Mitigating the Effects of Employee Burnout: What You Need to Know

Make absolutely no mistake about it: Not only is employee burnout very real, it’s probably costing your business a lot more money than you realize. It’s also not a problem that you’re necessarily going to be able to buy your way out of, either.

According to one recent study, a massive 70 percent of the workforce in the United States is not engaged with their current jobs in any type of meaningful way ― and employee burnout is a major contributing factor to this. As stated, if you think that this is because people don’t feel like they’re making enough money, the chances are very high that you’re wrong. The same study revealed that 89 percent of employers THINK that people leave jobs to get more money elsewhere, but in reality, that’s only actually true about 12 percent of the time. But perhaps the most damning statistic of all is the following: Collectively, disengaged employees cost organizations in the United States between $450 and $550 billion every year in terms of lost productivity alone.

So, once you’ve come to the realization that this is, in fact, a problem, you must then turn your attention toward taking advantage of any possible solution in front of you. The good news is that it is possible to mitigate the effects of employee burnout ― you just need to keep a few key things in mind.

Understand What Employee Burnout Looks Like
Not every employee is necessarily burned out ― even if they’re pulling long hours or giving everything to help you achieve your goals. But in an effort to avoid the major downsides of burnout on your business, you need to know more about how to spot it in its nascent stages. If an employee is burned out, they’re probably exhibiting one or even all of the following signs:

  • They’re exhausted, either physically or emotionally. The resources needed to cope with their work environment in these two areas are totally spent, and they tend to act accordingly. We’ve all been here, so you should know what it looks like.
  • They’re increasingly cynical. They know what they’re supposed to do and why it matters, but they’re less convinced that it really matters to THEM in the long run.
  • They’re growing more inefficient as time goes on. Burned-out employees tend to give up “trying” pretty quickly as a result of the cynical attitude outlined above, and the quality of the work they offer suffers as a result.

Put a Premium on the Mental Health of Your Employees
If you truly want to mitigate the effects of employee burnout, you need to focus on trying to prevent it from happening in the first place, instead of correcting the problem after it occurs.

This means placing a high priority on the mental health and wellness of all of your workers, something you can do in a few different ways.

Some experts recommend that you should hold walking meetings, for example. Instead of holding yet another meeting with your team in a stuffy boardroom with absolutely no natural lighting, get outside and take a walk around the block. You can still discuss all the same things (and thanks to cloud technology, you can likely refer to all of the same files on devices like smartphones and tablets), but the change of scenery will really make a big difference.

Along the same lines, don’t be afraid to encourage people to take mental health days ― especially during busy periods or the holiday season. Remember that a burned-out employee ultimately isn’t doing you any good anyway, so if they need to leave early one day or not come in at all, they’ll be at far more of an advantage than you are at a disadvantage in terms of lost productivity. Just knowing that you support their health and wellness like this will really go a long way toward mitigating this type of risk.

Likewise, you should always maintain an open door policy with your employees. If they feel like they need to come in and talk to you for any reason, good or bad, they should feel comfortable with their ability to do so. If they need something to thrive in their job every day, they shouldn’t be afraid to come ask for it because they should know you’ll work hard to get it. If they have a problem, they should feel willing to come talk to you to look for a solution. Again, the importance of this level of managerial support is something that you absolutely cannot overstate.

Everyone feels burned out every now and again ― this is not something you can avoid. But if you truly want to avoid letting employee burnout have a long-term negative effect on everything that you’ve already worked so hard to build, you need to recognize the problem and take steps now to do something about it. Oftentimes, success to that end is less the product of one big move and more about a series of smaller ones. Provided you follow tips like these every day, you’ll soon realize that a large portion of the hard work has already been done for you.

Three Common Family Tax Mistakes

When it comes to transactions between family members, the tax laws are frequently overlooked, if not outright trampled upon. The following are three commonly encountered situations and the tax ramifications associated with each.

Renting to a Relative – When a taxpayer rents a home to a relative for long-term use as a principal residence, the rental’s tax treatment depends upon whether the property is rented at fair rental value (the rental value of comparable properties in the area) or at less than the fair rental value.

Rented at Fair Rental Value – If the home is rented to the relative at a fair rental value, it is treated as an ordinary rental reported on Schedule E, and losses are allowed, subject to the normal passive loss limitations.

Rented at Less Than Fair Rental Value – When a home is rented at less than the fair rental value, it is treated as being used personally by the owner; the expenses associated with the home are not deductible, and no depreciation is allowed. The result is that all of the rental income is fully taxable and reported as “other income” on the 1040. If the taxpayer were able to itemize their deductions, the property taxes on the home would be deductible, subject to the $10,000 cap on state and local taxes effective starting with 2018. The taxpayer might also be able to deduct the interest on the rental home by treating the home as their second home, up to the debt limits on a first and second home.

Possible Gift Tax Issue – There also could be a gift tax issue, depending if the difference between the fair rental value and the rent actually charged to the tenant-relative exceeds the annual gift tax exemption, which is $15,000 for 2018. If the home has more than one occupant, the amount of the difference would be prorated to each occupant, so unless there was a large difference ($15,000 per occupant, in 2018) between the fair rental value and actual rent, or other gifting was also involved, a gift tax return probably wouldn’t be needed in most cases.

Below-Market Loans – It is not uncommon to encounter situations where there are loans between family members, with no interest being charged or the interest rate being below market rates.

A below-market loan is generally a gift or demand loan where the interest rate is less than the applicable federal rate (AFR). The tax code defines the term “gift loan” as any below-market loan where the forgoing of interest is in the nature of a gift, while a “demand loan” is any loan that is payable in full at any time, at the lender’s demand. The AFR is established by the Treasury Department and posted monthly. As an example, the AFR rates for October 2018 were:

Term AFR (Annual) Oct. 2018
3 years or less 2.55%
Over 3 years but not over 9 years 2.83%
Over 9 years 2.99%

Generally, for income tax purposes:

Borrower – Is treated as paying interest at the AFR rate in effect when the loan was made. The interest is deductible for tax purposes if it otherwise qualifies. However, if the loan amount is $100,000 or less, the amount of the forgone interest deduction cannot exceed the borrower’s net investment income for the year.

Lender – Is treated as gifting to the borrower the amount of the interest between the interest actually paid, if any, and the AFR rate. Both the interest actually paid and the forgone interest are treated as investment interest income.

Exception – The below-market loan rules do not apply to gift loans directly between individuals if the loan amount is $10,000 or less. This exception does not apply to any gift loan directly attributable to the purchase or carrying of income-producing property.

Parent Transferring a Home’s Title to a Child – When an individual passes away, the fair market value (FMV) of all their assets is tallied up. If the value exceeds the lifetime estate tax exemption ($11,180,000 in 2018; about half that amount in 2017), then an estate tax return must be filed, which is rarely the case, given the generous amount of the exclusion. Because the FMV is used in determining the estate’s value, that same FMV, rather than the decedent’s basis, is the basis assigned to the decedent’s property that is inherited by the beneficiaries. The basis is the value from which gain or loss is measured, and if the date-of-death value is higher than the decedent’s basis was, this is often referred to as a step-up in basis.

If an individual gifts an asset to another person, the recipient generally receives it at the donor’s basis (no step-up in basis).

So, it is generally better for tax purposes to inherit an asset than to receive it as a gift.

Example: A parent owns a home worth (FMV) $350,000 that was originally purchased for $75,000. If the parent gifts the home to the child and the child sells the home for $350,000, the child will have a taxable gain of $275,000 ($350,000 − $75,000). However, if the child inherits the home, the child’s basis is the FMV at the date of the parent’s death. So in this case, if the date-of-death FMV is $350,000 and if the home is sold for $350,000, there will be no taxable gain.

This brings us to the issue at hand. A frequently encountered problem is when an elderly parent signs the title of his or her home over to a child or other beneficiary and continues to reside in the home. Tax law specifies that an individual who transfers a title and retains the right to live in a home for their lifetime has established a de facto life estate. As such, when the individual dies, the home’s value is included in the decedent’s estate, and no gift tax return is applicable. As a result, the beneficiary’s basis would be the FMV at the date of the decedent’s death.

On the other hand, if the elderly parent does not continue to reside in the home after transferring the title, no life estate has been established, and as discussed earlier, the transfer becomes a gift, and the child’s (gift recipient’s) basis would be the parent’s basis in the home at the date of the gift. In addition, if the child were to sell the home, the home gain exclusion would not apply unless the child moves into the home and meets the two-out-of-five-years use and ownership tests.

Another frequently encountered situation is when the parent simply adds the child’s name to the title, while retaining a partial interest. If the home is subsequently sold, the parent, provided they met the two-out-of-five-years use and ownership rules, would be able to exclude $250,000 ($500,000 if the parent is married and filing a joint return) of his, her or their portion of the gain. A gift tax return would be required for the year the child’s name was included on the title, and the child’s basis would be the portion of the parent’s adjusted basis transferred to the child. As mentioned previously, the child would not be able to use the home gain exclusion unless the child occupied and owned the home for two of the five years preceding the sale.

These are only three examples of the many tax complications that can occur in family transactions. It is better to structure a transaction within the parameters of tax law in the first place than to suffer unexpected consequences afterwards. We highly recommended that you contact us before completing any family financial transaction.

Rejoice — Business Meals Are Still Deductible

f you are a business owner who is accustomed to treating clients to sporting events, golf getaways, concerts and the like, you were no doubt saddened by part of the tax reform that passed last December. A part of the tax reform did away with the business-related deductions for entertainment, amusement or recreation expenses, beginning in 2018. You can still entertain your clients; you just can’t deduct the costs of doing so as a business expense.

While the ban on deducting business entertainment was quite clear in the revised law, a lingering question among tax experts has been whether the tax reform’s definition of entertainment also applied to business meals, such as when you take a customer or business contact to lunch. Some were saying yes, and others no. Either way, both sides recommended keeping the required receipts and documentation until the issue was clarified.

The IRS recently issued some very business-friendly guidance, pending the release of more detailed regulations. In a notice, the IRS has announced that taxpayers generally may continue to deduct 50 percent of the food and beverage expenses associated with operating their trade or business, including business meals, provided:

  1. The expense is an ordinary and necessary expense paid or incurred during the taxable year in carrying out any trade or business;
  2. The expense is not lavish or extravagant under the circumstances;
  3. The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
  4. The food and beverages are provided to a current or potential business customer, client, consultant or similar business contact; and
  5. Food and beverages provided during or at an entertainment activity are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices or receipts.

The IRS notice also included the following interesting examples related to #5: The taxpayer invites a business contact to a baseball game. The tickets to the game are entertainment and not deductible. However, the taxpayer also purchased hot dogs and a beverage for himself and the business contact. Because the food and drinks were purchased separately, they are not disallowed as entertainment and are deductible if they otherwise qualify as an ordinary and necessary business expense. Had the ticket price included the hot dogs and beverages, they would be treated as non-deductible entertainment. If the ticket price separately stated the ticket price and the food and beverage price, then the food and beverage portion would not be disallowed as entertainment.

Of course, the substantiation requirements still apply. You must be able to establish the amount spent, the time and place, the business purpose and the business relationship and names of the individuals involved. You should keep a diary, an account book, digital files or similar records with this information and record the details within a short time of incurring the expenses. If the meal expense is $75 or more, documentary proof (receipts, etc.) is also required.

If you are an employee, starting in tax year 2018, you will not be able to deduct your unreimbursed employee business expenses, including the cost of client meals. These expenses have been deductible as miscellaneous itemized deductions when you itemized deductions and when your total deductions in that category exceeded 2% of your adjusted gross income. Under the tax reform, this category of deductions is not deductible for years 2018 through 2025. So, unfortunately, the IRS’s expansive definition of meal expenses will not benefit you.

If you have questions related to business meals, substantiation, or the ban on entertainment expenses, please give us a call.

Will You Get a Refund or Owe for 2018?

As a result of tax reform, most taxpayers will be paying less tax for 2018 than they did in 2017. But that may not translate into a larger refund. Your refund is the amount that your pre-payments (withheld income tax, estimated tax payments, and certain credits) exceed your tax liability, and if the pre-payment also got reduced, you could be in for an unpleasant surprise at tax time.

So, why would the pre-payments, particularly withholding, be less? Simply because the current W-4 form on which employers base the amount of tax to withhold, and the withholding tables provided by the government that employers use to determine the amount to withhold, are not sophisticated enough to deal with the revised tax laws. Congress passed the changes at the 11th hour of 2017, without giving the IRS sufficient time to adjust the W-4 form and withholding tables to account for the changed laws. The IRS did come out with a revised W-4 late in February, but there are serious concerns that the revised W-4 and withholding tables are not coming up with the correct amounts based upon the new tax law and that the form itself is much more complicated for employees to complete than prior versions were. In fact, the government is so concerned about this that the IRS issues almost daily notices cautioning taxpayers to double check their withholding.

Checking one’s withholding does little good, since it is difficult to determine if your withholding will produce near the desired refund result without also projecting what your tax will be for 2018 and then comparing that to your pre-payments, including withholding, for the year. Prior to the tax reform, you generally could use the tax liability from the prior year, compare that against your current year pre-payments, and be pretty confident in what the bottom line would be for the current year. However, that is not possible for 2018, since the tax computation is significantly different from how it was in 2017 and earlier years.

The IRS is developing a new W-4 form to hopefully do a better job of determining the proper withholding based on your wages but just recently announced that it will continue to use the current W-4 for 2019 and unfortunately won’t be releasing the new one until 2020.

If you count on a large refund to pay other liabilities, such as property taxes, you may want to take the time to project your 2018 tax and then compare it to your pre-payments to see if you can expect a refund and determine approximately how much it will be.

At the same time, if your pre-payments are short and you end up owing taxes, you could be hit with underpayment penalties.

We are approaching year-end, and any adjustments to withholding or estimated payments should be made sooner rather than later to produce the desired result at tax time. Please contact us with any questions and for assistance with your year-end planning.

How to Enter Bills in QuickBooks

It’s not as much fun as creating invoices, but the bills must be paid. Here’s how QuickBooks helps.

We’re in a bit of a transitional period with business bill-paying. Some paper bills still come via the U.S. Mail, however you may also be getting some through email. Others don’t come at all: You might get a reminder email, but you have to go to the vendor’s site to make a payment.

How do you keep track of it all so you don’t miss any due dates? You could record them on a calendar, but you’d still have to go back to the actual bill to retrieve the amount. But where is it? Is it online, in your email inbox, in a file folder, or hanging on the wall?

QuickBooks can organize this unpleasant process, saving time and helping you avoid confusion. Here’s how it works.

A 2-Step Process
QuickBooks divides your accounts payable tasks into two separate processes: entering bills and paying them. It requires some extra time upfront as you complete the first step, but streamlines the second so that the actual bill-paying only takes a few seconds.

To get started, click Enter Bills on QuickBooks’ home page to open a window like this:

Before you can pay a bill in QuickBooks, you need to create a record for it.

The toolbar for the Enter Bills window is not pictured in the image above, but you don’t need it yet. Rather, you start by clicking the down arrow in the field next to VENDOR and selecting the biller’s name from your list (or clicking if you haven’t yet created a record for that entity). The ADDRESS should fill in automatically, as should the date.

If you set up default payment TERMS in that vendor’s record, your preference should show in that field and the BILL DUE date should be correct. Enter the AMOUNT DUE and complete any of the optional fields that the transaction requires (REF. NO., DISCOUNT DATE, and MEMO).

Since this is a utility bill, the Expenses tab should be highlighted, and the amount you entered above should appear in it. Below that is the ACCOUNT field; open that list and choose the right one. Don’t worry about the CUSTOMER:JOB and BILLABLE fields. These will only be completed when you’re charging a customer for an expense or item.

Warning: If you’re not familiar with the concept of assigning accounts to transactions, please schedule some time with us. This is a critical designation that affects so many other areas of QuickBooks.

Saving Your Work


The toolbar from the Enter Bills window

Once you save your bill, you’ll be able to access it when it’s time to apply payment. How will you remember when it’s due, though? QuickBooks can remind you – or even pay it automatically. So, before you leave the Enter Bills window, click Memorize in the toolbar pictured above.

The Memorize Transaction window will open with your vendor already entered in the Name field. You’ll have three options here:

  • Add to my Reminders list. QuickBooks can add this bill to its list of Reminders. To ensure that you’ll see this every time you open the software and can make any changes necessary, open the Edit menu and click Preferences | Reminders | My Preferences. Click in the box in front of Show Reminders List when opening a Company file. Then click the Company Preferences tab (if you’re the administrator) and find the Bills to Pay row. Click the appropriate button to indicate whether you want QuickBooks to Show Summary or Show List, and enter the number of days before due date.
  • Do Not Remind Me. Just what it sounds like.
  • Automate Transaction Entry. You can only select this if the transaction will be exactly the same every time (except for the date). If the number of transactions will be limited, enter the Number Remaining. And tell QuickBooks how many Days in Advance To Enter.

If you choose the third option here, be very careful when you define the automation. You should really only do this if you’re an advanced user.

When you’re done, click OK to close the box, and save the bill.

Please contact us to schedule an appointment to review any aspect of your accounts payable, or anything else in QuickBooks.

Understanding Tax-Deferred Investing

When you are attempting to save money for your children’s future education or your retirement, you may do so in a number of ways, Strategies include investing in the stock market, buying real estate for income and appreciation, or simply saving money in education savings accounts or retirement plans.

Knowing how these various savings vehicles are taxed is important for choosing the ones best suited to your particular circumstances. Let’s begin by examining the tax nuances of IRA accounts.

Individual Retirement Account (IRA) – There are two types of IRA accounts—the traditional and the Roth—and even though they are both IRAs, there is a huge difference in their tax treatment.

  • Traditional IRA – Contributions to a traditional IRA are generally tax-deductible unless you have a retirement plan at work, and then the IRA contribution may not be deductible if you are a higher-income taxpayer. All of the earnings from a traditional IRA are tax-deferred, meaning they are not taxable currently but will be when funds from the account are withdrawn; since the contributions were tax-deductible, everything you withdraw from the traditional IRA will be taxable. An exception to that last statement is when you didn’t claim a deduction for money that you contributed to the IRA, either by choice or when the law didn’t allow a deduction. In this case, withdrawals from a traditional IRA would be prorated as partly taxable and partly tax-free.
  • Roth IRA – Roth IRA contributions are never tax-deductible, but the earnings are never taxable if the account meets a 5-year aging rule and the distributions begin after you reach age 59.5.

So, which is best? Well, that depends upon your particular circumstances. If you need the tax deduction to fund the IRA, then by all means use the traditional IRA. However, if you can afford to the make a contribution without the deduction, then the Roth IRA will be the best because everything is tax-free when withdrawn, usually at retirement.

Retirement Plans – The tax code provides for a variety of retirement plans, both for employees and for self-employed individuals. These include: 401(k) deferred compensation plans, Keogh self-employed retirement plans, simplified employee plans (SEP), tax-sheltered annuity (403(b)) plans – most commonly for teachers and employees of nonprofits), and government employee plans (457) plans. For the most part, the consequences of these arrangements are the same as for a traditional IRA, allowing the amount contributed to be excluded from income (deferred), and then the distributions are fully taxable when they are taken. However, 401(k) and 457 plans may have a Roth option, under which there is no income exclusion for the contributions but the distributions at retirement are tax-free. If individuals have used both methods, the non-Roth contributions are deferred, and the earnings are fully taxable.

Bank Savings – When money is put away into a bank savings account or CD, the earnings are fully taxable in the year earned. However, after the tax on the annual earnings is paid, the full balance in the account is available, without any further tax.

Short- and Long-Term Capital Gains – Capital gains refers to the gain from the sale of capital assets – typically stocks, bonds, and real estate. Short-term capital gains are taxed at ordinary tax rates, while long-term capital gains enjoy special lower rates. For lower-income taxpayers, there is actually no tax on capital gains; for very high-income taxpayers, the capital gains rate maxes out at 20%, whereas the top regular tax rate for high-income taxpayers is 37%. However, for the average taxpayer, the capital gains rate is 15%, which provides a significant savings over the regular tax rates. To qualify for long-term treatment, the capital asset must be held for a year and a day.

Education Savings Accounts – The tax code provides two tax-advantaged plans that allow taxpayers to save for the cost of college for each eligible student: the Coverdell Education Savings Account and the Qualified Tuition Plan (frequently referred to as a Sec. 529 Plan). Neither provides tax-deductible contributions, but both plans’ earnings are tax-deferred and are tax-free if used for allowable expenses, such as tuition. Therefore, with either plan, the greatest benefit is derived by making contributions to the plan as soon as possible—even the day after a child is born—to accumulate years of investment earnings and maximize the benefits.

However, there are different limitations for the two plans, in that only $2,000 per year per student can be contributed to a Coverdell account, while huge amounts can be contributed to Sec. 529 plans, limited only by the estate-planning issues of each contributor and each state’s cap on account contributions, which goes into six figures.

Health Savings Accounts – A health savings account (HSA) can generally be established by taxpayers only if they have high-deductible health plans. The contributions are tax-deductible, the earnings accumulate tax-free, and the distributions are tax-free if used for qualified medical expenses. When part of an employer-sponsored plan, HSA contributions are excluded from the employee’s wages. Once the account owner reaches age 65, taxable but penalty-free distributions can be taken, even if they are not used to pay for medical expenses or to reimburse the taxpayer for medical expenses previously paid for out-of-pocket. Thus, these plans can serve as a combination tax-free medical reimbursement plan and taxable retirement savings arrangement. The maximum annual contribution is inflation adjusted; for 2018, it is $3,450 for self-only coverage and $6,900 for family coverage. Like other tax-advantaged plans, the key is to allow the account to grow through tax-deductible contributions and the accumulated earnings.

Unqualified Withdrawals – Be careful about making unqualified withdrawals – those that are taken before reaching retirement age, in the case of retirement plans, and those taken for unqualified expenses, in the case of education savings accounts and health savings accounts. Doing so can result in costly tax ramifications and potential penalties.

Like all tax matters, nothing is simple, and a myriad of rules apply to the foregoing arrangements. Please contact us for more information or a planning appointment.

Reasonable Compensation and S Corporations

Unlike a C corporation, which itself pays the tax on its taxable income, an S corporation does not directly pay taxes on its income; instead, its income, losses, deductions, and credits are distributed across its shareholders’ individual tax returns on a pro rata basis. These distributions are not subject to self-employment (Social Security and Medicare) taxes. As a result, many S corporations ignore the requirement that each shareholder-employee must take reasonable compensation in the form of W-2 wages in exchange for services performed for the corporation. These wages are subject to Social Security and Medicare taxes (which the corporation and the employee generally split equally); the corporation is also responsible for paying the Federal Unemployment Tax (as well as any state unemployment taxes).

The Internal Revenue Code establishes that an officer of an S corporation is an employee of that corporation for Federal Unemployment Tax purposes. S corporations should not attempt to avoid paying this tax by treating their officers’ compensation as distributions rather than as wages.

This has been an issue for decades; in 1974, the IRS issued a ruling stating that, when a shareholder-employee fails to take a salary, or if that salary is unreasonable, an auditor should assert that the salary is unreasonable. The officer’s distributions will then be shifted to account for reasonable compensation, and he or she will be assessed the related employment taxes and penalties. At stake here are the employee’s 6.2% Social Security and 1.45% Medicare payroll taxes, the S corporation’s matching amounts, the Federal Unemployment Tax, and whatever state taxes happen to apply.

Who Is an Employee of the Corporation? – Generally, an officer of a corporation is considered an employee of that corporation. The fact that an officer is also a shareholder does not change the requirement that any payments made to that officer must be treated as wages. Courts have consistently held that S corporation shareholders who provide more than minor services to their corporation (and receive payment in return) are employees whose compensation is subject to federal taxes.

Tax regulations do provide an exception for officers who do not perform services or who perform only minor services. These officers are not considered employees.

What’s a Reasonable Salary? – The instructions for Form 1120S (“U.S. Income Tax Return for an S Corporation”) state: “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.” There are no specific guidelines in the tax code regarding the definition of reasonable compensation. The various courts that have ruled on this issue have based their determinations on the facts and circumstances of the individual cases. These are some factors that courts have considered when determining reasonable compensation:

  • The officer’s training and experience
  • The officer’s duties and responsibilities
  • The time and effort that the officer devotes to the business
  • The corporation’s dividend history
  • The corporation’s payments to non-shareholder employees
  • The timing and manner of the bonuses paid to key people at the corporation
  • The payments that comparable businesses have made for similar services
  • The corporation’s compensation agreements
  • The formulas that similar corporations have used to determine compensation

The problem here, of course, is that it is easy for the IRS to simply list contributing factors that courts have used when determining reasonable compensation and leave it to each corporation to quantify these factors and determine a reasonable salary—all while retaining the ability to challenge the selected amount later if an auditor decides that the compensation is not reasonable. The IRS has a long history of examining S corporations’ tax returns to ensure that reasonable compensation is being paid, particularly when a corporation pays no compensation to employee-stockholders.

New Issue For 2018 – The late-2017 tax reform added a new flow-through deduction (also referred to as the “199A deduction” after the section of the tax code that describes it). This deduction applies to S corporations (among many other business entities) and adds another level of complexity to the determination of reasonable compensation.

    • The wages of an S corporation’s employee-stockholder are NOT treated as qualified business income (QBI) that is eligible for the individual’s 199A deduction. However, the corporation deducts these wages as a business expense when it calculates the profit that passes through to the shareholder as QBI on Schedule K-1. Thus, larger wages mean less K-1 flow-through income (QBI) and thus a smaller 199A deduction (as that is equal to 20% of QBI). In this case, S corporations tend to minimize stockholders’ salaries in order to maximize flow-through income; this strategy increases the employee-stockholder’s 199A deduction and lowers the payroll taxes for both the corporation and the employee-stockholder.
    • If married taxpayers who are filing a joint return have 1040 taxable income that exceeds $315,000 (or $157,500 for those with other filing statuses), the 199A deduction begins to be subject to a wage limitation. Once the 1040 taxable income for married taxpayers filing jointly exceeds $415,000 (or $207,500 for those with other filing statuses), the wage limitation is fully phased in. In that event, the 199A deduction becomes the lesser of the wage limitation or 20% of the QBI; if the wage limitation is zero, there is no 199A deduction.The wage limitation comprises the wages that the corporation paid, including those paid to stockholders, plus the unadjusted cost of the qualified property that the corporation owned and used during the year. To be more specific, the wage limitation is the larger of
      • 50% of the wages that the corporation paid or
      • 25% of the corporation’s paid wages plus 2.5% of the unadjusted cost of its qualified property.
Thus, for those high-income shareholders for whom the wage limitation applies, if the corporation pays no wages and has no qualified property, the shareholder will not have a 199A deduction.If an S corporation is a specified service trade or business, the 199A deduction phases out; for married taxpayers who are filing a joint return, it phases out at taxable incomes between $315,000 and $415,000 (for those with other filing statuses, it phases out between $157,500 and $207,500). The IRS describes specified service trades or businesses are those in the fields of health, law, accounting, actuarial science, performing arts, athletics, consulting, financial services, and brokerage services, as well as those for which reputation and/or skill are contributing factors (for more details on what constitutes an specified service trade or business, please give us a call).

Thus, if married taxpayers who are filing jointly have taxable income in excess of $415,000 (or $207,500 for those with other filing statuses), they receive no benefit from the wage limitation; therefore, they also tend to minimize their reasonable compensation in order to minimize their FICA taxes.

Of course, taxpayers cannot pick and choose a particular level of reasonable compensation to minimize their taxes or maximize their deductions; therein lies a trap. Taxpayers instead should consider all the factors related to reasonable compensation. However, pulling all the data together to support such a determination can be difficult and time-consuming. Some commercial firms have the necessary data and resources to properly apply the various factors mentioned in this article so as to determine the proper level of reasonable compensation; this can provide backup in the case of an IRS challenge.

Please give us a call if you have questions related to reasonable compensation for S corporation shareholders or how it impacts your specific tax situation.

Surrogacy Fees and Taxes

Articles about the taxability and deductibility of surrogacy fees are rare because there are far fewer surrogacies than conventional births. Surrogacy is a legal arrangement in which a surrogate mother, new parents and (often) a surrogacy agency enter into a binding contract. In the event of a breach of that contract, any party can be held to the terms of the agreement.

Tax Treatment for the Surrogate
The Internet contains a wide variety of opinions related to the taxability of the surrogacy fee to the surrogate mother. Some authors classify this fee as a gift; however, a U.S. Supreme Court decision (Commissioner vs. LoBue, Philip (1956, S Ct)) stated that, for tax purposes, gifts must be made out of detached or disinterested generosity. Any payment that parents make to a surrogate mother cannot reasonably be considered detached or disinterested, so surrogate fees are not gifts.

On the other hand, many surrogacy agencies advise their clients that surrogacy payments are for pain and suffering and thus are exempt under Sec 104 of the Internal Revenue Code (IRC). This section is about “compensation for injury or sickness”; however, the term “pain and suffering” does not appear anywhere in that section. Surrogacy does not meet the definition of an excludable physical injury under IRC Sec 104 such as an injury associated with a car accident, bungled surgery or other accident. Thus surrogacy fees do not fall under the compensation exclusion for injury or sickness.

IRC Sec 61 states, “Except as otherwise provided, gross income means all income from whatever source derived.” There is no exception in the code for surrogacy fees, so such fees are considered taxable income for the surrogate mother. To complicate matters, the surrogate mother is providing a personal service and thus may be subject to the self-employment (Social Security and Medicare) taxes in addition to income tax if such a fee is received in the course of business.

To be subject to Social Security taxes, the surrogacy arrangement would have to rise to the level of a trade or business. The determination of whether that is the case is dependent on the facts and circumstances of the individual surrogacy. For instance, if a surrogate has entered into such an arrangement previously or intends to do so again, the fee will likely be considered self-employment income. However, if the surrogacy is a one-time activity, an argument could be made that this act is not a business—in which case the surrogacy fee would not be subject to Social Security taxes.

If the fee is considered self-employment income, it may be offset with benefits that are available to any self-employed taxpayer, including the ability to deduct health insurance above the line rather than as an itemized deduction and the ability to make deductible contributions to a self-employed retirement plan or IRA. Although there are not many deductible business expenses in such a situation, the legal or other costs associated with drafting and executing the surrogacy contract are deductible.

A self-employment surrogacy activity would fall into the category of a specified service business for the purposes of the new, self-employed and pass-through business deduction that will be available in 2018 through 2025. Thus, provided that the surrogate mother’s return has taxable income that does not exceed $157,500 (or $315,000 if she is married and files a joint return with her spouse), she would be eligible for the new IRC Sec 199A pass-through deduction, which is equal to 20% of the net self-employment income. However, this deduction phases out at taxable incomes between $157,500 and $207,500 (or $315,000 and $415,000 if filing jointly). The income from self-employment surrogacy can be used to determine the earned income tax credit if a surrogate mother is otherwise qualified.

Unfortunately, tax novices on the Internet are creating their own interpretations of the tax code, and many of them are attempting to justify their preferences instead of instead of describing the actual rules.

As a result, many – dare we say, most – surrogate mothers are not reporting their surrogacy income. The IRS is not catching up with them because neither the parents nor the agencies are issuing 1099-MISC forms to surrogate mothers. The parents are under no obligation to issue a 1099-MISC because, for them, the payment is not related to a business. The agency, on the other hand, is a business, so if the surrogacy fee passes through it, the agency is obligated to issue a 1099-MISC.

Tax Treatment for the Parents
Surrogate mothers’ expenses are not specifically addressed in the IRC or in other regulations. Under current tax law, the only place that a surrogate fee could be deducted is as a medical expense. However, consider the following:

  • Medical deductions are allowed only for the medical care of the taxpayer and his or her spouse and dependents (IRC Sec 213(a)).
  • These expenses must be for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body (IRC Sec 213(a)(1)(A)).

A surrogate mother is, by definition, neither the taxpayer nor the taxpayer’s spouse, and she is typically not a dependent, either. An unborn child is also not a dependent (Cassman v. United States, 31 Fed. Cl. 121 (1994)). Thus, medical expenses paid to a surrogate mother and her unborn child do not qualify for a medical deduction.

This fee also cannot be construed as a treatment for a female taxpayer’s inability to conceive.

Thus, the new parents cannot deduct the surrogacy fee or any agency fees, legal fees, and medical expenses for the surrogate mother and unborn fetus.

Please call us if you have questions about surrogacy fees and taxes.

Five Reasons to Amend a Previously Filed Tax Return

The most recent data from the IRS on individual tax returns indicates that of 131 million returns filed, about 5 million were expected to be amended. This comes to less than 4 percent, but that projection still affects a significant number of taxpayers. Filing an amended tax return can be a hassle that you definitely want to avoid if possible. But there are some situations where you’ll have to do so, and it’s prudent to seek out the help of a tax advisor who can guide you through the process. Here’s why you may need to file an amended tax return.

1. You made a math or data entry mistake and didn’t realize it until after you submitted your tax return.

For example, you added up your charitable deductions, and after filing your return, you realize you added them up incorrectly, and the difference was sizeable. Filing an amended return can correct that math error and get a refund.

Perhaps you were entering your gross income from your self-employed business into your software while it was late and you were tired, and you inadvertently transposed the numbers and entered the gross income as $78,000 when it was really $87,000. You will need an amended return to correct that error.

However, you would not usually amend a return if you incorrectly entered W-2 income since the IRS receives a copy of the W-2 and will compare it with what you reported and if there was an error, they will automatically make a correction and send you a bill or a refund as the case might be. The IRS website instructs taxpayers not to amend a return in such a situation.

The statute of limitations for refunds is three years for the due date the tax return and if the IRS has not automatically made the correction and you have a refund coming don’t let the statute of limitations expire before filing an amended return. That holds true for any situation were an amended return will result in a refund.

2. You used an incorrect filing status.

Single parents, caregivers of elderly parents, and recently married or divorced people often make the mistake of using “Single” status when it’s the wrong one. “Heads of Household” miss out on crucial tax benefits, while married people will generally need to use “Married Filing Separately” if they don’t wish to file a joint return with their spouse. Because filing status affects so many elements of your tax return, you need to file an amended return to pay additional taxes you owe or receive a refund once the correct one is used.

3. You didn’t realize that there was a tax benefit you qualified for, and you’d like to claim it now.

There are many frequently overlooked tax benefits a tax professional would be aware of that the average DIY person wouldn’t, such as the ability for most individuals and small business owners to make pension and profit-sharing contributions in a new year before the tax-filing deadline and still have it count for the current filing season.

This also works in reverse in that people accidentally claim benefits they weren’t actually entitled to. Often, the best way to know for sure is to consult a tax professional.

4. You had investing activities that affect your tax return.

Typically, you don’t realize a capital gain or loss until you actually sell an asset. But if securities become worthless, this results in a capital loss that needs to be reported the year it was deemed worthless, and not the year you discovered the fact. If this security was deemed worthless a long time ago, you may have to amend prior year returns to account for the capital loss.

This can be significant since you are limited to deducting $3,000 in capital losses from all of your other income and result in capital loss carryovers that last several years. If you have any other investment losses that were forgotten or miscalculated on your original tax return, filing an amended return is the next logical stop to ensure your carryovers are done correctly for future tax returns.

5. You received tax forms after filing your tax return.

If you were due a W-2 or 1099 form, you might not receive it when you’re initially preparing your taxes. It could be a surprise corrected form or the payer was just late sending it to you. But if you already filed your tax return, then got additional forms later on, amending your tax return becomes inevitable.

Amending your tax return can be a cumbersome process, especially if you’re self-employed and/or have a great deal of investing activity. Asking a tax professional to assist you with filing amended returns can eliminate the headaches that come with the process. Many even offer a free review of self-prepared returns and ask the right questions to determine if it’s worth it to amend this year’s return and any prior years’. You may also have to amend your state tax return(s), which can grow more complex if your residency is or was multistate.

The Key Steps to Take BEFORE You Start a New Business

Very few people think that starting a new business is easy. But at the same time, there are few first-time entrepreneurs who realize just how involved things are from the moment you start trying to bring that idea that previously only existed in your head into the real world.

There’s a massive amount of commitment required, even before your business technically exists at all. This is okay, because as the old saying goes, “anything worth doing is worth doing right.”

In fact, there are a number of key steps that you need to take BEFORE you’ve even started the business of your dreams that you’ll absolutely want to pay close attention to moving forward.

Identify the “Why” of It All
First thing’s first: Before you do anything else, you need to determine why you feel so compelled to start this particular business at this particular time.

Is it just because you think you have a great, sure-fire idea that is going to generate a lot of money? If so, you may want to take a step back… you’ll likely be disappointed. But if it’s because this will allow you to genuinely do something you love, and something that you think will make an impact on the lives of a lot of people, then, by all means, push ahead.

Identify the NEED
Next, you need to verify that this idea of yours is actually a viable one in the first place; essentially, you have to confirm that there is a genuine need in the marketplace for a product or service like the one you want to create.

DO NOT allow yourself to become “a solution in search of a problem.” Make sure that people are asking for a business like yours and that need is currently going unfulfilled.

DON’T Quit Your Day Job
Building a successful business is not something that happens overnight. This often takes years of planning and hard work, not to mention many mistakes along the way.

All of this is to say that if your ability to quit your day job and focus on your new business full time depends on an instant success… don’t quit your day job just yet.

DON’T Neglect Your Family
Yes, starting a business is something that requires a huge amount of your time. Yes, you need to devote every ounce of space in your brain and every free moment to this goal. But do not, under any circumstances, let that come at the expense of your loved ones and those around you.

You’re going to need quite a bit of support to get your new business up and running. If you neglect your family now, you’re not going to have that support later.

The Art of Writing a Business Plan
At this point, you can start working on making your vision a reality. This part of the journey always begins in the same basic way: writing a realistic, actionable business plan that will guide your every move in the future.

With a business plan, you really do need to be as specific as humanly possible. You know where you’re starting, and you know where you want to end up. The job of a business plan is to connect those dots by way of a series of smaller, logical and achievable steps. It’s essentially the roadmap you’ll use to shine a light through the darkness, guaranteeing that you’re always moving in the right direction (and that this direction is forward).

The Entrepreneur’s Bet
As you write your business plan, you’ll also have to make what is often referred to as “The Entrepreneur’s Bet.” Essentially, you need to figure out how much money a business like yours needs to make in order to become profitable.

You also need to acknowledge that, once again, your business is very unlikely to be successful enough right away to have this bet pay off in the short term. A lot of new businesses are operating at a loss at first — that’s okay. But this is yet another step that confirms the path you’re on is actually viable and it’s one that you absolutely do not want to skip.

The Myth of the “One Size Fits All” Approach
At this point, it’s also important to acknowledge that there really is no one “right way” to start a business. The choices you have to make will be influenced by a wide range of different factors, many of which are unique to your industry, your business plan and even the vision that you’re starting with.

Case in point: You need to review all local, state and federal regulations pertaining to what you’re trying to accomplish. Different places have different laws, and ignorance is not an excuse for breaking them. Factors like how to become compliant, what standards a product has to meet and more will all be influenced by these regulations, and they will impact a lot of the steps on your business plan as well.

It’s Time to Start Thinking About Technology
Once this foundation is all in place, it’s time to start thinking about the tools you’ll need to bring your new business into the world. These days, that involves a lot more technology than people often realize.

This is another one of those steps that will obviously be impacted by the type of business you’re starting. A local brick-and-mortar retail store will obviously have different technological needs (point of sale systems, inventory management equipment, etc.) than an online marketing agency (graphic design software, collaboration tools, etc.).

But when built properly, your technology strategy and your business strategy are essentially one and the same. They feed into one another, and your IT helps generate the momentum you need to continue to grow and expand while remaining agile as well. It’s far too important to neglect.

Choosing the Right Business Entity
This is another important step you don’t want to skip because it dictates things like taxes, paperwork, liability and other legal elements of your business.

One of the most common types of business entities is the limited liability structure, or LLC. This is because it provides you with the level of flexibility you need right now, coupled with the protection you’ll need from a personal liability standpoint.

But that isn’t a guarantee that this is right for you. Other structures like sole proprietorships, partnerships, S corporations and C corporations all have their fair share of advantages and disadvantages. You need to pick the right one today or you’ll open yourself up to a world of problems tomorrow.

Finding the Help You Need (and You WILL Need It)
Finally, as your journey toward true entrepreneurship is about to begin in earnest, you need to understand two of the core pillars of successful business ownership:

  1. You do not know everything, even if you think you do.
  2. You cannot do it all alone, even if you think you can.

The difference between failed and successful business owners often comes down to the acknowledgment of these two points.

Rather than do a poor job at a business task for which you don’t have the skills, don’t be afraid to hire someone who does have those skills. Rather than guess at answers to questions, find the right advisors and mentors to guide you. Reach out and find the people who are willing to assist you and don’t be afraid to share your vision with them.

You WILL need help and there are people who are absolutely willing to stand by your side. You just have to want to look for them.

In the End
It’s fair to say that starting a new business is harder than you probably thought it was going to be, especially when you consider the sheer amount of time you’ll need to devote to the steps outlined above. But provided that you have a realistic vision and a passion that cannot be extinguished, success is no longer a question of “if” but “when.”

The stakes are high and the risk is higher, but the rewards are even greater if you persevere. Never let anyone tell you otherwise.