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Cash or Accrual Accounting: Which is Best for Tax Purposes?

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Businesses often face the choice between using the cash or accrual method of accounting for tax purposes. While the cash method can offer substantial tax benefits for those who qualify, some businesses might find the accrual method more advantageous. It’s crucial to carefully assess the most suitable tax accounting method for your business to maximize benefits.

Understanding Your Options

According to the tax code, “small businesses” generally have the option to use either the cash or accrual accounting method for tax purposes. In some cases, businesses may also be eligible to use a hybrid approach. Prior to the Tax Cuts and Jobs Act (TCJA), the gross receipts threshold for qualifying as a small business ranged from $1 million to $10 million. This variation depended on factors such as the business’s structure, industry, and whether inventory played a significant role in income generation.

The TCJA brought simplification by setting a single gross receipts threshold and increasing it to $25 million (adjusted for inflation). This change extended small business benefits to a larger group of companies. For 2024, a business is considered a small business if its average annual gross receipts for the three-year period ending before the 2024 tax year are $30 million or less (an increase from $29 million in 2023).

In addition to eligibility for the cash method, small businesses benefit from simplified inventory accounting, exemption from uniform capitalization rules, and the business interest deduction limit, among other tax advantages. Notably, certain businesses can use the cash method even if their gross receipts exceed the threshold, including S corporations, partnerships without C corporation partners, farming businesses, and specific personal service corporations. However, tax shelters, regardless of their size, are not eligible for the cash method.

Key Advantages

For many businesses, the cash method offers significant tax benefits. Under this method, businesses recognize income when it is received and deduct expenses when they are paid, providing greater control over the timing of income and deductions. For example, a business can defer income by delaying invoicing until the next tax year or accelerate deductions by paying expenses earlier.

Conversely, businesses using the accrual method recognize income when it is earned and deduct expenses when they are incurred, irrespective of when cash transactions occur. This method offers less flexibility in managing the timing of income and expense recognition for tax purposes.

The cash method can also aid in cash flow management, as income is taxed in the year it is received, ensuring businesses have the necessary funds to meet their tax obligations.

However, in some cases, the accrual method might be more advantageous. If a company’s accrued income is typically lower than its accrued expenses, using the accrual method could result in a reduced tax liability compared to the cash method. Other potential benefits of the accrual method include the ability to deduct year-end bonuses paid within the first 2.5 months of the next tax year and the option to defer taxes on certain advance payments.

Considerations When Changing Methods

Even if switching from the accrual to the cash method (or vice versa) offers tax advantages, it is essential to weigh the administrative costs of making the change. For example, businesses that prepare financial statements according to U.S. Generally Accepted Accounting Principles (GAAP) must use the accrual method for financial reporting.

Does this mean the cash method cannot be used for tax purposes? No, businesses can still use the cash method for tax purposes, but this would require maintaining two separate sets of books. Additionally, changing accounting methods for tax purposes may require approval from the IRS.

Choosing between cash and accrual accounting methods is a significant decision with considerable tax implications. Contact us to learn more about each method and determine the best option for your business.

Q&A:

What are the main differences between the cash and accrual methods of accounting for tax purposes? 

The cash method recognizes income when it’s received and deducts expenses when they’re paid, offering businesses flexibility in timing income and deductions. The accrual method recognizes income when it’s earned and expenses when they’re incurred, regardless of when cash transactions occur, providing less flexibility in timing for tax purposes.

How did the Tax Cuts and Jobs Act (TCJA) impact small businesses regarding their choice of accounting method?

The TCJA simplified the definition of a small business by establishing a single gross receipts threshold and increasing it to $25 million (adjusted for inflation). For 2024, the threshold is $30 million. This change allowed more businesses to qualify as small businesses, making them eligible for the cash method of accounting and other tax benefits.

What are the potential advantages of using the cash method of accounting for tax purposes?

The cash method offers significant tax advantages by allowing businesses to control the timing of income and deductions. It also provides cash flow benefits, as income is taxed when received, ensuring funds are available to pay tax liabilities. Additionally, it allows for income deferral and deduction acceleration, offering greater flexibility.

What considerations should businesses keep in mind when switching between cash and accrual accounting methods?

Businesses should consider the administrative costs of maintaining two sets of books if using different methods for financial reporting and tax purposes. They should also be aware that switching methods may require IRS approval. It’s essential to evaluate the overall tax benefits against these potential costs before making a change.

 

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Hiring Your Child for Your Business: A Smart Tax Strategy

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As the school year concludes in New Jersey, you might be contemplating ways to keep your child engaged in a learning environment. One valuable option is hiring your child to work at your business. This not only imparts essential business knowledge to your child but also offers potential tax advantages for both of you.

Benefits for Your Child

Special tax breaks are available for hiring your child if you operate your business as one of the following:

  • A sole proprietorship
  • A partnership owned by both spouses
  • A single-member LLC treated as a sole proprietorship for tax purposes
  • An LLC treated as a partnership owned by both spouses

These entities can employ an owner’s under-age-18 children either full- or part-time. The wages paid to these children will be exempt from the following federal payroll taxes:

  • Social Security tax
  • Medicare tax
  • Federal Unemployment Tax Act (FUTA) tax (until the child reaches age 21)

Moreover, your dependent employee-child’s standard deduction can shelter up to $14,600 of 2024 wages from federal income tax.

Benefits for Your Business

When you hire your child, you can deduct their wages as a business expense, reducing your federal income tax bill, self-employment tax bill, and state income tax bill, if applicable.

Note: Different rules apply to corporations. If you operate as a C or S corporation, your child’s wages are subject to Social Security, Medicare, and FUTA taxes like any other employee. However, you can still deduct your child’s wages as a business expense on your corporation’s tax return, and your child can use the $14,600 standard deduction for single filers to shelter the wages from federal income tax.

Traditional and Roth IRAs

Regardless of the type of business you operate, your child can contribute to an IRA or Roth IRA. With a Roth IRA, contributions are made with after-tax dollars, allowing for tax-free withdrawals of contributions and earnings after age 59½, provided the account has been open for more than five years.

In contrast, contributions to a traditional IRA are deductible, subject to income limits, and reduce the child’s taxable income. However, Roth IRA contributions are often more beneficial for young individuals. Since the standard deduction will shelter up to $14,600 of earned income, any additional income is likely to be taxed at very low rates, making traditional IRA deductions less impactful.

Furthermore, your child can withdraw Roth IRA contributions without any federal income tax or penalty for college or other expenses. Despite this flexibility, the optimal strategy is to leave the Roth balance untouched until retirement to maximize tax-free growth.

To make Roth IRA contributions, your child must have earned income for the year that equals or exceeds the amount contributed. There is no age restriction. For the 2024 tax year, the contribution limit is the lesser of:

  • Earned income
  • $7,000

Regular Roth contributions can accumulate significantly over time. For instance, if your child contributes $1,000 annually to a Roth IRA for four years, the account could grow to about $32,000 in 45 years at a 5% annual return, or significantly more with higher returns.

Caveats

While hiring your child can be tax-efficient, their wages must be reasonable for the work performed. Maintain thorough records, including timesheets, job descriptions, and W-2 forms, to substantiate hours worked and duties performed.

For any questions about employing your child in your business, please contact us. We are here to help ensure compliance and maximize your tax benefits.

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IRS Releases 2025 Inflation-Adjusted Amounts for Health Savings Accounts (HSAs)

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The IRS has recently issued guidance on the 2025 inflation-adjusted amounts for Health Savings Accounts (HSAs). These adjustments, made annually based on inflation, are announced earlier than other inflation-adjusted amounts to allow employers adequate time to prepare for the upcoming year.

Fundamentals of HSAs

A Health Savings Account (HSA) is a trust established exclusively for covering the qualified medical expenses of its beneficiary. An HSA can only be created for an eligible individual covered under a high-deductible health plan (HDHP). Additionally, participants must not be enrolled in Medicare or have other health coverage, with exceptions including dental, vision, long-term care, accident, and specific disease insurance.

Contributions to an HSA within specified limits are tax-deductible above the line. These annual contribution limits, along with the deductible and out-of-pocket expenses under the tax code, are adjusted annually for inflation.

Inflation Adjustments for 2025

In Revenue Procedure 2024-25, the IRS announced the 2025 inflation-adjusted figures for HSA contributions:

  • Annual Contribution Limits: For 2025, the annual contribution limit is $4,300 for individuals with self-only coverage under an HDHP, and $8,550 for individuals with family coverage. These limits have increased from $4,150 and $8,300, respectively, in 2024.
  • Catch-Up Contributions: For both 2024 and 2025, individuals aged 55 or older by the end of the tax year can make an additional $1,000 catch-up contribution.
  • High-Deductible Health Plan Limits: For 2025, an HDHP must have an annual deductible of at least $1,650 for self-only coverage or $3,300 for family coverage (up from $1,600 and $3,200 in 2024). Additionally, annual out-of-pocket expenses (deductibles, co-payments, and other amounts, excluding premiums) must not exceed $8,300 for self-only coverage or $16,600 for family coverage (up from $8,050 and $16,100 in 2024).

Health Reimbursement Arrangements (HRAs)

The IRS also announced the inflation-adjusted amount for Health Reimbursement Arrangements (HRAs). HRAs must receive contributions from an eligible individual (employers cannot contribute). These contributions are not included in income, and HRA reimbursements for eligible medical expenses are not taxed. In 2025, the maximum amount that may be made newly available for the plan year for an excepted benefit HRA will be $2,150, up from $2,100 in 2024.

Benefits of HSAs

HSAs offer various benefits that are appreciated by both employers and employees. Contributions to HSAs are made on a pre-tax basis, and the funds can accumulate tax-free over the years. Withdrawals from HSAs are tax-free when used to pay for qualifying medical expenses such as doctor visits, prescriptions, chiropractic care, and premiums for long-term care insurance. Additionally, HSAs are “portable,” meaning they remain with the account holder even if they change employers or leave the workforce. Many employers find HSAs to be a valuable fringe benefit that helps attract and retain employees.

For any questions regarding HSAs and their implementation in your business, please contact us.

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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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Tax Treatment of Partner-Incurred Expenses in Service Partnerships

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It is not uncommon for partners in service partnerships, such as architecture or law firms, to incur expenses related to the partnership’s business. For example, partners may incur entertainment expenses when developing new client relationships or expenses for transportation to and from client meetings, professional publications, continuing education, and home office expenses. What is the tax treatment of such expenses? Here are the answers.

Reimbursable Expenses

As long as the expenses are those that a partner is expected to pay without reimbursement under the partnership agreement or firm policy (written or unwritten), the partner can deduct these expenses on Schedule E of Form 1040. Conversely, a partner cannot deduct expenses if the partnership would have honored a request for reimbursement.

A partner’s unreimbursed partnership business expenses should also generally be included as deductions in arriving at the partner’s net income from self-employment on Schedule SE.

For instance, suppose you are a partner in a local architecture firm. According to the firm’s partnership agreement, partners are expected to bear the costs of soliciting potential new business except in cases where attracting a large potential new client is a firm-wide goal. If you spend $4,500 of your own money on meal expenses to attract new clients and receive no reimbursement, you should report a deductible item of $2,250 (50% of $4,500) on your Schedule E. This $2,250 should also be included as a deduction in calculating your net self-employment income on Schedule SE.

However, it is crucial to note that a partner cannot deduct expenses if they could have been reimbursed by the firm. No deduction is allowed for “voluntary” out-of-pocket expenses. To avoid any confusion regarding the tax treatment of unreimbursed partnership expenses, it is advisable to establish a written firm policy clearly stating what will and will not be reimbursed. This ensures that partners can deduct their unreimbursed business expenses without issues from the IRS.

Home Office Deduction

Subject to the normal deduction limits under the home office rules, a partner can deduct expenses allocable to the regular and exclusive use of a home office for partnership business. The partner’s deductible home office expenses should be reported on Schedule E in the same manner as other unreimbursed partnership expenses.

If a partner has a deductible home office, the Schedule E home office deduction can provide multiple tax-saving benefits because it is effectively deducted for both federal income tax and self-employment tax purposes.

Additionally, if the partner’s home office qualifies as a principal place of business, commuting mileage from the home office to partnership business temporary work locations (such as client sites) and partnership permanent work locations (such as the partnership’s official office) counts as business mileage.

The principal place of business test can be satisfied in two ways:

  1. The partner conducts most of the partnership’s income-earning activities in the home office.
  2. The partner conducts partnership administrative and management tasks in the home office and does not make substantial use of any other fixed location (such as the partnership’s official office) for these tasks.

Conclusion

When a partner can be reimbursed for business expenses under a partnership agreement or standard operating procedures, they should submit these expenses for reimbursement. Otherwise, the partner cannot deduct the expenses. The partnership should establish a written policy clearly stating what expenses will and will not be reimbursed, including home office expenses if applicable. This applies equally to members of LLCs treated as partnerships for federal tax purposes since those members are considered partners under tax law.

For assistance with these issues or any other concerns related to your partnership, please contact us.

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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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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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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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Business Automobiles: How The Tax Depreciation Rules Work

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Do you use an automobile in your trade or business? If so, you may question how depreciation tax deductions are determined. The rules are complicated, and special limitations that apply to vehicles classified as passenger autos (which include many pickups and SUVs) can result in it taking longer than expected to fully depreciate a vehicle.

Depreciation is built into the cents-per-mile rate

First, be aware that separate depreciation calculations for a passenger auto only come into play if you choose to use the actual expense method to calculate deductions. If, instead, you use the standard mileage rate (65.5 cents per business mile driven for 2023), a depreciation allowance is built into the rate.

If you use the actual expense method to determine your allowable deductions for a passenger auto, you must make a separate depreciation calculation for each year until the vehicle is fully depreciated. According to the general rule, you calculate depreciation over a six-year span as follows: Year 1, 20% of the cost; Year 2, 32%; Year 3, 19.2%; Years 4 and 5, 11.52%; and Year 6, 5.76%. If a vehicle is used 50% or less for business purposes, you must use the straight-line method to calculate depreciation deductions instead of the percentages listed above.

For a passenger auto that costs more than the applicable amount for the year the vehicle is placed in service, you’re limited to specified annual depreciation ceilings. These are indexed for inflation and may change annually. For example, for a passenger auto placed in service in 2023 that cost more than a certain amount, the Year 1 depreciation ceiling is $20,200 if you choose to deduct first-year bonus depreciation. The annual ceilings for later years are: Year 2, $19,500; Year 3, $11,700; and for all later years, $6,960 until the vehicle is fully depreciated.

These ceilings are proportionately reduced for any nonbusiness use. And if a vehicle is used 50% or less for business purposes, you must use the straight-line method to calculate depreciation deductions.

Reminder: Under the Tax Cuts and Jobs Act, bonus depreciation is being phased down to zero in 2027, unless Congress acts to extend it. For 2023, the deduction is 80% of eligible property and for 2024, it’s scheduled to go down to 60%.

Heavy SUVs, pickups and vans

Much more favorable depreciation rules apply to heavy SUVs, pickups, and vans used over 50% for business, because they’re treated as transportation equipment for depreciation purposes. This means a vehicle with a gross vehicle weight rating (GVWR) above 6,000 pounds. Quite a few SUVs and pickups pass this test. You can usually find the GVWR on a label on the inside edge of the driver-side door.

What matters is the after-tax cost

What’s the impact of these depreciation limits on your business vehicle decisions? They change the after-tax cost of passenger autos used for business. That is, the true cost of a business asset is reduced by the tax savings from related depreciation deductions. To the extent depreciation deductions are reduced, and thereby deferred to future years, the value of the related tax savings is also reduced due to time-value-of-money considerations, and the true cost of the asset is therefore that much higher.

The rules are different if you lease an expensive passenger auto used for business. Contact us if you have questions or want more information.

© 2023

 

Q&As

 

What is the difference between using the actual expense method and standard mileage rate when calculating depreciation for a passenger auto?

Under the actual expense method, you calculate depreciation by tracking and deducting the actual expenses incurred for the vehicle, such as fuel, repairs, maintenance, insurance, and depreciation. This method requires you to keep detailed records of all expenses related to the vehicle. On the other hand, the standard mileage rate method allows you to deduct a set amount per mile driven for business purposes. The IRS sets this rate each year. For 2023, the standard mileage rate is 65.5 cents per mile. When it comes to depreciation specifically, under the actual expense method, you can deduct the actual depreciation expense of your vehicle based on its cost and useful life. With the standard mileage rate method, depreciation is already factored into the mileage rate. So when you claim deductions using the standard mileage rate, you cannot separately deduct depreciation expenses. It’s important to note that once you choose a method for calculating depreciation (either actual expense or standard mileage rate), you generally must continue using that same method for as long as you use that vehicle for business purposes.

 

How do I choose whether to use the actual expense method or standard mileage rate when calculating depreciation for my passenger auto?

To decide which method is best for you, you should consider factors such as your annual mileage, the age and condition of your vehicle, and whether you have high or low expenses related to operating your car for business purposes. It may be helpful to consult with a tax professional who can assess your specific situation and provide guidance on which method will result in the most favorable tax outcome for you.

 

Why do heavy SUVs have favorable depreciation rules?

Heavy SUVs have favorable depreciation rules because they are classified as “light trucks” for tax purposes. The tax code allows businesses to deduct a larger portion of the cost of heavy SUVs in the year that they are purchased, rather than spreading out the deduction over several years. This is known as bonus depreciation or Section 179 expensing. The rationale behind this favorable treatment is to encourage businesses to invest in vehicles that are used for business purposes, such as transporting goods or employees, by providing a financial incentive in the form of accelerated depreciation. It is worth noting that these rules apply specifically to vehicles that are used for business purposes at least 50% of the time.

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How IRS Auditors Learn About Your Business Industry

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Ever wonder how IRS examiners know about different industries so they can audit various businesses? They generally do research about specific industries and issues on tax returns by using IRS Audit Techniques Guides (ATGs). A little-known fact is that these guides are available to the public on the IRS website. In other words, your business can use the same guides to gain insight into what the IRS is looking for in terms of compliance with tax laws and regulations.

Many ATGs target specific industries, such as construction, aerospace, art galleries, architecture and veterinary medicine. Other guides address issues that frequently arise in audits, such as executive compensation, passive activity losses and capitalization of tangible property.

Issues unique to certain taxpayers

IRS auditors need to examine all different types of businesses, as well as individual taxpayers and tax-exempt organizations. Each type of return might have unique industry issues, business practices and terminology. Before meeting with taxpayers and their advisors, auditors do their homework to understand various industries or issues, the accounting methods commonly used, how income is received, and areas where taxpayers might not be in compliance.

By using a specific ATG, an IRS auditor may be able to reconcile discrepancies when reported income or expenses aren’t consistent with what’s normal for the industry or to identify anomalies within the geographic area in which the business is located.

Updates and revisions

Some guides were written several years ago and others are relatively new. There isn’t a guide for every industry. Here are some of the guide titles that have been revised or added in recent years:

  • Entertainment Audit Technique Guide (March 2023), which covers income and expenses for performers, producers, directors, technicians and others in the film and recording industries, as well as in live performances;
  • Capitalization of Tangible Property Audit Technique Guide (September 2022), which addresses potential tax issues involved in capital expenditures and dispositions of property.
  • Oil and Gas Audit Technique Guide (February 2023), which explains the complex tax issues involved in the exploration, development and production of crude oil and natural gas;
  • Cost Segregation Audit Technique Guide (June 2022), which provides IRS examiners with an understanding of why and how cost segregation studies are performed in order for businesses to claim refunds related to depreciation deductions.
  • Attorneys Audit Technique Guide (January 2022), which covers issues including retainers, contingent fees, client trust accounts, travel expenses and more;
  • Child Care Provider Audit Technique Guide (January 2022), which enables IRS examiners to audit businesses that provide care in homes or day care centers; and
  • Retail Audit Technique Guide (March 2021), which details tax issues unique to businesses that purchase items from a supplier or wholesaler and resell them at a profit.

Although ATGs were created to help IRS examiners uncover common methods of hiding income and inflating deductions, they also can help businesses ensure they aren’t engaging in practices that could raise audit red flags. For a complete list of ATGs, visit the IRS website.

© 2023

Q&As

How can I learn about what IRS auditors are looking for in my specific business industry?

The IRS uses Audit Techniques Guides (ATGs) when researching tax laws and regulations specific to an industry. ATGs are available to the public on the IRS website.

What are Audit Techniques Guides (ATGs)?

Audit Techniques Guides (ATGs) are publications created by the Internal Revenue Service (IRS) to provide guidance and insights into specific industries or tax-related issues. These guides are designed to assist IRS examiners in understanding the unique characteristics and potential tax issues associated with different industries or types of transactions. ATGs cover a wide range of topics, including but not limited to the construction industry, retail industry, cash-intensive businesses, and passive activity losses. These guides provide valuable information on common practices, accounting methods, industry trends, and potential areas of noncompliance that examiners should be aware of during an audit. It is important to note that ATGs are not official IRS pronouncements or regulations but rather educational resources that offer insight into how the IRS may approach certain tax issues during examinations.

How do IRS auditors use Audit Techniques Guides (ATGs)?

IRS auditors use Audit Techniques Guides (ATGs) as a resource to assist them in conducting audits. These guides provide detailed information on specific industries or areas of tax law and offer insights into common issues, potential audit risks, and examination techniques. By using ATGs, auditors can gain a deeper understanding of the industry-specific practices and transactions they are examining, allowing them to identify potential areas of non-compliance and conduct more thorough audits. The ATGs serve as a tool to ensure consistency in the examination process and help auditors make informed decisions based on relevant industry practices and applicable tax laws.

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2023 Q4 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 fourth quarter of 2023. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

Note: Certain tax-filing and tax-payment deadlines may be postponed for taxpayers who reside in or have businesses in federally declared disaster areas.

Monday, October 2

  • The last day you can initially set up a SIMPLE IRA plan, provided you (or any predecessor employer) didn’t previously maintain a SIMPLE IRA plan. If you’re a new employer that comes into existence after October 1 of the year, you can establish a SIMPLE IRA plan as soon as administratively feasible after your business comes into existence.

Monday, October 16

  • If a calendar-year C corporation that filed an automatic six-month extension:
    • File a 2022 income tax return (Form 1120) and pay any tax, interest and penalties due.
    • Make contributions for 2022 to certain employer-sponsored retirement plans.
    • Establish and contribute to a SEP for 2022, if an automatic six-month extension was filed.

Tuesday, October 31

  • Report income tax withholding and FICA taxes for third quarter 2023 (Form 941) and pay any tax due. (See exception below under “November 13.”)

Monday, November 13

  • Report income tax withholding and FICA taxes for third quarter 2023 (Form 941), if you deposited on time (and in full) all of the associated taxes due.

Friday, December 15

  • If a calendar-year C corporation, pay the fourth installment of 2023 estimated income taxes.

Contact us if you’d like more information about the filing requirements and to ensure you’re meeting all applicable deadlines.

© 2023

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Update On Depreciating Business Assets

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The Tax Cuts and Jobs Act liberalized the rules for depreciating business assets. However, the amounts change every year due to inflation adjustments. And due to high inflation, the adjustments for 2023 were big. Here are the numbers that small business owners need to know.

Section 179 deductions

For qualifying assets placed in service in tax years beginning in 2023, the maximum Sec. 179 deduction is $1.16 million. But if your business puts in service more than $2.89 million of qualified assets, the maximum Sec. 179 deduction begins to be phased out.

Eligible assets include depreciable personal property such as equipment, computer hardware and peripherals, vehicles and commercially available software.

Sec. 179 deductions can also be claimed for real estate qualified improvement property (QIP), up to the maximum allowance of $1.16 million. QIP is defined as an improvement to an interior portion of a nonresidential building placed in service after the date the building was placed in service. However, expenditures attributable to the enlargement of a building, elevators or escalators, or the internal structural framework of a building don’t count as QIP and usually must be depreciated over 39 years. There’s no separate Sec. 179 deduction limit for QIP, so deductions reduce your maximum allowance dollar for dollar.

For nonresidential real property, Sec. 179 deductions are also allowed for qualified expenditures for roofs, HVAC equipment, fire protection and alarm systems, and security systems.

Finally, eligible assets include depreciable personal property used predominantly in connection with furnishing lodging, such as furniture and appliances in a property rented to transients.

Deduction for heavy SUVs

There’s a special limitation on Sec. 179 deductions for heavy SUVs, meaning those with gross vehicle weight ratings (GVWR) between 6,001 and 14,000 pounds. For tax years beginning in 2023, the maximum Sec. 179 deduction for heavy SUVs is $28,900.

First-year bonus depreciation has been cut

For qualified new and used assets that were placed in service in calendar year 2022, 100% first-year bonus depreciation percentage could be claimed.

However, for qualified assets placed in service in 2023, the first-year bonus depreciation percentage dropped to 80%. In 2024, it’s scheduled to drop to 60% (40% in 2025, 20% in 2026 and 0% in 2027 and beyond).

Eligible assets include depreciable personal property such as equipment, computer hardware and peripherals, vehicles and commercially available software. First-year bonus depreciation can also be claimed for real estate QIP.

Exception: For certain assets with longer production periods, these percentage cutbacks are delayed by one year. For example, the 80% depreciation rate will apply to long-production-period property placed in service in 2024.

Passenger auto limitations

For federal income tax depreciation purposes, passenger autos are defined as cars, light trucks and light vans. These vehicles are subject to special depreciation limits under the so-called luxury auto depreciation rules. For new and used passenger autos placed in service in 2023, the maximum luxury auto deductions are as follows:

  • $12,200 for Year 1 ($20,200 if bonus depreciation is claimed),
  • $19,500 for Year 2,
  • $11,700 for Year 3, and
  • $6,960 for Year 4 and thereafter until fully depreciated.

These allowances assume 100% business use. They’ll be further adjusted for inflation in future years.

Advantage for heavy vehicles

Heavy SUVs, pickups, and vans (those with GVWRs above 6,000 pounds) are exempt from the luxury auto depreciation limitations because they’re considered transportation equipment. As such, heavy vehicles are eligible for Sec. 179 deductions (subject to the special deduction limit explained earlier) and first-year bonus depreciation.

Here’s the catch: Heavy vehicles must be used over 50% for business. Otherwise, the business-use percentage of the vehicle’s cost must be depreciated using the straight-line method and it’ll take six tax years to fully depreciate the cost.

Consult with us for the maximum depreciation tax breaks in your situation.

© 2023

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Divorcing Business Owners Should Pay Attention To The Tax Consequences

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If you’re getting a divorce, you know the process is generally filled with stress. But if you’re a business owner, tax issues can complicate matters even more. Your business ownership interest is one of your biggest personal assets and in many cases, your marital property will include all or part of it.

Transferring property tax-free

In general, you can divide most assets, including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).

For example, let’s say that under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding period for the home and the stock would carry over to the person who receives them.

Tax-free transfers can occur before a divorce or at the time it becomes final. Tax-free treatment also applies to post-divorce transfers as long as they’re made “incident to divorce.” This means transfers that occur within:

  • A year after the date the marriage ends, or
  • Six years after the date the marriage ends if the transfers are made pursuant to your divorce agreement.

Additional future tax issues

Eventually, there will be tax implications for assets received tax-free in a divorce settlement. The ex-spouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies).

What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.

Note: The person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement.

In addition, the beneficial tax-free transfer rule is now extended to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in a divorce, these types of ordinary-income assets can also be transferred tax-free. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.

Avoid surprises by planning ahead

Like many major life events, divorce can have significant tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher. Contact us. We can help you minimize the adverse tax consequences of settling your divorce.

© 2023

Q&As

How can business owners minimize the tax implications of a divorce settlement?

Business owners can minimize the tax implications of a divorce settlement by structuring the settlement as a property division rather than as alimony or spousal support, utilizing qualified domestic relations orders (QDROs) to help divide retirement accounts between spouses without incurring taxes or penalties, and considering the timing of asset transfers. It is important to consult with a professional who can provide personalized advice based on your specific circumstances.

How can business owners ensure they are properly valuing their businesses during divorce proceedings to avoid tax complications?

Business owners can ensure they are properly valuing their businesses during divorce proceedings by hiring a professional appraiser, providing accurate and up-to-date financial information, considering all assets and liabilities associated with the business including intellectual property, inventory, equipment, debts, and outstanding loans, and consulting with tax and legal professionals.

What are some of the potential tax consequences that business owners should be aware of when going through a divorce?

When going through a divorce, business owners should be aware of potential tax consequences including entity structure changes, the requirement for the spouse who ends up with an appreciated asset to recognize the taxable gain when selling the asset, and more. It is important to consult with a tax professional to minimize the adverse tax consequences of settling your divorce.

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Advantages And Disadvantages Of Claiming Big First-Year Real Estate Depreciation Deductions

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Your business may be able to claim big first-year depreciation tax deductions for eligible real estate expenditures rather than depreciate them over several years. But should you? It’s not as simple as it may seem.

Qualified improvement property

For qualifying assets placed in service in tax years beginning in 2023, the maximum allowable first-year Section 179 depreciation deduction is $1.16 million. Importantly, the Sec. 179 deduction can be claimed for real estate qualified improvement property (QIP), up to the maximum annual allowance.

QIP includes any improvement to an interior portion of a nonresidential building that’s placed in service after the date the building is placed in service. For Sec. 179 deduction purposes, QIP also includes HVAC systems, nonresidential building roofs, fire protection and alarm systems and security systems that are placed in service after the building is first placed in service.

However, expenditures attributable to the enlargement of the building, any elevator or escalator, or the building’s internal structural framework don’t count as QIP and must be depreciated over several years.

Mind the limitations

A taxpayer’s Sec. 179 deduction can’t cause an overall business tax loss, and the maximum deduction is phased out if too much qualifying property is placed in service in the tax year. The Sec. 179 deduction limitation rules can get tricky if you own an interest in a pass-through business entity (partnership, LLC treated as a partnership for tax purposes, or S corporation). Finally, trusts and estates can’t claim Sec. 179 deductions, and noncorporate lessors face additional restrictions. We can give you full details.

First-year bonus depreciation for QIP

Beyond the Sec. 179 deduction, 80% first-year bonus depreciation is also available for QIP that’s placed in service in calendar year 2023. If your objective is to maximize first-year write-offs, you’d claim the Sec. 179 deduction first. If you max out on that, then you’d claim 80% first-year bonus depreciation.

Note that for first-year bonus depreciation purposes, QIP doesn’t include nonresidential building roofs, HVAC systems, fire protection and alarm systems, or security systems.

Consider depreciating QIP over time

Here are two reasons why you should think twice before claiming big first-year depreciation deductions for QIP.

1. Lower-taxed gain when property is sold

First-year Sec. 179 deductions and bonus depreciation claimed for QIP can create depreciation recapture that’s taxed at higher ordinary income rates when the QIP is sold. Under current rules, the maximum individual rate on ordinary income is 37%, but you may also owe the 3.8% net investment income tax (NIIT).

On the other hand, for QIP held for more than one year, gain attributable to straight-line depreciation is taxed at an individual federal rate of only 25%, plus the 3.8% NIIT if applicable.

2. Write-offs may be worth more in the future

When you claim big first-year depreciation deductions for QIP, your depreciation deductions for future years are reduced accordingly. If federal income tax rates go up in future years, you’ll have effectively traded potentially more valuable future-year depreciation write-offs for less-valuable first-year write-offs.

As you can see, the decision to claim first-year depreciation deductions for QIP, or not claim them, can be complicated. Consult with us before making depreciation choices.

© 2023

 

FAQs

What are some potential tax consequences of taking large depreciation deductions in the first year of owning a property?

Taking large depreciation deductions in the first year of owning a property can have both immediate and long-term tax consequences. While it may reduce your taxable income for that year, it can also decrease your basis in the property, which may lead to higher capital gains taxes when you sell the property. Additionally, if you take a large depreciation deduction in the first year and then sell the property soon after, you may be subject to recapture taxes on the amount of depreciation claimed.

How do you determine the amount of depreciation to claim in the first year for a new property?

The amount of depreciation to claim in the first year for a new property is determined by using the Modified Accelerated Cost Recovery System (MACRS) established by the IRS. The MACRS system assigns a recovery period and depreciation method to each property based on its classification. For example, residential rental properties are typically assigned a 27.5-year recovery period and use the straight-line depreciation method. To calculate the first year’s depreciation, you would take the depreciable basis of the property (the original cost minus land value) and divide it by the assigned recovery period. The resulting amount is then multiplied by a percentage based on the chosen depreciation method and prorated for the portion of the year that the property was in service. It is recommended to consult with a tax professional or accountant for specific guidance on your individual situation.

What are some of the limitations of the first-year Section 179 depreciation deduction?

While the Section 179 depreciation deduction can provide significant tax savings for eligible businesses, there are some limitations to be aware of. Firstly, the maximum amount that can be deducted under Section 179 is subject to an annual limit ($1.16 million for qualifying assets placed in service in 2023), which is adjusted for inflation each year. Additionally, trusts and estates can’t claim Sec. 179 deductions, and noncorporate lessors face additional restrictions. Finally, there are limitations based on the total amount of qualifying property purchased during the year—if it exceeds a certain threshold in a given year, the Section 179 deduction may be reduced or eliminated entirely.

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2023 Q3 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 third quarter of 2023. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

July 31 

  • Report income tax withholding and FICA taxes for second quarter 2023 (Form 941) and pay any tax due. (See the exception below, under “August 10.”)
  • File a 2022 calendar-year retirement plan report (Form 5500 or Form 5500-EZ) or request an extension.

August 10 

  • Report income tax withholding and FICA taxes for second quarter 2023 (Form 941), if you deposited on time and in full all of the associated taxes due.

September 15

  • If a calendar-year C corporation, pay the third installment of 2023 estimated income taxes.
  • If a calendar-year S corporation or partnership that filed an automatic six-month extension:
    • File a 2022 income tax return (Form 1120-S, Form 1065 or Form 1065-B) and pay any tax, interest and penalties due.
    • Make contributions for 2022 to certain employer-sponsored retirement plans.

© 2023

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Keep These DOs And DON’Ts In Mind When Deducting Business Meal And Vehicle Expenses

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If you’re claiming deductions for business meals or auto expenses, expect the IRS to closely review them. In some cases, taxpayers have incomplete documentation or try to create records months (or years) later. In doing so, they fail to meet the strict substantiation requirements set forth under tax law. Tax auditors are adept at rooting out inconsistencies, omissions and errors in taxpayers’ records, as illustrated by one recent U.S. Tax Court case.

Facts of the case

In the case, a married couple claimed $13,596 in car and truck expenses, supported only by mileage logs that weren’t kept contemporaneously and were made using estimates rather than odometer readings. The court disallowed the entire deduction, stating that “subsequently prepared mileage records do not have the same high degree of credibility as those made at or near the time the vehicle was used and supported by documentary evidence.”

The court noted that it appeared the taxpayers attempted to deduct their commuting costs. However, it stated that “expenses a taxpayer incurs traveling between his or her home and place of business generally constitute commuting expenses, which … are nondeductible.”

A taxpayer isn’t relieved of the obligation to substantiate business mileage, even if he or she opts to use the standard mileage rate (65.5 cents per business mile in 2023), rather than keep track of actual expenses.

The court also ruled the couple wasn’t entitled to deduct $5,233 of travel, meal and entertainment expenses because they didn’t meet the strict substantiation requirements of the tax code. (TC Memo 2022-113)

Stay on the right track

This case is an example of why it’s critical to maintain meticulous records to support business expenses for vehicle and meal deductions. Here’s a list of “DOs and DON’Ts” to help meet the strict IRS and tax law substantiation requirements for these items:

DO keep detailed, accurate records. For each expense, record the amount, the time and place, the business purpose, and the business relationship of any person to whom you provided a meal. If you have employees who you reimburse for meals and auto expenses, make sure they’re complying with all the rules.

DON’T reconstruct expense logs at year end or wait until you receive a notice from the IRS. Take a moment to record the details in a log or diary or on a receipt at the time of the event or soon after. Require employees to submit monthly expense reports.

DO respect the fine line between personal and business expenses. Be careful about combining business and pleasure. Your business checking account shouldn’t be used for personal expenses.

DON’T be surprised if the IRS asks you to prove your deductions. Vehicle and meal expenses are a magnet for attention. Be prepared for a challenge.

With organization and guidance from us, your tax records can stand up to inspection from the IRS. There may be ways to substantiate your deductions that you haven’t thought of, and there may be a way to estimate certain deductions (called “the Cohan rule”), if your records are lost due to a fire, theft, flood or other disaster.

© 2023

Q&As

What are some common mistakes that people make when claiming deductions for business meals or auto expenses?

Some common mistakes people make when claiming deductions for business meals or auto expenses include failing to keep accurate records of the expenses, claiming personal expenses as business expenses, and failing to meet the IRS requirements for deducting these expenses.

How do I keep accurate records of my business meals and auto expenses to comply with IRS requirements?

To help meet IRS substantiation requirements for business meal and auto expenses, include the date, amount, location, and purpose of the expense. For auto expenses, you should maintain a logbook that tracks your mileage and includes details such as the date, starting and ending locations, purpose of the trip, and total miles driven. It may also be helpful to keep receipts or other documentation to support your expenses.

Why does claiming deductions for business meals or auto expenses attract IRS attention?

Deducting business meal or auto expenses can attract IRS attention because these expenses are often over-reported or inaccurately reported. The IRS has specific rules and limitations for deducting these expenses, and if they are not properly documented or supported, it can trigger an audit. Additionally, some taxpayers may try to deduct personal expenses as business expenses, which is a red flag for the IRS. It is important to keep accurate records and follow all IRS guidelines when deducting business meal or auto expenses to avoid any potential issues with the IRS.

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If You’re Hiring Independent Contractors, Make Sure They’re Properly Handled

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Many businesses use independent contractors to help keep their costs down — especially in these times of staff shortages and inflationary pressures. If you’re among them, be careful that these workers are properly classified for federal tax purposes. If the IRS reclassifies them as employees, it can be an expensive mistake.

The question of whether a worker is an independent contractor or an employee for federal income and employment tax purposes is a complex one. If a worker is an employee, your company must withhold federal income and payroll taxes and pay the employer’s share of FICA taxes on the wages, plus FUTA tax. A business may also provide the worker with fringe benefits if it makes them available to other employees. In addition, there may be state tax obligations.

On the other hand, if a worker is an independent contractor, these obligations don’t apply. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if it’s $600 or more).

No One Definition

Who’s an “employee?” Unfortunately, there’s no uniform definition of the term.

The IRS and courts have generally ruled that individuals are employees if the organization they work for has the right to control and direct them in the jobs they’re performing. Otherwise, the individuals are generally independent contractors. But other factors are also taken into account including who provides tools and who pays expenses.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Section 530. This protection generally applies only if an employer meets certain requirements. For example, the employer must file all federal returns consistent with its treatment of a worker as a contractor and it must treat all similarly situated workers as contractors.

Note: Section 530 doesn’t apply to certain types of workers.

You Can Ask The IRS But Think Twice

Be aware that you can ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, you should also be aware that the IRS has a history of classifying workers as employees rather than independent contractors.

Businesses should consult with us before filing Form SS-8 because it may alert the IRS that your business has worker classification issues — and it may unintentionally trigger an employment tax audit.

It may be better to properly set up a relationship with workers to treat them as independent contractors so that your business complies with the tax rules.

Workers who want an official determination of their status can also file Form SS-8. Dissatisfied independent contractors may do so because they feel entitled to employee benefits and want to eliminate their self-employment tax liabilities.

If a worker files Form SS-8, the IRS will notify the business with a letter. It identifies the worker and includes a blank Form SS-8. The business is asked to complete and return the form to the IRS, which will render a classification decision.

How do I determine if someone is an employee or an independent contractor?

There is no uniform definition of the term “employee,” but the IRS and courts have generally ruled that individuals are employees if the organization they work for has the right to control and direct them in the jobs they’re performing. Various other factors, including the worker’s level of autonomy and independence and the nature of the work being performed, are also considered. The IRS provides guidance on this issue, including a set of criteria known as the “Common Law Rules,” which help employers determine whether a worker is an employee or an independent contractor.

What is the risk of asking the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee?

Asking the IRS to rule on worker classification may trigger an audit and potential tax liabilities for the employer. The IRS may also require back payment of employment taxes, penalties, and interest. The IRS has a history of classifying workers as employees rather than independent contractors. Businesses should consult with us before filing Form SS-8 to avoid these issues.

What are some tax-related differences between employees and independent contractors?

There are several tax-related differences between employees and independent contractors. For example, businesses are obligated to withhold taxes from employees’ paychecks. For independent contractors, businesses are only required to issue form 1099-NEC (if compensation for the year was $600 or more) and are not obligated to withhold taxes.

These are the basic tax rules. Contact us if you’d like to discuss how to classify workers at your business. We can help make sure that your workers are properly classified.

© 2023

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Do You Run A Business From Home? You May Be Able To Deduct Home Office Expenses

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Many people began working from home during the COVID-19 pandemic — and many still work from their home offices either all the time or on a hybrid basis. If you’re self-employed and run your business from home or perform certain functions there, you might be able to claim deductions for home office expenses against your business income. There are two methods for claiming this tax break: the actual expense method and the simplified method.

How to qualify

In general, you qualify for home office deductions if part of your home is used “regularly and exclusively” as your principal place of business.

If your home isn’t your principal place of business, you may still be able to deduct home office expenses if:

  1. You physically meet with patients, clients or customers on your premises, or
  2. You use a storage area in your home (or a separate free-standing structure, such as a garage) exclusively and regularly for business.

Expenses you can deduct

Many eligible taxpayers deduct actual expenses when they claim home office deductions. Deductible home office expenses may include:

  • Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,
  • A proportionate share of indirect expenses, including mortgage interest, rent, property taxes, utilities, repairs and insurance, and
  • Depreciation.

But keeping track of actual expenses can take time and it requires organized recordkeeping.

The simpler method

Fortunately, there’s a simplified method: You can deduct $5 for each square foot of home office space, up to a maximum of $1,500.

The cap can make the simplified method less valuable for larger home office spaces. Even for small spaces, taxpayers may qualify for bigger deductions using the actual expense method. So, tracking your actual expenses can be worth it.

Changing methods 

When claiming home office deductions, you’re not stuck with a particular method. For instance, you might choose the actual expense method on your 2022 return, use the simplified method when you file your 2023 return next year and then switch back to the actual expense method for 2024. The choice is yours.

What if I sell the home?

If you sell — at a profit — a home on which you claimed home office deductions, there may be tax implications. We can explain them to you.

Also be aware that the amount of your home office deductions is subject to limitations based on the income attributable to your use of the office. Other rules and limitations may apply. But any home office expenses that can’t be deducted because of these limitations can be carried over and deducted in later years.

Different rules for employees

Unfortunately, the Tax Cuts and Jobs Act suspended the business use of home office deductions from 2018 through 2025 for employees. Those who receive paychecks or Form W-2s aren’t eligible for deductions, even if they’re currently working from home because their employers closed their offices due to COVID-19.

We can help you determine if you’re eligible for home office deductions and how to proceed in your situation.

© 2023

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Protect The “Ordinary And Necessary” Advertising Expenses Of Your Business

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Under tax law, businesses can generally deduct advertising and marketing expenses that help keep existing customers and bring in new ones. This valuable tax deduction can help businesses cut their taxes.

However, in order to be deductible, advertising and marketing expenses must be “ordinary and necessary.” As one taxpayer recently learned in U.S. Tax Court, not all expenses are eligible. An ordinary expense is one that’s common and accepted in the industry. And a necessary expense is one that’s helpful and appropriate for the business.

According to the IRS, here are some advertising expenses that are usually deductible:

  • Reasonable advertising expenses that are directly related to the business activities.
  • An expense for the cost of institutional or goodwill advertising to keep the business name before the public if it relates to a reasonable expectation to gain business in the future. For example, the cost of advertising that encourages people to contribute to the Red Cross or to participate in similar causes is usually deductible.
  • The cost of providing meals, entertainment, or recreational facilities to the public as a means of advertising or promoting goodwill in the community.

Facts of the recent case

An attorney deducted his car-racing expenses and claimed they were advertising for his personal injury law practice. He contended that his racing expenses, totaling over $303,000 for six tax years, were deductible as advertising because the car he raced was sponsored by his law firm.

The IRS denied the deductions and argued that the attorney’s car racing wasn’t an ordinary and necessary expense paid or incurred while carrying on his business of practicing law. The Tax Court agreed with the IRS.

When making an ordinary and necessary determination for an expense, most courts look to the taxpayer’s primary motive for incurring the expense and whether there’s a “proximate” relationship between the expense and the taxpayer’s occupation. In this case, the taxpayer’s car-racing expenses were neither necessary nor common for a law practice, so there was no “proximate” relationship between the expense and the taxpayer’s occupation. And, while the taxpayer said his primary motive for incurring the expense was to advertise his law business, he never raced in the state where his primary law practice was located and he never actually got any legal business from his car-racing activity.

The court noted that the car “sat in his garage” after he returned to the area where his law practice was located. The court added that even if the taxpayer raced in that area, “we would not find his expenses to be legitimate advertising expenses. His name and a decal for his law firm appeared in relatively small print” on his car.

This form of “signage,” the court stated, “is at the opposite end of the spectrum from (say) a billboard or a newspaper ad. Indeed, every driver’s name typically appeared on his or her racing car.” (TC Memo 2023-18)

Keep meticulous records

There are no deductions allowed for personal expenses or hobbies. But as explained above, you can deduct ordinary and necessary advertising and marketing expenses in a bona fide business. The key to protecting your deductions is to keep meticulous records to substantiate them. Contact us with questions about your situation.

© 2023

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Have Employees Who Receive Tips? Here Are The Tax Implications

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Many businesses in certain industries employ individuals who receive tips as part of their compensation. These businesses include restaurants, hotels and salons.

Tip definition

Tips are optional payments that customers make to employees who perform services. They can be cash or noncash. Cash tips include those received directly from customers, electronically paid tips distributed to employees by employers and tips received from other employees under tip-sharing arrangements. Generally, workers must report cash tips to their employers. Noncash tips are items of value other than cash. They may include tickets, passes or other items that customers give employees. Workers don’t have to report noncash tips to employers.

For tax purposes, four factors determine whether a payment qualifies as a tip:

  1. The customer voluntarily makes the payment,
  2. The customer has the unrestricted right to determine the amount,
  3. The payment isn’t negotiated with, or dictated by, employer policy, and
  4. The customer generally has the right to determine who receives the payment.

 

Tips can also be direct or indirect. A direct tip occurs when an employee receives it directly from a customer, even as part of a tip pool. Directly tipped employees include wait staff, bartenders and hairstylists. An indirect tip occurs when an employee who normally doesn’t receive tips receives one. Indirectly tipped employees include bussers, service bartenders, cooks and salon shampooers.

Daily tip records

Tipped workers must keep daily records of the cash tips they receive. To keep track of them, they can use Form 4070A, Employee’s Daily Record of Tips. It is found in IRS Publication 1244.

Workers should also keep records of the dates and value of noncash tips. Although the IRS doesn’t require workers to report noncash tips to employers, they must report them on their tax returns.

Reporting to employers

Employees must report tips to employers by the 10th of the month following the month they were received. The IRS doesn’t require workers to use a particular form to report tips. However, a worker’s tip report generally should include:

  • The employee’s name, address, Social Security number and signature,
  • The employer’s name and address,
  • The month or period covered, and
  • Total tips received during the period.

Note: Employees whose monthly tips are less than $20 don’t need to report them to their employers but must include them as income on their tax returns.

Employer requirements

Employers should send each employee a Form W-2 that includes reported tips. Employers also must:

  • Keep their employees’ tip reports.
  • Withhold taxes, including income taxes and the employee’s share of Social Security tax and Medicare tax, based on employees’ wages and reported tip income.
  • Pay the employer share of Social Security and Medicare taxes based on the total wages paid to tipped employees as well as reported tip income.
  • Report this information to the IRS on Form 941, Employer’s Quarterly Federal Tax Return.
  • Deposit withheld taxes in accordance with federal tax deposit requirements.

In addition, “large” food or beverage establishments must file an annual report disclosing receipts and tips on Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips.

What qualifies as a tip for tax purposes?

For tax purposes, a payment qualifies as a tip if the customer voluntarily makes the payment, the customer has unrestricted right to determine the amount, the payment isn’t negotiated with or dictated by employee policy, and the customer has the right to determine who receives the payment.

How should tipped workers keep track of their tips?

Tipped workers should use Form 4070A, Employee’s Daily Record of Tips, to keep track of their cash tips.

When should employees report tips to employers?

Employees must report tips to employers by the 10th of the month following the month they were received.

What is the difference between a direct tip and an indirect tip?

A direct tip is received directly from the customer (including as part of a tip pool), while an indirect tip occurs when an employee who doesn’t normally receive a tip receives one (i.e. a cook in a restaurant).

Tip tax credit

If you’re an employer with tipped workers providing food and beverages, you may qualify for a federal tax credit involving the Social Security and Medicare taxes that you pay on employees’ tip income. The tip tax credit may be valuable to you. If you have any questions about the tax implications of tips, don’t hesitate to contact us.

© 2023

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Many Tax Limits Affecting Businesses Have Increased For 2023

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An array of tax-related limits that affect businesses are indexed annually, and due to high inflation, many have increased more than usual for 2023. Here are some that may be important to you and your business.

Social Security tax

The amount of employees’ earnings that are subject to Social Security tax is capped for 2023 at $160,200 (up from $147,000 for 2022).

Deductions

  • Section 179 expensing:
    • Limit: $1.16 million (up from $1.08 million)
    • Phaseout: $2.89 million (up from $2.7 million)
  • Income-based phase-out for certain limits on the Sec. 199A qualified business income deduction begins at:
    • Married filing jointly: $364,200 (up from $340,100)
    • Other filers: $182,100 (up from $170,050)

Retirement plans

  • Employee contributions to 401(k) plans: $22,500 (up from $20,500)
  • Catch-up contributions to 401(k) plans: $7,500 (up from $6,500)
  • Employee contributions to SIMPLEs: $15,500 (up from $14,000)
  • Catch-up contributions to SIMPLEs: $3,500 (up from $3,000)
  • Combined employer/employee contributions to defined contribution plans (not including catch-ups): $66,000 (up from $61,000)
  • Maximum compensation used to determine contributions: $330,000 (up from $305,000)
  • Annual benefit for defined benefit plans: $265,000 (up from $245,000)
  • Compensation defining a highly compensated employee: $150,000 (up from $135,000)
  • Compensation defining a “key” employee: $215,000 (up from $200,000)

Other employee benefits

  • Qualified transportation fringe-benefits employee income exclusion: $300 per month (up from $280)
  • Health Savings Account contributions:
    • Individual coverage: $3,850 (up from $3,650)
    • Family coverage: $7,750 (up from $7,300)
    • Catch-up contribution: $1,000 (no change)
  • Flexible Spending Account contributions:
    • Health care: $3,050 (up from $2,850)
    • Dependent care: $5,000 (no change)

These are only some of the tax limits and deductions that may affect your business and additional rules may apply. Contact us if you have questions.

© 2023

 

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Forms W-2 And 1099-NEC Are Due To Be Filed Soon

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With the 2023 filing season deadline drawing near, be aware that the deadline for businesses to file information returns for hired workers is even closer. By January 31, 2023, employers must file these forms:

Form W-2, Wage and Tax Statement. W-2 forms show the wages paid and taxes withheld for the year for each employee. They must be provided to employees and filed with the Social Security Administration (SSA). The IRS notes that “because employees’ Social Security and Medicare benefits are computed based on information on Form W-2, it’s very important to prepare Form W-2 correctly and timely.”

Form W-3, Transmittal of Wage and Tax Statements. Anyone required to file Form W-2 must also file Form W-3 to transmit Copy A of Form W-2 to the SSA. The totals for amounts reported on related employment tax forms (Form 941, Form 943, Form 944 or Schedule H for the year) should agree with the amounts reported on Form W-3.

Failing to timely file or include the correct information on either the information return or statement may result in penalties.

Independent contractors

The January 31 deadline also applies to Form 1099-NEC, Nonemployee Compensation. These forms are provided to recipients and filed with the IRS to report non-employee compensation to independent contractors.

Payers must complete Form 1099-NEC to report any payment of $600 or more to a recipient.

If the following four conditions are met, you must generally report payments as nonemployee compensation:

You made a payment to someone who isn’t your employee,
You made a payment for services in the course of your trade or business,
You made a payment to an individual, partnership, estate, or, in some cases, a corporation, and
You made payments to a recipient of at least $600 during the year.
Your business may also have to file a Form 1099-MISC for each person to whom you made certain payments for rent, medical expenses, prizes and awards, attorney’s services and more.

We can help

If you have questions about filing Form W-2, Form 1099-NEC or any tax forms, contact us. We can assist you in staying in compliance with all rules.

© 2023

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Employers Should Be Wary Of ERC Claims That Are Too Good To Be True

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The Employee Retention Credit (ERC) was a valuable tax credit that helped employers that kept workers on staff during the height of the COVID-19 pandemic. While the credit is no longer available, eligible employers that haven’t yet claimed it might still be able to do so by filing amended payroll returns for tax years 2020 and 2021.

However, the IRS is warning employers to beware of third parties that may be advising them to claim the ERC when they don’t qualify. Some third-party “ERC mills” are promising that they can get businesses a refund without knowing anything about the employers’ situations. They’re sending emails, letters and voice mails as well as advertising on television. When businesses respond, these ERC mills are claiming many improper write-offs related to taxpayer eligibility for — and computation of — the credit.

These third parties often charge large upfront fees or a fee that’s contingent on the amount of the refund. They may not inform taxpayers that wage deductions claimed on the companies’ federal income tax returns must be reduced by the amount of the credit.

According to the IRS, if a business filed an income tax return deducting qualified wages before it filed an employment tax return claiming the credit, the business should file an amended income tax return to correct any overstated wage deduction. Your tax advisor can assist with this.

Businesses are encouraged to be cautious of advertised schemes and direct solicitations promising tax savings that are too good to be true. Taxpayers are always responsible for the information reported on their tax returns. Improperly claiming the ERC could result in taxpayers being required to repay the credit along with penalties and interest.

ERC Basics

The ERC is a refundable tax credit designed for businesses that:

  • Continued paying employees while they were shut down due to the COVID-19 pandemic, or
  • Had significant declines in gross receipts from March 13, 2020, to September 30, 2021 (or December 31, 2021 for certain startup businesses).

Eligible taxpayers could have claimed the ERC on an original employment tax return or they can claim it on an amended return.

To be eligible for the ERC, employers must have:

  • Sustained a full or partial suspension of operations due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19 during 2020 or the first three quarters of 2021,
  • Experienced a significant decline in gross receipts during 2020 or a decline in gross receipts during the first three quarters of 2021, or
  • Qualified as a recovery startup business for the third or fourth quarters of 2021.

As a reminder, only recovery startup businesses are eligible for the ERC in the fourth quarter of 2021. Additionally, for any quarter, eligible employers cannot claim the ERC on wages that were reported as payroll costs in obtaining Paycheck Protection Program (PPP) loan forgiveness or that were used to claim certain other tax credits.

How to Proceed

If you didn’t claim the ERC, and believe you’re eligible, contact us. We can advise you on how to proceed.

© 2023

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The Standard Business Mileage Rate Is Going Up In 2023

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Although the national price of gas is a bit lower than it was a year ago, the optional standard mileage rate used to calculate the deductible cost of operating an automobile for business will be going up in 2023. The IRS recently announced that the 2023 cents-per-mile rate for the business use of a car, van, pickup or panel truck is 65.5 cents. These rates apply to electric and hybrid-electric automobiles, as well as gasoline and diesel-powered vehicles.

In 2022, the business cents-per-mile rate for the second half of the year (July 1 – December 31) was 62.5 cents per mile, and for the first half of the year (January 1 – June 30), it was 58.5 cents per mile.

How rate calculations are done

The 3-cent increase from the 2022 midyear rate is somewhat surprising because gas prices are currently lower than they have been. On December 29, 2022, the national average price of a gallon of regular gas was $3.15, compared with $3.52 a month earlier and $3.28 a year earlier, according to AAA Gas Prices. However, the standard mileage rate is calculated based on all the costs involved in driving a vehicle — not just the price of gas.

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, including gas, maintenance, repair and depreciation. Occasionally, if there’s a substantial change in average gas prices, the IRS will change the cents-per-mile rate midyear, as it did in 2022.

Standard rate versus actual expenses

Businesses can generally deduct the actual expenses attributable to business use of vehicles. This includes gas, oil, tires, insurance, repairs, 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 beneficial if you don’t want to keep track of actual vehicle-related expenses. With this method, you don’t have to account for all your actual expenses. However, you still must record certain information, such as the mileage for each business trip, the date and the destination.

Using the cents-per-mile rate is also popular with businesses that reimburse employees for business use of their personal vehicles. These reimbursements can help attract and retain employees who drive their personal vehicles a great deal 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 do use the cents-per-mile rate, keep in mind that you must comply with various rules. If you don’t comply, the reimbursements could be considered taxable wages to the employees.

The standard rate can’t always be used

There are some cases when you can’t use the cents-per-mile rate. It partly depends on how you’ve claimed deductions for the same vehicle in the past. In other situations, it depends 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 vehicle expenses. We can help if you have questions about tracking and claiming such expenses in 2023 — or claiming 2022 expenses on your 2022 income tax return.

© 2023

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Choosing A Business Entity? Here Are The Pros And Cons Of A C Corporation

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If you’re launching a new business venture, you’re probably wondering which form of business is most suitable. Here is a summary of the major advantages and disadvantages of doing business as a C corporation.

A C corporation allows the business to be treated and taxed as a separate entity from you as the principal owner. A properly structured corporation can protect you from the debts of the business yet enable you to control both day-to-day operations and corporate acts such as redemptions, acquisitions and even liquidations. In addition, the corporate tax rate is currently 21%, which is lower than the highest noncorporate tax rate.

Following formalities

In order to ensure that a corporation is treated as a separate entity, it’s important to observe various formalities required by your state. These include:

  • Filing articles of incorporation,
  • Adopting bylaws,
  • Electing a board of directors,
  • Holding organizational meetings, and
  • Keeping minutes of meetings.

Complying with these requirements and maintaining an adequate capital structure will ensure that you don’t inadvertently risk personal liability for the debts of the business.

Potential disadvantages

Since the corporation is taxed as a separate entity, all items of income, credit, loss and deduction are computed at the entity level in arriving at corporate taxable income or loss. One potential disadvantage to a C corporation for a new business is that losses are trapped at the entity level and thus generally cannot be deducted by the owners. However, if you expect to generate profits in year one, this might not be a problem.

Another potential drawback to a C corporation is that its earnings can be subject to double tax — once at the corporate level and again when distributed to you. However, since most of the corporate earnings will be attributable to your efforts as an employee, the risk of double taxation is minimal since the corporation can deduct all reasonable salary that it pays to you.

Providing benefits, raising capital

A C corporation can also be used to provide fringe benefits and fund qualified pension plans on a tax-favored basis. Subject to certain limits, the corporation can deduct the cost of a variety of benefits such as health insurance and group life insurance without adverse tax consequences to you. Similarly, contributions to qualified pension plans are usually deductible but aren’t currently taxable to you.

A C corporation also gives you considerable flexibility in raising capital from outside investors. A C corporation can have multiple classes of stock — each with different rights and preferences that can be tailored to fit your needs and those of potential investors. Also, if you decide to raise capital through debt, interest paid by the corporation is deductible.

Although the C corporation form of business might seem appropriate for you at this time, you may in the future be able to change from a C corporation to an S corporation, if S status is more appropriate at that time. This change will ordinarily be tax-free, except that built-in gain on the corporate assets may be subject to tax if the assets are disposed of by the corporation within 10 years of the change.

The optimum choice

This is only a brief overview. Contact us if you have questions or would like to explore the best choice of entity for your business.

© 2022

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Businesses may receive notices about information returns that don’t match IRS records

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The IRS has begun mailing notices to businesses, financial institutions and other payers that filed certain returns with information that doesn’t match the agency’s records.

These CP2100 and CP2100A notices are sent by the IRS twice a year to payers who filed information returns that are missing a Taxpayer Identification Number (TIN), have an incorrect name or have a combination of both.

Each notice has a list of persons who received payments from the business with identified TIN issues.

If you receive one of these notices, you need to compare the accounts listed on the notice with your records and correct or update your records, if necessary. This can also include correcting backup withholding on payments made to payees.

Which returns are involved?

Businesses, financial institutions and other payers are required to file with the IRS various information returns reporting certain payments they make to independent contractors, customers and others. These information returns include:

  • Form 1099-B, Proceeds from Broker and Barter Exchange Transactions,
  • Form 1099-DIV, Dividends and Distributions,
  • Form 1099-INT, Interest Income,
  • Form 1099-K, Payment Card and Third-Party Network Transactions,
  • Form 1099-MISC, Miscellaneous Income,
  • Form 1099-NEC, Nonemployee Compensation, and
  • Form W-2G, Certain Gambling Winnings.
  • Do you have backup withholding responsibilities?

The CP2100 and CP2100A notices also inform recipients that they’re responsible for backup withholding. Payments reported on the information returns listed above are subject to backup withholding if:

  • The payer doesn’t have the payee’s TIN when making payments that are required to be reported.
  • The individual receiving payments doesn’t certify his or her TIN as required.
  • The IRS notifies the payer that the individual receiving payments furnished an incorrect TIN.
  • The IRS notifies the payer that the individual receiving payments didn’t report all interest and dividends on his or her tax return.
  • Do you have to report payments to independent contractors?

By January first of the following year, payers must complete Form 1099-NEC, “Nonemployee Compensation,” to report certain payments made to recipients. If the following four conditions are met, you must generally report payments as nonemployee compensation:

  • You made a payment to someone who isn’t your employee,
  • You made a payment for services in the course of your trade or business,
  • You made a payment to an individual, partnership, estate, or, in some cases, a corporation, and
  • You made payments to a recipient of at least $600 during the year.
  • Contact us if you receive a CP2100 or CP2100A notice from the IRS or if you have questions about filing Form 1099-NEC. We can help you stay in compliance with all rules.
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