Facing a Huge Gain from a Real Estate Sale?

Article Highlights:

  • Adjusted Basis
  • Passive Loss Carryovers
  • Installment Sale
  • Tax-Deferred Exchange
  • Tax on Net Investment Income
  • Qualified Opportunity Fund
  • Home Sale Exclusion

If you are contemplating selling real estate property, there are a number of issues that could impact the taxes that you might owe. Fortunately, there are steps you can take to minimize the gain, defer the gain, or spread it over several years. The first and possibly most important issue is adjusted basis. When computing the gain or loss from the sale of property, your gain or loss is measured from your adjusted basis in the property. Thus, your gain or loss would be the sales price minus the sales expenses and adjusted basis.

Adjusted Basis – So, what is adjusted basis? Determining adjusted basis can sometimes be complicated. In a simplified overview, it is a dollar amount that starts with your acquisition value and is then adjusted up for improvements to the property, down for depreciation taken on the property, and down for any casualty losses claimed on the property. The acquisition value could be the price you paid for the property, the fair market value of an inheritance at the date of the decedent’s death, or, in the case of a gift, the donor’s adjusted basis at the time of making the gift.

It is extremely important to keep track of your basis, since it is a key factor in determining gain or loss upon the sale of the property. Failure to maintain proper records and supporting documentation could result in a significant income tax liability.

Passive Loss Carryover – If the property was a rental and the rental operated at a loss, there is a chance that the losses were not fully deductible in the year(s) of the loss because of the passive loss limitation rules. In this case, you will have a passive loss carryover that can be used to offset the gain. In addition, current year passive losses and passive loss carryovers you may have from other properties can also be used to offset any gain from selling a rental property.

Next, you have to decide whether you want to take (i.e., report on your tax return) all the income in one year or whether to attempt to spread the income over a period of years with an installment sale (by carrying back a loan). Or you can defer the income into a replacement property through a tax-deferred exchange.

Installment Sale – In an installment sale, the seller acts as the lender to the buyer. That can entail holding the first trust deed or taking back a second trust deed for only a portion of the loan amount. However, second trust deeds are as the name implies: They are second in line to be paid if the buyer defaults on the loan and thus are riskier. When they are set up as an installment sale, part of the gain is reported for each year that payments are received, generally as capital-gain income. In addition, the interest that the buyer pays the seller is taxable as ordinary income to the seller. Installment sales can be structured as short- or long-term loans, but remember, the buyer can always pay off the loan early or refinance. Either of these actions would make the balance of the profit from the sale taxable at that time.

Tax Deferred Exchange – Another option if the property is held for investment or used in a trade or business is to defer the gain in the future. This is accomplished by using the rules of IRS Code Section 1031, which allows the taxpayer to acquire like-kind property and defer the gain into the replacement property, which also must be used for business or be held for investment. However, the rules for like-kind exchanges are complicated, have strict timing issues, and require advance planning with a professional familiar with Section 1031 rules.

Net Investment Income Tax – Adding complications to the sale-planning issue is the surtax on net investment income. This 3.8% additional tax kicks in when a taxpayer’s modified adjusted gross income (MAGI) exceeds $200,000 ($250,000 for married joint filers and $125,000 for married individuals filing separately). Gain from the realty sale is included in the MAGI and could cause the MAGI threshold to be exceeded, resulting in this surtax applying to some or all of the realty gain. However, it may be minimized, or possibly eliminated, by using an installment sale and spreading the gain over several years or deferring down the road with a tax-deferred exchange.

Qualified Opportunity Fund (QOF) – Taxpayers who have a capital gain from selling or exchanging any property to an unrelated party may elect to defer that gain if it is reinvested in a QOF within 180 days of the sale or exchange. One exception is that the gain from the subsequent sale of the QOF cannot be deferred into another QOF. Only one election may be made with respect to a given sale or exchange. If the taxpayer reinvests less than the full amount of the gain in the QOF, the remainder is taxable in the sale year, as usual. Only the gain need be reinvested in a QOF, not the entire proceeds from the sale. This is in sharp contrast to a 1031 exchange where the entire proceeds must be reinvested to defer the gain.

Home Sale Exclusion – If the real estate is your home (primary residence), there are special rules. Generally, if you own and occupy the home in two out of the five years prior to the sale, you will be able to exclude a substantial portion of your gain. The tax-deferred exchange rules do not apply to personal-residence sales. The amount of the home exclusion can be as much $250,000 ($500,000 for married couples filing jointly). There are even special rules that allow a reduced exclusion under certain special circumstances.

As you can see, the result of selling real estate property can include several tax issues, and minimizing current taxes requires some careful planning. Please contact us for assistance in planning your real estate transactions.

All the Expert Tips You Need to Properly Manage Cash Flow for Your New Business

Handling the cash flow for your new business is exactly what it sounds like ‒ you’re trying to get the clearest level of visibility into “money coming in versus money going out.” However, managing cash flow is about a lot more than that, too. It’s about making sure that you not only have the funds on hand to remain operational, but that you can capitalize on opportunities as they arise. To properly manage cash flow, it is necessary to prepare for any financial challenges that may develop in the future.

The importance of gaining a precise understanding of your cash flow cannot be overstated.

Indeed, running out of money is also one of the most common ways that new businesses are forced to close their doors ‒ usually very quickly after their initial launch. But while this is certainly an essential topic, it isn’t necessarily a difficult one. Properly managing the cash flow for your new business is a lot more straightforward than you might fear. Keep the following key factors in mind:

The “Breakeven” Point

By far, one of the most important metrics for you to understand about your new small business is your “breakeven” point. That is the point at which your current (or projected) revenues will allow you to meet all of your operating expenses. This is the bare minimum amount of money you need to keep your employees paid, keep your bills up-to-date, and keep your doors open. Unfortunately, it usually changes on a regular basis.

As your business continues to scale, your revenue should increase, but your expenses will increase, too. Therefore, it is of paramount importance that you don’t make finding your “breakeven” point something you “do once and forget about.” For the best results, you should return to this figure on a regular basis to make sure you: a) understand what it is in the literal sense; and b) understand what actions you need to perform to achieve that.

Once you have a handle on your breakeven point, you will, at the very least, be able to remain functioning. This means you can start to devote more of your attention to growing your new business.

The Importance of Cash Reserves

If you look at some of the other reasons why small businesses usually fail, you’ll quickly see that they’re closely related:

  • About 79% of businesses fail because they start out with too little money, according to one study.
  • 77% run into trouble when they fail to price properly, or don’t include all necessary items when establishing prices.
  • 73% fail because they were either too optimistic about achievable sales, or about the money required to generate those sales, or both at the same time.

These types of issues are common with small businesses, and particularly with those controlled by an entrepreneur who is running their first small business. As much as all of these ideas ultimately tie directly back into cash flow management, they also underline another very important best practice:

The Value of Maintaining a Cash Reserve

  • Absolutely every new business, regardless of its size or the industry it’s in, should expect problems on a regular basis. Working hard to keep a quality cash reserve will not only help to reduce the ultimate impact of those problems, but it can also help reduce stress and distractions too.
  • If you have no cash reserve, every problem becomes a major cash flow problem. If, at the very least, you have something to fall back on, you will have the clarity you need to learn from the situation, maintain your focus on growing your business, and keep moving forward.

Take Control of Those Receivables

Typically, new businesses do not have a problem with the “money out” side of cash flow management. Even if business leaders do start to spend money too quickly, hopefully, they are able to recognize it so that they can make adjustments as soon as possible.

But it’s difficult to make adjustments if you’re not bringing any money in, which is why taking control over your receivables is so important.

For example, if a client owes $1,000, but you have no idea when they are going to pay it, do you really have $1,000? No, not really ‒ which is why you should try to make invoices “due immediately.” If someone needs additional time to pay, try to make sure the terms give them no longer than a week or two at most.

Depending on your specific circumstances, you may even want to offer discounts for clients who pay early. This can be a great way to incentivize them to pay their invoices and get essential money into your bank account.

At a bare minimum, you should have a staff person tasked with maintaining visibility into receivables and this employee should follow-up with clients who have outstanding invoices.

The more money you bring into your business, the more money you can spend on those initiatives that will continue driving your organization forward.

Every Dollar Spent Has a Purpose

Everyone knows that you should only spend money on essentials, but in the fragile early days of a new business, you need to take that concept one step further.

With every purchase you make, you need to be able to see the verified return on investment that it will bring. For example, if you’re buying a new piece of equipment, what does it get you? Will it speed up your production, allowing you to more quickly achieve a larger volume of higher quality finished products? In that case, the return on investment absolutely justifies the initial money you need to spend.

However, if you really want that new piece of equipment simply because it’s the “latest and greatest,” that isn’t really the “good idea” you thought it was.

Another example of this would be investing in a new payment solution that allows you to accept online payments. It may not be a “fun” purchase, but if it allows you to expand into a true e-commerce solution and if it creates new opportunities to introduce your products to a larger audience and sell them online, it becomes an “essential,” and is a step worth taking.

In absolutely no uncertain terms, you cannot afford to spend money “just for the sake of it.” Determine your essentials and make sure you have the cash on-hand to support them. Then, eliminate the costs for any non-essentials, at least until your business is in a fully profitable state.

In the end, remember that you need to be proactive about properly managing your cash flow. Not only do you need to know your current cash flow status at all times, you also need a clear plan and “line of sight” where you’re headed tomorrow. When everything is functioning as it should, your cash flow best practices support the former while making the latter possible. If they aren’t, there could be a serious issue with your current process that you should find and eliminate as quickly as possible.

If you have any questions, or need assistance managing your cash flow, please contact us.

How to File Taxes After Getting Married

Article Summary:

  • Filing Options
  • Married Filing Jointly
  • Unpleasant Consequences
  • Pleasant Consequences
  • Married Filing Separately
  • Notifying SSA, IRS, employers
  • Other Issues to Consider

A taxpayer’s filing status for the year is based upon his or her marital status at the close of the tax year. Thus, if you get married on the last day of the tax year, you are treated as married for the entire year. The options for married couples are to file jointly or separately. Both statuses can result in surprises – some pleasant and some unpleasant – for individuals who previously filed as unmarried.

Individuals filing jointly must combine their incomes, and if both spouses are working, combining income can trigger several unpleasant surprises, as many tax benefits are eliminated or reduced for higher-income taxpayers. To follow are some of the more frequently encountered issues created by higher incomes:

  • Being pushed into a higher tax bracket
  • Causing capital gains to be taxed at higher rates
  • Reducing the childcare credit
  • Limiting the deductible IRA amount
  • Triggering a tax on net investment income that only applies to higher-income taxpayers
  • Causing Social Security income to be taxed
  • Reducing the Earned Income Tax Credit
  • Reducing or eliminating medical deductions

Generally, filing separately will not alleviate the issues because the tax code includes provisions to prevent married taxpayers from circumventing the loss of tax benefits that apply to jointly filing higher-income taxpayers by filing separately.

On the other hand, if only one spouse has income, filing jointly will generally result in a lower tax because of the lower joint tax brackets and a higher standard deduction, double the amount for single individuals ($24,400 for 2019), if the couple does not itemize deductions. In addition, some of the higher-income limitations that might have applied to an unmarried individual with the same amount of income may be reduced or eliminated on a joint return.

Filing as married but separate will generally result in a higher combined income tax for married taxpayers. For instance, if a couple files separately, the tax code requires both to itemize their deductions if either does so, meaning that if one itemizes, the other cannot take the standard deduction. Another example relates to how a married couple’s Social Security (SS) benefits are taxed: on a joint return, none of the SS income is taxed until half of the SS benefits plus other income exceeds $32,000. On a married-but-separate return, and where the spouses have lived together at any time during the year, the taxable threshold is reduced to zero.

Aside from the amount of tax, another consideration that married couples need to be aware of when deciding on their filing status is that when married taxpayers file jointly, they become jointly and individually responsible (often referred to as “jointly and severally liable”) for the tax and interest or penalty due on their returns. This is true even if they later divorce. When using the married-but-separate filing status, each spouse is only responsible for his or her own tax liability.

Once a couple files as married filing jointly they cannot undo that. However, if they file separately, they can later amend that filing status to married filing jointly.

As soon as a couple is married, the Social Security Administration should be notified of any name changes, and if they’ve moved, the IRS needs to be notified of the couple’s new address.

If either or both newlyweds purchased their health insurance through a government marketplace, the marketplace should be advised of the couple’s marriage. Any advance premium tax credit (APTC) being applied to pay the insurance premiums can be adjusted when necessary. Doing so could prevent having to repay some or all the APTC when filing their federal return(s) for the year of the marriage.

Of course, the couple needs to notify their employers of their new marital status so any affected benefits can be updated. Usually new W-4 forms should be prepared and given to their employers so income tax withholding can be revised for the new filing status.

Other issues that may come into play and should be considered are:

  • If one of the spouses has an outstanding liability with the IRS or state taxing authority, that situation could jeopardize any future refund on a jointly filed return.
  • It may be appropriate not to commingle income from assets a spouse wants to maintain as separate property or where the spouses want to name separate beneficiaries.
  • Individuals marrying later in life may wish to keep their incomes separate or only pay the tax on their own income.

If you have questions or would like an appointment to evaluate the impact of marriage on your tax liability before getting married, please contact us.

Small Business Owners May Qualify for a Home-Office Deduction

Article Highlights:

  • Qualifications
  • Actual Expense Method
  • Simplified Method
  • Home Office Expenses for Renters vs. Homeowners
  • How Moving Affects the Home-Office Deduction
  • Other Issues
  • Gross Income Limitation

“Home office” is a type of tax deduction that applies to the business use of a home; the space itself may not actually be an office. One of the following must apply to be able to deduct home office expenses. The home office:

  • Must be the taxpayer’s main place of business. OR
  • Must be a place of business where the taxpayer meets patients, clients or customers. The taxpayer must meet these people in the normal course of business. OR
  • Must be in a separate structure that is not attached to the taxpayer’s home. The taxpayer must use this structure in connection with their business. OR
  • Must be a place where the taxpayer stores inventory or samples. This place must be the sole, fixed location of their business. OR
  • Under certain circumstances, must be where the taxpayer provides day-care services.

Generally, except when used to store inventory, an office area must be used on a regular and continuing basis and be exclusively restricted to the trade or business (i.e., no personal use).

Two Methods – There are two methods to determine the amount of a home-office deduction: the actual-expense method and the simplified method.

  • Actual-Expense Method – The actual-expense method prorates home expenses based on the portion of the home that qualifies as a home office, which is generally based on square footage. Aside from prorated expenses, 100% of directly related costs, such as painting and repair expenses specific to the office, can be deducted. Unlike the simplified method, the business is not limited to 300 square feet.
  • Simplified Method – The simplified method allows for a deduction equal to $5 per square foot of the home used for business, up to a maximum of 300 square feet, resulting in a maximum simplified deduction of $1,500. A taxpayer may elect to take the simplified method or the actual-expense method (also referred to as the regular method) on an annual basis. Thus, a taxpayer may freely switch between the two methods each year.Additional office expenses such as utilities, insurance, office maintenance, etc., are not allowed when the simplified method is used. Prorated rent or home interest and taxes are not either, although 100% of home interest and taxes are deductible if the taxpayer itemizes deductions.

    To determine the average square footage when using the simplified method, no more than 300 square feet for any month can ever be used, even if the taxpayer has multiple businesses for which he or she uses space in the home. If there are multiple businesses, a reasonable method to allocate between businesses is used. Zero is used for months when there was no business use or when the business was not operating for a full year. Don’t count any month when the business use was less than 15 days.

    Example: Sandra begins using 400 square feet of her home for business on July 20, 2019 and continues using the space as a home office through the end of the year. Her average monthly allowable square footage for 2019 is 125 square feet (300 x 5 months = 1,500/12 = 125).

Home Office Expenses – There are differences as to which prorated home expenses are deductible by renters and homeowners when computing the actual expense method, as illustrated in the table below.

Prorated Expense Own Rent
Mortgage Interest X
Property Tax X
Rent X
Homeowner’s Insurance X
Renter’s Insurance X
Utilities X X
Depreciation X
Home Maintenance X X

Note that the principal payments made on a home loan are not eligible expenses. Instead, homeowners claim a deduction for depreciation on the office portion of the home’s basis.

Rent vs. Own: What Happens If You Move or Sell the Home?

Rent – When you pay rent for your home and use part of it for business, move and then use space at the new location as a home office, for the year of the move, you’ll need to figure out the deduction separately for each home office based on the specific expenses and business use area of each home. If you don’t use space at your new living quarters for business purposes, then your home-office deduction for the year of the move will need to factor in just the expenses for the time you lived in the first home.

Own – On the other hand, if you own the home, sell it and had lived in it for two of the five years prior to the sale date, you can exclude up to $250,000 of gain ($500,000 for a married couple). However, you cannot exclude the part of any gain to the extent of depreciation you claimed for the home after May 6, 1997. For exclusion purposes, it makes a difference whether the home office was within the home itself or in a separate structure on the same property. If within the same structure, the exclusion will apply to the entire gain from the home (other than the depreciation component). If the office was within a separate structure, then the sale must be treated as two sales – one for the home and one for the office – and the gain from the office portion cannot be excluded.

Additional Issues That May Apply – As with everything tax, there are always special rules.

  • Multiple Businesses – If there are multiple businesses, only one method may be used for the year – either the regular or simplified.
  • Mixed-Use Property – A taxpayer who has a qualified business use of a home and a rental use of the same home cannot use the simplified method for the rental use.
  • Taxpayers Sharing a Home – Taxpayers sharing a home (for example, roommates or spouses, regardless of filing status), if otherwise eligible, may each use the simplified method but not for a qualified business use of the same portion of the home.As an example, a husband and wife, if otherwise eligible and regardless of filing status, may each use the simplified method for a qualified business use of the same home, for up to 300 square feet of different portions of the home.
  • Depreciation Rate When Switching Methods – When the simplified method is used and the taxpayer subsequently switches to the actual expense method, there are no special adjustments, and the depreciation is determined in the normal manner.

Final Notes – Even if you qualify for a home-office deduction, your deduction is limited to the business activity’s gross income. For this purpose, it is defined as the activity’s gross income, reduced by the home expenses that would be deductible if there were no business use (e.g., mortgage interest, property taxes, certain casualty losses), and the business expenses unrelated to the home’s use. When using the actual expense method, the disallowed amount will be carried over to the next year subject to the same limitations. However, there is no carryover when using the simplified method.

Business use of the home is deducted on a self-employed individual’s business schedule.

If you have questions or concerns about how the home-office deduction applies to your specific circumstances, please contact us.

Looking Ahead to 2019 Taxes

Article Highlights:

  • Solar Credit
  • Plug-In Electric Vehicle Credit
  • Penalty for Not Having Health Insurance
  • Medical Deduction Restrictions
  • New Alimony Rules
  • Standard Deduction Increase
  • Increased Retirement Contributions
  • Federal Tax Brackets Increase

You have your 2018 tax return filed, or perhaps on extension, and now it is time to look forward to the changes that will impact your 2019 return when you file it in 2020.

Keeping up with the constantly changing tax laws can help you get the most benefit out of the laws and minimize your taxes. Many tax parameters, such as the standard deduction, contributions to retirement plans, and tax rates, are annually inflation adjusted, while some tax changes are delayed and take effect in future years. On top of all that, Congress is considering the retroactive extension of some tax provisions that expired after 2017, as well as, proposing new tax legislation.

The inflation adjustments shown are not the only items adjusted for inflation. For a full list, see IRS Revenue Procedure 2018-57.

At any rate, here are some changes that might affect your 2019 return:

  1. Solar Credit– Although the solar credit remains at 30% for 2019, as a reminder, the credit rate will drop to 26% in 2020. This means that for each $1,000 spent on qualified solar property, the credit will be $40 less in 2020 than if the expense were paid and the credit was claimed in 2019. However, this is a non-refundable credit, meaning it can only offset your tax liability, but the unused credit can carry over to a future tax year if the credit is allowed; it is currently scheduled to end after 2021. So, be cautious of overzealous salespeople trying to talk you into an expenditure for which you may not get the full credit.
  2. Plug-In Electric Vehicle Credit– Although the credit amounts have not changed, the credit begins to phase-out for each manufacturer after it produces its 200,000th qualifying vehicle. For example, the very popular Tesla vehicle did qualify for the full credit in 2018. However, Tesla has entered the phase-out stage, and for 2019, the credit is only $3,750 for purchases in the first six months of the year, then drops to $1,875 for vehicles bought through the rest of 2019 and is zero for post-2019 purchases. If you are contemplating buying a plug-in electric vehicle, check the IRS website for the current credit by manufacturer.
  3. Penalty for Not Being Insured– The Affordable Care Act required individuals to have health insurance and imposed a “shared responsibility payment” – really a penalty – for those who didn’t comply. The penalty could have been as much as $2,085 for most families. That penalty will no longer apply in 2019 or the foreseeable future.
  4. Medical Deductions Further Restricted– Unreimbursed medical expenses are allowed as an itemized deduction to the extent they exceed a percentage of a taxpayer’s adjusted gross income (AGI). As part of the Affordable Care Act, Congress increased that percentage from 7.5% to 10%. That increase was temporarily rescinded in the most recent tax form. However, starting with the 2019 returns and for the foreseeable years, the AGI medical floor will be 10% of AGI. This is where the “bunching” strategy may benefit your ability to deduct medical expenses. This means paying as much of your medical expenses as possible in a single year so that the total will exceed the AGI floor and your overall itemized deductions will exceed the standard deduction. Example: Your child is having orthodontic work done, which will cost a total of $12,000, and the dentist offers a payment plan. If you pay in installments, you will spread the payments out over several years and may not exceed the medical AGI floor in any given year. However, by paying all at once, you will exceed the floor and get a medical deduction. 
  5. New Alimony Rules– For divorces and separation agreements entered after 2018, the alimony paid is not deductible, and the alimony received is not taxable. In addition, the alimony recipient can no longer make an IRA contribution based on the alimony received.It is important to understand that this treatment of alimony only applies to alimony payments paid under agreements entered into after 2018 or under prior agreements modified after 2018 that include this new provision. For agreements entered before 2019 that haven’t been modified, the old rules continue to apply: the alimony paid is deductible, and the alimony received is included in income. Also, an IRA deduction can be made based upon the taxable alimony received.
  6. Standard Deduction– The standard deduction, which is inflation adjusted annually, is used by taxpayers who do not have enough deductions to itemize. For 2019, the standard deductions have increased as follows:

    •  Single: $12,200 (up from $12,000 in 2018)
    • Married filing jointly: $24,400 (up from $24,000 in 2018)
    • Married filing separately: $12,200 (up from $12,000 in 2018)
    • Head of household: $18,350 (up from $18,000 in 2018)

    Individuals who are blind and/or age 65 or over are allowed standard deduction add-ons. These add-ons are for the taxpayer and spouse but not for dependents. The add-on amounts are $1,300 for those filing jointly (unchanged from 2018) and $1,650 for all others (up from $1,600 in 2018).

  7. Increased Retirement Contributions– All IRA and retirement contributions are subject to inflation adjustment, meaning the allowable amounts may be increased each year. This gives you the opportunity to increase your retirement savings in 2019.

    • Simplified Employee Pension (SEP) Plans – The maximum amount for 2019 is $56,000 (up from $55,000 in 2018).
    • Individual Retirement Accounts (IRAs) – For both traditional and Roth IRAs, the maximum contribution has been increased to $6,000 (up from $5,500 in 2018). This is the first change to IRAs since 2013. The additional amount taxpayers age 50 and over can contribute remains unchanged at $1,000.
     401(k) Plans – The maximum employee contribution has been increased to $19,000 (up from $18,500 last year). The additional amount for taxpayers who’ve reached age 50 remains unchanged at $6,000.
    • Simple Plans – The maximum elective contribution is $13,000 (up from $12,500 in 2018). The additional amount for taxpayers age 50 and older remains unchanged at $3,000.
    • Health Savings Accounts (HSAs) – Although meant to be a way for individuals covered by a high-deductible health plan to save money for future medical expenses, these plans can also be used as a supplemental retirement plan. Contributions are deductible, earnings accumulate tax-free, and if distributions are used for qualified medical expenses, they are tax-free. However, when used as a supplemental retirement plan, the distributions would be taxable. The following are the contribution limits for 2019:

    • Self-only coverage: $3,500 (up from $3,450 last year)
    • Family Coverage: $7,000 (up from $6,900)

  1. Federal Tax Brackets– The tax brackets were inflation adjusted (by approximately 2% over the 2018 brackets), meaning more of your income is taxed at a lower bracket in 2019 than it was in 2018. As an example, here are the brackets for 2019 for taxpayers using the single filing status:

    10%: $9,700 or less
     12%: More than $9,700 but not more than $39,475
    • 22%: More than $39,475 but not more than $84,200
     24%: More than $84,200 but not more than $160,725
    • 32%: More than $160,725 but not more than $204,100
    • 35%: More than $204,100 but not more than $510,300
     37%: Applies to taxable incomes of more than $510,300

    These are the brackets for married taxpayers filing jointly:

    • 10%: $19,400 or less
     12%: More than $19,400 but not more than $78,950
    • 22%: More than $78,950 but not more than $168,400
    • 24%: More than $168,400 but not more than $321,450
    • 32%: More than $321,450 but not more than $408,200
     35%: More than $408,200 but not more than $612,350
    • 37%: Applies to taxable incomes of more than $612,350

    For other filing statuses, see Revenue Procedure 2018-57.

    Note: These are step functions, so for example, the first $9,700 of taxable income is taxed at 10%, the next $29,775 ($39,475 − $9,700) is taxed at 12%, and so forth.

For further information or to request a 2019 tax planning appointment, please contact us.

How Does Combining a Vacation with a Foreign Business Trip Affect the Tax Deduction for Travel Expenses of a Self-Employed Individual?

Article Highlights:

  • Primarily Business
  • Primarily Vacation
  • Special Circumstances
  • Foreign Conventions, Seminars and Meetings
  • Cruise Ships
  • Spousal Travel Expenses

Effective for years 2018 through 2025, the Tax Cuts and Jobs Act of 2017 suspended the deduction of miscellaneous itemized expenses that must be reduced by 2% of the taxpayer’s adjusted gross income. Employee business expenses, including travel expenses, fall into this category. Therefore, this discussion only applies to self-employed individuals for years 2018-2025.

When a self-employed individual makes a business trip outside of the U.S. and the trip is 100% devoted to business, all the ordinary and necessary business travel expenses are deductible, just as if the business trip were within the U.S. On the other hand, if the trip also incorporates a vacation, special rules determine the deductibility of the travel expenses to and from the destination; when the other business travel expenses, such as lodging, meals, local travel and incidentals, can be deducted; and when they must be allocated. So, whether you are just visiting one of our neighboring countries or traveling to Europe or even more exotic locales, here are some travel tax pointers:

Primarily Vacation – If the travel is primarily for vacation and only a few hours are spent attending professional seminars or meeting with foreign business colleagues, none of the expenses incurred in traveling to and from the general business location are deductible. Other travel expenses must be allocated on a day-by-day basis, and only the business portion is deductible.

Primarily Business – If the trip is primarily for business and meets one of the conditions listed below, the expenses incurred in traveling to and from the business destination are deductible in full (same as for travel within the U.S.).

(1) The travel outside the U.S. is for a period of one week or less (seven consecutive days, excluding the departure day but including the day of return). In addition, all other ordinary and necessary travel expenses are fully deductible.

(2) Less than 25% of the total time outside the U.S. is spent on non-business activities. In addition, all other ordinary and necessary travel expenses are fully deductible. (If 25% of more of the total time is spent on non-business activities, a day-by-day allocation of all travel expenses between personal and business activities is necessary and only the business portion is deductible.)

(3) The individual incurring the travel expenses can establish that a personal vacation or holiday was not a major consideration. In addition, all other ordinary and necessary travel expenses are fully deductible.

(4) The taxpayer did not have “substantial control” over arranging the trip. (For self-employed taxpayers, who would generally have substantial control over the trip arrangements, this provision likely won’t apply.) In addition, all other ordinary and necessary travel expenses are fully deductible.

When determining what constitutes business and non-business time, business days include: days en route to or from the business destination by a reasonably direct route without interruption; days when actual business is transacted; weekends or standby days that fall between business days; and days when business was to have been transacted but was canceled due to unforeseen circumstances.

Non-business days are days spent on non-business activities as well as weekends, holidays and other standby days that fall at the end of the business activity, if the taxpayer remains at the business destination for personal reasons.

Foreign Conventions, Seminars or Meetings – Tax law does not permit a deduction for travel expenses to attend a convention, seminar or similar meeting held outside of the North American area unless the taxpayer establishes that:

(1) The meeting is directly related to the active conduct of the taxpayer’s trade or business, and
(2) It is “as reasonable” for the meeting to be held outside of the North American area as it is within the North American area.

The IRS defines “North American area” quite broadly and includes not just the U.S., Canada and Mexico, as you would expect, but also Bermuda, several countries in the Caribbean basin, U.S. possessions such as American Samoa and other Pacific island nations, and some Central American countries as well.

Cruise Ship Conventions – In order for a taxpayer to deduct the cost of attending a convention related to his or her trade or business on a cruise ship, the ship must be a U.S. flagship, and all the ports of call must be within the U.S. or its possessions. In addition, the maximum deduction is limited to $2,000 per attendee. Substantiation requirements include certain signed statements by both the taxpayer and an officer of the convention sponsor.

Spousal* Travel Expenses – Generally, deductions are denied for travel expenses for a spouse, dependent or employee of the taxpayer on a business trip unless:

  1. The spouse is an employee of the taxpayer, and
  2. The travel of the spouse, etc., is for a bona fide business purpose; and
  3. The expenses would otherwise be a deductible business travel expense for the spouse.*These rules also apply to a dependent or employee of the taxpayer.

Since a spouse, dependent or other individual who is an employee will be denied a deduction for business travel expenses in years 2018 through 2025, condition #3 can’t be met. This means that “spousal” travel expenses won’t be deductible for years 2018 through 2025.

However, the law allows a deduction for the single rate for lodging on qualified business trips, and frequently, there is no rate difference between one and two occupants. Thus, virtually the entire lodging expense for an accompanying spouse will be deductible. When traveling by car, the law does not require any allocation because the spouse is also traveling in the vehicle. Thus, if traveling by vehicle, the entire cost of the business-related transportation would be deductible. Generally, this would also apply to taxis at the destination.

As you can see, determining the tax deduction for a foreign business trip of a self-employed individual that is combined with a vacation can be complicated. If you need additional tax guidance or assistance planning such a trip, please contact us.

States’ SALT Deduction Workarounds Shot Down

Article Highlights:

  • Limit on Tax Allowed as an Itemized Deduction
  • States’ Attempted Workarounds
  • Supreme Court Ruling
  • Final Regulations
  • Notice 2019-12

The Treasury Department and the IRS have essentially shot down efforts by several states to help their residents circumvent the $10,000 cap on the itemized deduction for state and local taxes (SALT).

When the Tax Cuts and Jobs Act (TCJA), aka tax reform, was passed, it imposed a $10,000 limit on the SALT deduction; this limitation had a greater impact on the residents of states that imposed the highest taxes on their residents. As it turns out, the states with the highest taxes – income or property taxes, or a combination of the two – are all blue (Democratic) states; thus, many saw it as political retribution, causing some state leaders to seek a workaround.

Ultimately, several affected states, including New Jersey, New York, and Connecticut, developed similar schemes to skirt the $10,000 limitation. Here’s how their workarounds were supposed to have worked.

  1. Federal tax law names state and local governments as qualified charities, thus allowing gifts to them to be deducted as a charitable itemized deduction.
  2. The states created charitable funds; in turn, a contributor to the fund would receive tax credits.
  3. The tax credits could then be used against contributors’ SALT liabilities on their state income tax returns or, in some cases, property tax bills. Effectively, taxpayers would get a charitable deduction for their tax payments.

However, the challenge for these arrangements has turned out to be a 1986 Supreme Court ruling that says that if the taxpayer receives something in return (referred to as “quid pro quo” in legalese) for a contribution, the deductible portion of the contribution is reduced by the fair market value (FMV) of what is received in return for making the contribution.

This concept has been applied uniformly to all charitable contributions since the Supreme Court ruling, which is why many written substantiations from charities will include the FMV of items provided to the donor in return for the donor’s charitable contribution.

As a result, when the final tax regulations for the SALT limitation were issued, they followed the Supreme Court ruling and treated the tax credits provided in return for the contribution as “quid pro quo” and not allowable to deduct as a charitable contribution.

Since the states only allowed tax credits for a portion of the contribution, typically 85% to 90%, the portion not allowed as a tax credit on the state return can be deducted as a charitable contribution on the taxpayer’s federal return.

Fortunately for taxpayers, in the preamble to the final regulations, the Treasury indicated its concern that the regulations could create unfair consequences for individuals who had made a charitable contribution in return for tax credits. Consequently, simultaneously with releasing the final regulations, the IRS published Notice 2019-12 saying it intends to publish a proposed regulation to provide a safe harbor for certain individuals who make a charitable contribution in return for tax credits. Under the safe harbor, an individual may treat the portion of a state or local tax payment that is or will be disallowed as “quid pro quo” contributions. To qualify for the safe harbor, taxpayers must itemize deductions for federal tax purposes, and their total state and local tax liability for the year must be less than $10,000. Until the proposed regulations are issued, taxpayers may rely on Notice 2019-12. The following examples are based on those in Notice 2019-12.

Example #1 – The taxpayer makes a $500 payment to a local or state-run charity and receives a dollar-for-dollar credit against the taxpayer’s state income tax credit. The taxpayer’s state tax liability is $500 or more. For federal purposes, this $500 contribution can be treated as a tax payment, subject to the $10,000 SALT limitation. Without the safe harbor provision, the taxpayer would not be allowed any deduction for the $500 payment because the regulations require that the amount claimed as a charitable contribution must be reduced by the state credit amount, in this example $500 – $500 = $0.

Example #2 – The taxpayer makes a $7,000 payment to a local or state-run charity and receives a dollar-for-dollar credit against the taxpayer’s state income tax. Under state law, the credit may be carried forward for three taxable years. The taxpayer’s state tax liability for year 1 is $5,000. The taxpayer applies $5,000 of the credit against the year 1 state tax liability and carries the balance forward to year 2, when it is used against the taxpayer’s year-2 state tax liability. The taxpayer’s year-2 state tax liability exceeds $2,000. For federal purposes, the contribution is treated as a tax payment, with the $5,000 being treated as a year-1 tax deduction and the $2,000 treated as a year-2 tax deduction. Both the $5,000 and $2,000 are subject to the $10,000 SALT limitation.

Example #3 – The taxpayer makes a $7,000 payment to a local or state-run charity. In return for the contribution, the taxpayer receives a real property tax credit of $1,750, which is 25% of the contribution, and applies it to his $3,500 property tax bill. For federal purposes, the $1,750 is treated as a property tax payment, subject to the $10,000 SALT limitation. The balance of the contribution, $5,250, can be deducted as a charitable contribution.

If you have questions related to this issue or about the $10,000 limit on SALT deductions, please contact us.

How to Organize Spending Priorities for Your Newer Growth Startup

According to a recent study conducted by U.S. Bank, over 80% of all newly formed businesses that ultimately fail do so due to cash flow problems. If you needed a reason to believe that getting your spending in order and dedicating the time to drafting a proper budget for your new startup is important, look no further than that statistic.

If you take the time to properly budget now, you’re mitigating a significant portion of the risk you’re likely to face in the not-too-distant future. If you don’t, or worse—if you assume that you can just “make it up on the fly”—all you’re doing is setting yourself up for disaster. Therefore, if you truly want to make sure that you have the budget you need to continue to build the business you’ve always wanted, there are a few key things to keep in mind.

It Begins by Looking Inward, Not Outward

Maybe the most critically important thing for you to understand is that there is no “one size fits all” approach to creating a budget for your startup. Just as it’s fair to say that nobody does what you do quite like how you do it, that same unique quality must extend into the world of budgeting for your startup business.

Every business is different ‒ so while you can certainly look to some similar organizations for guidance and inspiration, be aware that their path is not one for you to rigidly follow. You need to start the process by looking at your long-term business goals ‒ where are you today, and where do you want to be in a year or five years from now? What are the steps you need to take to help you accomplish that? What are the mile markers you’ll need to hit along the way? Once you have the specific answers to these questions, then you can begin the process of figuring out what budget is most appropriate for your small business.

Once you contextualize everything through that lens, many of your priorities will easily reveal themselves. At that point, your job becomes making sure you’re spending money in a way that supports those goals first, and everything else second.

As you develop your budget, you can even use it as an opportunity to learn more about the business and the way it operates. Once you can better identify how much money you have on hand and where it’s going, you start to better understand things like:

  • The money you’re spending on labor and other materials necessary for your products and services;
  • Your overall costs of operations;
  • The level of revenue you’ll need to generate to support your business moving forward; and
  • A realistic idea of how much money you can expect to make in terms of profit, and when.

So, as you develop a budget that is more specific to your growth startup, you also begin to better understand how that startup works. At that point, you’re not just able to make accurate, informed decisions about things like hiring or materials spending ‒ you can also go back and reconfigure your budget to account for any trends or patterns that you’ve discovered. This cyclical process is also a great way to make sure that you always have the cash necessary to take advantage of opportunities as quickly as possible, even ones that you didn’t necessarily expect.

The “Day One” Budget

For the sake of an example, let’s say that you’re planning a budget for a business that hasn’t technically gotten off the ground yet. At that point, your priorities are a bit different as you’re essentially trying to make “Day One” possible. Again, every business is going to be different from the next. But having said that, there are a few key things you will want to focus on to make sure that your opening goes as smoothly as possible:

  • Facilities costs – Where, specifically, are you going to do business? Do you need to rent a storefront? Are you working out of a commercial office space? Will you need a warehouse or other logistical assets? Regardless of which one best describes your situation, you’ll need to think about things like security deposits, any cosmetic or structural changes you need to make to the building, and even things like signage.
  • Fixed assets – Also commonly referred to as “capital expenditures,” these are things that your staff will need to do the jobs you’ve asked of them. This includes thinking about purchases like work vehicles (if applicable). You’ll also have to buy furniture and other equipment like computers and other technologies.
  • Materials and supplies – Costs in this category would refer not only immediate needs like office supplies, but also those related to marketing and other promotional activities in which you might be engaged. You’re going to need a steady stream of all these items to hit the ground running.
  • Miscellaneous – These are all the other costs of physically opening a business that don’t fall into the other three categories. You’ll need to work with an attorney and your Tarlow advisor to make sure the backend of your business is in order. Depending on your industry, you may need things like licenses and permits, which can be costly.

Remember: these aren’t necessarily the costs associated with running your business in the long-term. These are just the things you’ll need to take care of to make sure you’re prepared to open your doors in the first place.

Get Your Priorities in Order

From a longer-term point of view, you will need to organize your spending for your newer, growth-focused startup and get your priorities in order. Expenses like those outlined here will remain important. However, those are related to meeting short-term needs. To meet your long-term needs, you will need to be judicious about where you spend your money and, more importantly, why.

For the best results, try to prioritize expenditures that generate revenue or some type of sizable return on investment in the future. If your startup depends on a particular piece of equipment in order to successfully produce a key product, it stands to reason that: A) buying that equipment and B) paying to maintain it and keep it in proper working order would be top priorities as you literally cannot function without it. The more products you can produce, the more you can sell—and thus the more revenue you can generate.

Carefully review all of your expenses and arrange them in order of importance. For the most part, the things that are necessary to avoid interrupting your business in any way should be at the top of your list.

As you re-order certain budget items, be thoughtful of both the short- and long-term implications of that move. If you prioritize Factor A over Factor B, what chain of events could that cause? If you choose not to focus on computer maintenance and instead move funds elsewhere, what issues would that potentially cause? Are you in a business where slower or more outdated equipment would hurt productivity and your ability to serve your customers? Because if you are, that’s a move you might want to re-think.

Creating the right budget and organizing your spending priorities for your newer startup can feel complicated and time-consuming. This is an example of a situation where “getting it done” is less important than “getting it right”.

If you have any questions about financing your small business, or need assistance with organizing your spending priorities, please contact us. We can help you create a budget that supports your startup as it exists today, and help you prepare for the business it will become tomorrow.

School’s Out – Who Is Going to Take Care of the Kids?

Article Highlights:

  • Child Age Limits
  • Employment-Related Expense
  • Married Taxpayer Earnings Limits
  • Disabled or Full-Time-Student Spouse
  • Expense Limits

Summer has just arrived, and working parents should know about a tax break. Many working parents must arrange for care of their children under 13 years of age (or any age if disabled) during the school vacation period. A popular solution — with a tax benefit — is a day camp program. The cost of day camp can count as an expense toward the child and dependent care credit. However, expenses for overnight camps, summer school, or tutoring programs do not qualify.

For an expense to qualify for the credit, it must be an “employment-related” expense; i.e., it must enable you and your spouse, if married, to work, and it must be for the care of your child, stepchild, foster child, brother, sister or stepsibling (or a descendant of any of these) who is under 13, lives in your home for more than half the year and does not provide more than half of his or her own support for the year. Married couples must file jointly, and both spouses must work (or one spouse must be a full-time student or disabled) to claim the credit.

The qualifying expenses are limited to the income you or your spouse, if married, earn from work, using the figure for whoever earns less. However, under certain conditions, when one spouse has no actual earned income and that spouse is a full-time student or disabled, that spouse is considered to have a monthly income of $250 (if the couple has one qualifying child) or $500 (two or more qualifying children). This means the income limitation is essentially removed for a spouse who is a student or disabled.

The qualifying expenses can’t exceed $3,000 per year if you have one qualifying child, while the limit is $6,000 per year for two or more qualifying persons. This limit does not need to be divided equally. For example, if you paid and incurred $2,500 of qualified expenses for the care of one child and $3,500 for the care of another child, you can use the total, $6,000, to figure the credit. The credit is computed as a percentage of your qualifying expenses; in most cases, 20%. (If your joint adjusted gross income [AGI] is $43,000 or less, the percentage will be higher, but it will not exceed 35%.)

Example: Al and Janice both work, each with earned income in excess of $40,000 per year. Janice has a part-time job, and her work hours coincide with the school hours of their 11-year-old daughter, Susan. However, during the summer vacation period, they place Susan in a day camp program that costs $4,000. Since the expense limitation for one child is $3,000, their child credit would be $600 (20% of $3,000).

The credit reduces a taxpayer’s tax bill dollar for dollar. Thus, in the above example, Al and Janice pay $600 less in taxes by virtue of the credit. However, the credit can only offset income tax and alternative minimum tax liability, and any excess is not refundable. The credit cannot be used to reduce self-employment tax, or the taxes imposed by the Affordable Care Act.

If the qualifying child turned 13 during the year, the care expenses paid for the child for the part of the year he or she was under age 13 will qualify.

If you have questions about how the childcare credit applies to your specific tax situation, please contact us.