax Cuts and Jobs Act. If the employee finances the car personally, the interest payments are nondeductible.

Are there any helpful best practices associated with supplying a company car?

Documentation and recordkeeping are essential. Personal use needs to be tracked and valued under the fringe benefit tax rules and treated as income. It is important to speak with a tax professional to ensure compliance with tax laws related to company cars.

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Key 2024 Inflation-Adjusted Tax Parameters For Small Businesses And Their Owners

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The IRS recently announced various inflation-adjusted federal income tax amounts. Here’s a rundown of the amounts that are most likely to affect small businesses and their owners.

Rates and brackets

If you run your business as a sole proprietorship or pass-through business entity (LLC, partnership or S corporation), the business’s net ordinary income from operations is passed through to you and reported on your personal Form 1040. You then pay the individual federal income tax rates on that income.

Here are the 2024 inflation adjusted bracket thresholds.

  • 10% tax bracket: $0 to $11,600 for singles, $0 to $23,200 for married joint filers, $0 to $16,550 for heads of household;
  • Beginning of 12% bracket: $11,601 for singles, $23,201 for married joint filers, $16,551 for heads of household;
  • Beginning of 22% bracket: $47,151 for singles, $94,301 for married joint filers, $63,101 for heads of household;
  • Beginning of 24% bracket: $100,526 for singles, $201,051 for married joint filers, $100,501 for heads of household;
  • Beginning of 32% bracket: $191,951 for singles, $383,901 for married joint filers, $191,951 for heads of household;
  • Beginning of 35% bracket: $243,726 for singles, $487,451 for married joint filers and $243,701 for heads of household; and
  • Beginning of 37% bracket: $609,351 for singles, $731,201 for married joint filers and $609,351 for heads of household.

Key Point: These thresholds are about 5.4% higher than for 2023. That means that, other things being equal, you can have about 5.4% more ordinary business income next year without owing more to Uncle Sam.

Section 1231 gains and qualified dividends

If you run your business as a sole proprietorship or a pass-through entity, and the business sells assets, you may have Section 1231 gains that passed through to you to be included on your personal Form 1040. Sec. 1231 gains are long-term gains from selling business assets that were held for more than one year, and they’re generally taxed at the same lower federal rates that apply to garden-variety long-term capital gains (LTCGs), such as stock sale gains. Here are the 2024 inflation-adjusted bracket thresholds that will generally apply to Sec. 1231 gains recognized by individual taxpayers.

  • 0% tax bracket: $0 to $47,025 for singles, $0 to $94,050 for married joint filers and $0 to $63,000 for heads of household;
  • Beginning of 15% bracket: $47,026 for singles, $94,051 for joint filers, $63,001 for heads of household; and
  • Beginning of 20% bracket: $518,901 for singles, $583,751 for married joint filers and $551,351 for heads of household.

If you run your business as a C corporation, and the company pays you qualified dividends, they’re taxed at the lower LTCG rates. So, the 2024 rate brackets for qualified dividends paid to individual taxpayers will be the same as above.

Self-employment tax

If you operate your business as a sole proprietorship or as a pass-through entity, you probably have net self-employment (SE) income that must be reported on your personal Form 1040 to calculate your SE tax liability. For 2024, the maximum 15.3% SE tax rate will apply to the first $166,800 of net SE income (up from $160,200 for 2023).

Section 179 deductions

For tax years beginning in 2024, small businesses can potentially write off up to $1,220,000 of qualified asset additions in year one (up from $1,160,000 for 2023). However, the maximum deduction amount begins to be phased out once qualified asset additions exceed $3,050,000 (up from $2,890,000 for 2023). Various limitations apply to Sec. 179 deductions.

Side Note: Under the first-year bonus depreciation break, you can deduct up to 60% of the cost of qualified asset additions placed in service in calendar year 2024. For 2023, you could deduct up to 80%.

Just the beginning

These are only the 2024 inflation-adjusted amounts that are most likely to affect small businesses and their owners. There are others that may potentially apply, including: limits on qualified business income deductions and business loss deductions, income limits on various favorable exceptions such as the right to use cash-method accounting, limits on how much you can contribute to your self-employed or company-sponsored tax-favored retirement account, limits on tax-free transportation allowances for employees, and limits on tax-free adoption assistance for employees. Contact us with questions about your situation.

© 2023

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A Cost Segregation Study May Cut Taxes And Boost Cash Flow

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Is your business depreciating over 30 years the entire cost of constructing the building that houses your enterprise? If so, you should consider a cost segregation study. It may allow you to accelerate depreciation deductions on certain items, thereby reducing taxes and boosting cash flow.

Depreciation basics

Business buildings generally have a 39-year depreciation period (27.5 years for residential rental properties). In most cases, a business depreciates a building’s structural components, including walls, windows, HVAC systems, elevators, plumbing and wiring, along with the building. Personal property — including equipment, machinery, furniture and fixtures — is eligible for accelerated depreciation, usually over five or seven years. And land improvements, such as fences, outdoor lighting and parking lots, are depreciable over 15 years.

Frequently, businesses allocate all or most of their buildings’ acquisition or construction costs to real property, overlooking opportunities to allocate costs to shorter-lived personal property or land improvements. In some cases, the distinction between real and personal property is obvious. For example, computers and furniture are personal property. But the line between real and personal property is not always clear. Items that appear to be “part of a building” may in fact be personal property. Examples are removable wall and floor coverings, removable partitions, awnings and canopies, window treatments, decorative lighting and signs.

In addition, certain items that otherwise would be treated as real property may qualify as personal property if they serve more of a business function than a structural purpose. These include reinforced flooring that supports heavy manufacturing equipment, electrical or plumbing installations required to operate specialized equipment and dedicated cooling systems for data processing rooms.

Identifying and substantiating costs

A cost segregation study combines accounting and engineering techniques to identify building costs that are properly allocable to tangible personal property rather than real property. Although the relative costs and benefits of a cost segregation study depend on your particular facts and circumstances, it can be a valuable investment.

Speedier depreciation tax breaks

The Tax Cuts and Jobs Act (TCJA) enhanced certain depreciation-related tax breaks, which may also enhance the benefits of a cost segregation study. Among other changes, the law permanently increased limits on Section 179 expensing, which allows you to immediately deduct the entire cost of qualifying equipment or other fixed assets up to specified thresholds.

In addition, the TCJA expanded 15-year-property treatment to apply to qualified improvement property. Previously, this tax break was limited to qualified leasehold-improvement, retail-improvement and restaurant property. And the law temporarily increased first-year bonus depreciation from 50% to 100% in 2022, 80% in 2023 and 60% in 2024. After that, it will continue to decrease until it is 0% in 2027, unless Congress acts.

Making favorable depreciation changes

It isn’t too late to get the benefit of faster depreciation for items that were incorrectly assumed to be part of your building for depreciation purposes. You don’t have to amend your past returns (or meet a deadline for claiming tax refunds) to claim the depreciation that you could have already claimed. Instead, you can claim that depreciation by following procedures, in connection with the next tax return you file, that will result in automatic IRS consent to a change in your accounting for depreciation.

Cost segregation studies can yield substantial benefits, but they’re not the best move for every business. Contact us to determine whether this strategy would work for your business. We’ll judge whether a study will result in tax savings that are greater than the costs of the study itself.

© 2023

Q&As below:

How does a cost segregation study help in maximizing tax savings for businesses?

A cost segregation study is a strategic tax planning tool that helps businesses maximize tax savings by accelerating the depreciation deductions for certain assets. The study involves identifying and reclassifying assets into shorter recovery periods, which allows businesses to take larger depreciation deductions in earlier years. By front-loading these deductions, businesses can reduce their taxable income and lower their overall tax liability. This can result in significant tax savings and improved cash flow for businesses.

What types of mistakes do businesses frequently make when allocating building costs between real and personal property?

Frequently, businesses allocate all or most of their buildings’ acquisition or construction costs to real property, overlooking opportunities to allocate costs to shorter-lived personal property or land improvements. In some cases, the distinction between real and personal property is obvious. For example, computers and furniture are personal property. But the line between real and personal property is not always clear. Items that appear to be “part of a building” may in fact be personal property. Examples are removable wall and floor coverings, removable partitions, awnings and canopies, window treatments, decorative lighting and signs.

How does The Tax Cuts and Jobs Act (TCJA) enhance the benefits of a cost segregation study?

The Tax Cuts and Jobs Act (TCJA) permanently increased limits on Section 179 expensing, which allows you to immediately deduct the entire cost of qualifying equipment or other fixed assets up to specified thresholds. In addition, the TCJA expanded 15-year-property treatment to apply to qualified improvement property. Previously, this tax break was limited to qualified leasehold-improvement, retail-improvement and restaurant property. Finally, the law temporarily increased first-year bonus depreciation from 50% to 100% in 2022, 80% in 2023 and 60% in 2024. After that, it will continue to decrease until it is 0% in 2027, unless Congress acts.

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New Per Diem Business Travel Rates Kicked In On October 1

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Are employees at your business traveling and frustrated about documenting expenses? Or perhaps you’re annoyed at the time and energy that goes into reviewing business travel expenses. There may be a way to simplify the reimbursement of these expenses. In Notice 2023-68, the IRS announced the fiscal 2024 special “per diem” rates that became effective October 1, 2023. Taxpayers can use these rates to substantiate the amount of expenses for lodging, meals and incidentals when traveling away from home. (Taxpayers in the transportation industry can use a special transportation industry rate.)

Basics of the method

A simplified alternative to tracking actual business travel expenses is to use the “high-low” per diem method. This method provides fixed travel per diems. The amounts, provided by the IRS, vary from locality to locality.

Under the high-low method, the IRS establishes an annual flat rate for certain areas with higher costs of living. All locations within the continental United States that aren’t listed as “high-cost” are automatically considered “low-cost.” The high-low method may be used in lieu of the specific per diem rates for business destinations. Examples of high-cost areas include Boston, and San Francisco. Other locations, such as resort areas, are considered high-cost during only part of the year.

Under some circumstances — for example, if an employer provides lodging or pays the hotel directly — employees may receive a per diem reimbursement only for their meals and incidental expenses. There’s also a $5 incidental-expenses-only rate for employees who don’t pay or incur meal expenses for a calendar day (or partial day) of travel.

Reduced recordkeeping

If your company uses per diem rates, employees don’t have to meet the usual recordkeeping rules required by the IRS. Receipts of expenses generally aren’t required under the per diem method. But employees still must substantiate the time, place and business purpose of the travel. Per diem reimbursements generally aren’t subject to income or payroll tax withholding or reported on an employee’s Form W-2.

The FY2024 rates

For travel after September 30, 2023, the per diem rate for all high-cost areas within the continental United States is $309. This consists of $235 for lodging and $74 for meals and incidental expenses. For all other areas within the continental United States, the per diem rate is $214 for travel after September 30, 2023 ($150 for lodging and $64 for meals and incidental expenses). Compared to the FY2023 per diems, the high-cost area per diem increased $12, and the low-cost area per diem increased $10.

Important: This method is subject to various rules and restrictions. For example, companies that use the high-low method for an employee must continue using it for all reimbursement of business travel expenses within the continental United States during the calendar year. However, the company may use any permissible method to reimburse that employee for any travel outside the continental United States.

For travel during the last three months of a calendar year, employers must continue to use the same method (per diem or high-low method) for an employee as they used during the first nine months of the calendar year. Also, note that per diem rates can’t be paid to individuals who own 10% or more of the business.

If your employees are traveling, it may be a good time to review the rates and consider switching to the high-low method. It can reduce the time and frustration associated with traditional travel reimbursement. Contact us for more information or read the IRS notice here.

© 2023

Q&As

What is the “high-low” per diem method for business travel expenses?

Under the high-low method, the IRS establishes an annual flat rate for certain areas with higher costs of living. All locations within the continental United States that aren’t listed as “high-cost” are automatically considered “low-cost.” The high-low method may be used in lieu of the specific per diem rates for business deductions.

How can the new IRS per diem rates benefit businesses and their traveling employees?

The new IRS per diem rates can benefit businesses and their traveling employees in several ways. Firstly, these rates provide a standardized and simplified method for reimbursing employees for their travel expenses. This helps businesses streamline their expense management processes and ensures that employees are fairly compensated for their out-of-pocket expenses. Additionally, the per diem rates set by the IRS are often higher than actual expenses incurred by employees. This means that employees can receive a tax-free reimbursement for their travel expenses, while businesses can potentially save on payroll taxes. Finally, using per diem rates can help eliminate the need for employees to keep detailed receipts and track individual expenses. This not only saves time and effort but also reduces the risk of errors or fraud in expense reporting.

What are the new per diem business travel rates that came into effect on October 1?

For travel after September 30, 2023, the per diem rate for all high-cost areas within the continental United States is $309. This consists of $235 for lodging and $74 for meals and incidental expenses. For all other areas within the continental United States, the per diem rate is $214 for travel after September 30, 2023 ($150 for lodging and $64 for meals and incidental expenses). Compared to the FY2023 per diems, the high-cost area per diem increased $12, and the low-cost area per diem increased $10.

Are there any limitations or restrictions on utilizing the IRS special per diem rates?

Yes, there are certain limitations and restrictions on utilizing the IRS special per diem rates. For example, companies that use the high-low method for an employee must continue using it for all reimbursement of business travel expenses within the continental United States during the calendar year. However, the company may use any permissible method to reimburse that employee for any travel outside the continental United States.

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Choosing a Business Entity: Which Way To Go?

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If you’re planning to start a business or thinking about changing your business entity, you need to determine what will work best for you. Should you operate as a C corporation or a pass-through entity such as a sole-proprietorship, partnership, limited liability company (LLC) or S corporation? There are many issues to consider.

Currently, the corporate federal income tax is imposed at a flat 21% rate, while individual federal income tax rates currently begin at 10% and go up to 37%. The difference in rates can be alleviated by the qualified business income (QBI) deduction that’s available to eligible pass-through entity owners that are individuals, and some estates and trusts.

Individual rate caveats: The QBI deduction is scheduled to end in 2026, unless Congress acts to extend it, while the 21% corporate rate is not scheduled to expire. Also, noncorporate taxpayers with modified adjusted gross incomes above certain levels are subject to an additional 3.8% tax on net investment income.

Organizing a business as a C corporation instead of a pass-through entity may reduce the current federal income tax on the business’s income. The corporation can still pay reasonable compensation to the shareholders and pay interest on loans from the shareholders. That income will be taxed at higher individual rates, but the overall rate on the corporation’s income can be lower than if the business was operated as a pass-through entity.

More to take into account

There are other tax-related factors to take into consideration. For example:

  • If most of the business profits will be distributed to the owners, it may be preferable to operate the business as a pass-through entity rather than a C corporation, since the shareholders will be taxed on dividend distributions from the corporation (double taxation). In contrast, owners of a pass-through entity will only be taxed once, at the personal level, on business income. However, the impact of double taxation must be evaluated based on projected income levels for both the business and its owners.
  • If the value of the assets is likely to appreciate, it’s generally preferable to conduct business as a pass-through entity to avoid a corporate tax when the assets are sold or the business is liquidated. Although corporate level tax will be avoided if the corporation’s shares, rather than its assets, are sold, the buyer may insist on a lower price because the tax basis of appreciated business assets cannot be stepped up to reflect the purchase price. That can result in much lower post-purchase depreciation and amortization deductions for the buyer.
  • If the business is a pass-through entity, an owner’s basis in his or her interest in the entity is stepped-up by the entity income that’s allocated to the owner. That can result in less taxable gain for the owner when his or her interests in the entity are sold.
  • If the business is expected to incur tax losses for a while, you may want to structure it as a pass-through entity so you can deduct the losses against other income. Conversely, if you have insufficient other income or the losses aren’t usable (for example, because they’re limited by the passive loss rules), it may be preferable for the business to be a C corporation, since it’ll be able to offset future income with the losses.
  • If the owner of a business is subject to the alternative minimum tax (AMT), it may be preferable to organize as a C corporation, since corporations aren’t subject to the AMT. Affected individuals are subject to the AMT at 26% or 28% rates.

As you can see, there are many factors involved in operating a business as a certain type of entity. This only covers a few of them. For more details about how to proceed in your situation, consult with us.

© 2023

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The Social Security Wage Base For Employees And Self-Employed People Is Increasing In 2024

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The Social Security Administration recently announced that the wage base for computing Social Security tax will increase to $168,600 for 2024 (up from $160,200 for 2023). Wages and self-employment income above this threshold aren’t subject to Social Security tax.

Basic details

The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees and self-employed workers — one for Old Age, Survivors and Disability Insurance, which is commonly known as the Social Security tax, and the other for Hospital Insurance, which is commonly known as the Medicare tax.

There’s a maximum amount of compensation subject to the Social Security tax, but no maximum for Medicare tax. For 2024, the FICA tax rate for employers will be 7.65% — 6.2% for Social Security and 1.45% for Medicare (the same as in 2023).

2024 updates

For 2024, an employee will pay:

  • 6.2% Social Security tax on the first $168,600 of wages (6.2% x $168,600 makes the maximum tax $10,453.20), plus
  • 1.45% Medicare tax on the first $200,000 of wages ($250,000 for joint returns, $125,000 for married taxpayers filing separate returns), plus
  • 2.35% Medicare tax (regular 1.45% Medicare tax plus 0.9% additional Medicare tax) on all wages in excess of $200,000 ($250,000 for joint returns, $125,000 for married taxpayers filing separate returns).

For 2024, the self-employment tax imposed on self-employed people will be:

  • 12.4% Social Security tax on the first $168,600 of self-employment income, for a maximum tax of $20,906.40 (12.4% x $168,600), plus
  • 2.90% Medicare tax on the first $200,000 of self-employment income ($250,000 of combined self-employment income on a joint return, $125,000 on a return of a married individual filing separately), plus
  • 3.8% (2.90% regular Medicare tax plus 0.9% additional Medicare tax) on all self-employment income in excess of $200,000 ($250,000 of combined self-employment income on a joint return, $125,000 for married taxpayers filing separate returns).

Employees with more than one employer

You may have questions if an employee who works for your business has a second job. That employee would have taxes withheld from two different employers. Can the employee ask you to stop withholding Social Security tax once he or she reaches the wage base threshold? The answer is no. Each employer must withhold Social Security taxes from the individual’s wages, even if the combined withholding exceeds the maximum amount that can be imposed for the year. Fortunately, the employee will get a credit on his or her tax return for any excess withheld.

We’re here to help

Do you have questions about payroll tax filing or payments? Contact us. We’ll help ensure you stay in compliance.

© 2023

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What Types Of Expenses Can’t Be Written Off By Your Business?

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If you read the Internal Revenue Code (and you probably don’t want to!), you may be surprised to find that most business deductions aren’t specifically listed. For example, the tax law doesn’t explicitly state that you can deduct office supplies and certain other expenses. Some expenses are detailed in the tax code, but the general rule is contained in the first sentence of Section 162, which states you can write off “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

Basic definitions

In general, an expense is ordinary if it’s considered common or customary in the particular trade or business. For example, insurance premiums to protect a store would be an ordinary business expense in the retail industry.

A necessary expense is defined as one that’s helpful or appropriate. For example, let’s say a car dealership purchases an automated external defibrillator. It may not be necessary for the operation of the business, but it might be helpful and appropriate if an employee or customer suffers cardiac arrest.

It’s possible for an ordinary expense to be unnecessary — but, in order to be deductible, an expense must be ordinary and necessary.

In addition, a deductible amount must be reasonable in relation to the benefit expected. For example, if you’re attempting to land a $3,000 deal, a $65 lunch with a potential client should be OK with the IRS. (Keep in mind that the Tax Cuts and Jobs Act eliminated most deductions for entertainment expenses but retained the 50% deduction for business meals.)

Examples of taxpayers who lost deductions in court

Not surprisingly, the IRS and courts don’t always agree with taxpayers about what qualifies as ordinary and necessary expenditures. Here are three 2023 cases to illustrate some of the issues:

  1. A married couple owned an engineering firm. For two tax years, they claimed depreciation of $76,264 on three vehicles, but didn’t provide required details including each vehicle’s ownership, cost and useful life. They claimed $34,197 in mileage deductions and provided receipts and mileage logs, but the U.S. Tax Court found they didn’t show any related business purposes. The court also found the mileage claimed included commuting costs, which can’t be written off. The court disallowed these deductions and assessed taxes and penalties. (TC Memo 2023-39)
  2. The Tax Court ruled that a married couple wasn’t entitled to business tax deductions because the husband’s consulting company failed to show that it was engaged in a trade or business. In fact, invoices produced by the consulting company predated its incorporation. And the court ruled that even if the expenses were legitimate, they weren’t properly substantiated. (TC Memo 2023-80)
  3. A physician specializing in gene therapy had multiple legal issues and deducted legal expenses of $360,295 for two years on joint Schedule C business tax returns. The Tax Court found that most of the legal fees were to defend the husband against personal conduct issues. The court denied the deduction for personal legal expenses but allowed a deduction for $13,000 for business-related legal expenses. (TC Memo 2023-42)

Proceed with caution

The deductibility of some expenses is clear. But for other expenses, it can get more complicated. Generally, if an expense seems like it’s not normal in your industry — or if it could be considered fun, personal or extravagant in nature — you should proceed with caution. And keep careful records to substantiate the expenses you’re deducting. Consult with us for guidance.

© 2023

Q&A

How do you know if a business expense is considered “ordinary”?

An expense is considered “ordinary” if it is common and accepted in the industry or trade in which the business operates. This means that the expense must be typical and customary for businesses in that particular industry. It should not be excessive or unusual compared to what other businesses in the same industry would typically incur. Determining if an expense is ordinary often requires professional judgment and knowledge of industry standards and practices. In general, expenses that are necessary for the day-to-day operations of a business and directly related to generating revenue are more likely to be considered ordinary. It is important to consult with a professional accountant or tax advisor for specific guidance on classifying expenses as ordinary for your particular business.

How do you know if a business expense is considered “necessary”?

A necessary expense is one that is helpful and appropriate for your business. To determine if a particular expense is necessary, you should consider whether it directly relates to your business operations, contributes to the generation of income, or helps you maintain or improve your business’s efficiency and productivity. It’s important to note that in order for an expense to be deductible, it must be both ordinary and necessary.

When determining whether to deduct an expense for your business, are there any other factors to consider in addition to whether the expense is ordinary and necessary?

When determining whether to deduct an expense for your business, there are a few other factors to consider in addition to whether the expense is ordinary and necessary. These factors include substantiation (having proper documentation to support the business purpose of the expense), reasonableness (in relation to the nature of your business and industry standards, treating excessively lavish expenses with caution and additional consideration), a direct connection to your business activities and income/operations, proportional use (only deducting the portion that is used for business purposes if the expense has both business and personal use), and compliance with tax laws (ensuring that the expense meets all applicable tax laws and regulations, including any specific rules or limitations related to certain types of expenses).

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