Small business owners are well aware of the increasing cost of employee health care benefits. As a result, your business may be interested in providing some of these benefits through an employer-sponsored Health Savings Account (HSA). Or perhaps you already have an HSA. It’s a good time to review how these accounts work since the IRS recently announced the relevant inflation-adjusted amounts for 2021.
The basics of HSAs
For eligible individuals, HSAs offer a tax-advantaged way to set aside funds (or have their employers do so) to meet future medical needs. Here are the key tax benefits:
Key 2020 and 2021 amounts
To be eligible for an HSA, an individual must be covered by a “high deductible health plan.” For 2020, a “high deductible health plan” is one with an annual deductible of at least $1,400 for self-only coverage, or at least $2,800 for family coverage. For 2021, these amounts are staying the same.
For self-only coverage, the 2020 limit on deductible contributions is $3,550. For family coverage, the 2020 limit on deductible contributions is $7,100. For 2021, these amounts are increasing to $3,600 and $7,200, respectively. Additionally, for 2020, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits cannot exceed $6,900 for self-only coverage or $13,800 for family coverage. For 2021, these amounts are increasing to $7,000 and $14,000.
An individual (and the individual’s covered spouse, as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional “catch-up” contributions for 2020 and 2021 of up to $1,000.
Contributing on an employee’s behalf
If an employer contributes to the HSA of an eligible individual, the employer’s contribution is treated as employer-provided coverage for medical expenses under an accident or health plan and is excludable from an employee’s gross income up to the deduction limitation. There’s no “use-it-or-lose-it” provision, so funds can be built up for years. An employer that decides to make contributions on its employees’ behalf must generally make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer doesn’t make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.
Paying for eligible expenses
HSA distributions can be made to pay for qualified medical expenses. This generally means those expenses that would qualify for the medical expense itemized deduction. They include expenses such as doctors’ visits, prescriptions, chiropractic care and premiums for long-term care insurance.
If funds are withdrawn from the HSA for any other reason, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it’s made after reaching age 65, or in the event of death or disability.
As you can see, HSAs offer a flexible option for providing health care coverage, but the rules are somewhat complex. Contact us with questions or if you’d like to discuss offering this benefit to your employees.
Many Americans receive disability income. You may wonder if — and how — it’s taxed. As is often the case with tax questions, the answer is … it depends.
The key factor is who paid for the benefit. If the income is paid directly to you by your employer, it’s taxable to you as ordinary salary would be. (Taxable benefits are also subject to federal income tax withholding, although depending on the employer’s disability plan, in some cases aren’t subject to the Social Security tax.)
Frequently, the payments aren’t made by the employer but by an insurance company under a policy providing disability coverage or, under an arrangement having the effect of accident or health insurance. If this is the case, the tax treatment depends on who paid for the coverage. If your employer paid for it, then the income is taxed to you just as if paid directly to you by the employer. On the other hand, if it’s a policy you paid for, the payments you receive under it aren’t taxable.
Even if your employer arranges for the coverage, (in other words, it’s a policy made available to you at work), the benefits aren’t taxed to you if you pay the premiums. For these purposes, if the premiums are paid by the employer but the amount paid is included as part of your taxable income from work, the premiums are treated as paid by you.
A couple of examples
Let’s say your salary is $1,000 a week ($52,000 a year). Additionally, under a disability insurance arrangement made available to you by your employer, $10 a week ($520 for the year) is paid on your behalf by your employer to an insurance company. You include $52,520 in income as your wages for the year: the $52,000 paid to you plus the $520 in disability insurance premiums. In this case, the insurance is treated as paid for by you. If you become disabled and receive benefits, they aren’t taxable income to you.
Now, let’s look at an example with the same facts as above. Except in this case, you include only $52,000 in income as your wages for the year because the amount paid for the insurance coverage qualifies as excludable under the rules for employer-provided health and accident plans. In this case, the insurance is treated as paid for by your employer. If you become disabled and receive benefits, they are taxable income to you.
Note: There are special rules in the case of a permanent loss (or loss of the use) of a part or function of the body, or a permanent disfigurement.
Social Security benefits
This discussion doesn’t cover the tax treatment of Social Security disability benefits. These benefits may be taxed to you under different rules.
How much coverage is needed?
In deciding how much disability coverage you need to protect yourself and your family, take the tax treatment into consideration. If you’re buying the policy yourself, you only have to replace your after tax, “take-home” income because your benefits won’t be taxed. On the other hand, if your employer pays for the benefit, you’ll lose a percentage to taxes. If your current coverage is insufficient, you may wish to supplement an employer benefit with a policy you take out.
Contact us if you’d like to discuss this in more detail.
If you’re considering buying or selling a business — or you’re in the process of a merger or acquisition — it’s important that both parties report the transaction to the IRS in the same way. Otherwise, you may increase your chances of being audited.
If a sale involves business assets (as opposed to stock or ownership interests), the buyer and the seller must generally report to the IRS the purchase price allocations that both use. This is done by attaching IRS Form 8594, “Asset Acquisition Statement,” to each of their respective federal income tax returns for the tax year that includes the transaction.
When buying business assets in an M&A transaction, you must allocate the total purchase price to the specific assets that are acquired. The amount allocated to each asset then becomes its initial tax basis. For depreciable and amortizable assets, the initial tax basis of each asset determines the depreciation and amortization deductions for that asset after the acquisition. Depreciable and amortizable assets include:
In addition to reporting the items above, you must also disclose on Form 8594 whether the parties entered into a noncompete agreement, management contract or similar agreement, as well as the monetary consideration paid under it.
The IRS may inspect the forms that are filed to see if the buyer and the seller use different allocations. If the IRS finds that different allocations are used, auditors may dig deeper and the investigation could expand beyond just the transaction. So, it’s in your best interest to ensure that both parties use the same allocations. Consider including this requirement in your asset purchase agreement at the time of the sale.
The tax implications of buying or selling a business are complicated. Price allocations are important because they affect future tax benefits. Both the buyer and the seller need to report them to the IRS in an identical way to avoid unwanted attention. To lock in the best postacquisition results, consult with us before finalizing any transaction.
Summer is just around the corner, so you might be thinking about getting some vacation time. If you’re self-employed or a business owner, you have a golden opportunity to combine a business trip with a few extra days of vacation and offset some of the cost with a tax deduction. But be careful, or you might not qualify for the write-offs you’re expecting.
Business travel expenses can potentially be deducted if the travel is within the United States and the expenses are:
Note: The tax rules for foreign business travel are different from those for domestic travel.
Business owners and the self-employed are generally eligible to deduct business travel expenses if they meet the tests described above. However, under the Tax Cuts and Jobs Act, employees can no longer deduct such expenses. The potential deductions discussed in this article assume that you’re a business owner or self-employed.
A business-vacation trip
Transportation costs to and from the location of your business activity may be 100% deductible if the primary reason for the trip is business rather than pleasure. But if vacation is the primary reason for your travel, generally no transportation costs are deductible. These costs include plane or train tickets, the cost of getting to and from the airport, luggage handling tips and car expenses if you drive. Costs for driving your personal car are also eligible.
The key factor in determining whether the primary reason for domestic travel is business is the number of days you spend conducting business vs. enjoying vacation days. Any day principally devoted to business activities during normal business hours counts as a business day. In addition:
Bottom line: If your business days exceed your personal days, you should be able to claim business was the primary reason for a domestic trip and deduct your transportation costs.
What else can you deduct?
Once at the destination, your out-of-pocket expenses for business days are fully deductible. Examples of these expenses include lodging, meals (subject to the 50% disallowance rule), seminar and convention fees, and cab fare. Expenses for personal days aren’t deductible.
Keep in mind that only expenses for yourself are deductible. You can’t deduct expenses for family members traveling with you, including your spouse — unless they’re employees of your business and traveling for a bona fide business purpose.
Keep good records
Be sure to retain proof of the business nature of your trip. You must properly substantiate all of the expenses you’re deducting. If you get audited, the IRS will want to see records during travel you claim was for business. Good records are your best defense. Additional rules and limits apply to travel expense deductions. Please contact us if you have questions.
If you’re a business owner and you hire your children (or grandchildren) this summer, you can obtain tax breaks and other nontax benefits. The kids can gain on-the-job experience, save for college and learn how to manage money. And you may be able to:
It must be a real job
When you hire your child, you get a business tax deduction for employee wage expenses. In turn, the deduction reduces your federal income tax bill, your self-employment tax bill (if applicable), and your state income tax bill (if applicable). However, in order for your business to deduct the wages as a business expense, the work performed by the child must be legitimate and the child’s salary must be reasonable.
For example, let’s say a business owner operates as a sole proprietor and is in the 37% tax bracket. He hires his 16-year-old son to help with office work on a full-time basis during the summer and part-time into the fall. The son earns $10,000 during 2019 and doesn’t have any other earnings.
The business owner saves $3,700 (37% of $10,000) in income taxes at no tax cost to his son, who can use his 2019 $12,200 standard deduction to completely shelter his earnings.
The family’s taxes are cut even if the son’s earnings exceed his or her standard deduction. The reason is that the unsheltered earnings will be taxed to the son beginning at a rate of 10%, instead of being taxed at his father’s higher rate.
How payroll taxes might be saved
If your business isn’t incorporated, your child’s wages are exempt from Social Security, Medicare and FUTA taxes if certain conditions are met. Your child must be under age 18 for this to apply (or under age 21 in the case of the FUTA tax exemption). Contact us for how this works.
Be aware that there’s no FICA or FUTA exemption for employing a child if your business is incorporated or a partnership that includes nonparent partners.
Start saving for retirement early
Your business also may be able to provide your child with retirement benefits, depending on the type of plan you have and how it defines qualifying employees. And because your child has earnings from his or her job, he can contribute to a traditional IRA or Roth IRA. For the 2018 tax year, a working child can contribute the lesser of his or her earned income, or $6,000 to an IRA or a Roth.
Raising tax-smart children
As you can see, hiring your child can be a tax-smart idea. Be sure to keep the same records as you would for other employees to substantiate the hours worked and duties performed (such as timesheets and job descriptions). Issue your child a Form W-2. If you have any questions about how these rules apply to your situation, don’t hesitate to contact us
While the number of plug-in electric vehicles (EVs) is still small compared with other cars on the road, it’s growing — especially in certain parts of the country. If you’re interested in purchasing an electric or hybrid vehicle, you may be eligible for a federal income tax credit of up to $7,500. (Depending on where you live, there may also be state tax breaks and other incentives.)
However, the federal tax credit is subject to a complex phaseout rule that may reduce or eliminate the tax break based on how many sales are made by a given manufacturer. The vehicles of two manufacturers have already begun to be phased out, which means they now qualify for only a partial tax credit.
Tax credit basics
You can claim the federal tax credit for buying a qualifying new (not used) plug-in EV. The credit can be worth up to $7,500. There are no income restrictions, so even wealthy people can qualify.
A qualifying vehicle can be either fully electric or a plug-in electric-gasoline hybrid. In addition, the vehicle must be purchased rather than leased, because the credit for a leased vehicle belongs to the manufacturer.
The credit equals $2,500 for a vehicle powered by a four-kilowatt-hour battery, with an additional $417 for each kilowatt hour of battery capacity beyond four hours. The maximum credit is $7,500. Buyers of qualifying vehicles can rely on the manufacturer’s or distributor’s certification of the allowable credit amount.
How the phaseout rule works
The credit begins phasing out for a manufacturer over four calendar quarters once it sells more than 200,000 qualifying vehicles for use in the United States. The IRS recently announced that GM had sold more than 200,000 qualifying vehicles through the fourth quarter of 2018. So, the phaseout rule has been triggered for GM vehicles, as of April 1, 2019. The credit for GM vehicles purchased between April 1, 2019, and September 30, 2019, is reduced to 50% of the otherwise allowable amount. For GM vehicles purchased between October 1, 2019, and March 31, 2020, the credit is reduced to 25% of the otherwise allowable amount. No credit will be allowed for GM vehicles purchased after March 31, 2020.
The IRS previously announced that Tesla had sold more than 200,000 qualifying vehicles through the third quarter of 2018. So, the phaseout rule was triggered for Tesla vehicles, effective as of January 1, 2019. The credit for Tesla vehicles purchased between January 1, 2019, and June 30, 2019, is reduced to 50% of the otherwise allowable amount. For Tesla vehicles purchased between July 1, 2019, and December 31, 2019, the credit is reduced to 25% of the otherwise allowable amount. No credit will be allowed for Tesla vehicles purchased after December 31, 2019.
Despite the phaseout kicking in for GM and Tesla vehicles, there are still many other EVs on the market if you’re interested in purchasing one. For an index of manufacturers and credit amounts, visit this IRS Web page: https://bit.ly/2vqC8vM. Contact us if you want more information about the tax breaks that may be available for these vehicles.
Many employers prefer to classify workers as independent contractors to lower costs, even if it means having less control over a worker’s day-to-day activities. But the government is on the lookout for businesses that classify workers as independent contractors simply to reduce taxes or avoid their employee benefit obligations.
Why it matters
When your business classifies a worker as an employee, you generally must withhold federal income tax and the employee’s share of Social Security and Medicare taxes from his or her wages. Your business must then pay the employer’s share of these taxes, pay federal unemployment tax, file federal payroll tax returns and follow other burdensome IRS and U.S. Department of Labor rules.
You may also have to pay state and local unemployment and workers’ compensation taxes and comply with more rules. Dealing with all this can cost a bundle each year.
On the other hand, with independent contractor status, you don’t have to worry about employment tax issues. You also don’t have to provide fringe benefits like health insurance, retirement plans and paid vacations. If you pay $600 or more to an independent contractor during the year, you must file a Form 1099-MISC with the IRS and send a copy to the worker to report what you paid. That’s basically the extent of your bureaucratic responsibilities.
But if you incorrectly treat a worker as an independent contractor — and the IRS decides the worker is actually an employee — your business could be assessed unpaid payroll taxes plus interest and penalties. You also could be liable for employee benefits that should have been provided but weren’t, including penalties under federal laws.
Filing an IRS form
To find out if a worker is an employee or an independent contractor, you can file optional IRS Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” Then, the IRS will let you know how to classify a worker. However, 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 inadvertently trigger an employment tax audit.
It can be better to simply treat independent contractors so the relationships comply with the tax rules. This generally includes not controlling how the workers perform their duties, ensuring that you’re not the workers’ only customer, providing annual Forms 1099 and, basically, not treating the workers like employees.
Workers can also ask for a determination
Workers who want an official determination of their status can also file Form SS-8. Disgruntled independent contractors may do so because they feel entitled to employee benefits and want to eliminate self-employment tax liabilities.
If a worker files Form SS-8, the IRS will send a letter to the business. 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.
Defending your position
If your business properly handles independent contractors, don’t panic if a worker files a Form SS-8. Contact us before replying to the IRS. With a proper response, you may be able to continue to classify the worker as a contractor. We also can assist you in setting up independent contractor relationships that stand up to IRS scrutiny.
The holiday season is a great time for businesses to show their appreciation for employees and customers by giving them gifts or hosting holiday parties. Before you begin shopping or sending out invitations, though, it’s a good idea to find out whether the expense is tax deductible and whether it’s taxable to the recipient. Here’s a brief review of the rules.
Gifts to customers
When you make gifts to customers, the gifts are deductible up to $25 per recipient per year. For purposes of the $25 limit, you need not include “incidental” costs that don’t substantially add to the gift’s value, such as engraving, gift-wrapping, packaging or shipping. Also excluded from the $25 limit is branded marketing collateral — such as pens or stress balls imprinted with your company’s name and logo — provided they’re widely distributed and cost less than $4.
The $25 limit is for gifts to individuals. There’s no set limit on gifts to a company (a gift basket for all to share, for example) as long as they’re “reasonable.”
Gifts to employees
Generally anything of value that you transfer to an employee is included in the employee’s taxable income (and, therefore, subject to income and payroll taxes) and deductible by you. But there’s an exception for noncash gifts that constitute “de minimis fringe benefits.”
These are items so small in value and given so infrequently that it would be administratively impracticable to account for them. Common examples include holiday turkeys or hams, gift baskets, occasional sports or theater tickets (but not season tickets), and other low-cost merchandise.
De minimis fringe benefits are not included in an employee’s taxable income yet are still deductible by you. Unlike gifts to customers, there’s no specific dollar threshold for de minimis gifts. However, many businesses use an informal cutoff of $75.
Keep in mind that cash gifts — as well as cash equivalents, such as gift cards — are included in an employee’s income and subject to payroll tax withholding regardless of how small and infrequent.
The Tax Cuts and Jobs Act reduced certain deductions for business-related meals and eliminated the deduction for business entertainment altogether. There’s an exception, however, for certain recreational activities, including holiday parties.
Holiday parties are fully deductible (and excludible from recipients’ income) provided they’re primarily for the benefit of non-highly-compensated employees and their families. If customers also attend, holiday parties may be partially deductible.
Gifts that give back
If you’re thinking about giving holiday gifts to employees or customers or throwing a holiday party, contact us. With a little tax planning, you may receive a gift of your own from Uncle Sam.
The pieces of tax legislation garnering the most attention these days are the Tax Cuts and Jobs Act (TCJA) signed into law last December and the possible “Tax Reform 2.0” that Congress might pass this fall. But for certain individual taxpayers, what happens with “extenders” legislation is also important.
Back in December of 2015, Congress passed the PATH Act, which made a multitude of tax breaks permanent. However, there were a few valuable breaks for individuals that it extended only through 2016. The TCJA didn’t address these breaks, but they were retroactively extended through December 31, 2017, by the Bipartisan Budget Act of 2018 (BBA), which was signed into law on February 9, 2018.
Now the question is whether Congress will extend them for 2018 and, if so, when. In July, House Ways and Means Committee Chair Kevin Brady (R-TX) released a broad outline of what Tax Reform 2.0 legislation may contain. And he indicated that it probably wouldn’t include the so-called “extenders” but that they would likely be addressed by separate legislation.
Mortgage insurance and loan forgiveness
Under the BBA, through 2017, you could treat qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction. This was an itemized deduction that phased out for taxpayers with AGI of $100,000 to $110,000.
The BBA likewise extended through 2017 the exclusion from gross income for mortgage loan forgiveness. It also allowed the exclusion to apply to mortgage forgiveness that occurs in 2018 as long as it’s granted pursuant to a written agreement entered into in 2017. So even if this break isn’t extended, you might still be able to benefit from it on your 2018 income tax return.
Tuition and related expenses
Also available through 2017 under the BBA was the above-the-line deduction for qualified tuition and related expenses for higher education. It was capped at $4,000 for taxpayers whose adjusted gross income (AGI) didn’t exceed $65,000 ($130,000 for joint filers) or, for those beyond those amounts, $2,000 for taxpayers whose AGI didn’t exceed $80,000 ($160,000 for joint filers).
You couldn’t take the American Opportunity credit, its cousin the Lifetime Learning credit and the tuition deduction in the same year for the same student. If you were eligible for all three breaks, the American Opportunity credit would typically be the most valuable in terms of tax savings.
But in some situations, the AGI reduction from the tuition deduction might prove more beneficial than taking the Lifetime Learning credit. For example, a lower AGI might help avoid having other tax breaks reduced or eliminated due to AGI-based phaseouts.
Still time …
There’s still plenty of time for Congress to extend these breaks for 2018. And, if you qualify and you haven’t filed your 2017 income tax return yet, there’s even still time to take advantage of these breaks on that tax return. The deadline for individual extended 2017 returns is October 15, 2018. Contact us with questions about these breaks and whether you can benefit.
There was talk of repealing the individual alternative minimum tax (AMT) as part of last year’s tax reform legislation. A repeal wasn’t included in the final version of the Tax Cuts and Jobs Act (TCJA), but the TCJA will reduce the number of taxpayers subject to the AMT.
Now is a good time to familiarize yourself with the changes, assess your AMT risk and see if there are any steps you can take during the last several months of the year to avoid the AMT, or at least minimize any negative impact.
AMT vs. regular tax
The top AMT rate is 28%, compared to the top regular ordinary-income tax rate of 37%. But the AMT rate typically applies to a higher taxable income base and will result in a larger tax bill if you’re subject to it.
The TCJA reduced the number of taxpayers who’ll likely be subject to the AMT in part by increasing the AMT exemption and the income phaseout ranges for the exemption:
You’ll be subject to the AMT if your AMT liability is greater than your regular tax liability.
In the past, common triggers of the AMT were differences between deductions allowed for regular tax purposes and AMT purposes. Some popular deductions aren’t allowed under the AMT.
New limits on some of these deductions for regular tax purposes, such as on state and local income and property tax deductions, mean they’re less likely to trigger the AMT. And certain deductions not allowed for AMT purposes are now not allowed for regular tax purposes either, such as miscellaneous itemized deductions subject to the 2% of adjusted gross income floor.
But deductions aren’t the only things that can trigger the AMT. Some income items might do so, too, such as:
AMT planning tips
If it looks like you could be subject to the AMT in 2018, consider accelerating income into this year. Doing so may allow you to benefit from the lower maximum AMT rate. And deferring expenses you can’t deduct for AMT purposes may allow you to preserve those deductions. If you also defer expenses you can deduct for AMT purposes, the deductions may become more valuable because of the higher maximum regular tax rate.
Please contact us if you have questions about whether you could be subject to the AMT this year or about minimizing negative consequences from the AMT.
Once upon a time, some parents and grandparents would attempt to save tax by putting investments in the names of their young children or grandchildren in lower income tax brackets. To discourage such strategies, Congress created the “kiddie” tax back in 1986. Since then, this tax has gradually become more far-reaching. Now, under the Tax Cuts and Jobs Act (TCJA), the kiddie tax has become more dangerous than ever.
A short history
Years ago, the kiddie tax applied only to children under age 14 — which still provided families with ample opportunity to enjoy significant tax savings from income shifting. In 2006, the tax was expanded to children under age 18. And since 2008, the kiddie tax has generally applied to children under age 19 and to full-time students under age 24 (unless the students provide more than half of their own support from earned income).
What about the kiddie tax rate? Before the TCJA, for children subject to the kiddie tax, any unearned income beyond a certain amount ($2,100 for 2017) was taxed at their parents’ marginal rate (assuming it was higher), rather than their own likely low rate.
A fiercer kiddie tax
The TCJA doesn’t further expand who’s subject to the kiddie tax. But it will effectively increase the kiddie tax rate in many cases.
For 2018–2025, a child’s unearned income beyond the threshold ($2,100 again for 2018) will be taxed according to the tax brackets used for trusts and estates. For ordinary income (such as interest and short-term capital gains), trusts and estates are taxed at the highest marginal rate of 37% once 2018 taxable income exceeds $12,500. In contrast, for a married couple filing jointly, the highest rate doesn’t kick in until their 2018 taxable income tops $600,000.
Similarly, the 15% long-term capital gains rate takes effect at $77,201 for joint filers but at only $2,601 for trusts and estates. And the 20% rate kicks in at $479,001 and $12,701, respectively.
In other words, in many cases, children’s unearned income will be taxed at higher rates than their parents’ income. As a result, income shifting to children subject to the kiddie tax will not only not save tax, but it could actually increase a family’s overall tax liability.
The moral of the story
To avoid inadvertently increasing your family’s taxes, be sure to consider the big, bad kiddie tax before transferring income-producing or highly appreciated assets to a child or grandchild who’s a minor or college student. If you’d like to shift income and you have adult children or grandchildren who’re no longer subject to the kiddie tax but in a lower tax bracket, consider transferring such assets to them.
Please contact us for more information about the kiddie tax — or other TCJA changes that may affect your family.
The Tax Cuts and Jobs Act (TCJA) liberalized the eligibility rules for using the cash method of accounting, making this method — which is simpler than the accrual method — available to more businesses. Now the IRS has provided procedures a small business taxpayer can use to obtain automatic consent to change its method of accounting under the TCJA. If you have the option to use either accounting method, it pays to consider whether switching methods would be beneficial.
Cash vs. accrual
Generally, cash-basis businesses recognize income when it’s received and deduct expenses when they’re paid. Accrual-basis businesses, on the other hand, recognize income when it’s earned and deduct expenses when they’re incurred, without regard to the timing of cash receipts or payments.
In most cases, a business is permitted to use the cash method of accounting for tax purposes unless it’s:
Cash method advantages
The cash method offers several advantages, including:
Simplicity. It’s easier and cheaper to implement and maintain.
Tax-planning flexibility. It offers greater flexibility to control the timing of income and deductible expenses. For example, it allows you to defer income to next year by delaying invoices or to shift deductions into this year by accelerating the payment of expenses. An accrual-basis business doesn’t enjoy this flexibility. For example, to defer income, delaying invoices wouldn’t be enough; the business would have to put off shipping products or performing services.
Cash flow benefits. Because income is taxed in the year it’s received, the cash method does a better job of ensuring that a business has the funds it needs to pay its tax bill.
Accrual method advantages
In some cases, the accrual method may offer tax advantages. For example, accrual-basis businesses may be able to use certain tax-planning strategies that aren’t available to cash-basis businesses, such as deducting year-end bonuses that are paid within the first 2½ months of the following year and deferring income on certain advance payments.
The accrual method also does a better job of matching income and expenses, so it provides a more accurate picture of a business’s financial performance. That’s why it’s required under Generally Accepted Accounting Principles (GAAP).
If your business prepares GAAP-compliant financial statements, you can still use the cash method for tax purposes. But weigh the cost of maintaining two sets of books against the potential tax benefits.
Making a change
Keep in mind that cash and accrual are the two primary tax accounting methods, but they’re not the only ones. Some businesses may qualify for a different method, such as a hybrid of the cash and accrual methods.
If your business is eligible for more than one method, we can help you determine whether switching methods would make sense and can execute the change for you if appropriate.
If you own a business and have a child in high school or college, hiring him or her for the summer can provide a multitude of benefits, including tax savings. And hiring your child may make more sense than ever due to changes under the Tax Cuts and Jobs Act (TCJA).
How it works
By shifting some of your business earnings to a child as wages for services performed, you can turn some of your high-taxed income into tax-free or low-taxed income. For your business to deduct the wages as a business expense, the work done must be legitimate and the child’s wages must be reasonable.
Here’s an example: A sole proprietor is in the 37% tax bracket. He hires his 20-year-old daughter, who’s majoring in marketing, to work as a marketing coordinator full-time during the summer. She earns $12,000 and doesn’t have any other earnings.
The father saves $4,440 (37% of $12,000) in income taxes at no tax cost to his daughter, who can use her $12,000 standard deduction (for 2018) to completely shelter her earnings. This is nearly twice as much as would have been sheltered last year, pre-TCJA, when the standard deduction was only $6,350.
The father can save an additional $2,035 in taxes if he keeps his daughter on the payroll as a part-time employee into the fall and pays her an additional $5,500. She can shelter the additional income from tax by making a tax-deductible contribution to her own traditional IRA.
Family taxes will be cut even if an employee-child’s earnings exceed his or her standard deduction and IRA deduction. Why? The unsheltered earnings will be taxed to the child beginning at a rate of 10% instead of being taxed at the parent’s higher rate.
Avoiding the “kiddie tax”
TCJA changes to the “kiddie tax” also make income-shifting through hiring your child (rather than, say, giving him or her income-producing investments) more appealing. The kiddie tax generally applies to children under age 19 and to full-time students under age 24. Before 2018, the unearned income of a child subject to the kiddie tax was generally taxed at the parents’ tax rate.
The TCJA makes the kiddie tax harsher. For 2018-2025, a child’s unearned income will be taxed according to the tax brackets used for trusts and estates, which for 2018 are taxed at the highest rate of 37% once taxable income reaches $12,500. In contrast, for a married couple filing jointly, the 37% rate doesn’t kick in until their taxable income tops $600,000. In other words, children’s unearned income often will be taxed at higher rates than their parents’ income.
But the kiddie tax doesn’t apply to earned income.
Other tax considerations
If your business isn’t incorporated or a partnership that includes nonparent partners, you might also save some employment tax dollars. Contact us to learn more about the tax rules surrounding hiring your child, how the kiddie tax works or other family-related tax-saving strategies.
When you think about recent tax law changes and your business, you’re probably thinking about the new 20% pass-through deduction for qualified business income or the enhancements to depreciation-related breaks. Or you may be contemplating the reduction or elimination of certain business expense deductions. But there are also a couple of recent tax law changes that you need to be aware of if your business sponsors a 401(k) plan.
1. Plan loan repayment extension
The Tax Cuts and Jobs Act (TCJA) gives a break to 401(k) plan participants with outstanding loan balances when they leave their employers. While plan sponsors aren’t required to allow loans, many do.
Before 2018, if an employee with an outstanding plan loan left the company sponsoring the plan, he or she would have to repay the loan (or contribute the outstanding balance to an IRA or his or her new employer’s plan) within 60 days to avoid having the loan balance deemed a taxable distribution (and be subject to a 10% early distribution penalty if the employee was under age 59½).
Under the TCJA, beginning in 2018, former employees in this situation have until their tax return filing due date — including extensions — to repay the loan (or contribute the outstanding balance to an IRA or qualified retirement plan) and avoid taxes and penalties.
2. Hardship withdrawal limit increase
Beginning in 2019, the Bipartisan Budget Act (BBA) eases restrictions on employee 401(k) hardship withdrawals. Most 401(k) plans permit hardship withdrawals, though plan sponsors aren’t required to allow them. Hardship withdrawals are subject to income tax and the 10% early distribution tax penalty.
Currently, hardship withdrawals are limited to the funds employees contributed to the accounts. (Such withdrawals are allowed only if the employee has first taken a loan from the same account.)
Under the BBA, the withdrawal limit will also include accumulated employer matching contributions plus earnings on contributions. If an employee has been participating in your 401(k) for several years, this modification could add substantially to the amount of funds available for withdrawal.
Nest egg harm
These changes might sound beneficial to employees, but in the long run they could actually hurt those who take advantage of them. Most Americans aren’t saving enough for retirement, and taking longer to pay back a plan loan (and thus missing out on potential tax-deferred growth during that time) or taking larger hardship withdrawals can result in a smaller, perhaps much smaller, nest egg at retirement.
So consider educating your employees on the importance of letting their 401(k) accounts grow undisturbed and the potential negative tax consequences of loans and early withdrawals. Please contact us if you have questions.