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Accounting and Tax Planning

Accounting and Tax Planning Special Coverage

Doing the Math

 

Joe Bova compared the past 18 months in the accounting profession

Joe Bova compared the past 18 months in the accounting profession to “trying to sail a ship while you’re building that ship.”

For accountants, the past 18 months have been a time of change, challenge, and adapting to everything from new ways of doing business to new responsibilities with clients to ever-changing tax laws. Looking forward, they note that many of these changes are permanent in nature.

It’s been called the ‘never-ending tax season.’

That’s just one of the many colorful ways those in the accounting sector have chosen to describe the past 18 months or so, a time of change, challenge, learning, and adapting — for them and for their clients.

Indeed, this time of COVID-19 has been marked by everything from changing tax laws to fluid filing deadlines; from new responsibilities, such as helping clients handle PPP and SBA loan paperwork, to changes when it comes to where and how work gets done; from a greater reliance on technology to the acceleration of a shift in accounting toward a more advisory role as opposed to merely adding up numbers.

Summing it all up, Joseph Bova, CPA, CVA, CGMA, a partner with Northampton-based Bova Harrington & Associates, said navigating all this has been “like trying to sail a ship while you’re building the ship.”

Nick Lapier, CPA, a partner with West Springfield-based LaPier Dillon, used phraseology from sports (sort of), but more from politics.

“It’s very hard for us to focus on our work when the government kept moving the goalposts.”

“It’s very hard for us to focus on our work when the government kept moving the goalposts,” he said, referring to the many changes in tax laws — some coming in the middle of tax season — and moving of filing deadlines. “For some people who filed their tax returns early, we then found ourselves amending those returns because they changed some of the rules. And some we didn’t file because we hoped they would change the rules.

“The end zone kept moving,” he went on. “We’d be on the 10-yard line, work really hard, and still be on the 10-yard line. There are 50 sovereign states that have the right to tax, so if you have clients filing tax returns in multiple states, each state was also possibly changing their laws and moving the goalposts.”

As the calendar turns to August, those we spoke with said this has been a time for many at area firms to catch their breath and take some of the vacation days they didn’t take last year or earlier this year. It’s also a time to reflect on what has transpired and what likely lies ahead in terms of the lessons learned and which of the changes seen over the past year and half are more permanent than temporary in nature.

Nick Lapier

Nick Lapier says a taxing period for all accountants was exacerbated by the federal and state governments constantly “moving the goalposts.”

Julie Quink, CPA, CFE, managing partner of West Springfield-based Burkhart Pizzanelli, P.C., said her firm, like most others, is not simply turning back the clock to late 2019 when it comes to returning to something approaching normal, especially when it comes to how and where business is conducted. She said most employees have returned to the office, but moving forward, there will be even more flexibility when it comes to schedules and working remotely because of what’s been learned over the past 18 months.

“We’re not going to dial back to everyone needing to be here those static hours of 8:30 to 5,” she noted. “I’m a glass-half-full person, and if there is a positive from the past 16 or 17 months that we’ve been dealing with, it’s taught us that we need to be more flexible, more mobile, and more adaptable — and understand that people don’t have to be actually sitting in their offices to get their job done.”

Meanwhile, Lapier told BusinessWest that many accountants, himself included, spent far less time meeting face-to-face with clients in 2020 and early 2021, and he expects that trend to continue.

“This current generation lives in the digital world; they don’t need to see people — they transact their personal and their business life electronically,” he explained. “What has changed because of COVID is that all the prior generations have adopted that same mentality — not 100%, but a heck of a lot more than before the pandemic.”

Howard Cheney, CPA, MST, a partner at Holyoke-based Meyers Brothers Kalicka, P.C. and director of the firm’s Audit and Accounting Services, agreed, while noting, as others did, that the pandemic in many ways accelerated a trend within the industry toward accountants shifting to roles that are more advisory in nature, with a greater focus on the future than the numbers from the past quarter or two.

“I’m a glass-half-full person, and if there is a positive from the past 16 or 17 months that we’ve been dealing with, it’s taught us that we need to be more flexible, more mobile, and more adaptable — and understand that people don’t have to be actually sitting in their offices to get their job done.”

“Accounting has for many years been an historical-look-back kind of thing,” said Cheney, part of an executive committee now managing the firm. “With the speed that people can now get data, they don’t need us to tell them about what happened six months ago; they need us to tell them what’s going to happen six months from now and help them interpret that.”

For this issue and its focus on accounting and tax planning, BusinessWest talked with several CPAs about the never-ending tax season, which still hasn’t ended — many are still dealing with a large number of extensions, many of them resulting from changing tax laws — and what will come next in a sector that has been taxed (yes, that’s an industry term) by this pandemic, and in all kinds of ways.

 

A Taxing Time

Chris Nadeau, CMA, CPA, CVA said he spent most of the past April — the height of tax season — in Florida. And hardly any of his clients knew he was working and handling their needs from more than 1,000 miles away.

Julie Quink

Among the many lessons learned from COVID, Julie Quink says, is the need for more flexibility in when and where people work.

“No one would have known unless I told them,” said Nadeau, a director with Hartford-based Whittlesey, which has offices locally in Holyoke, adding that he would never have considered such a working arrangement prior to the pandemic, but COVID provided ample proof that a CPA doesn’t have to share an area with a client to get the work done.

This anecdote speaks volumes about just how profoundly the landscape has changed in the accounting and tax-planning world over the past year and a half. There have been a number of seismic shifts, and where people work is just one of them, said Nadeau, who has come to his office on Bobala Road in Holyoke only a few times since St. Patrick’s Day of 2020 and was in on this day only to meet with BusinessWest.

Others we spoke with told of similar learning experiences during what has been a year and a half of acting and reacting to everything that has been thrown at them since those days in mid-March of last year when everyone — well, almost everyone — packed up and went home for what they thought would be a few weeks.

As everyone knows, that certainly wasn’t the case, and thus accountants, like all those in business, had to adjust to a new playing field, finding new and sometimes better ways to do things and communicate with clients and fellow team members alike.

“We had to reinvent our processes — how we communicated with the team and how we shared information back and forth, especially when working remotely,” said Lapier of those early days, noting that a three-month extension of the traditional April 15 filing deadline helped spread the work out and was a saving grace.

Bova agreed, noting that his firm of nine employees adjusted to the new landscape out of necessity, with investments in technology, a move to a paperless work process, Zoom meetings between employees and with clients, visits by appointment only, and other steps.

Moving forward, many of these new ways of doing things will continue, with perhaps the biggest being where people work. Indeed, most of the firms we spoke with said some variation of hybrid schedules will become the norm for at least some employees .

“In the future, there will be more hybrid work models, where people work in the office, but they do some work at home — I can see some real potential for that,” said Bova, adding that not all workers have returned to the office, and he’s not sure when they will. “We’re going to explore our options with this; there’s no need to deal with it in the summer — it will be more of a fall issue.”

Howard Cheney says the pandemic

Howard Cheney says the pandemic may have accelerated, or amplified, a shift within accounting to an advisory role, with more emphasis on the future than the past.

Cheney agreed. “We’ve been really flexible as a business with not requiring people to come back just yet,” he said, adding that most at the company have returned to their offices in the PeoplesBank building, but some are still working remotely. “The likelihood is that some kind of hybrid work schedule will be the future for our business.”

Whittlesey recently adopted a hybrid work policy, one that enables people to work “from wherever they will be most efficient,” said Nadeau, adding that most are finding it more efficient to work remotely, and they will continue to do so in the future.

“Some people are not coming in at all, and some are coming in a day or two a week,” he explained. “It’s ‘work where you need to for that day.’ Some employees have actually moved away to another state during COVID, so you could definitely call them ‘remote.’ And it’s been pretty seamless — and flawless.”

And this shift brings a number of benefits for the company, including a possible reduction of its physical footprint, he said, adding that it is likely that the firm will be able to downsize in Holyoke. “At some point down the road, we’ll see what kind of space we’ll need.”

It also means more and better opportunities to recruit top talent to the company because such employees will be able to work from anywhere, including another state, as Nadeau did earlier this year.

“It’s incredibly challenging to recruit people — I think there are fewer accounting students graduating now, and a lot of the people who do graduate end up going to Boston or New York to work for the Big Four firms,” he explained. “So having a remote-work or hybrid-work policy is an added benefit that we can offer, and one that firms are probably going to have to offer if they want to attract top talent.”

As for interaction and communication with clients, while all those we spoke with said face-to-face is still the preferred option, COVID has shown that Zoom and even the telephone work well — and, as with working arrangements, when it comes to interacting with clients, flexibility is the new watchword.

“As we’re talking with our clients, we’re seeing a combination of the two, in-person meetings and those by Zoom and phone — some want meetings in person, and other times, a Zoom meeting or phone call is sufficient,” said Nadeau, noting, as others did, a significant time savings from not physically traveling to see clients, so those at the firm are able to do more with the hours in the day.

Cheney agreed, to some extent, but noted there will always be plenty of room for, and need for, in-person service to clients.

“You don’t want to lose sight of that personal-touch aspect,” he told BusinessWest. “You don’t want to do everything remotely — I don’t think clients want to do everything remotely. But they’re OK with some level [of remote interaction] because we’ve gotten used to it, and they see the efficiency, too.”

 

Crunching the Numbers

As he tried to put all the changes to tax laws — and changes to the changes — into perspective, Joe Bova recalled the communication he received from the U.S. Small Business Administration concerning PPP loans that came with the header “Interim Final Rules.”

This oxymoron was just one of many challenging measures and changes that CPAs had to make sense of over the past 18 months, a time that Bova described as “a shooting gallery.”

“What’s been different during these past two seasons is that tax-law changes have been happening during tax season,” he told BusinessWest. “And when the PPP loans first came out … the SBA and the Treasury were updating their websites almost daily, and there was a lot of ambiguity in the definitions. We [accountants] were kind of on the front lines because people were calling us, even the banks.

“We all had the same information, which wasn’t clear, so people were calling us to help them interpret these changes,” he went on. “You were in the water on the boat, but you were still building the boat.”

In addition to coping with new legislation and changing rules, there was simply more work to do, said those we spoke with.

“Our workload has gone up probably a good 20% without adding a single client,” said Lapier, listing PPP applications, forgiveness, and audit work, as well as helping companies with SBA loans and the unemployment-tax credit as just some of the additional assignments.

Indeed, on top of all that, there was simply more consulting work to do as companies, especially smaller ones, leaned on their accountants as perhaps never before to help them make what were often very difficult decisions during truly unprecedented times.

Now, with the pandemic easing in some respects, the nature of some of this advisory work is changing, said Quink, noting that many business owners are now able to focus more on the future instead of being consumed by the present.

“We’re seeing a lot of clients that are buying and selling businesses, which is a good sign,” she noted. “And overall, people are starting to think forward now; they were in survival mode for a period of time, and now they’re starting to think forward from a business perspective.”

And there is a lot to think about, she went on, noting that what she and others at her firm are advising clients on is how to adapt to change and navigate challenge — such as a global pandemic.

“We’re talking to our clients that we see as potentially at risk because they don’t have the ability to adapt or they’re not identifying how to adapt,” she explained. “We know that things can change in the blink of an eye; we’ve seen a client, a third-generation business, close because it wasn’t able to look forward and move in a way that still made them competitive. You can’t rest on what you have — you have to be always looking forward, and that’s a hard thing for some of our more mature clients and businesses who have done things they’ve always done, and it’s worked.”

This additional advisory work, as Cheney noted earlier, is merely an acceleration of a trend that has been ongoing for many years now when it comes to clients and what they want and need from their accounting firm, with the accent on the future and how to be prepared for it.

Quink agreed that this shift, if that’s the proper term, has been ongoing for some time now as technology has enabled clients of all kinds to access data more quickly and more easily than ever before.

“We see robots in all aspects of life, and our profession is going to go that way as well,” she explained. “We’re using technology to do the things we’ve always done by hand; we’re now going to have programs that run that data for us. What we’re seeing and what we’re preparing people in our profession for is a shift to more of an advisory-slash-consulting role.”

 

Bottom Line

For several years now, Quink told BusinessWest, Burkhart Pizzanelli has closed its doors on Fridays. Historically, those Fridays between Memorial Day and Labor Day have served as comp time for those who logged considerable overtime during tax time, and it’s been a time to recharge the batteries.

This year, staff members have needed those Fridays off more than ever, she said, adding that, for many reasons — from all the additional work detailed above to the vacations that haven’t been taken over the past 18 months — there have been many signs of fatigue.

It’s certainly understandable. Indeed, while every business sector has been impacted by COVID, those in accounting were affected in different ways, with more work to do, different work to take on, and learning curves when it came to new and different ways of doing business.

They don’t call it the ‘never-ending tax season’ for nothing. It’s far from over, but in many ways, things are … well, less taxing.

 

George O’Brien can be reached at [email protected]

Accounting and Tax Planning

Where There’s Smoke…

By Kristina Drzal Houghton, CPA, MST

 

Kristina Drzal Houghton

Kristina Drzal Houghton

The production and distribution of cannabis, once known to many only as marijuana, is the newest and most variegated industry in America. Some would even say it is one of the toughest industries in America in which to do business. This article will discuss a few unique challenges from a financial perspective faced by the industry.

The first complexity starts with the difference between cannabis and CBD. When you look at a cannabis plant and a hemp plant side by side, the plants themselves look identical to an untrained eye, making it a bit challenging to identify, as the real difference lies in the chemistry of the plants.

CBD can be extracted from hemp or marijuana. Hemp plants are cannabis plants that contain less than 0.3% THC (the compound that creates the ‘high’ sensation), while marijuana plants are cannabis plants that contain higher concentrations of THC. This article will refer to all products containing more than 0.3% THC as cannabis, while products with less will be referred to as CBD.

So, basically, the only difference from a scientific standpoint is the level of one chemical. However, things are much more complex from a legal and tax perspective. Under the 2018 Farm Bill, CBD and hemp are now legal, and not on the schedule I list of controlled narcotics right up there with heroin and LSD. In 2016, Massachusetts passed a law making all cannabis legal, and all but five other states have passed laws making it either fully legalized, decriminalized, or medically authorized. While cannabis is federally illegal, the Internal Revenue Service is perfectly willing to collect taxes on companies that handle the product.

Federal tax law is very punitive on the cannabis industry. Internal Revenue Code Section 280E is a very short part of the tax code (just one sentence) and states:

“No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by federal law or the law of any state in which such trade or business is conducted.”

Under 280E, you’re not allowed any deductions or credits on your return, but you can deduct the cost of goods sold, as that is part of the definition of taxable income. A cannabis farm will only be allowed to allocate various costs, direct and indirect, into cost of goods sold and inventory. Section 280E will affect only cannabis entities. CBD companies, since they are legal, are allowed all normal business deductions and credits available to other non-cannabis companies. This provides many more opportunities to reduce taxable income to a hemp/CBD company.

It is not only the federal tax difference which significantly attributes to the disproportionate cost of cannabis versus CBD. Due to discrepancies between state and federal law, legal cannabis businesses are forced to operate almost entirely in cash, with very little access to financial services, since most banks are federally insured and therefore unable to establish accounts for this federally illegal business. This leaves thousands of dollars stored in backroom safes and transported in shoeboxes and backpacks, creating a prime target for crime. Another banking challenge that cannabis businesses regularly face is exorbitant monthly account fees, or banks that take a percentage of each deposit.

The industry faces many other challenges as well. For example, most states have a mandated ‘seed to sale’ software-tracking system that must be used and accurate (daily), and must be reconciled with POS (point of sale) systems and accounting systems. Additionally, because this is a new industry, many of the tools other industries use are simply not readily available, including a cannabis-tailored chart of accounts, QB POS systems, reliable inventory software, and common merchant service platforms.

There is an opportunity for dispensaries to separate some revenue streams outside of the cannabis division, meaning normal business deductions are allowed for the non-cannabis division. These might include clothing, paraphernalia, coffee, CBD, and other goods. While this is good news for the industry, it only creates even more complexities when allocating selling and administrative expenses.

A recent report from the U.S. Treasury inspector general for Tax Administration recommends increased audits by the IRS of cannabis businesses to identify potential non-filers and returns that are not 280E-compliant. For this as well as the above reasons, cannabis businesses need to find an accounting firm that really knows what it’s doing. The cannabis accountant has to not only understand Section 280E, but also know how to treat a business that deals strictly (and necessarily) in cash. Many cannabis companies have bad books because their bookkeepers do not understand the special accounting and therefore didn’t properly categorize expenses. It can be time-consuming to fix them.

So, while the many layers of regulatory control and reporting may be of utmost importance to those operating in the cannabis industry, overlooking the complexities in the finance area of the business can lead to the proverbial perfect storm — or the business going up in smoke.

 

Kristina Drzal Houghton, CPA, MST is a partner at the Holyoke-based accounting firm Meyers Brothers Kalicka, P.C.

Accounting and Tax Planning Special Coverage

Selling Online?

In the early days of e-commerce, states attempted to get out-of-state companies to collect sales tax on transactions into the state — without success. Enter the Supreme Court, which issued a landmark decision that physical presence is no longer needed, and if a company’s activity has substantial ‘economic nexus’ with a state, it can be required to collect sales tax. That means online businesses of all kinds may have tax exposure they’re not even aware of.

By Kristina Drzal Houghton, CPA, MST

 

The shutdown of stores and malls during COVID-19 fueled the already-prospering world of internet shopping. Many businesses were forced into direct-to-consumer marketing on their own webpages or using e-commerce online marketplace companies such as Wayfair, Amazon, and Etsy, just to name a few.

So, why is this important to you? Well, if you are one of those businesses who started selling direct to consumers on your website or if you turned a previous hobby into a business venture that markets using an online marketplace that does not collect sales tax for you, you might have a significant tax exposure you’re not even aware of.

In the 1980s and 1990s, states attempted to get companies to collect sales tax on transactions into the state. These companies were predominantly located out of state and were making sales via mail or telephone calls. The companies were not collecting sales tax on the transactions.

The states were less than pleased. One state, North Dakota, passed a law requiring any company engaging in ‘regular or systematic’ solicitation in the state to become registered for and collect sales tax. In 1992, the U.S. Supreme Court held that a company needed to have a physical presence (employees, property, or offices) in a state before the state could require the company to collect sales tax. This landmark case was Quill Corp. v. North Dakota.

Quill made sales-tax compliance easy for companies: if a company was physically present in a state, it had to collect sales tax for that state. If the company was not physically present in a state, it did not have to collect sales tax, although it was inevitable that there would be some controversy about when companies were ‘present.’

Seeing revenues were on the decline, states began adjusting their tax laws or regulations. One by one, states devised new requirements to make companies collect sales tax. States enacted various laws or promulgated regulations to creatively find nexus, such as Massachusetts, which taxed sales based on an electronic ‘cookie’ on a computer, and New York, which developed so-called click-through nexus, taxing internet sales that were derived from clicking through advertisements on websites.

South Dakota was one state that enacted an economic nexus law. The South Dakota law says that if a seller makes $100,000 of sales into the state or has 200 or more sales transactions into the state in a calendar year, the seller must collect sales tax. The law did not impose sales taxes retroactively; it law was designed to provoke litigation and for the issue it raised to reach the U.S. Supreme Court as quickly as possible. South Dakota pursued four large companies it knew would meet its threshold. Three of those companies sued: Newegg, Overstock.com, and Wayfair.

The case became known as South Dakota v. Wayfair Inc. After rocketing the case through state courts and losing, South Dakota took its arguments to the U.S. Supreme Court and won. Now, physical presence is no longer needed; if a company’s activity has substantial nexus with a state, the state can require the company to collect sales tax on sales into the state.

“If you are one of those businesses who started selling direct to consumers on your website or if you turned a previous hobby into a business venture that markets using an online marketplace that does not collect sales tax for you, you might have a significant tax exposure you’re not even aware of.”

Almost all states with economic nexus allow an exception for small remote sellers, which is determined by a remote seller’s sales and/or transactions in the state (the economic-nexus threshold).

Any remote seller whose sales into the state meet or exceed a state’s economic-nexus threshold must register with that state’s tax authority, collect and remit sales tax, validate exempt transactions, and file sales-tax returns as required by law. Remote sellers whose sales and/or transactions in a state are under the state’s threshold don’t need to register; however, they do need to monitor their sales into the state, so they know if they develop economic nexus.

Unfortunately, state economic-nexus thresholds vary widely. This seriously complicates nexus determinations.

In a post-Wayfair sales-tax world, how are states enforcing the new economic-nexus rules and identifying companies that fall within them? Given the budget shortfalls due to COVID-19, states are identifying new ways to increase their revenue, and what better way than enforcing the Wayfair economic-nexus rules as they relate to sales-tax obligations?

Accordingly, states have taken a broader perspective on enforcing economic-nexus rules on various sellers (including internet retailers) by creating new registration and collection tools for all registered sellers. Under this new nexus standard, it is important to note that, if states find that the taxpayer purposefully did not comply with state law, then the departments of revenue (DORs) can not only require that the taxpayer pay back sales tax, but also assert that it is liable for penalties as well as interest.

 

Since the Decision

In the nearly three years since the Supreme Court in Wayfair upheld South Dakota’s economic-nexus law, overruling the court’s physical-presence precedents, states have faced challenges enforcing this new nexus standard on remote internet sellers, given that traditional audit approaches leverage information that is geared toward identifying sellers with some physical identity or connection within the state.

For example, if employees work in the state, the entity is required to file payroll taxes, or if the entity owns real property, then DORs can obtain real property and tax records to help validate sales tax compliance or identify potential audit targets. Economic nexus, however, provides fewer avenues for states to prove that an entity should collect sales tax in comparison to traditional physical-presence standards, where data is more readily available.

On the other hand, some states are taking an aggressive approach in seeking out taxpayers for compliance with the new nexus rules. For example, DORs are sending out more nexus questionnaires to various companies to, for all intents and purposes, scare them into compliance. Companies should take great care in responding to these questionnaires because states can use this information to force reporting for sales tax and other areas of taxation. To find targets, state auditors have been known to visit an e-commerce site and place an order to see if the seller charges sales tax. If no tax is charged, a questionnaire is then mailed to the seller.

Auditors can also check on companies that advertise heavily in their state or have achieved some level of public notoriety. States will also continue to look for sellers that may have established facilities in their state to make sales or store inventory. A facility or in-state inventory constitutes old-school physical presence and can be the basis of an audit stretching back to well before economic-nexus standards came into existence.

Some states are now ostensibly working to make sales-tax compliance and collection easier for taxpayers. Some examples include websites that allow users to manually calculate sales tax based on address, or an application programming interface (such as California’s) that can be integrated into retailers’ online order forms to determine the appropriate rate and taxing location in real time.

A majority of states now have such a lookup tool in one form or another. Arkansas has a tool for searching by ZIP code or address. The state of Washington’s lookup tool incorporates a state map, allows searching by geographical coordinates, and calculates the tax for any given taxable amount of sale. Colorado’s site incorporates a clickable map and provides a breakdown of tax-rate components.

Companies should be aware of and monitor their physical and economic presence nexus on a quarterly basis. Also, companies should defend against and challenge state assertions concerning sales-tax nexus rules, as well as petition Congress for clearer and more equitable nexus guidelines, especially during these times of financial upheaval caused by COVID-19. If organizations decide to register to collect sales tax in a state, they should take advantage of any benefits and tools the state is providing.

A company will be in a better position to manage its sales-tax collection responsibilities for a state if it determines whether it has physical or economic nexus before it receives a notice, letter, or nexus questionnaire from the state DOR.

 

Kris Houghton is a partner and executive committee member at Holyoke-based accounting firm Meyers Brothers Kalicka, P.C.; (413) 536-8510.

Accounting and Tax Planning

Death and Taxes

By Jim Moran, CPA

 

On April 28, the Biden administration released its FY 2022 revenue proposals. Along with raising the corporate tax rate to 28% and the top individual rate to 39.6%, widespread changes have been proposed to the capital gains tax rate and estate tax.

Under current federal law, upon death, property passes to a beneficiary at fair market value, with a few exceptions. This means the beneficiary’s basis generally becomes the value of the property at the decedent’s date of death, also referred to as ‘step-up in basis.’ For gifts made during a donor’s lifetime, the donee receives the donor’s basis in the property. This means the donee’s basis remains the same as the donor’s basis, generally original cost plus any improvements. No taxable gain or loss occurs upon the transfer of the property. Gain or loss is realized only when the property is eventually sold.

Under the Biden administration’s proposal, transfers of appreciated property upon death, or by gift, may result in the realization of capital gain to the donor or decedent at the time of the transfer. This means tax may be triggered at the date of the transfer regardless of whether the property is subsequently sold. This would be accomplished by eliminating the step-up in basis upon death of a decedent and requiring a tax be paid on a portion of the value of a gift made.

Fortunately, the Biden proposal would allow a $1 million per-person exclusion from recognition of unrealized capital gains on property either transferred by gift or held at death. The per-person exclusion would be indexed for inflation after 2022 and would be portable to the decedent’s surviving spouse under the same rules that apply to portability for estate- and gift-tax purposes (making the exclusion effectively $2 million per married couple). It is important to note, however, in the case of gifts, the donee’s basis in property received by gift during the donor’s life would be the donor’s basis in that property at the time of the gift to the extent that the unrealized gain on that property counted against the donor’s $1 million exclusion from recognition.

“Under the Biden administration’s proposal, transfers of appreciated property upon death, or by gift, may result in the realization of capital gain to the donor or decedent at the time of the transfer. This means tax may be triggered at the date of the transfer regardless of whether the property is subsequently sold.”

Tangible personal property (other than collectibles) would also be excluded from the triggering of gain. The exclusion under current law for certain small-business stock would remain, and the $250,000 per-person exclusion under current law for capital gain on a principal residence would apply to all residences currently allowed under IRC Section 121 and would be portable to the decedent’s surviving spouse, making the exclusion effectively $500,000 per couple.

The Biden proposal allows for some exempt transferees. Property transferred by a decedent to a charity would be exempt. Transfers by a decedent to a U.S. spouse would be at be the carryover basis of the decedent, and capital gain would not be recognized by the surviving spouse until the surviving spouse disposes of the asset or dies.

In addition to transfers upon death or gift to an individual, transfers of appreciated property into, or distributed in kind from, trusts (other than revocable grantor trusts) and partnerships may be treated as recognition events for the donor or donor’s estate. Valuation is another important concern in regard to a partial interest. The transfer of a partial interest would be at the ‘proportional share.’ Valuation discounts for minority interests will not apply.

Under Biden’s proposal, the donor would report any deemed recognition events on the donor’s gift-tax return. A decedent would report any capital gains on an estate-tax return or, potentially, a separate capital-gains return. A decedent would be able to offset capital gains against any unused capital-loss carry-forwards and up to $3,000 of ordinary income on their final individual income-tax returns. Any capital-gains taxes deemed realized at death would be deductible on the decedent’s federal estate-tax return if required.

The proposal would be effective for gains on property transferred by gift and on property owned at death by decedents dying after Dec. 31, 2021.

With a 50/50 partisan split in the U.S. Senate, it is currently unclear what the final proposal will end up being. Now is the time to start thinking about the how the proposed changes will affect you. Make an appointment with your tax or financial-planning professional to discuss what steps you should consider taking. You may need to be willing to act quickly should these proposals become reality.

 

Jim Moran, CPA, MST is a manager with Melanson CPAs, focusing on commercial services and tax planning, compliance, and preparation.

Accounting and Tax Planning Special Coverage

Reading the Fine Print

By Julie Quink

 

The economic stress created by the COVID-19 pandemic compelled business owners and individuals to apply for the relief funds provided by the Small Business Administration (SBA) in the form of Paycheck Protection Program (PPP) loans and Economic Injury Disaster Loans (EIDL).

The rollout of these programs came at a time when the reality of the pandemic began to unfold, creating a frenzy for businesses and individuals to apply for the funding, in some cases, before the funding ran out.

Before the ink on the guidance and requirements for these stimulus funds was dry, applications for the funding were being processed, and funds were in the hands of businesses and individuals. To expedite getting funds to those who needed them, much of the clarification about the use of the funds, taxability of the funds, and criteria for forgiveness were ironed out after the funding was in hand and being spent by the recipients. What ensued was months of additions to the SBA’s frequently-asked-questions (FAQ) document clarifying the eligible uses of the funding to ensure forgiveness and further attempts by Congress and the SBA to adjust program requirements as the pandemic continued.

More than 50 FAQs were issued to clarify the PPP requirements, and 20 relating to the EIDL loans.

In the frenzy to obtain the funding for the PPP and EIDL loans, it became clear that not everyone read the fine print, or that the fine print changed as clarity was provided for these programs. The fine print provided recipients with additional requirements for the funding they may have been unaware of at the time of application or even during the spend-down period.

As trained professionals, accountants and business advisors spent months learning the requirements and pivoting as they changed. It would be unreasonable to assume that those who received the funding could keep up with the fast-paced changes that were occurring, including the fine print. For accountants, there have been times we could barely keep up with the changes.

Julie Quink

Julie Quink

“With the second round of PPP funding recently released and requirements more recently clarified, reading the fine print should hopefully not be such a daunting or surprising task.”

The result is that those receiving the funding need to be aware of those items in the fine print for the PPP funding and the EIDL loans that may impact them.

 

EIDL

Recipients of the EIDL loans, which could be up to $2 million in amount, were required to sign loan paperwork, outlining the terms of the funding. In the fine print of these loan documents are provisions that the borrower should look out for and be aware of. Some of the provisions are:

• For loans under $25,000, collateral is not required. For loans of more than $25,000, the SBA is provided collateral through business assets, current and future. Transfers or sales of collateral, except inventory, require prior SBA approval. In addition, prior approval is required by the SBA in the event these business assets will be used to secure other financing;

• Borrowers are required to keep itemized receipts, paid invoices, contracts, and all related paperwork for three years from the date of disbursement;

• Borrowers are encouraged to the extent feasible to purchase only American-made equipment and products with the proceeds of this loan;

• Borrowers must keep all accounting records five years before the loan and three years after in a manner satisfactory to the SBA;

• Borrowers must agree to audits and inspection of assets, if requested by the SBA, at the expense of the borrower;

• Borrowers have a duty to provide hazard insurance on collateral and may be asked to provide proof;

• Within 90 days of the borrower’s year end, financial statements, in the format specified by the SBA, are required to be furnished by the borrower;

• The SBA may require a review-level financial statement for a borrower upon written request by the SBA at the borrower’s expense;

• Prior approval from the SBA is required for distributions of the borrower’s assets to the owners or employees, including loans, gifts, or bonuses;

• Borrowers must submit, within 180 days of receiving a loan, an SBA certificate or resolution. For most borrowers, the SBA has followed up or is following up on this requirement now;

• Default under the provisions may result if a borrower merges, consolidates, reorganizes, or changes ownership without prior SBA approval; and

• The loans can be prepaid, without penalty, if the borrower does not need the funds or secures other financing.

For most borrowers, the requirements may be routine considerations, but for others, these may be new requirements.

 

PPP

In the fine print of the PPP loan documents are also provisions that the borrower should consider, as follows:

• For borrowers who received a PPP loan greater than $2 million, the SBA has indicated it will likely audit those borrowers for compliance with spending requirements;

• Although Congress has confirmed that the proceeds of the PPP loan are not taxable and the expenses paid with PPP are deductible, some states, such as Massachusetts, are not following the federal laws relative to forgiveness of the PPP loans as they have their own rules. For individuals in Massachusetts, the loan forgiveness is taxable income. This affects sole proprietors, S-corp shareholders, and partners of partnerships. A bill, co-sponsored by state Sen. Eric Lesser, state Rep. Brian Ashe, and five other co-sponsors, has been proposed to allow for non-taxability of the forgiveness amounts in Massachusetts;

• Depending on when the PPP loan was funded, the borrower may have a repayment term of two or five years for the loan; and

• Although forgiveness may be granted, the borrower should retain the records used for forgiveness. Generally, most records should be retained for seven years.

 

Bottom Line

Navigating the fine print is key for those who received the PPP and EIDL loans. The navigation becomes increasingly more difficult when the requirements continue to change and the funds have already been received and used to operate the business.

With the second round of PPP funding recently released and requirements more recently clarified, reading the fine print should hopefully not be such a daunting or surprising task.

 

Julie Quink is managing partner with West Springfield-based Burkhart Pizzanelli; (413) 734-9040.

Accounting and Tax Planning

Round 2

By Jonathan Cohen-Gorczyca, CPA, and Amila Hadzic

On Dec. 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act was signed into law to assist businesses who have been financially impacted by the COVID-19 pandemic. As a result of the Economic Aid Act, the Paycheck Protection Program’s second-draw loan program was created.

This program will allow the U.S. Small Business Administration to provide eligible businesses with additional loans, similar to those from the original Paycheck Protection Program (PPP). The last day to apply for the second-draw loan is March 31, 2021, and there are eligibility and documentation requirements that need to be met during the application process.

 

Eligibility

This loan can only be made to a business that has received a first-draw PPP loan and has used the full amount of the loan on eligible expenses before the disbursement of the second loan. A business that was ineligible for the first loan cannot receive the second-draw PPP loan.

In order to be eligible for this second-draw PPP loan, the business must have 300 or fewer employees. The business must have also experienced at least a 25% reduction in revenue in 2020 compared to 2019. The revenue reduction can be calculated by comparing one quarter in 2019 with the same quarter in 2020. However, if the business was not in operation for the full year in 2019, there are other periods that can be used for this calculation. If an entity was in operation for all four quarters in 2019, then the annual revenue can be compared with 2020.

 

Loan Amount

The maximum loan amount for the second loan is the lesser of $2 million or two and half months of the business’ average monthly payroll. For those who are assigned a NAICS code with 72 or are a seasonal employer, the loan amount can be greater than two and a half months. The borrower can use either total wages paid in 2019 or wages paid in a 12-month period before the loan was made to calculate average monthly payroll. There is also the option to use 2020 wages.

 

Application and Documentation

In order to apply for this loan, the SBA Form 2483-SD needs to be completed. Form 941, state quarterly wage unemployment forms for the applicable quarter used, and other payroll records may be needed depending on the payroll period used to calculate the loan amount. For ease of applying for a second-draw loan, it is recommended that you apply using the same lender, as much less payroll documentation will be needed because it should already be on file with the institution.

The documentation requirements are similar to the first PPP loan. If the loan is greater than $150,000, documentation will be needed to show the revenue reduction at the time of application. Bank statements, annual tax forms, and quarterly financial statements can be provided as documentation. For loans under $150,000, this information can be submitted during the loan-forgiveness process.

 

What If I Did Not Receive a First-draw PPP Loan?

The SBA is also accepting applications for first-time PPP borrowers. The loan is capped at $10 million for eligible businesses. If the loan is used to pay for payroll and other eligible expenses during the eight- or 24-week period, it is eligible for forgiveness. Eligible costs for both the second-draw loan and first-draw PPP loan include payroll costs, business mortgage interest, rent, lease payments, utility payments, worker-protection costs, property damage costs due to looting and vandalism not covered by insurance, and other supplier and operation costs. Payments made to an independent contractor do not qualify.

As with the first-draw PPP loan, it is best to reach out to both your accountant and loan provider to find out if a second-draw PPP loan is right for you. They will be able to help you determine what is right for your business and help walk you through the application process.

 

Jonathan Cohen-Gorczyca, CPA, is a manager, and Amila Hadzic is a staff accountant with the accounting firm Melanson, which has offices in Greenfield and Andover, as well as Merrimack, N.H. and Ellsworth, Maine.

Accounting and Tax Planning

A Tax-planning Checklist

By Dan Eger

 

It is that time again, your favorite and mine, tax season!

As we have made it through hopefully the worst of the pandemic, dealing with all the ups and downs of learning this new normal in life, one thing will remain the same — the IRS still wants our money. At some things have not changed due to COVID-19.

Here are some steps to take now to help make filing for the 2020 tax season easier. Below is a list of items to gather. These are the most common required forms and items. The list is not all-inclusive, as everyone’s tax situation is different. Also included are a few other things for you to consider as you prepare to file your 2020 tax return.

 

Documentation of Income

• W-2 – Wages, salaries, and tips

• W-2G – Gambling winnings

• 1099-Int and 1099-OID – Interest income statements

• 1099-DIV – Dividend income statements

• 1099-B – Capital gains (sales of stock, land, and other items)

• 1099-G – Certain government payments

— Statement of state tax refunds

— Unemployment benefits

• 1099-Misc – Miscellaneous income

• 1099-S – Sale of real estate (home)

• 1099-R – Retirement income

• 1099-SSA – Social Security income

• K-1 – Income from partnerships, trusts, and S-corporations

 

Documentation for Deductions

If you think all your deductions for Schedule A will not add up to more than $12,400 for single, $18,650 for head of household, or $24,800 for married filing jointly, save yourself the time required to itemize deductions and just plan to take the standard deduction.

 

• Medical Expenses (out of pocket, limited to 7.5% of adjusted gross income)

— Medical insurance (paid with post-tax dollars)

— Long-term-care insurance

— Prescription medicine and drugs

— Hospital expenses

— Long-term care expenses (in-home nurse, nursing home, etc.)

— Doctor and dentist payments

— Eyeglasses and contacts

— Miles traveled for medical purposes

 

• Taxes You Paid (limited to $10,000)

— State withholding from your W-2

— Real-estate taxes paid

— Estimated state tax payments and amount paid with prior year return

— Personal property (excise)

 

• Interest You Paid

— 1098-Misc – mortgage-interest statement

— Interest paid to private party for home purchase

— Qualified investment interest

— Points paid on purchase of principal residence

— Points paid to refinance (amortized over life of loan)

— Mortgage-insurance premiums

 

• Gifts to Charity (For 2020, filers who claim the standard deduction can take an additional deduction up to $300 for cash contributions.)

— Cash and check receipts from qualified organization

— Non-cash items, which need a summary list and responsible gift calculation (IRS tables). If the gift is more than $5,000, a written appraisal is required.

— Donation and acknowledgement letters (over $250)

— Gifts of stocks (you need the market value on the date of gift)

 

• Additional Adjustments (Non-Schedule A)

— 1098-T – Tuition statement

— Educator expenses (up to $250)

— 1098-E – Student-loan interest deduction

— 5498 HSA – Health savings account contributions

— 1099-SA – Distributions from HAS

— Qualified child and dependent care expenses

— Verify any estimated tax payments (does not include taxes withheld)

 

Sole proprietors (Schedule C) or owners of rental real estate (Schedule E, Part I) need to compile all income and expenses for the year. You need to retain adequate documentation to substantiate the amounts that are reported.

 

Other Items to Consider

Identity-protection PIN

If you are a confirmed identity-theft victim, the IRS will mail you a notice with your IP PIN each year. You need this number to electronically file your tax return.

Starting in 2021, you may opt into the IP PIN program. Visit www.irs.gov/identity-theft-fraud-scams/get-an-identity-protection-pin to set up your IP PIN. An IP PIN helps prevent someone else from filing a fraudulent tax return using your Social Security number.

 

What If You Have Been Compromised?

How do you know if someone has filed a return with your information? The most common way is that your tax return will get rejected for e-file. These scammers file early. You may also get a letter from the IRS requesting you verify certain information.

If this does happen, there are steps to take to get this rectified:

1. File Form 14039 (Identity Theft Affidavit).

2. Paper-file your return.

3. Visit identitytheft.gov for additional steps.

 

New for 2021: Recovery Rebate Credit

Eligible individuals who did not receive a 2020 economic impact payment (stimulus check), or received a reduced amount, may be able to claim the Recovery Rebate Credit on their 2020 tax return. There is a worksheet to use to figure the amount of credit for which you are eligible based on your 2020 tax return. Generally, this credit will increase the amount of your tax refund or lower the amount of the tax you owe.

 

Who Will Prepare My Return?

Are you going to be preparing your tax return, or will you hire someone to file on your behalf? You might want to plan that out now so you know the required information you will need and the fee structure you can expect to pay for completion of all applicable forms. In addition to all the items listed above, the tax preparer will ask you for a copy of your last tax return that was filed. The IRS offers a ‘file free platform’ to file your tax return if your income is under $72,000. You can find this at irs.gov or the IRS2Go app. There are also some local tax-assistance and counseling programs, depending on your age and income levels (VITA/TCE).

 

Interactive Tax Assistant

The Interactive Tax Assist (ITA) is an IRS online tool (irs.gov) to help you get answers to several tax-law items. ITA can help you determine what income is taxable, which deductions are allowed, filing status, who can be claimed as a dependent, and available tax credits.

 

Be Vigilant

Finally, be especially careful during this time of year to protect yourself against those trying to defraud or scam you. The IRS will never — let me repeat that: NEVER — call you directly unless you are already in litigation with them. They will not initiate contact by e-mail, text, or social media. The IRS will contact you by U.S. mail.

However, you still need to be wary of items received by mail. Anything requesting your Social Security number or any credit-card information is a dead giveaway. Watch out for websites and social-media attempts that request money or personal information and for schemes tied to economic impact payments. You can check the irs.gov website to research any notice you receive or any concerns you may have. You can also contact your tax practitioner for help and assistance.

 

Dan Eger is a senior associate at Holyoke-based accounting firm Meyers Brothers Kalicka; (413) 536-8510.

Accounting and Tax Planning Coronavirus Special Coverage

Year-end Tax Planning

By Kristina Drzal Houghton, CPA, MST

 

This year has been unlike any other in recent memory. Front and center, the COVID-19 pandemic has touched virtually every aspect of daily living and business activity in 2020. In addition to other financial consequences, the resulting fallout is likely to have a significant impact on year-end tax planning for both individuals and small businesses.

Kristina Drzal Houghton

Kristina Drzal Houghton

Furthermore, if the election of Joe Biden is confirmed and the Republican party does not hold a majority in the Senate following the runoff elections in Georgia, it is likely to affect the tax situation in 2021 and beyond. This article will first address 2020 planning and then summarize some of the Biden tax proposals at the end.

In response to the pandemic, Congress authorized economic-stimulus payments and favorable business loans as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act also features key changes relating to income and payroll taxes. This new law follows close on the heels of the massive Tax Cuts and Jobs Act (TCJA) of 2017. The TCJA revised whole sections of the tax code and includes notable provisions for both individuals and businesses.

This is the time to paint your overall tax picture for 2020. By developing a year-end plan, you can maximize the tax breaks currently on the books and avoid potential pitfalls.

 

BUSINESS TAX PLANNING

Depreciation-related Deductions

Under current law, a business may benefit from a combination of three depreciation-based tax breaks: the Section 179 deduction, ‘bonus’ depreciation, and regular depreciation.

• Place qualified property in service before the end of the year. Typically, a small business can write off most, if not all, of the cost in 2020.

• The maximum Section 179 allowance for 2020 is $1,040,000 provided asset purchases do not exceed $2,590,000.

• Be aware that the Section 179 deduction cannot exceed the taxable income from all your business activities this year. This could limit your deduction for 2020.

• If you buy a heavy-duty SUV or van for business, you may claim a first-year Section 179 deduction of up to $25,000. The ‘luxury car’ limits do not apply to certain heavy-duty vehicles.

• If your deduction is limited due to either the income threshold or the amount of additions, a first-year bonus depreciation deduction of 100% for property placed in 2020 is also available.

• Massachusetts does not follow the bonus depreciation, but does allow the increased Section 179 expense; however, many states do not follow that increased expense either.

 

Business Interest

• Prior to 2018, business interest was fully deductible. But the TCJA generally limited the deduction for business interest to 30% of adjusted taxable income (ATI). Now the CARES Act raises the deduction to 50% of ATI, but only for 2019 and 2020.

• Determine if you qualify for a special exception. The 50%-of-ATI limit does not apply to a business with average gross receipts of $25 million (indexed for inflation) or less for the three prior years. The threshold for 2020 is $26 million.

 

Bad-debt Deduction

During this turbulent year, many small businesses are struggling to stay afloat, resulting in large numbers of outstanding receivables and collectibles.

• Increase your collection activities now. For instance, you may issue a series of dunning letters to debtors asking for payment. Then, if you are still unable to collect the unpaid amount, you can generally write off the debt as a business bad debt in 2020.

• Generally, business bad debts are claimed in the year they become worthless. To qualify as a business bad debt, a loan or advance must have been created or acquired in connection with your business operation and result in a loss to the business entity if it cannot be repaid.

 

Miscellaneous

• If you pay year-end bonuses to employees in 2020, the bonuses are generally deductible by your company and taxable to the employees in 2020. A calendar-year company operating on the accrual basis may be able to deduct bonuses paid as late as March 15, 2021 on its 2020 return.

• Generally, repairs are currently deductible, while capital improvements must be depreciated over time. Therefore, make minor repairs before 2021 to increase your 2020 deduction.

• Switch to cash accounting. Under a TCJA provision, a C-corporation may use this simplified method if average gross receipts for last year exceeded $26 million (up from $5 million).

• An employer can claim a refundable credit for certain family and medical leaves provided to employees. The credit is currently scheduled to expire after 2020.

• Investigate Paycheck Protection Program (PPP) forgiveness. Under the CARES Act, PPP loans may be fully or partially forgiven without tax being imposed. Despite recent guidance, this remains a complex procedure, so consult with your professional tax advisor about the details.

 

INDIVIDUAL TAX PLANNING

Charitable Donations

Generally, itemizers can deduct amounts donated to qualified charitable organizations, as long as substantiation requirements are met. Be aware that the TCJA increased the annual deduction limit on monetary contributions from 50% of adjusted gross income (AGI) to 60% for 2018 through 2025. Even better, the CARES Act raises the threshold to 100% for 2020.

• In addition, the CARES Act authorizes an above-the-line deduction of up to $300 for monetary contributions made by a non-itemizer in 2020 ($600 for a married couple).

• In most cases, you should try to ‘bunch’ charitable donations in the year they will do you the most tax good. For instance, if you will be itemizing in 2020, boost your gift giving at the end of the year. Conversely, if you expect to claim the standard deduction this year, you may decide to postpone contributions to 2021.

• For donations of appreciated property that you have owned longer than one year, you can generally deduct an amount equal to the property’s fair market value (FMV). Otherwise, the deduction is typically limited to your initial cost. Also, other special rules may apply to gifts of property. Notably, the annual deduction for property donations generally cannot exceed 30% of AGI.

• If you donate to a charity by credit card in December — for example, if you make an online contribution — you can still write off the donation on your 2020 return, even if you do not actually pay the credit-card charge until January.

 

Family Income Splitting

The time-tested technique of family income splitting still works. Currently, the top ordinary income-tax rate is 37%, while the rate for taxpayers in the lowest income tax bracket is only 10%. Thus, the tax rate differential between you and a low-taxed family member, such as a child or grandchild, could be as much as 27% — not even counting the 3.8% net investment-income tax (more on this later).

• Shift income-producing property, such as securities, to family members in low tax brackets through direct gifts or trusts. This will lower the overall family tax bill. But remember that you are giving up control over those assets. In other words, you no longer have any legal claim to the property.

• Also, be aware of potential complications caused by the ‘kiddie tax.’ Generally, unearned income above $2,200 received in 2020 by a child younger than age 19, or a child who is a full-time student younger than age 24, is taxed at the top marginal tax rate of the child’s parents. (Recent legislation reverses a TCJA change on the tax treatment.) The kiddie tax could affect family income-splitting strategies at the end of the year.

 

Higher-education Expenses

The tax law provides tax breaks to parents of children in college, subject to certain limits. This often includes a choice between one of two higher-education credits and a tuition-and-fees deduction.

• Typically, you can claim either the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC). The maximum AOTC of $2,500 is available for qualified expenses of each student, while the maximum $2,000 LLC is claimed on a per-family basis. Thus, the AOTC is usually preferable. Both credits are phased out based on modified adjusted gross income (MAGI).

• Alternatively, you may claim the tuition-and-fees deduction, which is either $4,000 or $2,000 before it is phased out based on MAGI. The tuition-and-fees deduction, which has expired and been revived several times, is scheduled to end after 2020, but could be reinstated again by Congress.

• When appropriate, pay qualified expenses for next semester by the end of this year. Generally, the costs will be eligible for a credit or deduction in 2020, even if the semester does not begin until 2021.

 

Medical and Dental Expenses

Previously, taxpayers could only deduct unreimbursed medical and dental expenses above 10% of their AGI. When it is possible, accelerate non-emergency qualifying expenses into this year to benefit from the lower threshold. For instance, if you expect to itemize deductions and have already surpassed the 7.5%-of-AGI threshold this year, or you expect to clear it soon, accelerate elective expenses into 2020. Of course, the 7.5%-of-AGI threshold may be extended again, but you should maximize the tax deduction when you can.

 

Estimated Tax Payments

The IRS requires you to pay federal income tax through any combination of quarterly installments and tax withholding. Otherwise, it may impose an ‘estimated tax’ penalty.

However, no estimated tax penalty is assessed if you meet one of these three ‘safe harbor’ exceptions under the tax law:

• Your annual payments equal at least 90% of your current liability;

• Your annual payments equal at least 100% of the prior year’s tax liability (110% if your AGI for the prior year exceeded $150,000); or

• You make installment payments under an ‘annualized income’ method. This option may be available to taxpayers who receive most of their income during the holiday season.

If you have received unemployment benefits in 2020 — for example, if you lost your job due to the COVID-19 pandemic — remember that those benefits are subject to income tax. Factor this into your estimated tax calculations for the year.

 

Capital Gains and Losses

Frequently, investors time sales of assets such as securities at year-end to produce optimal tax results. For starters, capital gains and losses offset each other. If you show an excess loss for the year, it offsets up to $3,000 of ordinary income before being carried over to the next year. If you sell securities at a loss and reacquire substantially identical securities within 30 days of the sale, the tax loss is disallowed.

• Long-term capital gains from sales of securities owned longer than one year are taxed at a maximum rate of 15%, or 20% for certain high-income investors. Conversely, short-term capital gains are taxed at ordinary income rates reaching up to 37% in 2020.

• Review your investment portfolio. Depending on your situation, you may harvest capital losses to offset gains realized earlier in the year or cherry-pick capital gains that will be partially or wholly absorbed by prior losses.

 

Net Investment-income Tax

In addition to capital-gains tax, a special 3.8% tax applies to the lesser of your net investment income (NII), or the amount by which your modified adjusted gross income (MAGI) for the year exceeds $200,000 for single filers or $250,000 for joint filers. (These thresholds are not indexed for inflation.) The definition of NII includes interest, dividends, capital gains, and income from passive activities, but not Social Security benefits, tax-exempt interest, and distributions from qualified retirement plans and IRAs.

• Assess the amount of your NII and your MAGI at the end of the year. When it is possible, reduce your NII tax liability in 2020 or avoid it altogether.

 

Required Minimum Distributions

As a general rule, you must receive required minimum distributions (RMDs) from qualified retirement plans and IRAs after reaching age 72 (70½ for taxpayers affected prior to 2020). The amount of the RMD is based on IRS life-expectancy tables and your account balance at the end of last year

• Take RMDs in 2020 if you need the cash. Otherwise, you can skip them this year, thanks to a suspension of the usual rules by the CARES Act. There is no requirement to demonstrate any hardship relating to the pandemic. Finally, although RMDs are no longer required in 2020, consider a qualified charitable distribution (QCD). If you are age 70½ or older, you can transfer up to $100,000 of IRA funds directly to a charity. Although the contribution is not deductible, the QCD is exempt from tax. This may benefit your overall tax picture.

 

IRA Rollovers

If you receive a distribution from a qualified retirement plan or IRA, it is generally subject to tax unless you roll it over into another qualified plan or IRA within 60 days. In addition, you may owe a 10% tax penalty on taxable distributions received before age 59½. However, some taxpayers may have more leeway to avoid tax liability in 2020 under a special CARES Act provision.

• Take your time redepositing the funds if it qualifies as a COVID-19-related distribution. The CARES Act gives you three years, instead of the usual 60 days, to redeposit up to $100,000 of funds in a plan or IRA without owing any tax.

• To qualify for this tax break, you (or your spouse, if you are married) must have been diagnosed with COVID-19 or experienced adverse financial consequences due to the virus (e.g., being laid off, having work hours reduced, or being quarantined or furloughed). If you do not replace the funds, the resulting tax is spread evenly over three years.

• This may be a good time to consider a conversion of a traditional IRA to a Roth IRA. With a Roth, future payouts are generally exempt from tax, but you must pay current tax on the converted amount. Have a tax professional help you determine if this makes sense for your situation.

 

Estate and Gift Taxes

Since the turn of the century, Congress has gradually increased the federal estate-tax exemption, while eventually establishing a top estate-tax rate of 40%. The TCJA doubled the exemption from $5 million to $10 million for 2018 through 2025, inflation-indexed to $11.58 million in 2020.

Under the ‘portability provision’ for a married couple, the unused portion of the estate-tax exemption of the first spouse to die may be carried over to the estate of the surviving spouse. This tax break is now permanent.

Finally, guidance has been published establishing that, when the exemption is decreased in the future, a recapture or ‘claw-back’ of the extra exemption used will not be required.

Update your estate plan to reflect current law. You may revise wills and trusts to accommodate the rule allowing portability of the estate-tax exemption. Additionally, consider the maximum gifting currently as allowable in your financial position.

 

Miscellaneous

You can contribute up to $19,500 to a 401(k) in 2020 ($26,000 if you are age 50 or older).

 

BIDEN’S NOTABLE TAX PROPOSALS

Business Tax

• The statutory corporate tax rate would be increased from 21% to 28%.

• The benefits of the Section 199A/qualified business-income deduction would be phased out for individuals with taxable income greater than $400,000.

• The real-estate industry will potentially be impacted. The Biden campaign had suggested potential changes to the §1031 like-kind exchange provisions as well as changes to effectively limit losses that may be utilized by real-estate investors.

 

Individual Tax

Many of the revenue-raising aspects of the Biden tax proposal for individuals apply only to those taxpayers with taxable income over $400,000. It has not been specified whether this threshold is to be adjusted for filing status.

• The top ordinary rate would be restored to 39.6% for taxpayers with income over $400,000. This reflects a return to pre-2017 tax reform when the top ordinary rate was dropped to 37%.

• For top income earners, this rate is currently capped at 20% (plus 3.8% to the extent subject to the net investment-income tax). Under the Biden plan, capital gains and qualified dividends will be subject to the top rate of 39.6% for individuals with more than $1 million in income.

• The Section 199A/qualified business-income deduction would begin to phase out for individuals over $400,000 in taxable income.

• Itemized deductions would be capped to 28% of value. Additionally, benefits would begin to phase out for individuals with taxable income over $400,000.

• The child and dependent care credit would be increased to a maximum of $8,000 for low-income and middle-class families. In addition, the credit would be made refundable.

• First-time homebuyers could receive up to $15,000 of refundable and advanceable tax credit.

• There could be temporary expansion of the child tax credit, depending on the progression of the pandemic and economic conditions. This expansion would increase the credit from $2,000 to $3,000 for children 17 or younger with an additional $600 for children under 6. The credit would also be refundable and allowable to be received in monthly installments.

 

Gift and Estate Tax

The gift- and estate-tax exemption amount would be reduced. Many are suggesting that Biden is looking to reduce the gift- and estate-tax exemption to the pre-TCJA levels.

 

Conclusion

This year-end tax-planning letter is based on the prevailing federal tax laws, rules, and regulations. Of course, it is subject to change, especially if additional tax legislation is enacted by Congress before the end of the year.

Finally, remember that this article is intended to serve only as general guideline. Your personal circumstances will likely require careful examination. u

 

Kristina Drzal Houghton, CPA, MST is partner, Executive Committee, and director of Taxation Services at Meyers Brothers Kalicka; (413) 536-8510.

Accounting and Tax Planning

Review, Refocus, and Reset

By Julie Quink, CPA, CFE

Julie Quink

Julie Quink

This year has been riddled with a series of unexpected and unanticipated events for business owners and organizations, the height of which continues to be the pandemic and its continued significant impact.

With the uptick in positive cases continuing, business owners and management continue to face difficult business decisions and worries surrounding the financial and safety impacts of the COVID-19 coronavirus. With much on their minds running a business day to day, it becomes difficult for business owners, management, and even accounting professionals to ‘see the forest for the trees,’ as they say, and, as a result, they often set aside the opportunity to plan.

Using the lessons learned in 2020, there is no better time to review, refocus, and reset.

Review

Countless impacts, some quantifiable and some undocumented or unknown, exist within organizations resulting from the events thus far in 2020. Among them:

• An unprecedented amount of fraud has occurred, impacting unemployment claims, accounting systems, and data breaches, to name a few areas of concern;

• Key accounting standards that were intended to be implemented in 2019 and 2020, including the lease-accounting and revenue-recognition standards, were deferred by the standard setters to ease the strain on companies in this high-pressure economic atmosphere;

• Significant stimulus funds have been made available to the business community through the Coronavirus Aid, Relief and Economic Security (CARES) Act, including the Paycheck Protection Program, the Provider Relief Fund for hospitals and healthcare providers, and the Economic Injury Disaster Loan Program;

• Businesses that have been severely impacted by the pandemic may qualify for the Credit for Sick and Family Leave and the Employee Retention Credits;

• Remote working has become the norm out of necessity rather than convenience as businesses try to keep employees safe, while maintaining the desired level of production;

• Not-for-profit organizations are feeling the pinch of decreased donation levels at a time when their services are needed the most; and

• Interruption of business globally due to the closure of various countries, limited travel, and availability of resources has contributed to the economic challenges for businesses.

Typically, reviewing the results and events of a previous year or period is instrumental in planning for an upcoming year. For many organizations, pivoting and reframing have partially replaced planning in 2020, sometimes just to survive.

Refocus

If there is any bright spot in the current environment, it is the ability to step back and refocus. Bringing the lessons learned from 2020 thus far into clear view, organizations can’t necessarily do what they have always done and survive. Some key areas that may need a refocus include:

• Technology and security of accounting systems and sensitive data;

• The review and planning for changing accounting standards. We know there is potential for new standards or revisions of existing standards to assist in evaluating the impacts of the pandemic on financial reporting. In addition, the timeline for implementation of standards that have already been deferred may be moved even further down the road.

• The use of PPP and other stimulus funds, including employer credits, requires additional consideration from a financial-reporting and a tax-compliance perspective. Will additional stimulus funds be made available in 2021?

• Long-term remote working may encourage the movement from traditional brick-and-mortar locations going forward.

• Fundraising efforts of not-for-profit organizations may need to continue to shift and adapt to our current virtual environment, with gathering restrictions for physical events still in place. The balance of budgeting between mission and funding will seemingly continue for the next few years. Will this spur mergers of not-for-profits to allow for continued mission?

• A shift of international business perspective, including supply chain, will need to continue to occur, perhaps to source more products and services locally.

A common thread weaved in among the suggested areas of refocus is the impact they have on the financial health and well-being of an organization. Taking the time to strategize and refocus in key areas opens new opportunities to shift and reset. With many demands on business owners and management to manage day-to-day operations, this process can be easily lost but remains critical.

Reset

The resetting process is the opportunity to remove the 2020 eyeglasses and pick up a prescription with new, improved lenses for 2021. This ‘new normal’ that organizations are facing encourages outside-the-box thinking, as the original box may not exist anymore or may look entirely different than before. Resetting may continue to be critical to an organization’s success and survival. Resetting in some key areas will help the organization be agile and adaptable to change.

It is clear that business owners and management may not be able to embark on the resetting process all on their own. The reliance on IT, accounting, legal counsel, investment advisors, and business consultants, included in an organization’s team of professionals, will become increasingly important. These spokes in your professional team’s wheel are critical to maneuver through the upcoming year.

Traditionally, strategic planning has encompassed perhaps a three, five-, and 10-year plan. Internal planning — and planning externally with your accounting professionals — have moved to a shorter-term focus, including many transactional and situational planning opportunities, as a result of the continuously changing environment, additional stimulus-fund opportunities, and compliance requirements.

Business owners and management do not need to hold all the information necessary to reset and reframe, but they do need to know the appropriate people to whom they can reach out.

Takeaways

As business owners and management think about the year ahead using the 2020 rearview mirror, one thing is for sure: they should have their team of professionals on speed dial.

If they do not have the right professionals in place, now is the time to make changes. The guidance provided by the spokes on the professional wheel should not be underestimated because one thing is clear: no one of us has all the answers to navigate the new normal, but collectively the team can help provide the input needed to move the organization to the next levels.

Remember: review, refocus, and reset.

Julie Quink, CPA, CFE is the managing principal of West Springfield-based Burkhart, Pizzanelli, P.C., certified public accountants; (413) 781-5609.

Accounting and Tax Planning Special Coverage

By All Accounts

By Jim Moran CPA, MST

Jim Moran CPA, MST

Jim Moran CPA, MST

The Coronavirus Aid, Relief, and Economic Security (CARES) Act has provided taxpayers affected by COVID-19 with some relief in the area of retirement-plan distributions and loans.

A coronavirus-related distribution is allowed by a qualified individual from an eligible retirement plan made from Jan. 1, 2020 to December 31, 2020, up to an aggregate amount of $100,000. A qualified individual must meet one of these criteria:

• Diagnosed with the virus SARS-CoV-2 or with the coronavirus disease 2019 (COVID-19) by a test approved by the Centers of Disease Control and Prevention (CDC);

• Spouse or dependent is diagnosed with SARS-CoV-2 or COVID-19 by a test approved by the CDC;

• Experienced adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, or being unable to work due to lack of childcare due to SARS-CoV-2 or COVID-19; or

• Experienced adverse financial consequences as a result of closing or reducing hours of a business that is owned or operated by the individual due to the SARS-CoV-2 or COVID-19.

An ‘eligible retirement plan’ is defined as the type of plan that is eligible to accept tax-free rollovers. It includes 401(k) plans, 403(b) plans, governmental 457 plans, and IRAs (including SEP-IRAs and SIMPLE-IRAs). It does not include non-governmental 457(b) plans. The $100,000 withdrawal limit applies in aggregate to all plans maintained by the taxpayers.

For individuals who are under age 59½, the act waives the 10% early-withdrawal penalty tax. Although the 10% penalty will be waived, any potential income taxes associated with the retirement plan or IRA withdrawal will still be assessed. The act also suspends the 20% tax-withholding requirements that may apply to an early distribution from a 401(k) or other workplace retirement plan.

“Your tax liability owed to the IRS at the end of the year may be higher than expected if you choose not to withhold the suggested 20%.”

Just keep in mind, your tax liability owed to the IRS at the end of the year may be higher than expected if you choose not to withhold the suggested 20%.

When it comes to paying the resulting tax liability incurred due to the coronavirus-related distributions, the CARES Act allows you a couple of options: spread the taxes owed over three years, or pay the taxes owed on your 2020 tax return if your income (and, thus, your tax rate) is much lower in that year.

Taxpayers may also repay the coronavirus-related distributions to an eligible retirement plan as long as the repayment is done within three years after the date the distribution was received. If the taxpayer does repay the coronavirus-related distribution in the three-year time period, it will be treated as a direct trustee-to-trustee transfer so there will be no federal tax on the distribution. This may mean an amended return will have to be filed to claim a refund attributable to the tax that was paid on the distribution amount that was included in income for those tax years.

Retirement-plan Loans

Loans from eligible retirement plans up to $100,000 to a qualified individual are available for any loans taken out during the six-month period from March 27, 2020 to Sept. 23, 2020. This is up from the previously allowed amount of $50,000.

Participants must repay standard retirement-account loans within five years. The CARES Act allows borrowers to forgo repayment during 2020. The five-year repayment clock begins in 2021. The loan will, however, continue to accrue interest during 2020.

If you have an existing loan outstanding from a qualified individual plan on or after March 27, 2020, and any repayment on the loan is due from March 27, 2020 to Dec. 31, 2020, the due date for any loan repayments are delayed for up to one year.

Employers may amend their plans for the above hardship provisions to apply no later than the last day of the plan year that begins on or after Jan. 1, 2022 (Dec. 31, 2022 for a calendar-year-end plan). An additional two-year window is allowed for governmental plans; however, IRS Notice 2020-51 clarifies that employers can choose whether to implement these coronavirus-related distribution and loan rules, and notes that qualified individuals can claim the tax benefits of coronavirus-related distribution rules even if plan provisions are not yet amended.

Administrators can rely on an individual’s certification that the individual is a qualified individual (and provides a sample certification), but also notes that an individual must actually be a qualified individual in order to obtain favorable tax treatment. IRS Notice 2020-50 provides employers a safe-harbor procedure for implementing the suspension of loan repayments otherwise due through the end of 2020, but notes there may be other reasonable ways to administer these rules.

Please note that the loan provisions apply only to qualified plans such as 401(k), 403(b), and governmental 457 plans; loans may not be taken from IRAs.

Each retirement plan’s rules and requirements supersede the CARES Act. In addition, it is important to remember that not all retirement-plan sponsors allow loans. Before taking out any loan, it is important to check that your employer’s plan adopts these provisions.

Suspension of RMDs

The CARES Act has suspended required minimum distributions (RMDs) for 2020. Individuals over age 70½ (for those born prior to July 1, 1949) or 72 (for those born after July 1, 1949) were required to take a minimum distribution from their tax-deferred retirement accounts.

Most non-spousal heirs who inherited tax-deferred accounts were also required to take an annual RMD. Under the CARES Act, RMDs from qualified employer retirement plans such as 401(k), 403(b), and 457 plans, will be waived. Even those individuals not affected by the coronavirus can waive the RMDs.

For individuals who have already taken their 2020 RMD, the CARES Act allows you to put it back into your retirement account. IRS Notice 2020-51 qualifies the distribution as an eligible rollover distribution if repaid in full by Aug. 31, 2020.

Jim Moran is a tax manager at Melanson, advising clients on individual and corporate tax matters; [email protected]

Accounting and Tax Planning

A Primer on RMDs

By Bob Suprenant, CPA, MST

Bob Suprenant, CPA, MST

With all that’s happened in the world this year, the SECURE Act, signed into law on Dec. 20, 2019, seems to have been robbed of the celebration it deserves.

Let’s give it its due and weave our way through the 2020 rules for what are known as RMDs.

First, what is an RMD, or required minimum distribution? It’s the minimum amount you must take out of your retirement plan — 401(k), IRA, 403(b), etc. — once you reach a certain age. The theory is that the amount in your retirement plan will be liquidated as you age.

To calculate the RMD, as a general rule, you divide the balance in your account at the end of the previous year — for this year, it would be Dec. 31, 2019 — by the distribution period found in the Uniform Lifetime Table. These tables currently run through age 115. Seriously.

Who Must Take an RMD?

This is where we blow the party horns and throw the confetti. These rules changed on Dec. 20, 2019. If you reached age 70½ in 2019, you were required to take your first distribution by April 1, 2020. If you reach age 70½ in 2020, you are not required to take your first distribution until April 1, 2022.

At the risk of putting a wet blanket on the fun, if you do not take the full amount of your RMD and/or you do not take it by the applicable deadline, there is a penalty. The penalty is an additional tax of 50% of the deficiency. The additional tax can be waived if due to reasonable error and you take steps to remedy the shortfall.

Did COVID-19 Change This?

Yes, the CARES Act, which was signed into law on March 27, 2020, included provisions that waived the requirement for RMDs in 2020. This also happened in 2009 when the stock market crashed. In 2020, RMDs are not required. The RMD waiver also applies to inherited IRAs.

It keeps getting better. On June 23, 2020, the IRS released Notice 2020-51, which allows those who have taken an RMD in 2020, but wish they hadn’t, to return the money to the retirement plan by Aug. 31.

There is a bit of a catch here, though. Most who take RMDs have federal and state tax withholdings on their distributions. Under this relief, the entire distribution must be returned to the retirement plan, not the distribution net of taxes.

By way of example, if you have a gross RMD of $20,000 and there is $3,000 in federal and state withholding, your net distribution is $17,000. To have none of your RMD taxed, the $20,000 must be returned to the retirement plan by Aug. 31. If you return only $17,000, you will be taxed on a $3,000 distribution.

Do I Take an RMD In 2020?

I know I don’t need to take an RMD in 2020, but should I? The answer is … it depends. And you should consult your tax advisor. Ask this individual to run projections to see what the best amount is for you to take as a distribution. For married joint filers, the 12% federal tax bracket includes taxable income up to $79,000. For amounts over $79,000, the tax bracket is at least 22%, a full 10% increase.

For many of my clients, I try to take full advantage of the lower tax bracket and get their incomes as close to the $79,000 as possible. Other clients, who use their retirement-plan distributions to make their charitable contributions (a very wise idea as you will generally save state taxes in addition to possibly saving federal taxes), should probably take a retirement-plan distribution in 2020.

Those who are aged may also want to take a distribution. Under the inherited IRA rules, your IRA beneficiaries will be required to take distributions, so consider their tax rates compared with yours.

As always, in the tax code, there are exceptions to exceptions, and this brief summary is only the cocktail hour. Be aware that you are not required to take an RMD for 2020. If you have taken an RMD, you can return it by Aug. 31. Do some tax planning to determine the best amount for your 2020 retirement-plan distribution.

Bob Suprenant, CPA, MST is a director of Special Tax Services at MP CPAs in Springfield. His focus is working with closely held businesses and their owners and identifying and implementing sophisticated corporate and business tax-planning strategies.

Accounting and Tax Planning Special Coverage

This Tax-relief Provision of the CARES Act Brings Advantages to Employers

By Carolyn Bourgoin, CPA

Businesses that either repaid in a timely fashion or did not receive a loan pursuant to the Paycheck Protection Program (PPP) should explore their eligibility for the new Employee Retention Credit, one of the tax-relief provisions of the CARES Act passed on March 27.

Like the PPP loan program, the Employee Retention Credit (ERC) is aimed at encouraging eligible employers to continue to pay employees during these difficult times. Qualifying businesses are allowed a refundable tax credit against employment taxes equal to 50% of qualified wages (not to exceed $10,000 in wages per employee).

Let’s take a look at who is eligible and how to determine the credit.

Who Is an Eligible Employer?

All private-sector employers, regardless of size, that carry on a trade or business during calendar year 2020, including tax-exempt organizations, are eligible employers for purposes of claiming the ERC. This is the case as long as the employer did not receive, or repaid by the safe-harbor deadline, a PPP loan. The IRS has clarified that self-employed individuals are not eligible to claim the ERC against their own self-employment taxes, nor are household employers able to claim the credit with respect to their household employees.

Carolyn Bourgoin

Carolyn Bourgoin

First Step: Determine Eligible Quarters to Claim the Credit

Eligible businesses can claim a credit equal to 50% of qualified wages paid between March 12 and Dec. 31, 2020 for any calendar quarter of 2020 where:

• An eligible employer’s business was either fully or partially suspended due to orders from the federal government, or a state government having jurisdiction over the employer limiting commerce, travel, or group meetings due to COVID-19; or

• There is a significant decline in gross receipts. Such a decline occurs when an employer’s gross receipts fall below 50% of what they were for the same calendar quarter in 2019. An employer with gross receipts meeting the 50% drop will continue to qualify thereafter until its gross receipts exceed 80% of its gross receipts for the same quarter in 2019. Exceeding the 80% makes the employer ineligible for the credit for the following calendar quarter.

This is an either/or test, so if a business fails to meet one criteria, it can look to the other in order to qualify. An essential business that chooses to either partially or fully suspend its operations will not qualify for the ERC under the first test, as the government did not mandate the shutdown. It can, however, check to see if it meets the significant decline in gross receipts for any calendar quarter of 2020 that would allow it to potentially claim the ERC.

The gross-receipts test does not require that a business establish a cause for the drop in gross receipts, just that the percentage drop be met.

Second Step: How Many Employees?

Determining the wages that qualify for the ERC depends in part on whether an employer’s average number of full-time-equivalent employees (FTEs) exceeded 100 in 2019. An eligible employer with more than 100 FTEs in 2019 may only count the wages it paid to employees between March 12, 2020 and prior to Jan. 1, 2021 for the time an employee did not provide services during a calendar quarter due to the employer’s operations being shut down by government order or due to a significant decline in the employer’s gross receipts (as defined previously).

“All private-sector employers, regardless of size, that carry on a trade or business during calendar year 2020, including tax-exempt organizations, are eligible employers for purposes of claiming the ERC.”

In addition, an employer of more than 100 FTEs may not count as qualifying wages any increase in the amount of wages it may have opted to pay employees during the time that the employees are not providing services (there is a 30-day lookback period prior to commencement of the business suspension or significant decline in gross receipts to make this determination).

In contrast, qualified wages of an employer that averaged 100 or fewer FTEs in 2019 include wages paid to any employee during any period in the calendar quarter where the employer meets one of the tests in step one. So even wages paid to employees who worked during the economic downturn may qualify for the credit.

Due to the potential difference in qualifying wages, it is important to properly calculate an employer’s ‘full-time’ employees for 2019. For purposes of the ERC, an employee is considered a full-time employee equivalent if he or she worked an average of at least 30 hours per week for any calendar month or 130 hours of service for the month. Businesses that were in operation for all of 2019 then take the sum of the number of FTEs for each month and divide by 12 to determine the number of full-time employee equivalents. Guidance has been issued by the IRS on this calculation for new businesses as well as those that were only in business for a portion of 2019.

Third Step: Calculate the Credit Based on Qualifying Wages

As mentioned earlier, the Employee Retention Credit is equal to 50% of qualifying wages paid after March 12, 2020 and before Jan. 1, 2021, not to exceed $10,000 in total per employee for all calendar quarters. The maximum credit for any one employee is therefore $5,000.

Wages that qualify toward the $10,000-per-employee cap can include a reasonable allocation of qualified healthcare costs. This includes an allocation of the employer portion of health-plan costs as well as the cost paid by an employee with pre-tax salary-reduction contributions. Employer contributions to health savings accounts or Archer Medical Savings Accounts are not considered qualified health-plan expenses for purposes of the ERC.

Qualifying wages do not include:

• Wages paid for qualified family leave or sick leave under the Family First Coronavirus Relief Act due to the potential payroll tax credit;

• Severance payments to terminated employees;

• Accrued sick time, vacation time, or other personal-leave wages paid in 2020 by an employer with more than 100 FTEs;

• Amounts paid to an employee that are exempt from Social Security and Medicare taxes (for example, wages paid to statutory non-employees such as licensed real-estate agents); or

• Wages paid to an employee who is related to the employer (definition of ‘related’ varies depending on whether the employer is a corporation, a non-corporate entity, or an estate or trust).

Eligible employers who averaged more than 100 FTEs in 2019 will then be potentially further limited to the qualifying wages paid to employees who were not providing services during an eligible calendar quarter.

How to Claim the ERC

An eligible business can claim the Employee Retention Credit by reducing its federal employment-tax deposit (without penalty) in any qualifying calendar quarter by the amount of its anticipated employee retention credit. By not having to remit the federal employment-tax deposits, an eligible business has the ability to use these funds to pay wages or other expenses. In its FAQs, the IRS clarified that an employer should factor in the deferral of its share of Social Security tax under the CARES Act prior to determining the amount of employment-tax deposits that it may retain in anticipation of the ERC. The retained employment taxes are accounted for when the Form 941, Employer’s Quarterly Federal Tax Return, is later filed for the quarter.

If the ERC for a particular quarter exceeds the payroll-tax deposits for that period, a business can either wait to file Form 941 to claim the refund, or it can file the new Form 7200, Advance Payment of Employer Credits Due to COVID-19, prior to filing Form 941 to receive a quicker refund.

If an employer later determines in 2021 that they had a significant decline in receipts that occurred in a calendar quarter of 2020 where they would have been eligible for the ERC, the employer can claim the credit by filing a Form 941-X in 2021.

Additional Rules

For purposes of determining eligibility for the credit as well as calculating the credit, certain employers must be aggregated and treated as a single employer.

Also, as a result of claiming the Employee Retention Credit, a qualifying business must reduce its wage/health-insurance deduction on its federal income-tax return by the amount of the credit.

In summary, the Employee Retention Credit is one of several tax-relief options provided by the CARES Act. As it is a refundable credit against federal employment taxes, it is advantageous to all employers, even those who will not have taxable income in 2020. Employers who did not receive PPP funding should check to see if they meet the eligibility requirements and take advantage of this opportunity.

Please note that, at the time this article was written, Congress was considering additional relief provisions that may or may not have impact on the information provided here. u

Carolyn Bourgoin, CPA is a senior manager at Holyoke-based accounting firm Meyers Brothers Kalicka, P.C.; [email protected]

Accounting and Tax Planning

Fight Back with Diligence, Communication, Monitoring, Education

By Julie Quink, CPA, CFE

Julie Quink

Julie Quink

In recent months, business owners have been faced with difficult business decisions and worries surrounding the financial and safety impacts of the COVID-19 pandemic, including the temporary closure of non-essential businesses, layoffs and the health of their workforce, remote work, and financial stability (short- and long-term) for their business.

In short, they have had much on their minds to stay operational on a day-to-day basis or in planning for reopening. And with that, businesses are prime targets for fraud schemes.

As professionals who counsel clients on best practices relative to fraud prevention and detection techniques, we unfortunately are not immune to fraud attempts as well. The filing of fraudulent unemployment claims is a scheme for which we have recent personal experience. The importance of internal controls — and making sure that appropriate controls are in place in a remote environment, with possibly leaner staff levels — should be heightened and reinforced.

Fraudulent Unemployment Claims

The filing of fraudulent unemployment claims has been one of the newest waves of fraud surrounding employees. These claims certainly have an impact for the individual for whom a claim is filed, but also have further-reaching implications for the victimized business as well.

In these schemes, an unemployment claim is filed using an employee’s identifying information, including Social Security number and address. Unfortunately, if you have ever been a victim of a data breach, you can feel confident that your personal information has been bought and sold many times since that initial breach.

Since these claims can be filed electronically, an online account is created by the fraudster for the individual. In that online setup and given that unemployment payments can be electronically paid, the fraudster sets up his or her own personal account as the receiver of the unemployment funds.

“The filing of fraudulent unemployment claims has been one of the newest waves of fraud surrounding employees. These claims certainly have an impact for the individual for whom a claim is filed, but also have further-reaching implications for the victimized business as well.”

In most cases, the first notification that an unemployment claim has been filed is a notice of monetary determination received by the individual via mail at their home address from the appropriate unemployment agency for the state that the claim has been filed with. By then, the claim has already made its way to the unemployment agency for approval and has gone through its system for approvals. In these pandemic times, the unemployment agencies have increased the speed at which claims are processed to get monies in the hands of legitimate claimants, but in the process have allowed fraudulent claims to begin to enter the process more rapidly.

So, you might wonder how this impacts a business if the claim is fraudulently claimed against an individual. Again, with some personal firm experience in tow, we can say that these claims are making it to determination status at the business level.

Even though the claim is fraudulent and, in some cases, the employee is gainfully employed at the business, the claim makes its way to the employer’s unemployment business account. Hopefully, affected individuals have been notified through some means that the claim has been filed. However, employers should not bank on that as a first means of notification of the fraud.

Perhaps employers are monitoring their unemployment accounts with their respective states more frequently because they may have laid off employees, but for those employers who still have their workforce intact, the need to monitor may not be top priority.

Impact of the Scheme

The impact on an employer of a fraudulently filed unemployment scheme targeting one of its employees is not completely known at this time because the scheme is just evolving. However, we do know this scheme merits notification to employees of the scam and increased monitoring of claims — both legitimate and false — by the company, all during a time when financial and human capital resources are stretched.

The scheme could cause employer unemployment contributions going forward to be inflated because of the false claims. For nonprofit organizations, which typically pay for unemployment costs because claims are presented against their employer account, this scheme could have significant financial implications.

For the individual, the false claim, if allowed to move through the system, shows they have received unemployment funds. This has several potential negative effects, including the ability to apply for unemployment in the future, the compromise of personal information, and the potential tax ramifications in the form of taxable unemployment benefits even though the monies were not actually received.

Detection and Prevention Techniques

Internal controls surrounding the human resources and payroll area should be heightened and monitored to encompass more frequent reviews of unemployment claims.

Communication with employees about the unemployment scam and the importance of forwarding any suspicious correspondence received by the employer is key. The employee may be the first line of defense.

Also, working in a remote environment should give business owners cause to pause and re-evaluate systems in place, including data security and privacy. It is unclear how these fraudsters may be obtaining information, but it is critical to be diligent and reinforce the need for heightened awareness relative to e-mail exchanges, websites visited, and data that is accessible.

Diligence, communication, monitoring, and education are important for business owners to prevent and detect fraud. Diligence in ensuring appropriate systems are in place, continued open and deep lines of communication with team members, monitoring relative to the effectiveness of systems, and educating team members on the changing schemes and the importance of their role are effective first steps.

Julie Quink is managing principal with West Springfield-based accounting firm Burkhart Pizanelli; (413) 734-9040.

Accounting and Tax Planning

Changes in Benefit Plans

By Melissa English

Melissa English

Melissa English

Audits of employee-benefit plans continue to evolve, and the pace of this evolution is unpredictable.

Areas such as technology and skills continue to grow, as well as industry standards. Now, throw COVID-19 into the mix, and we have to adjust not only to new ways of having these plans audited, but to additional standards that come into play with it.

The Auditing Standards Board has recently been issuing new standards. These standards go hand-in-hand with changes in technology and skills. These standards will improve the provisions of plans, affect the audits of plans, and address risk assessment and quality control. Auditors, as well as plan sponsors and administrators, should understand what these changes are and how they will affect retirement plans.

So what are some of the changes we can expect to see in the near future?

• Accounting Standards Updates (ASU) 2018-09 and 2018-13, which improve the standards on valuation of investments that use net-asset value as a practical expedient and improvements to fair-value disclosures. These both will be effective for years beginning after Dec. 15, 2019; and

• Statement on Auditing Standards (SAS) 134-141, with the biggest impact on limited-scope audits, which will now be called ERISA Section 103(a)(3)(c) audits. These standards will also affect the form and content of engagement letters, auditors’ opinions, and representation letters. The Statement on Auditing Standards was previously effective for years beginning after Dec. 15, 2020 but, due to COVID-19, has been moved, and is effective for years beginning after Dec. 15, 2021.

“Now, throw COVID-19 into the mix, and we have to adjust not only to new ways of having these plans audited, but to additional standards that come into play with it.”

In addition to these new standards, new acts recently came into law:

• The Bipartisan Budget Act of 2018, which was signed into law on Feb. 9, 2018. This act made changes in regulations for hardship distributions;

• The SECURE Act which became law on Dec. 20, 2019. This act will make it easier for small businesses to set up safe-harbor plans, allow part-time employees to participate in retirement plans, push back the age limit for required minimum distributions from 70 1/2 to 72, allow 401(k) plans to offer annuities, and change distribution rules for beneficiaries. This act also added new provisions for qualified automatic contribution arrangements (QACAs), birth and adoption distributions, and in-service distributions for defined benefit plans; and

• The CARES Act, which was signed into law on March 27, 2020 and acts as an aid and relief initiative from the impact of the COVID-19 pandemic. This act allows participants who are in retirement plans the option of taking distributions and/or loan withdrawals early without penalties during certain time periods for qualified individuals.

Lastly, there are constant discussions on cybersecurity. Cybercrime is one of the greatest threats to every company. Some questions to consider: does your company have a cybersecurity policy in place? Do you have insurance for cybersecurity? What is management’s role on cyber risk management? Do you offer trainings on how to handle cybercrime for both your IT department and all employees of the company? Cyberattacks are a normal part of daily business, but they can be significantly reduced if companies understand the risk, offer adequate resources and trainings, and maintain effective monitoring.

These changes affect most defined-contribution and defined-benefit plans. Plan sponsors should be evaluating these changes and the impact they have on retirement plans.

Some of these changes are optional, some are required, and some require amendments to plan documents. Plan sponsors should be discussing these changes as soon as possible with their third-party administrators and auditors. Remember, it’s the fiduciary’s responsibility to run the plan in the sole interest of its participants and beneficiaries, and to do this in accordance with all industry rules, regulations, and updated standards.

Melissa English is an audit manager at MP P.C. in its Springfield location. She specializes in employee benefit-plan work, such as audits; researching plan issues; compliance regulations, including voluntary plan corrections and self-corrections; and DOL and IRS audit examinations; (413) 739-1800.

Accounting and Tax Planning

This Measure Changes the Retirement Landscape in Several Ways

It’s called the Setting Every Community Up for Retirement Enhancement Act, and it was signed into law just a few weeks ago and took effect on Jan. 1. It is making an impact on taxpayers already, and individuals should know and understand its many provisions.

By Ian Coddington and Gabriel Jacobson

Signed into law Dec. 20, 2019, the SECURE Act, or Setting Every Community Up for Retirement Enhancement Act, has changed the retirement landscape for Americans retiring or planning to retire in the future.

The prominent components of the SECURE Act remove the maximum age for Traditional IRA contributions, increase the age for required minimum distributions, change how IRA benefits are received after death, and expand the types of expenses applicable to education savings funds. This law offsets some of the spending included in the budget bill by accelerating distribution of tax-deferred accounts.

Ian Coddington

Gabriel Jacobson

Due to the timing of this new legislation, there will be many questions from tax filers regarding the new rules and what changes apply to their plans. We hope this article will provide a starting point for understanding the changes that will impact us come tax time.

A Traditional IRA, or Traditional Individual Retirement Account, can be opened at most financial institutions.

Unless your income is above a certain threshold, every dollar of earned income from wages or self-employment contributed to the account by an individual reduces your annual taxable income dollar for dollar. This assumes you do not contribute above the annual limit into one or more tax-deferred retirement accounts.

Due to increasing life expectancy, the SECURE Act has eliminated the maximum age limit that an individual may contribute to a Traditional IRA. Prior to 2020, the maximum age was 70½.

The SECURE Act also raises the age that an individual with investments held in a Traditional IRA or other tax-deferred retirement account, such as a 401(k), must take distributions from 70½ to 72. These required minimum distributions, or RMDs, serve as the government’s way of collecting on tax-deferred income and are taxed at the individual’s income-tax rates, so no special investment-tax rates apply.

Each year, the distribution must equal a certain fraction of the year-end balance of an individual’s tax-deferred retirement account. The tax penalty for omitting all or a portion of your annual RMD is 50% of the amount of the RMD not withdrawn. The fraction is known as the life-expectancy factor and is based on the individual’s age.

The SECURE Act did not change the life-expectancy factors for 2020, but a change is expected for 2021. Unfortunately, RMDs for individuals who reached 70½ by Dec. 31, 2019 are not delayed. Such individuals must continue to take their RMDs under the same rules as prior to passage of the SECURE Act.

“With the SECURE Act going into effect Jan. 1, 2020, the law is making an impact on taxpayers now. The effects of this will continue over the next few years, as death benefits for beneficiaries and minimum distributions will not affect all retirees immediately.”

Individuals who inherit Traditional or Roth IRAs during or after Jan. 1, 2020 are now subject to a shorter time frame for RMDs pursuant to the SECURE Act. Prior to passage of the SECURE Act, individuals were able to withdraw funds from their IRAs over various schedules. The longest schedule was based on the beneficiary’s life expectancy and could last the majority of the individual’s life.

This allowed those who inherited Traditional IRAs to stretch the tax liabilities on those RMDs discussed previously over a longer period, reducing the annual tax burden. Under the current law, distributions to most non-spouse beneficiaries are required to be distributed within 10 years following the plan participant’s or IRA owner’s death (the 10-year rule). This may increase the size of RMD payments and push an individual to a higher tax bracket.

Exceptions to the 10-year rule are allowed for distributions to the following recipients: the surviving spouse, who receives the account value as if they were the owner of the IRA; an IRA owner’s child who has not yet reached majority; a chronically ill individual; and any other individual who is not more than 10 years younger than the IRA owner. Those beneficiaries who qualify under this exception may continue to take their distributions through the predefined life-expectancy rules.

Section 529 plans have also been expanded by the SECURE Act. These plans can be opened at most financial institutions and are established by a state or educational institution.

These 529 plans use post-tax contributions to generate tax-free earnings to pay for qualified educational expenses. As long as the distributions pay for these expenses, they will be tax-free. Qualified distributions include tuition, fees, books, and supplies. Previously, distributions were only tax-free if paid toward qualified education expenses for public and private institutions; now, they will include registered apprenticeships and repayment of certain student loans.

This will expand the qualified distributions to include equipment needed to complete apprenticeships and technical classes and training. For repayment of student loans, an individual is able to pay the principal or interest on qualified education loans of the beneficiary, up to $10,000. This can also include a sibling of the beneficiary, if the account holder has multiple children.

With the SECURE Act going into effect Jan. 1, 2020, the law is making an impact on taxpayers now. The effects of this will continue over the next few years, as death benefits for beneficiaries and minimum distributions will not affect all retirees immediately.

This article does not qualify as legal advice. Seek your tax professional or retirement advisor with additional questions on the impact this will have in your individual situation.

Ian Coddington and Gabriel Jacobson are associates with Holyoke-based public accounting firm Meyers Brothers Kalicka, P.C.; [email protected]; [email protected]

Accounting and Tax Planning

The State of Things

By Jonathan Cohen-Gorczyca, CPA

Very rarely do court cases related to state taxation make national news. South Dakota v. Wayfair Inc. (2018) was a Supreme Court case that decided in a 5-4 vote that states can charge and collect tax on out-of-state sellers, allowing the new precedent to supersede the physical-presence standard that most states were practicing.

Jonathan Cohen-Gorczyca

Typically, when a case is decided, states react quickly in order to increase tax revenues. While this case predominately affects Internet retailers who exceed a certain amount of shipments to a state or a certain dollar threshold of sales, it should cause all businesses to rethink what state tax filings and business registrations they are required to complete in order to maintain compliance with state tax laws and reduce exposure. In addition, pass-through entities, such as partnerships and S corporations, could have partners and shareholders that may also have tax-filing requirements in these states.

Businesses should maintain records of the number of completed transactions as well as the dollar amount of sales to each of the 50 states. Since each state has different laws that could trigger nexus for income or sales tax, this is a starting point to determine if additional state filings are required or if they should have been filed in prior years.

Nexus is the amount and degree of a taxpayer’s business activity that must be present in a state before the taxpayer is required to file a return and pay tax on income earned in the state. Individual states determine what degree of nexus triggers a tax-return filing requirement, and those rules can vary from state to state. Other questions that should be asked and analyzed include, but are not limited to, the following:

• How much property and equipment does the company own in another state?

• How much payroll is paid to employees that are in another state?

• If the company is selling tangible property, how is the property delivered? Are they using a third-party carrier? Are they sending company employees to make the delivery?

• Are employees or hired independent contractors installing the property once it is delivered in another state?

While these questions relate to the more traditional physical-presence standard in various states, the answers should be looked at in conjunction with the number of completed transactions and the dollar sales in a state. For example, Connecticut and New York have implemented a factor-based nexus standard (also known as a bright-line nexus test) for sales, payroll, and property (even if the taxpayer does not have a substantial physical presence in the state) in an attempt to increase tax revenue.

If, during the tax year, sales exceed $500,000 to Connecticut or $1 million to New York, a company located in Massachusetts with very little or no physical presence would be required to file tax returns in these states. Various states are now collecting income and sales tax revenue when an out-of-state company is not even setting foot into the state.

“Individual states determine what degree of nexus triggers a tax-return filing requirement, and those rules can vary from state to state.”

In order to help businesses determine if a sales or income-tax nexus exists in a particular state, states will commonly post a nexus questionnaire on their Department of Taxation’s website. Numerous questions will be asked about current and prior business activity in the state, such as sales amounts, how items are shipped, if employees are traveling to the state, and many other questions. Once submitted, the state will decide on whether sales or income-tax nexus exists in the state and what filings would be required. You should consult with your accountant or attorney prior to filling out these questionnaires because, if they are filled out incorrectly, it could cause a state to make an incorrect determination.

In addition to the questionnaires, many states have set up voluntary disclosure programs. If it is clear that a business has established nexus in a state in the current year but also failed to make this determination in prior years, there is the risk of exposure and potential tax audits, which could lead to additional taxes due plus penalties and interest.

By disclosing prior years’ sales, activities, and other connections to the state, the state may potentially waive penalties and interest through its voluntary disclosure program. Once again, the voluntary disclosure program should only be entered into after a determination is made by your accountant or attorney.

The states’ changes in nexus standards, which determine when a company may become subject to sales or income taxes in outside states, should be cause to review and analyze a company’s annual activities in other states. As these state laws may change every year, a company is responsible for maintaining tax compliance in each respective state and should review the nexus standards every year in order to stay compliant.

Jonathan Cohen-Gorczyca, CPA, MSA is a tax supervisor in Melanson Heath’s Greenfield office; (413) 773-5405.

Accounting and Tax Planning

Complicating Matters

By Kristina Drzal Houghton, CPA, MST

Year-end tax planning in 2019 remains as complicated as ever. Notably, we are still coping with the massive changes included in the biggest tax law in decades — the Tax Cuts and Jobs Act (TCJA) of 2017 — and pinpointing the optimal strategies. This monumental tax legislation includes myriad provisions affecting a wide range of individual and business taxpayers.

Among other key changes for individuals, the TCJA reduced tax rates, suspended personal exemptions, increased the standard deduction, and revamped the rules for itemized deductions. Generally, the provisions affecting individuals went into effect in 2018, but are scheduled to “sunset” after 2025. This provides a limited window of opportunity in some cases.

Kristina Drzal Houghton

Kristina Drzal Houghton

The impact on businesses was just as significant. For starters, the TCJA imposed a flat 21% tax rate on corporations, doubled the maximum Section 179 ‘expensing’ allowance, limited business interest deductions, and repealed write-offs for entertainment expenses. Unlike the changes for individuals, most of these provisions are permanent, but could be revised if Congress acts again.

For your convenience, this article is divided into two sections: individual tax planning and business tax planning. Be aware that the concepts discussed in this article are intended to provide only a general overview of year-end tax planning. It is recommended that you review your personal situation with a tax professional.

INDIVIDUAL TAX PLANNING

Age-old Planning

Postpone income until 2020 and accelerate deductions into 2019 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2019 that are phased out over varying levels of adjusted gross income (AGI). These include deductible IRA contributions, child tax credits, higher-education tax credits, and deductions for student-loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. In some cases, however, it may pay to actually accelerate income into 2019. For example, that may be the case where a person will have a more favorable filing status this year than next (e.g., head of household versus individual filing status), or expects to be in a higher tax bracket next year.

“Generally, the provisions affecting individuals went into effect in 2018, but are scheduled to ‘sunset’ after 2025. This provides a limited window of opportunity in some cases.”

If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA in 2019 if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for 2019, and possibly reduce tax breaks geared to AGI (or modified AGI).

It may be advantageous to try to arrange with your employer to defer, until early 2020, a bonus that may be coming your way. This could cut as well as defer your tax.

Capital-gain Planning

Long-term capital gain from sales of assets held for more than one year is taxed at 0%, 15%, or 20%, depending on the taxpayer’s taxable income. The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that it, when added to regular taxable income, is not more than the maximum zero-rate amount (e.g., $78,750 for a married couple).

YEAR-END ACTION: If the 0% rate applies to long-term capital gains you took earlier this year. For example, if you are a joint filer who made a profit of $5,000 on the sale of stock bought in 2009, and other taxable income for 2019 is $70,000, then before year-end, try not to sell assets yielding a capital loss because the first $5,000 of such losses won’t yield a benefit this year. And if you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains sheltered by the 0% rate.

Itemized Deductions

Among the most prominent tax changes for individuals, the TCJA essentially doubled the standard deduction while modifying the itemized-deduction rules for 2018 through 2025. For 2019, the inflation-indexed standard deduction is $12,200 for single filers and $24,400 for joint filers.

YEAR-END ACTION: With the assistance of your professional tax advisor, figure out if you will be claiming the standard deduction or itemizing deductions in 2019. The results of this analysis will likely dictate your tax planning approach at the end of the year.

Some or all of these TCJA provisions on itemized deductions may affect the outcome:

• The deduction for state and local taxes (SALT) is limited to $10,000 annually. This includes any combination of SALT payments for (1) property taxes and (2) income or sales taxes.

• The deduction for mortgage interest expenses is modified, but you can still write off interest on ‘acquisition debt’ within generous limits.

• The deduction for casualty and theft losses is eliminated (except for disaster-area losses).

• The deduction for miscellaneous expenses is eliminated, but certain reimbursements made by employers may be tax-free to employees.

• The threshold for deducting medical and dental expenses, which was temporarily lowered to 7.5% of adjusted gross income (AGI), reverts to 10% of AGI, beginning in 2019.

TIP: Depending on your situation, you may want to accelerate deductible expenses into the current year to offset your 2019 tax liability. However, if you do not expect to itemize deductions in 2019, you might as well postpone these expenses to 2020 or beyond.

Charitable Donations

Generally, itemizers can deduct amounts donated to qualified charitable organizations, as long as substantiation requirements are met. The TCJA increased the annual deduction limit for monetary contributions from 50% of AGI to 60% for 2018 through 2025. Any excess is carried over for up to five years.

If you are age 70½ or older by the end of 2019, have traditional IRAs, and particularly if you can’t itemize your deductions, consider making 2019 charitable donations via qualified charitable distributions from your IRAs. Such distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. But the amount of the qualified charitable distribution reduces the amount of your required minimum distribution, which can result in tax savings.

YEAR-END ACTION: Absent extenuating circumstances, try to ‘bunch’ charitable donations in the year they will do you the most tax good. For instance, if you will be itemizing in 2019, boost your gift giving at the end of the year. Conversely, if you are claiming the standard deduction this year, you may decide to postpone contributions to 2020.

For donations of appreciated capital-gain property that you have owned longer than one year, such as stock, you can generally deduct an amount equal to the property’s fair market value (FMV). Otherwise, the deduction is typically limited to your initial cost. Also, other special rules may apply to gifts of property. Notably, the annual deduction for property donations generally cannot exceed 30% of AGI.

If you intend to donate securities to a charity, you might choose securities you have held longer than one year that have appreciated substantially in value. Conversely, it usually is preferable to keep securities you have owned less than a year.

TIP: If you donate to a charity by credit card late in the year — for example, if you are making an online contribution — you can write off the donation on your 2019 return, even if you do not actually pay the credit-card charge until 2020.

Alternative Minimum Tax

Briefly stated, the alternative minimum tax (AMT) is a complex calculation made parallel to your regular tax calculation. It features several technical adjustments, inclusion of ‘tax preference items,’ and subtraction of an exemption amount (subject to a phase-out based on your income). After comparing AMT liability to regular tax liability, you effectively pay the higher of the two.

YEAR-END ACTION: Have your AMT status assessed. Depending on the results, you may then shift certain income items to 2020 to reduce AMT liability for 2019. For instance, you might postpone the exercise of incentive stock options (ISOs) that count as tax preference items.

Thanks to the TCJA, the AMT is now affecting fewer taxpayers. Notably, the TCJA substantially increased the AMT exemption amounts (and the thresholds for the phase-out), unlike the minor annual ‘patches’ authorized by Congress in the recent past.

TIP: The two AMT rates for single and joint filers for 2019 are 26% on AMT income up to $194,800 ($97,400 if married and filing separately) and 28% on AMT income above this threshold. Note that the top AMT rate is still lower than the top ordinary income-tax rate of 37%.

Education Tax Breaks

The tax law provides tax benefits to parents of children in college, within certain limits. These tax breaks, including a choice involving two higher-education credits, have been preserved by the TCJA.

YEAR-END ACTION: If you pay qualified expenses for next semester by the end of the year, the costs will be eligible for a credit in 2019, even though the semester does not begin until 2020.

Typically, you must choose between the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). The maximum AOTC of $2,500 is available for qualified expenses of each student, while the maximum $2,000 LLC is claimed on a per-family basis. Thus, the AOTC is usually preferable. Both credits are phased out based on modified adjusted gross income.

The TCJA also allows you to use Section 529 plan funds to pay for up to $10,000 of K-12 tuition expenses tax-free. Previously, qualified expenses only covered post-secondary schools.

TIP: If your student may be graduating in 2020, you may want to hold off and pay the spring 2020 tuition in early January 2020. The student can usually use this credit to offset their own 2020 tax liability even if the parent’s income exceeds the thresholds.

Estimated Tax Payments

The IRS requires you to pay federal income tax through any combination of quarterly installments and tax withholding. Otherwise, it may impose an ‘estimated tax’ penalty.

YEAR-END ACTION: No estimated tax penalty is assessed if you meet one of these three ‘safe-harbor’ exceptions under the tax law. These exceptions consider the timing of quarterly estimates as well as your withholdings. You should review your payments with a tax professional prior to year-end.

BUSINESS TAX PLANNING

Depreciation-related Deductions

Under the TCJA, a business may benefit from a combination of three depreciation-based tax breaks: (1) the Section 179 deduction, (2) ‘bonus’ depreciation, and (3) regular depreciation.

YEAR-END ACTION: Acquire property and make sure it is placed in service before the end of the year. Typically, a small business can then write off most, if not all, of the cost in 2019.

1. Section 179 deductions: This tax-code section allows you to ‘expense’ (i.e., currently deduct) the cost of qualified property placed in service during the year. The maximum annual deduction is phased out on a dollar-for-dollar basis above a specified threshold.

The maximum Section 179 allowance has been raised gradually over the last decade, but the TCJA gave it a massive boost. In 2017, the deduction limit was $510,000, and the phase-out threshold was $2.03 million. Those figures rose to $1 million and $2.5 million in 2018, and $1.02 million and $2.55 million in 2019.

However, note that the Section 179 deduction cannot exceed the taxable income from all your business activities this year. This could limit your deduction for 2019.

2. Bonus depreciation: The TCJA doubled the previous 50% first-year bonus depreciation deduction to 100% for property placed in service after Sept. 27, 2017. It also expanded the definition of qualified property to include used, not just new, property.

Note that the TCJA gradually phases out bonus depreciation after 2022. This tax break is scheduled to disappear completely after 2026.

3. Regular depreciation: Finally, if there is any remaining acquisition cost, the balance may be deducted over time under the Modified Accelerated Cost Recovery System (MACRS).

TIP: A MACRS depreciation deduction may be reduced if the cost of business assets placed in service during the last quarter of 2019 (Oct. 1 through Dec. 31) exceeds 40% of the cost of all assets placed in service during the year (not counting real estate). Additionally, many states, including Massachusetts and Connecticut, do not recognize bonus depreciation. This should be included in your planning considerations.

Travel Expenses

Although the TCJA repealed the deduction for entertainment expenses beginning in 2018, you can still deduct expenses for travel and meal expenses while you are away from home on business and in other limited situations. The primary purpose of the expense must meet strict business-related rules.

If you travel by car, you may be able to deduct your actual expenses, including a depreciation allowance, or opt for the standard mileage deduction. The standard mileage rate for 2019 is 58 cents per business mile (plus tolls and parking fees). Annual depreciation deductions for ‘luxury cars’ are limited, but the TCJA generally enhanced those deductions for vehicles placed in service in 2018 and thereafter.

TIP: The IRS recently issued a ruling that explains when food and beverage costs are deductible when those costs are stated separately from entertainment on invoices or receipts.

QBI Deductions

The TCJA authorized a deduction of up to 20% of the ‘qualified business income’ (QBI) earned by a qualified taxpayer. This deduction may be claimed by owners of pass-through entities — partnerships, S corporations, and limited liability companies (LLCs) — as well as sole proprietors.

YEAR-END ACTION: The QBI deduction is reduced for some taxpayers based on the amount of their income. Depending on your situation, you may accelerate or defer income at the end of the year, according to the figures.

First, however, it must be determined if you are in a ‘specified service trade or business’ (SSTB). This includes most personal-service providers. Then three key rules apply:

1. If you are a single filer with income in 2019 below $160,725 or a joint filer below $321,400, you are entitled to the full 20% deduction.

2. If you are a single filer with income in 2019 above $210,700 or a joint filer above $421,400, your deduction is completely eliminated if you are in an SSTB. For non-SSTB taxpayers, the deduction is reduced, possibly down to zero.

3. If your income falls between the thresholds stated above, your QBI deduction is reduced, regardless of whether you are in an SSTB or not.

TIP: Other rules and limits may apply, including new guidelines for real-estate activities. Consult with your tax advisor for more details about your situation.

Business Repairs

While expenses for business repairs are currently deductible, the cost of improvements to business property must be written off over time. The IRS recently issued regulations that clarify the distinctions between repairs and improvements.

YEAR-END ACTION: When appropriate, complete minor repairs before the end of the year. The deductions can offset taxable business income in 2019.

Estimated Tax Payments

A corporation (other than a large corporation) that anticipates a small net operating loss for 2019 (and substantial net income in 2020) may find it worthwhile to accelerate just enough of its 2020 income (or to defer just enough of its 2019 deductions) to create a small amount of net income for 2019.

YEAR-END ACTION: This will permit the corporation to base its 2020 estimated tax installments on the relatively small amount of income shown on its 2019 return, rather than having to pay estimated taxes based on 100% of its much larger 2020 taxable income.

Bottom Line

These are just some of the year-end steps that can be taken to save taxes. As previously mentioned, be aware that the concepts discussed in this article are intended to provide only a general overview of year-end tax planning. It is recommended that you review your personal situation with a tax professional.

Kristina Drzal-Houghton, CPA, MST is the partner in charge of Taxation at Holyoke-based Meyers Brothers Kalicka, P.C.; (413) 536-8510.

Accounting and Tax Planning

Section 199A

Section 199A of the Tax Cuts and Jobs Act was created to level the playing field when it comes to lowering the corporate tax rate for those businesses not acting as C corporations. For most profit-seeking ventures, qualifying for the deduction is not difficult, but for rental real estate, it becomes more difficult.

By Lisa White, CPA

On Dec. 22, 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law, bringing with it a plethora of changes, affecting, albeit in varying degrees, every taxable and non-taxable entity and individual.

One of the primary focuses of the act was to lower the corporate tax rate to a flat rate of 21%. In order to keep the taxable-entity landscape equitable, however, a provision was necessary for those businesses not operating as C corporations.

Thus, Section 199A was created, providing for a deduction of up to 20% of qualified business income from a domestic business operating as a sole proprietorship, partnership, S corporation, trust, or estate.

The first step in assessing the benefit of the Section 199A deduction is to determine if there is a qualified activity. The statute uses Section 162 of the Internal Revenue Code to designate qualification — which is difficult since Section 162 does not actually provide a clear definition of what constitutes a trade or business.

“What might be the easiest way to approach making the determination is the ‘walks like a duck, quacks like a duck’ scenario. If the activity is a profit-seeking venture that requires regular and continuous involvement, there should not be an issue with rising to the level of a qualified trade or business under Section 162 — and thus being eligible for the Section 199A deduction.”

Instead, case law must be used to support the position taken. What might be the easiest way to approach making the determination is the ‘walks like a duck, quacks like a duck’ scenario. If the activity is a profit-seeking venture that requires regular and continuous involvement, there should not be an issue with rising to the level of a qualified trade or business under Section 162 — and thus being eligible for the Section 199A deduction.

For rental real estate, the determination becomes a bit more complicated. If the rental activity consists of property being rented to or among a group of commonly controlled businesses, where the same owner — or group of owners — owns directly or indirectly at least 50% of both the rental property and the operating business, and the operating business is not a C corporation, then the qualifying designation is automatic. Otherwise, to make the determination, we must once again turn to case law.

Here, this becomes problematic, as there is limited history supporting the position that rental activities rise to the level of a Section 162 trade or business, as the designation heretofore was unnecessary.

In response to concerns about the lack of guidance, the Internal Revenue Service issued Revenue Procedure 2019-7, which provides for a safe harbor under which a rental-real-estate activity will be treated as qualifying for the Section 199A deduction. In addition to holding the rental property either directly or through a disregarded entity, other qualifying factors include the following:

• Separate books and records are maintained for each rental activity (or rental activity group);

• At least 250 hours of rental services are performed each year on each rental activity; and

• For tax years ending after 2018, contemporaneous records are maintained detailing hours of services performed, description of services performed, dates on which services were performed, and, who performed the services.

When making the determination of whether an activity rises to the level of a trade or business under the general rules, each activity must be assessed separately, and no grouping is permitted.

Alternatively, the safe-harbor provision provides an opportunity to elect to group rental activities together in order to meet the other qualifications. The caveat here is that commercial properties must be grouped only with other commercial properties, and likewise for residential properties. Once made, the grouping election can be changed only if there is a significant change in the facts and circumstances. The rental services performed that qualify for the 250-hour requirement include tasks such as advertising, negotiating leases, collecting rent, and managing the property, among others. Financial-management activities, such as arranging financing or reviewing financial statements, do not qualify as ‘rental services,’ nor does the time spent traveling to and from the property. The rental services can be performed by the owners of the property or by others, such as a property-management company.

The safe-harbor election is available to both individuals and pass-through entities and is made by attaching a signed affidavit to the filed return stating that the requirements under the safe-harbor provision have been met.

It’s important to note here that, although meeting the safe-harbor requirements will qualify the activity for Section 199A, it does not provide automatic qualification under Section 162. Similarly, failure to satisfy the safe-harbor requirements does not mean the activity automatically does not qualify for the deduction. Instead, support for the position will just need to be derived from considering other relevant factors and/or case law that can be used as precedent.

Additionally, the safe-harbor election cannot be made for residences used personally for more than 14 days during the year, nor for properties rented on a triple-net-lease basis, a scenario where the tenant is responsible for the taxes, insurance, and general maintenance related to a rental property.

If pursuing the Section 199A deduction for rental property without using the safe-harbor provision, some factors to consider documenting would be the type of property rented, the day-to-day involvement of the owner (or the owner’s agent), and the types and significance of any ancillary services provided.

It seems the courts have applied a relatively low threshold in finding rental activities to rise to the level of a Section 162 trade or business, but it’s also important to note that implications of that designation have changed significantly. One thing is for certain: if the position is taken that the rental activity is a trade or business for the Section 199A deduction, then it needs to be treated as a trade or business in all other aspects, as well, which could mean additional filings (i.e. Forms 1099) and becoming subject to different tax regulations (i.e. interest-limitation rules).

Ultimately, although the Section 199A deduction was implemented as a means of leveling the playing field for the tax impact of entity choice and could potentially offer significant tax savings, in order to take advantage of the deduction, the related activity must first qualify for the deduction.

Reaching this designation is relatively easy for most business operations, but might require more analysis when considering rental activities. There are some options available, such as the safe-harbor and grouping elections, but the related tax impact should be carefully considered prior to making any election.

Be sure to consult with your tax advisor if you have any questions.

Lisa White, CPA is a tax manager with the Holyoke-based public accounting firm Meyers Brothers Kalicka, P.C.; (413) 322-3542; [email protected]

Accounting and Tax Planning

Employee or Contractor?

By Danielle Fitzpatrick

Taxpayers often ask about the difference between being an independent contractor and an employee. Although it may seem like they both perform similar work, there are some significant differences when it comes to their responsibilities and when filing annual income-tax returns.

Perhaps you are currently working for an employer and are considering becoming a contractor, or maybe you have just graduated college with a degree and are trying to decide which option is best for you. Whichever route you decide to take, it is important to know the differences so that you can plan accordingly.

Differences in Responsibilities

You are considered an employee when the business you work for has the right to direct and control the work you perform. You are given specific instructions on when and where to work, and are often provided training and the necessary equipment needed to perform specific duties. As an employee, you receive regular wages and may be eligible for benefits such as insurance, retirement, vacation, and sick pay.

You are considered a contractor when services are provided for a specific period of time. Rather than being paid a regular wage, you are paid a flat fee for contractual services. As an independent contractor, you are not eligible for benefits or training through the businesses you are performing services for. You are in charge of your own schedule and typically have several clients for which you are providing services.

Differences at Tax Time

One of the biggest differences between being an employee and a contractor is how your income is taxed on your income-tax return. Unfortunately, the difference is often not realized until an individual files their return and is faced with a significant tax burden.

As an employee, your employer pays 50% of your Medicare and Social Security (FICA) taxes. The other 50% is withdrawn from your regular paycheck along with federal and state (if applicable) tax withholdings. If any expenses are incurred and unreimbursed by your employer, the expenses are not deductible for the employee. On an annual basis, you receive a Form W-2, which shows your taxable income along with all taxes that you had withheld throughout the year.

“One of the advantages of being a contractor is that you can deduct expenses you incur in relation to the income you receive. Record keeping is extremely important when becoming self-employed in order to ensure that you are tracking all applicable income and expenses.”

As a contractor, you are considered self-employed (a sole proprietor). You are now responsible for 100% of the FICA taxes, also known as self-employment taxes. No federal or state tax withholdings are withdrawn from the income you receive, and you may be required to make quarterly estimated tax payments. On an annual basis, you receive a Form 1099-MISC showing the gross income you received in excess of $600 for each business you performed services for. All of the income you receive as a contractor is reportable on Schedule C, which is filed with your individual income-tax return, or on a business tax return if you choose to become incorporated.

One of the advantages of being a contractor is that you can deduct expenses you incur in relation to the income you receive. Record keeping is extremely important when becoming self-employed in order to ensure that you are tracking all applicable income and expenses. Expenses that may help offset your income include, but are not limited to, vehicle expenses, travel expenses, supplies, fees paid for continuing education, and the renewal of professional licenses.

Some Examples

Say you are an employee making $25 an hour and working 40 hours a week. For this example, note that nothing is being withheld for benefits. Your paycheck would look like the following:

Weekly Pay ($25 x 40 hrs.) $1,000
Less:
Federal Taxes Withheld       $200
State Taxes Withheld             $50
FICA Taxes Withheld             $77
Total Weekly Pay              $673

Now, say you are a contractor and charge $25 an hour to provide services to three businesses totaling 40 hours for the week. You receive a total of $1,000 for the week. In addition, you purchased $30 in office supplies and drove 250 miles for the week. Your net income for the week would be:

Gross Income             $1,000
Less:
Office Supplies                $30
Mileage Expense           $145
Taxable Net Income    $825

Now you’re thinking, why am I not a contractor? I bring home over $300 more a week! Yes, you bring home more for the week, but you cannot forget that taxes are not being withheld from your income. You will be responsible for paying these taxes on a quarterly basis and/or when you file your tax return.

As an employee, you report $1,000 as taxable wages on your income-tax return, from which federal and state taxes have already been withheld and will hopefully cover your tax liability. As a contractor, you have taxable net income of $825, but you are now responsible for self-employment tax, in addition to regular income tax that you have not yet paid.

Conclusion

So, should you become an independent contractor or an employee? There is no right or wrong answer; each individual needs to make their own decision and determine what will work best for them and their situation. However, whichever route you decide to take, be sure to consult your tax professional for advice to eliminate any potential surprises and ensure that you are prepared when it comes to filing your annual income-tax returns.

Danielle Fitzpatrick, CPA, is a tax manager at Melanson Heath. She is part of the Commercial Services department and is based out of the Greenfield office. Her areas of expertise include individual income taxes and planning, as well as nonprofit taxes. She also works with many businesses, helping with corporate and partnership taxes and planning.

Accounting and Tax Planning

Recording Revenue

By Rebecca Connolly

Recording revenue is, in anyone’s mind, seen as a job well done when you complete selling your product or service or receiving a donation for your organization.

But a new revenue-recognition standard for non-public companies is effective for years ending Dec. 31, 2019 and annual periods then after, and business owners and managers must be aware of what this new standard means.

The new revenue-recognition standard, Accounting Standards Codification 605, Revenue Recognition, created a five-step process to determine when you should recognize revenue.

• Step 1: Identify a contract with a customer. This contract can include an invoice, a formal signed contract, and other various forms agreed to upon the purchase of goods or services. Once a contract has been identified, you proceed to step 2.

“Know what you are signing and know, if you are entering into a long-term contract, how to structure it in accordance with generally accepted accounting principles.”

• Step 2: Identify the performance obligations (promises) in the contract. Contracts can have one or more performance obligations. An example of one performance obligation is to deliver the 10 office chairs that were ordered by a customer. An example of multiple performance obligations within a contract is a construction contract that requires a house to be built and suitable for living, a driveway to be installed, and a garage to be constructed. The key item here is to know what you are signing and know, if you are entering into a long-term contract, how to structure it in accordance with generally accepted accounting principles. Then you proceed to step 3.

• Step 3: Determine the transaction price. Transaction price is the amount of consideration the entity expects to be entitled to, in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. This item concerns how much money the entity expects to receive. As one example, if you sell office chairs for $59 a chair, but there is a sale and the chairs are now $45 a chair, then the revenue the entity can expect to receive for the chair at this time is $45 a chair. Elements from step 2 and step 3 are then used in step 4.

• Step 4: Allocate the transaction price to the performance obligation in the contract. If there is only one performance obligation of the office- chair delivery, then no allocation is needed. It gets complicated when you have more than one performance obligation in a contract. The best method is to allocate the price per performance obligation in the contract itself. Continuing the example of the construction of a house, the price could be allocated at $200,000 and the garage and driveway obligation could potentially be allocated at $100,000. An important element here is to be consistent in your application of the price allocations and document your process with the allocation among performance obligations. Once prices are allocated, you can proceed to step 5.

• Step 5: Recognize revenue when (or as) the reporting organization satisfies a performance obligation. Recognizing the revenue in the amount determined in step 4 has become more of a checklist item, as, yes, we have completed the performance obligation, and now the revenue can be recorded. This step is ‘I have delivered the office chairs and have completed the performance obligation with this contract.’

Conclusion

The moral of the new revenue-recognition standard is that the rules are changing, and it is best to look at your contracts and how you record revenue now before your accountant comes in and notes your revenue is overstated by $300,000.

Rebecca Connelly, CPA is a manager for West Springfield-based Burkhart, Pizzanelli, P.C. She is involved in the accounting and consulting aspects of the practice and manages engagements of various size and complexity, including nonprofit and construction companies, manufacturing, and distributors; (413) 734-9040.

Accounting and Tax Planning

Looking Back — and Ahead

April 15 has come and gone, and many people are not looking back on the recent tax season with fond memories. Indeed, for many there were surprises and refunds lower than expected. One of the keys to not being surprised or disappointed is planning, as in year-round planning.

By Danielle Fitzpatrick, CPA

Many taxpayers think about taxes only once a year, and that one time is when they are filing their income-tax return. However, taxpayers should be thinking about their taxes year-round.

Many people do not consider how a change in their life may affect their taxes until they see the outcome the following year. Surprises may be avoided if they were to seek the advice of their tax professional ahead of time.

Seeking the advice of a tax professional throughout the year is very important. Certified public accountants (CPAs) who specialize in tax are not just tax preparers. CPAs can be trusted advisors who can help meet your personal wealth-creation, business-management, and financial goals.

Danielle Fitzpatrick

Danielle Fitzpatrick

The 2018 tax-filing season brought some of the biggest tax-law changes that we’ve seen in more than 30 years, and left many taxpayers surprised with their tax outcome. Perhaps you were pleasantly surprised by the additional money you received because you have children, or maybe you were one of the many who were shocked because of the reduced refunds or liability that you owed for the very first time.

If you were unhappy with the results of your 2018 tax return, you now have an opportunity to plan for the future. Review your 2018 income-tax return and determine if changes need to be made. Did you owe money for the first time because your withholdings decreased too much, or because you are now taking the standard deduction due to the loss of several itemized deductions?

Consider this — if your income and deductions were to remain relatively the same in 2019 as they were in 2018, would you be happy with your results, or do you wish they were different?

“If you were unhappy with the results of your 2018 tax return, you now have an opportunity to plan for the future.”

After you have looked at your 2018 income-tax return, you should then consider what changes may need to occur in 2019. Your tax accountant can help you determine how an expected change can impact your tax liability and try to ensure that you are safe-harbored from potential underpayment penalties.

Individuals may be subject to underpayment penalties on both their federal and state returns if they do not meet specific payment requirements each year through withholdings and/or estimated tax payments. Your accountant can also help you determine if a change in withholdings at work or through your retirement is necessary, or whether there is a need to adjust or make estimated tax payments.

These changes can help you avoid, or reduce, any potential underpayment penalties.

There are so many changes in a person’s life that could impact their tax return. Some changes include, but are not limited to, getting married or divorced, having a baby, sending a child to college, retiring, or starting a new job.

Maybe you have decided to start your own business and now are responsible for self-employment tax. Or maybe you have decided that you need to sell that rental property or second home you have had for many years. Perhaps you are a beneficiary of an estate for a loved one who passed away or have decided to sell stock through your investments. These are all examples of changes that could significantly impact your taxes.

Businesses also experience changes that could have an impact on their business returns. These changes include, but are not limited to, purchasing or selling a business, investing in a new vehicle or piece of equipment, or maybe the company has grown and you want to start providing benefits to your employees.

All the above examples could have a major impact on your individual or business income-tax returns, and that impact could be reduced if you were to reach out to a tax professional for advice before the next tax season. Besides the changes briefly mentioned above, here are two lists of questions (personal and business) that may be helpful in your next discussion with your tax professional.

First, some questions to ask your accountant in relation to your personal taxes:

• How much should I be contributing to my retirement, and which type of retirement best suits my needs?

• Am I adequately saving for my children’s education, and should I consider an education savings plan?

• Do I have adequate health, disability, and life insurance?

• When should I start taking Social Security benefits?

• When do I sign up for Medicare?

• Have I properly planned for Medicaid?

• Do I need a will, or when should my existing will be updated?

• Should I consider a living trust?

• Are my bank accounts, retirement accounts, and investment accounts set up appropriately so they avoid probate if I pass away?

• Are my withholdings and/or estimated tax payments adequate?

• When should I sell my rental property, and how much should I expect to pay in taxes?

• Can I still claim my child as a dependent even though they are no longer a full-time student?

• I’m inheriting money from a loved one who passed away; will this affect my taxes?

• I’m thinking about starting my own business; how will this impact my taxes going forward?

• My financial advisor told me I would have significant capital gains; how will this affect my tax liability?

Here are some questions to ask your accountant in relation to your business:

• What business structure is most appropriate for my circumstances?

• How do I know if my business is generating a profit?

• Am I pricing my products and services properly?

• How would my business function if my bookkeeper left tomorrow?

• What controls should I have in place to prevent employees from misusing company funds?

• Should I upgrade my accounting software?

• Do I need compiled, reviewed, or audited financial statements?

• Are my withholdings and/or estimated tax payments adequate?

• Can I claim a deduction for an office in my home?

• Should I buy a new truck or equipment before year-end?

• Should I buy or lease a vehicle?

• Should I implement a retirement plan before year-end?

• What is the overall value of my business?

• What should my exit strategy be?

• What are the tax consequences of selling my business?

Whether you are experiencing a major change in your life or want to plan for your future, do not forget to reach out to your tax professional to determine how it may affect your income taxes. u

Danielle Fitzpatrick, CPA, is a tax manager at Melanson Heath. She is part of the Commercial Services Department and is based out of the Greenfield office. Her areas of expertise include individual income taxes and planning, as well as nonprofit taxes. She also works with many businesses, helping with corporate and partnership taxes and planning

Accounting and Tax Planning

A Proactive Step That Adds Up

By Joe Lemay, CPA

I’m sure you’ve heard by now, but there were quite a few changes to the tax law in 2018. When the Tax Cuts and Jobs Act (TCJA) was signed into law into December 2017, it took an axe to many itemized deductions on your personal return.

Of these, the deduction for unreimbursed employee business expenses, such as business travel or car expenses, tolls, and parking, is one of significant note. However, despite the lost deduction, there may be an alternative solution that can be a win-win for employers and employees.

Prior to the TCJA, unreimbursed employee business expenses were deductible as a ‘miscellaneous’ deduction on an individual’s return. All miscellaneous deductions were deductible in excess of 2% of adjusted gross income (AGI).

For example, if your AGI was $100,000 in 2017, you could claim only a deduction for the amount of your total miscellaneous expenses that exceeded $2,000. If you had a total of $3,200 of unreimbursed employee expenses, you would have been able to deduct $1,200 on your personal return in 2017. Now fast-forward to 2018, and the $3,200 of unreimbursed employee expenses are not deductible at all on the individual return.

The Solution

You may be thinking the changes noted above sound unfair. However, a company can establish an ‘accountable plan,’ which may serve to remedy this change. An accountable plan is a reimbursement or other expense-allowance arrangement between an employer and employee, which reimburses employees for business expenses that are not recorded as income to the employee and are generally deductible by the employer as business expenses.

If the accountable plan is followed properly, the company reimburses an employee for substantiated business expenses, and then, in turn, the company deducts those business expenses on its income-tax return. The reimbursements are excluded from the employee’s gross income, not reported as wages or other compensation on the employee’s W-2, and are also exempt from federal income-tax withholding and employment taxes.

The company can negotiate with the employee to reduce the employee’s wages in exchange for the reimbursement, thereby saving the company payroll taxes, which includes Social Security tax of 6.2% on gross wages, capped at $132,900 (for 2018) and Medicare tax of 1.45%. By executing this transaction appropriately, the employee receives full reimbursement for business expenses, while seeing no change in their overall income, and the company benefits by saving on payroll taxes.

For example, Johnson Inc. has a sales team, which includes its ace salesman, Dave. During 2017, Dave earned $105,000 in base compensation and had $7,000 of unreimbursed business expenses. Assuming Dave’s base compensation of $105,000 is also his adjusted gross income, Dave would have been able to deduct $4,900 of his unreimbursed business expenses on his personal tax return in 2017. The remaining $2,100 of unreimbursed business expenses is a lost deduction.

Now let’s assume Johnson Inc. establishes and properly follows an accountable plan in 2018. During 2018, Dave earns the same $105,000 reduced by the elective expense allowance of $7,000 to a new taxable base of $98,000. Under the accountable plan, Dave is reimbursed in full for his business expenses; therefore, his net income, subsequent to reimbursements, remains the same as 2017 at $98,000. However, in this scenario, the company saves Social Security and Medicare tax in the amount of $535 (7.65% combined tax rate multiplied by $7,000 of reduced wages). While this savings may not seem like a lot, imagine a sales team of 25 employees; that is a potential savings of $13,375. Think about what you could do with that savings as a business owner.

How to Establish an Accountable Plan

The following criteria must be met for the plan to be accountable:

The accountable plan must prove the business connection for the reimbursements and/or allowances. The typical allowable deductions are travel, supplies, local transportation, meals incurred while away on business, and lodging.

The accountable plan must also have adequate support and records (such as itemized receipts) that substantiate the expense’s amount and purpose. The substantiation should be examined and approved by a manager or supervisor. The plan also requires the employee to return any advances back to the company which are not business expenses. Excess advances must be returned to the company within a reasonable period after the expense is paid or incurred. If excess advances to employees are pocketed by the employee, the excess advances are subject to federal income-tax withholdings and employment taxes.

The business-connection requirement is satisfied if a plan only reimburses employees when a deductible business expense has been incurred in connection with performing services for the company and the reimbursement is not in lieu of wages that the employees would otherwise receive. The company cannot simply shift taxable wages to the employee to non-taxable reimbursements without adequately proving the business connection.

There is no specific IRS form used to adopt an accountable plan, nor does the tax law require an accountable plan to be in writing; however, it would behoove employers to write down a formal plan.

Costs and Benefits of an Accountable Plan

The benefits produced from an effective accountable plan are clear. The employee is reimbursed in full for business expenses, and the company can save on payroll taxes, a win all around for everyone. However, the costs of implementing an accountable plan must also be factored in.

The company must have an organized process for tracking employee reimbursements, maintaining appropriate support that substantiates the business connection of employee reimbursements and is timely with reimbursements and requests for payback from its employees.

Companies with highly functioning accounting and/or human-resource departments will not have an issue with meeting these tasks; however, companies with low-functioning accounting and human-resource departments could struggle with appropriately maintaining an accountable plan.

Conclusion

Utilizing an accountable plan is an overall win for employers and employees. But consistency must be maintained throughout the year in order to yield the benefits.

Joe Lemay, CPA is a senior associate with the Holyoke-based public accounting firm Meyers Brothers Kalicka, P.C.; (413) 322-3520; [email protected]

Accounting and Tax Planning

When Experts Become Victims

By Julie Quink

Julie Quink

Julie Quink

As professionals who counsel clients on best practices relative to fraud prevention and detection techniques, we unfortunately are not immune to fraud attempts as well.

The schemes that individuals and companies have fallen victim to are many, but here are two schemes we feel are important to mention for which we have recent personal experience.

The Fake Check Scheme

In a fake check scheme, the fraudster can obtain a check for the company and replicate the check using software that can be acquired easily on the Internet. The replicated check may look like an authentic company check written to a legitimate vendor.

By creating a replica of a legitimate company check, the fraudster now can generate a check payable to themselves or another entity for any amount. The check is entered into the banking system, deposited or cashed like a normal, routine check. If the check is negotiated at an out- of-state bank, it can take longer to move through the clearing process, and the fraudster can get the funds before the company or bank, which the company uses, is notified.

In this scheme, the original, authentic check is kept intact, and a fake replacement is generated using the information from the original check with slight modifications.

The Forged Payee Scheme

The forged payee scheme is a scheme whereby a fraudster intercepts a company check paid to a vendor for a legitimate invoice and washes the check to remove the original payee, amount, and sometimes date. The washing is done through a chemical process that removes the unwanted information so that the check becomes ‘blank’ again and can be modified with the information that the fraudster includes.

“It is always best practice to keep blank checks secured and accessible to only those who need access, thereby limiting the opportunity to generate fake checks.”

The original, authorized check signer’s signature is still on the check, so on its face, the check appears authentic to the bank clearing the check, and the fraudster can negotiate the check through deposit or check cashing. On its face, most times the check does not look to be altered or modified, so visually it is difficult to determine that the check is not a valid, authentic check.

Effects of Fraudulent Checks

In addition to the possible loss of company funds to the fraud, a level of business interruption can occur as a result of these schemes. The fraudster now knows the company’s routing information, bank account, name, and other critical information on the check and can continue to attempt to perpetuate the fraud. It is best practice to change the bank account to assist in preventing the fraud from continuing to occur.

Changing a bank account may not seem a significant interruption, perhaps, but if you consider all the transactions that occur within that account, it can be significant. Many companies use outside payroll firms that automatically withdraw funds from their account. Clients or customers may pay their bills automatically through ACH transactions. Vendors may also be paid electronically through the bank account.

The changing of the bank account requires consideration of all the transactions and activities that occur within that account and making the appropriate notifications to those parties to ensure the correct bank account information is provided to ensure continued operations.

Detection and Prevention Techniques

It is always best practice to blank checks secured and accessible only to those who need access, thereby limiting the opportunity to generate fake checks. Internal controls over the check-processing and mailing functions within a company are preventive measures to assist in minimizing the risk of forged payees.

These techniques can include a segregation of duties in the check-disbursement process to allow for appropriate oversight and control over the process.

Keep in mind that potential fraudsters can exist within a company as employees. They can also be external to the company. Consider that it is difficult at best to contemplate when a check, which has been mailed to a legitimate vendor for a legitimate expense, will be intercepted from the time it is mailed to the time it reaches a fraudster and is then replicated. The fraudster could be employed by the vendor that is receiving the company check.

In the age of electronic banking and ease of access to information, it is critical that bank-account activity be reconciled on a recurring, consistent basis to identify any unusual items. In addition, the reconciliation will identify older checks that have not yet cleared through the account but normally would clear in a timely fashion.

Through routine and timely reconciliation of bank accounts, items such as unusual, unauthorized checks can be easily identified and quickly investigated.

Many banks offer a service, which is most commonly referred to as ‘positive pay.’ This service requires the company to send over a check-disbursement list to the bank indicating all checks written. The bank will use the list to determine which checks will clear the company bank accounts. It is a higher-level control that can assist in preventing unauthorized checks.

Bottom Line

A heightened sense of awareness and evaluation of internal controls in place, including reconciliations, in addition to feeling comfortable with your banking partners and their controls, is critical to ensuring that your accounts are protected.

Julie Quink, CPA is managing principal of the West Springfield-based accounting firm Burkhart Pizzanelli; (413) 734-9040.

Accounting and Tax Planning

Items That Add Up

By Kathryn A. Sisson, CPA, MST

There are many changes that businesses and individuals should be aware of under The Tax Cuts and Jobs Act (TCJA), the most significant tax legislation in the U.S. in more than 30 years. Here are the 10 changes that will have the most significant impact this tax season.

Individuals

1. Tax Rates. The 2018 tax brackets have changed, resulting in lower tax rates for most individuals. For example, the 15% tax bracket has been reduced to 12% and the 25% bracket to 22%.

2. Income-tax Withholding. As a result of the lower taxes rates, income-tax withholding during 2018 also decreased for most individuals. This could result in underpayment of taxes for 2018, depending on your tax situation. Taxpayers should carefully review their withholding going into 2019 and discuss it with their tax professional.

3. Itemized Deductions. TCJA made several changes to itemized deductions as noted below.

Medical Expenses: TCJA lowered the threshold for the medical-expense deduction to 7.5% of AGI for 2017 and 2018. The threshold for 2019 is 10% for most taxpayers.

State and Local Taxes: TCJA limits the deduction for state and local taxes to $10,000 per year. This includes payments for state income tax, property tax, and excise tax. The same $10,000 limit applies regardless of whether you are a single taxpayer or if you are married and file a joint return. The deduction for taxpayers who are married and filing separate returns is limited to $5,000.

Kathryn A. Sisson

Kathryn A. Sisson

Mortgage Interest: Interest is generally deductible on original home acquisition debt up to $750,000. Home-equity interest is deductible only if the funds were used to improve the mortgaged property.

Charitable Donations: Donations are generally deductible up to 60% of AGI, up from 50%, for most donations. You could also consider giving directly from your IRA if you are over age 70 1/2 or gifting appreciated stock directly to a charity. Discuss with your tax professional in order to maximize your benefit.

Miscellaneous Itemized Deductions: TCJA has eliminated miscellaneous itemized deductions. These include deductions for unreimbursed employee business expenses, tax-preparation fees, and investment-advisory fees.

4. Increased Standard Deduction. One of the most significant provisions of TCJA is the near-doubling of the standard deduction for all taxpayers. For 2018, the standard deduction amounts are $24,000 for joint filers, $18,000 for head of household, and $12,000 for all other filers. The limitations on itemized deductions as noted above and the increased standard deduction amounts may make it less advantageous to itemize deductions.

5. Personal Exemptions. TCJA eliminated personal exemptions for 2018. For 2017, taxpayers received a personal exemption deduction of $4,050 per person. Therefore, a family of four received a deduction of $16,200 in 2017 that is no longer available under the new tax act.

Businesses

6. Tax Rates. A flat tax rate of 21% replaces the graduated tax rate brackets for C corporations that ranged from 15% to 39% in prior years.

7. Qualified Business Income (QBI) Deduction. A deduction of up to 20% of business income may be available to owners of pass-through entities. There are limitations based on several factors, including income of the taxpayer as well as the type of trade or business. The purpose of the deduction is to provide some parity between the new flat 21% corporate rate and the tax rates paid by owners of pass-through entities on their individual income-tax returns.

8. Depreciation. TCJA made significant changes to encourage businesses to expand and invest in new property; 100% bonus depreciation is now available for federal purposes, and the limitation on expensing certain assets has been increased to $1 million, with a $2.5 million investment limitation.

9. Business Credits. TCJA created a Family Leave Credit for employers making family-leave payments to employees. The credit is available only to employers who have a written policy in place for the payment and credit.

10. Deductions. Previously, the deduction for meals and entertainment was limited to 50% of expenses incurred. For 2018, 50% of meals are still deductible; however, entertainment expenses are no longer deductible.

Many of these changes are significant and warrant your full attention. As you approach tax season this year, seek the assistance of tax professionals, and do not follow your neighbor’s tax advice.

Kathryn A. Sisson, CPA, MST is a tax manager in the Commercial Services Department of Melanson Heath in Greenfield. She has 20 years of experience in public accounting and has been with Melanson Heath for 10 years. She has extensive experience in corporate and individual income-tax planning and review as well as financial-statement compilations and reviews. Her corporate experience includes working with businesses doing business in multiple states. She is also a QuickBooks ProAdvisor assisting many clients with general ledger systems and software training.

Accounting and Tax Planning

2018 Tax Planning (in 2019)

By Brendan Healy, CPA

Brendan Healy

Even though we’re into 2019, there are still tax-saving opportunities available for the 2018 tax year.

This article summarizes a number of options that businesses and taxpayers should consider to help minimize their tax burden when they file their 2018 tax returns. As with any tax-savings strategy, you should discuss these post-2018 year-end planning techniques with your tax advisor before implementing them.

Retirement-plan Contributions

Although some retirement plans needed to have been in place before Dec. 31 to be used for the 2018 year, there are plans that could be set up in 2019, funded, and then used as deductions for the 2018 tax return.

A simplified employee pension (or SEP) IRA, for example, can be set up after year-end and funded up to the due date (including extensions) of the taxpayer’s business.

New Opportunity-zone Funds

The new tax law created a significant tax incentive to encourage capital investment in certain locations that need development. If you sell an asset with a large capital gain, you may be able to defer that gain if you essentially reinvest that gain into an “opportunity-zone fund” within six months of that sale. If done properly, you wouldn’t recognize the tax gain until the latter of when your new investment is sold or Dec. 31, 2026. You can also get up to 15% of the deferred gain forgiven entirely for holding the investment for specified time period. And if you held the investment for an additional 10 years, you’d pay no tax on subsequent capital gains.

Capital-expenditure Tax Writeoff

The new tax law allows businesses to write off (or expense) larger amounts of fixed-asset purchases. The new law not only applies to personal property (machinery, equipment, computers, office furniture, etc.) but also increases the ability to write off certain real-estate improvements. It also increases the amount of tax deduction available for business-owned automobiles. These capital-expense writeoff elections are made at the time you file the tax return.

State Tax Planning

If you ship product to different states or if you sell over the internet across the country, there may be state tax-planning strategies available for your business. Certain businesses can take advantage of apportioning their revenue across several states. And if they do not have to file tax returns in those states, that apportioned revenue may never be subject to state income tax.

There have been significant changes this past year in the way states are allowed to (or not allowed to) tax out-of-state shipments entering their state. You should review your state income tax plan as well as your state sales tax reporting process in light of these new and significant changes.

Tax Credits

The tax law provides certain incentives to businesses by offering tax credits. The research and experimentation tax credit, for example, allows a business to convert a dollar of deduction into a dollar of tax credit. Since tax credits reduce taxes on a dollar-for-dollar basis, a tax credit is more valuable to the business than a tax deduction. So if the business is allowed to convert an expenditure into a credit, the tax savings could be substantial.

Many businesses (such as manufacturers or software companies) are not taking advantage of this tax credit that may be available to them.

Estate Planning and Gifts During Lifetime

The new tax law significantly increases the ability for families to transfer wealth upon death as well as allowing gifts during lifetime on a tax-free basis. Although estate and gift planning can get very complicated, the limits available today (which will expire in about seven years) are substantially higher than they have been in the past and allow for great flexibility in wealth-transfer planning.

Bottom Line

Just because 2018 is over does not mean we should stop thinking about tax-planning strategies for 2018 tax returns that will be filed over the next several months.

There are many tax incentives written into the tax law to encourage business and individual taxpayers to reinvest. It is up to you to make sure you are taking advantage of every one available to you and your business.

Brenden Healy, CPA, a partner at Whittlesey, is an expert in state and federal tax matters who consults with businesses and individuals and focuses his practice on closely held businesses in the real-estate, manufacturing and distribution, and retail industries.

Accounting and Tax Planning

Life in the Cloud Age

By Rebecca J. Connolly, CPA

Rebecca J. Connolly

Rebecca J. Connolly

If you’re anything like me, you wonder what a cloud is, besides the one I see when I look out my office window.

Most people resist change because they don’t know what it truly is, but let’s take a moment to ignore our instinct of ‘no’ and think about what this truly is and if it is right for your business. The cloud is not something you touch, but it is a tool in your corporate toolbox that you should consider using.

For business owners, the true questions are, what is cloud computing? How do I use it? Is it safe? And, why would I spend the money?

The true definition of cloud computing is confusing to most, but the information element is ease of use and availability. Many small-business owners need frequent access to their office network, and what if that office was fully accessible at your home computer?

There are many options that allow a business owner or worker to access their office computer, but cloud computing offers your business software to not be stored not on your laptop or desktop, but on an online solution that can help save the costs and late nights spent in the office.

I was skeptical as to how cloud computing would work and the true speed and efficiency of it, but I can travel all over the Northeast part of the U.S. for my clients and have everything available to me from any computer, including my laptop. How many of us are stuck carrying a laptop and waiting 15 minutes a day to load due to how large our software is? My laptop takes a minute or less to load due to minimal software being loaded on it because our office uses cloud computing.

You might ask, is cloud computing safe for my business? Nowadays we hear so often about data breaches that they are not shocking anymore, but just a thing of the times. So, let’s take a step back and think about how secure we are with our work computers, company data, and Internet access.

If you practice the gold standard of security, you don’t store any company files on your laptop itself, the laptop is backed up every day, and you do not use the internet except for required business activities. How many people do all three of these items? If you are part of the general population of business owners and workers, you put systems in place the best you can using your knowledge or your hired consultants’ suggestions. You then attempt to follow those processes and procedures, but again, you’re human, so maybe the local drive on your laptop is backed up only once at month at best.

Cloud computing could be your answer, or at least make you think about where your business stands and determine if you are losing time with your current work setup. Cloud computing has layers of security most people never think about, including frequent backups, two-factor authentication, and audit logs.

Another question people have once they partially understand the aspects of cloud computing is price. Now, I ask you, what is the price you are willing to pay to allow yourself and your workers access into your software securely at any time from any location?

The next question you should ask yourself is how much time, effort, and money are you losing using your current platform. Do you wait for your system to boot up for a long period of time every day, and so do all your employees? Is your current system secure, or do you just tell yourself it is so that you can sleep at night?

There are so many questions to ask here, but the first item to resolve when looking at how to move your company into the next phase of information technology is realizing that we know our business inside and out, whether it is making a product or providing a great service to our community. Just because we’re not experts in the field of cloud computing or technology in general does not mean that we couldn’t save time, money, and frustration, while also enhancing security, by looking into new technology to help the business grow.

Working in public accounting with many small-business owners allows me to realize there isn’t enough time in the day or week to allow for everything that needs to get done. Losing data and hard work because of a computer glitch or a bad information-technology setup is not only unacceptable, but also costly to businesses beyond price tags.

I’m not saying everyone needs to be using the cloud, because each business and every business owner is different. I am saying that it is prudent to take the time to access your current system, no matter how much time and effort it costs you, and evaluate if you are doing yourself and your business a disservice by not using cloud computing or a similar technology.

Rebecca J. Connolly, CPA is audit manager for the West Springfield-based accounting firm Burkhart Pizzanelli, certified public accountants; (413) 734-9040.

Accounting and Tax Planning

Five Hot Tax Topics

The Tax Cuts and Jobs Act represents a seismic shift within the broad realm of accounting and tax planning, and some of the aftershocks may not be felt, and fully understood, for some time. But some things are known, and individuals and businesses should understand their implications.

By Teresa Judycki

For better or worse, the Tax Cuts and Jobs Act was the most significant tax-law overhaul since the Reagan Administration, and there’s potential for more change on the way. With the breadth and depth of this law, it can be hard to determine what might be meaningful to you and your business.

This article will highlight five hot tax topics that may be particularly meaningful for this tax year.

Qualified Opportunity Funds

Taxpayers with large gains from sales of property to an unrelated person should be aware of Qualified Opportunity Funds. Enacted as part of the Tax Cuts and Jobs Act, a new Opportunity Zone program encourages investment in low-income community businesses.

Terri Judycki, CPA, MST

Terri Judycki, CPA, MST

The program allows individual and corporate taxpayers to defer tax on gains from the sale of stock or other assets by investing in an Opportunity Fund, which invests in businesses in Opportunity Zones. The tax is deferred until the earlier of Dec. 31, 2026 or the date the new investment is sold. To defer a gain, the taxpayer must invest within 180 days of the sale.

For example, if a taxpayer sells appreciated securities for $1 million at a $700,000 gain, tax on the $700,000 could be deferred until Dec. 31, 2026 (or earlier if the investment is sold prior to that date) by investing $700,000 in a Qualified Opportunity Fund within 180 days of sale. Capital gains on the new investment are exempt from tax if the investment is held for more than 10 years. Opportunity Funds may be a multi-investor fund or a single-investor fund established by a taxpayer to invest in projects he or she selects.

While there are a few multi-investor funds, many are hesitant to promise tax deferral until the IRS issues proposed regulations in this area, but September news is that the proposed rules are being reviewed and should be issued soon.

Foreign Accounts

For taxpayers with unreported income from foreign accounts, the Streamlined Filing Procedures (SFP) are still available. The Offshore Voluntary Disclosure Program ended Sept. 28, 2018.

Under SFP, taxpayers who can certify that the failure was non-willful can file amended returns and pay a reduced penalty. The IRS also has procedures in place for filing delinquent information returns reporting the existence of a foreign account when there has been no unreported income.

For example, a life-insurance policy with Sun Life may have a cash value that’s now increased to more than $10,000. That is a ‘foreign account’ that must be reported or could be subject to penalties. Consider reviewing any asset that is a foreign account and ensuring that tax filings are current, because penalties are confiscatory and may include criminal penalties.

The civil penalties for willful violations are capped at the greater of $124,588 or 50% of the amount in the account.

Employee Parking

I hoped to be able to provide you with specifics related to employee parking, but that guidance has not been issued as of the date of this writing. Perhaps there will be guidance by the time you are reading this article.

As a reminder, the Tax Cuts and Jobs Act provides that no deduction is allowed for the expense of a qualified transportation fringe, which includes van pools, transit passes, and qualified parking. Qualified parking is parking provided to an employee on or near the business premises of the employer or on or near a location from which the employee commutes to work by commuter highway vehicle or carpool. Tax-exempt organizations are subject to tax on the expense. But what is the ‘expense’ of qualified parking? At the 2018 AICPA Not-for-Profit Industry Conference, a speaker said that guidance had not yet been issued, because those in Treasury could not agree on the meaning of the law.

The cost of a parking permit is easy to quantify, but the law encompasses all expenses of providing parking. There are some practitioners who think a portion of depreciation on a parking lot owned by the business could be disallowed. Some others think the IRS may require apportioning office rent if the lease entitles the tenant to a certain number of parking spaces. As the law applies to amounts paid or incurred after Dec. 31, 2017, it affects computation of taxable income for entities with fiscal years ending in 2018. There are many practitioners hoping for retroactive repeal or postponement.

State and Local Tax Itemized Deduction

In August, the IRS issued proposed regulations in response to state legislation intended to circumvent the $10,000 limit on the state and local tax itemized deduction. A few states have enacted or considered enacting programs permitting state residents to make contributions to state agencies or charities in exchange for state and local tax credits that could be applied to income or property taxes.

In the proposed regulations, IRS restates the general rule that charitable deductions must be reduced by anything of value received in return for the charitable donation. The proposed rules, applicable to contributions made after Aug. 27, 2018, provide that, if a taxpayer receives a tax credit in return for a donation, the tax credit is a benefit to the taxpayer that must reduce the charitable contribution deduction.

It is important to note that these rules apply to programs created in response to the Tax Cuts and Jobs Act as well as to pre-existing programs, such as the Massachusetts program that provides tax credits in exchange for gifts of conservation land.

There has been no response from the IRS to the Connecticut strategy; Connecticut now imposes tax on a pass-through entity instead of on the individual partner or shareholder, which should result in shifting the deduction away from the individual who is subject to the $10,000 limit. The shareholder or partner should now be able to report his or her share of the entity’s income net of the state tax.

Trusts that pay taxes are also subject to the $10,000 limit, but a trust does not have to share the beneficiary’s $10,000 limit, providing a potential benefit.

Alimony

Finally, for those who will be divorced soon, the tax consequences of alimony differ for payments under instruments finalized after Dec. 31, 2018.

Before the Tax Cuts and Jobs Act, alimony was deductible by the payor and taxable to the payee. This resulted in shifting income from the higher-earning spouse paying the alimony to the former spouse who may be in a lower tax bracket. Alimony payments finalized after Dec. 31, 2018 will no longer be deductible by the paying spouse and no longer included in the income of the recipient spouse. There are some workarounds such as division of property where the spouse in the lower tax bracket receives property with the greatest unrealized gain or by using a Qualified Domestic Relations Order to shift retirement assets (along with the tax burden) to the lower-income spouse.

While this change will not affect pre-2019 alimony instruments, it may apply if the parties modify the pre-2019 agreement and state in the modification that the new rules are to apply. If this law change will impact you, be sure to discuss its effects with your attorney.

If you have any questions about the material featured in this article or how it might apply to you specifically, be sure to consult your tax professional or CPA.

Terri Judycki is a senior tax manager with Holyoke-based public accounting firm Meyers Brothers Kalicka, P.C.; (413) 322-3510; [email protected]

Accounting and Tax Planning

New Rules of the Road

By Julie Quink, CPA

Tax-IncentivesIn 2018, nonprofit organizations face implementation of the first major overhaul of accounting standards in two decades. The goal of the overhaul is to improve the communication of financial results for donors and other outside stakeholders and to emphasize transparency in financial reporting.

With these changes, nonprofit organizations can expect significant changes in financial reporting practices. Donors and outside stakeholders can expect enhanced information on liquidity, access to cash and endowments.

What are the significant financial reporting changes for nonprofits?

Some of the major changes in the new standards encompass net asset classification, liquidity and availability, investment returns, reporting of functional expenses, and presentation of statement of cash flows.

Net Assets

The new accounting standards focus on the existence or absence of donor restrictions as opposed to the type of restriction. The new rules provide for two classes of ‘net assets’ — with donor restrictions and without donor restrictions. Previously, nonprofits have reported three required classes of net assets — unrestricted, temporarily restricted, and permanently restricted.

Julie Quink, CPA

Julie Quink, CPA

For underwater endowments, in which the fair value of the endowment at the reporting date is less than the original gift or the amount required to be maintained by the donor or by law, the cumulative amount of losses is netted in assets with donor restrictions under the new classifications. Previously, the accumulated losses were included in unrestricted net assets.

Disclosures relative to underwater endowments now encompass the aggregate amount of original gifts required to be maintained, endowment spending policies, and discussion of actions taken or strategy relative to the underwater status of the endowment. For the nonprofit, a concern may be that the status of and strategy of managing underwater endowments is highlighted in the new financial-statement disclosures.

The goal of the change is to simplify tracking and reporting of donor restrictions and also to enhance disclosures on the nature, amounts, and types of donor restrictions.

Liquidity and Availability

Quantitative and qualitative information is required under the new standards relative to liquidity and availability of liquid assets, which are typically cash and investments.

The qualitative disclosures require analysis of how the organization manages its liquid assets to meet cash needs for expenditures within one year of the statement of financial-position date. The quantitative information regarding the liquid assets and their availability to meet the current-year needs can be presented on the face of the financial statements or in the notes to the financial statements.

Donors, grantors, creditors, and other stakeholders want to understand that these nonprofit organizations that they are evaluating have adequate financial resources to meet obligations as they become due. For the nonprofit organization, a concern is that this liquidity information can highlight potential liquidity shortfalls, which may affect future donations and grants.

Investment Returns

Investment income is to be reported net of internal and external investment expenses. This has been an optional presentation under current standards. The requirement to disclose investment expenses net in investment income has been removed. The netting of fees against income does not suggest that nonprofits should not still manage and monitor investment fees, but assists in eliminating the burden of trying to identify embedded investment fees.

Functional Expenses

Currently, only health and welfare organizations are required to report expenses by function. Under the revised standards, all nonprofits must report expenses by function and must disclose the methodology used for the allocations to program and overhead expenses in the notes to the financial statements.

Nonprofit organizations should have been allocating expenses to programmatic and administrative expenses even though not required to detail the expenses by function. The requirement for functional reporting and disclosures may require nonprofits to review their allocation policies for consistency.

Statement of Cash Flows

The new rules continue to allow nonprofits to choose the method, direct or indirect, by which they present operating cash flows. The new guidance does eliminate the need to add an indirect reconciliation if using the direct method in presenting operating cash flows.

By streamlining the requirements, it is believed that the statement of cash flows will be a more useful statement and result in a reduction of costs to the nonprofit to prepare the financial statements.

Conclusion

The new accounting and reporting standards are intended to provide more transparency to donors and other stakeholders. These changes may, however, have a significant time and financial impact on nonprofit organizations as they implement the new requirements.

Julie Quink, CPA is the managing principal of Burkhart, Pizzanelli, P.C., specializing in the accounting and consulting aspects of the practice. She is also a certified fraud examiner.

Accounting and Tax Planning Sections

Upping the Ante

By Kristina Drzal Houghton, CPA, MST

It’s June. This is generally not the time to be thinking about taxes. In reality, though, businesses and individuals should always be contemplated taxes and how to reduce their burden. And the Tax Cuts and Jobs Act signed into law late last year gives people even more to think about.

Kristina Drzal Houghton

Kristina Drzal Houghton

The Tax Cuts and Jobs Act, (TCJA), signed into law on Dec. 22, 2017, brought the biggest changes to both individual and corporate taxes that we’ve seen in the past 30 years. These changes were primarily effective for tax years 2018 and after. For many reasons I’ll highlight in this article, these changes make starting your planning early extremely important.

I will briefly acknowledge that the TCJA reduced the C-corporation tax rate to a flat 21%, from the previous maximum rate of 34%. Additionally, there were changes made to U.S. taxation of income earned abroad by U.S. C-corporations and their affiliates.

The focus of this article will revolve around planning for individuals and small businesses.

Where to Start

I would suggest having an accountant run mock 2018 returns as a starting point. Running those future numbers can flag potential issues. That said, state revenue departments and the Internal Revenue Service have had little time to process the changes, so much remains in flux. The IRS and states haven’t decided how some provisions of the new tax law will be calculated yet. I expect that the IRS and states will start to share their 2018 guidance later this summer. In the meantime, here are some suggestions:

Rework Your Withholding

The new law means that the W-4 you filled out, however many years ago, may need to be adjusted. The IRS encourages everyone to use the Withholding Calculator, available on irs.gov, to perform a quick ‘paycheck checkup.’ Remember, the new tables don’t reflect all the changes that may affect a taxpayer next year, so they are a somewhat blunt tool.

The calculator helps you identify your tax withholding to make sure you have the right amount of tax withheld from your paycheck at work.

If workers leave their W-4s as is, they could wind up withholding too little, which can bring penalties, or they may get a smaller-than-expected refund next year. Workers in higher tax brackets who receive large bonuses could see a higher tax bill next season if they don’t tweak W-4s, since one of the ways employers can set the withholding rate on ‘supplemental income’ such as bonuses in the new law is to use a flat rate of 22%.

Think About Deduction Planning

A big change that could affect many taxpayers is the tax overhaul’s controversial cap on state and local income tax (SALT) deductions, a provision Democrats have labeled a war on blue-state Americans. The deduction, which used to be unlimited, will be capped at $10,000 next year. The new law’s near-doubling of the standard deduction to $12,000 for single filers and $24,000 for married couples filing jointly does mean fewer will itemize.

States were busy devising workarounds to keep those residents from seeing a big spike in federal taxes next year, but the IRS recently informed taxpayers that proposed regulations will be issued addressing the deduction of contributions to state and local governments and other state-specified funds, for federal tax purposes. The proposed regulations will make clear that the Internal Revenue Code, not the label used by states, governs the federal income-tax treatment of such transfers.

As a result of the decreased SALT deduction and the increased standard deduction, the tax benefit from charitable contributions may be lost if the standard deduction exceeds itemized deductions. One strategy for people who regularly donate to charity is to bunch up into one year what they would have given over multiple years. For those who itemize, charitable donations remain deductible on federal returns and can help lift married taxpayers who file jointly above the $24,000 standard deduction hurdle.

By putting a few years’ worth of donations into a donor-advised fund — many financial-services firms have units that offer them — you can take the deduction the year you put the money in, but distribute the money to charity over multiple years. For taxpayers older than 70½ who are taking required distributions from an IRA, they should consider making distributions to charities directly from their IRA.

Mortgage and Home-equity Loan Deductions

The new tax law lowered the amount of deductible interest expense on ‘acquisition indebtedness.’ For new loans made after Dec. 14, 2017, the maximum interest is limited to a mortgage ceiling of $750,000; previously, this was $1 million. It also eliminated the interest deduction on loans, such as home-equity loans, that are not used to ‘buy, build, or substantially improve’ a home.

New College Savings Plan Uses

The new tax law expands the allowable use of tax-exempt 529 college savings plans for education costs that accrue while your child is between kindergarten and high-school graduation. This added allowable use is limited to $10,000 per year per beneficiary. But be careful — while some states automatically follow the federal code, others choose to decouple from certain parts of it. So, while the U.S. government may say you can use 529 money for K-12 expenses, a state may consider such a withdrawal a non-qualified distribution and could tax the earnings and charge you penalties.

Section 199A Pass-through Optimization

Section 199A, which is a new section of the tax code arising from the Tax Cuts & Jobs Act of 2017, introduces a 20% deduction on qualified business income (QBI) for the owners of various pass-through business entities which include S-corporations, limited liability companies, partnerships, and sole proprietorships — or, really, any business that is not a C-corporation.

The QBI deduction will provide big tax breaks for many business-owning clients, but unfortunately, the new deduction is highly complicated, and it may take some time before the IRS can even provide more meaningful guidance on how it will be applied. However, the reality is that the planning opportunities created by IRC Section 199A are tremendous, and practitioners are already eagerly exploring how they can help clients reduce their tax burden through creative strategies around the QBI deduction.

Business owners will generally fall within one of three categories when it comes to the QBI deduction:

• Business owners below their applicable threshold amount — which is $157,500 of taxable income for all filers except joint filers, and $315,000 for those filing jointly — can enjoy a QBI deduction for the lesser of 20% of their qualified business income or 20% of their taxable income. It does not matter what type of business is generating the income, nor is there a need to analyze W-2 wages paid by the business or depreciable assets owned by the business. The QBI deduction is what it is.

• Business owners over their applicable threshold who derive their income from a ‘specified service’ business (i.e., some specialized trade or service business) — which includes doctors, lawyers, CPAs, financial advisors, athletes, musicians, and any business in which the principal asset of the business is the skill or reputation of one or more of its employees — will have their QBI deduction phased out. The phase-out range is $50,000 for all filers except joint filers, and $100,000 for those filing jointly. Once a business owner’s taxable income exceeds the upper range of their phase-out threshold ($207,500 for individuals and $415,000 for married filing jointly), they cannot claim a QBI deduction for income generated from a specialized trade or service business. Period. End of story. ‘Do not pass go, do not collect $200.’

• Business owners over their applicable threshold who derive their income from a business that is not a specialized trade or service business may also have their QBI deduction at least partially phased out, but the full deduction may be ‘saved’ based on how much they pay in W-2 wages and/or how much depreciable property they have in the business. Business owners with qualified business income from non-specified service businesses whose taxable income exceeds the upper range of their phase-out threshold can still take a QBI deduction equal to or less than the greater of:

1. 50% of the W-2 wages paid by the business generating the qualified business income; or

2. 25% of the W-2 wages paid by the business generating the qualified business income, plus 2.5% of the unadjusted basis of depreciable property owned by the business.

A careful analysis of the rules above will lead one to realize that, when it comes to maximizing a business owner’s opportunity for a QBI deduction, strategies will fall into one of three main buckets:

• Income-reduction strategies, such as trying to lower taxable income by increasing deductions or spreading out the income over multiple taxpayers, to stay below the income threshold where the specified service business or wage-and-property tests kick in;

• ‘Income alchemy’ strategies, where we try to transform income derived from a specified service business into income derived from a company that is not a specified service business, to avoid the phase-out (for those over the income threshold); and

• Business strategies, such as changing an entity, revisiting compensation models, and revisiting business assets, to more favorably characterize business income in the first place.

Relook at Filing Separate Returns for Married Couples

The tax code has long limited married couples filing separate returns from taking advantage of a number of tax breaks, either by barring those tax breaks entirely under the ‘married filing separately’ status, or phasing them out at very modest income thresholds. As a result, in the past, it’s rarely been a tax-efficient move for married couples to file separate returns, except in highly unusual circumstances. That will likely still be the case for most married couples, but the creation of the QBI deduction does tilt the balance somewhat for some couples.

Should You Revoke S-corp Status?

The hot question since the passage of the Tax Cuts & Jobs Act of 2017 and Section 199A is, “should I revoke S-corp status and go to C-corp?” The answer is no.

While the TCJA reduced C-corporation tax rates to 21%, the QBI reduces the maximum rate on pass-through income to 29.6% (80% of 37%). Previously, the maximum tax rate on pass-through income was 39.6% plus the effect this income had on itemized deduction and personal exemption phase-outs, producing an even greater effective rate.

This rate exceeded the prior maximum C-corporation rate of 34%. Owners elected to operate their businesses in pass-through entities for many reasons beyond the current year’s tax. None of these considerations have changed.

For most small businesses and their owners, the key point is to acknowledge that TCJA creates a tremendous number of planning opportunities. New strategies with QBI will certainly continue to be developed with time and further guidance from the IRS, but even in the present, there exists enough reasons to reach out to your advisors and have them help them reduce your tax liabilities.

Kristina Drzal Houghton, CPA, MST is a partner and director of the Taxation Division at Holyoke-based Meyers Brothers Kalicka; (413) 536-8510.

Accounting and Tax Planning Sections

The Fraud Triangle

By Julie Quink, CPA

Julie Quink

Julie Quink

As a culture, we generally believe that people are honest and are trustworthy. Failures like Enron and WorldCom, whose combined fraud losses totaled $46 billion, have raised an awareness of the costs of fraud and have highlighted the need for management to understand and monitor the business risks within their organizations.

What Is Fraud?

Fraud is an intentional act that results in misrepresenting financial information (lying) or misappropriation of assets (stealing). The misrepresentation of financial information typically encompasses misstating earnings to meet market or company expectations and to meet compensation-plan benchmarks. Misappropriation of assets is the taking of company assets, whether cash and equivalents, inventory or supplies, for personal benefit and use.

Statistics indicate that:

• 10% of employees would never, ever commit fraud;

• 10% of employees are actively exploring ways to commit small-scale fraud against their employer, which could include padded mileage and expense reports, small-scale theft of supplies and other materials; and

• 80% of employees would never commit fraud unless certain factors are present.

The factors that would provide the motivation for 80% of employees to consider committing fraud are termed the Fraud Triangle. These factors include:

• Pressure — a financial need created by gambling addictions, substance and alcohol abuse, family illness, or extramarital affairs;

• Opportunity — the ability to access cash or items easily convertible to cash (inventory); and

• Rationalization — the feeling of entitlement or the feeling that there is no other way to financially meet the pressure unless taken from their employer.

Otherwise honest employees may commit fraud under these circumstances.

Indicators that an employee may be committing fraud include the appearance that the employee is living beyond their lifestyle, suspected or known substance or alcohol abuse, and resistance to relinquishing control of duties to others.

Common Ways Fraud Occurs

Generally, misrepresented financial results are accomplished through fictitious transactions or adjustments recorded in accounting records.

Fraud is an intentional act that results in misrepresenting financial information (lying) or misappropriation of assets (stealing).”

The most common ways that an individual can misappropriate funds are:

• Creating fictitious employees on the payroll system and generating payroll checks that the fraudulent employee cashes — the ghost- employee scheme;

• Creating fictitious vendors and generating checks to the fraudster for goods and services never received by the company — the ghost-vendor scheme; and

• Taking customer checks or cash before being deposited into the bank and modifying the accounting records to conceal the theft.

Preventing Fraud

According to the 2018 Report to the Nations published by the Assoc. of Certified Fraud Examiners, 50% of fraud and corruption cases are detected by a tip. Meanwhile, weaknesses in internal control are responsible for nearly 50% of all frauds, and losses are up to 50% higher when collusion of fraudsters exists.

When considering effective prevention and detection techniques, it is critical to:

• Implement a whistleblower policy that provides a mechanism for confidential communication of suspected impropriety;

• Assess areas of risk and evaluate internal controls over the most susceptible business cycles, including cash receipts, cash disbursements, and payroll; and

• Review financial and operational trends to determine routine and unusual patterns.

Simple techniques to strengthen internal controls over significant business cycles include the receipt of unopened bank statements by owner for independent review of monthly activity, and varying of procedures relative to the review the payroll journals or signing of vendor checks, if another individual is typically responsible for those areas. Inquiry and observation, such as camera systems, in areas that pose a concern may act as a deterrent for the occurrence of fraud due to the mere fact that someone is reviewing activity or inquiring.

When techniques fail to prevent and detect fraud, it is important to gather and review evidence. It is recommended that legal counsel be involved in suspected fraud and investigations at the onset. Legal counsel will likely engage an accountant to assist in the review of evidence and documents.

Business owners and management cannot afford not to be aware of fraud indicators and assess the associated risks within their own organizations. Awareness of who puts your organization at risk, review of trends, and simple monitoring tasks can assist in preventing fraud losses, which can create significant, unplanned costs for an organization.

Julie Quink, CPA is the managing principal of Burkhart, Pizzanelli, P.C., specializing in the accounting and consulting aspects of the practice. She is also a certified fraud examiner.

Accounting and Tax Planning Sections

A Time to Plan

taxplanningbw1117a

It’s never a bad time for companies to assess their tax situation and plan ahead, but with the end of 2017 approaching — and plenty of uncertainty over potential tax reform clouding the picture — it’s an especially good moment to start formulating a strategy to save tax dollars down the line. Here’s a checklist of actions based on current tax rules that may help businesses do just that.

By Kris Houghton, CPA

Taxes and the possibility of tax reform have been in the news so frequently, many are just tuned out on the subject. However, with year-end approaching, it is a good time to think of planning moves that will help lower your tax bill for this year and possibly the next.

Kristina Drzal-Houghton

Kristina Drzal-Houghton

For many years, experts have suggested the approach of deferring income until next year and accelerating deductions into this year to minimize taxes. This time-honored approach could turn out to be even more valuable this year if Congress succeeds in enacting tax reform that reduces business tax rates beginning next year in exchange for slimmed-down deductions.

Regardless of whether tax reform is enacted, deferring income also may help you minimize or avoid AGI-based phaseouts of various tax breaks that are applicable for 2017. Except in general terms, I will refrain from comparing the current tax laws to proposed legislation since its enactment in its current form is very speculative.

Regardless of whether tax reform is enacted, deferring income also may help you minimize or avoid AGI-based phaseouts of various tax breaks that are applicable for 2017.”

The following is a checklist of actions based on current tax rules that may help you save tax dollars if you act before year-end.

Year-end Tax-planning Moves for Businesses and Business Owners

• Businesses should consider making expenditures that qualify for the business-property-expensing option.

For tax years beginning in 2017, the expensing limit is $510,000, and the investment-ceiling limit is $2,030,000. Expensing is generally available for most depreciable property (other than buildings), off-the-shelf computer software, air-conditioning and heating units, and qualified real property-qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. The generous dollar ceilings that apply this year mean that many small and medium-sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment.

What’s more, the expensing deduction is not prorated for the time that the asset is in service during the year. The fact that the expensing deduction may be claimed in full (if you are otherwise eligible to take it), regardless of how long the property is held during the year, can be a potent tool for year-end tax planning. Thus, property acquired and placed in service in the last days of 2017, rather than at the beginning of 2018, can result in a full expensing deduction for 2017.

• Businesses should also consider making expenditures that qualify for 50% bonus first-year depreciation if bought and placed in service this year (the bonus percentage declines to 40% next year). The bonus-depreciation deduction is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 50% first-year bonus write-off is available even if qualifying assets are in service for only a few days in 2017.

• Businesses may be able to take advantage of the ‘de minimis safe-harbor election’ (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies. To qualify for the election, the cost of an item of property can’t exceed $5,000 if the taxpayer has a certified audited financial statement along with an independent CPA’s report. Otherwise, the cost of an item of property can’t exceed $2,500.

• Businesses contemplating large equipment purchases also should keep a close eye on the tax-reform plan being considered by Congress. The current version contemplates immediate expensing — with no set dollar limit — of all depreciable asset (other than building) investments made after Sept. 27, 2017, for a period of at least five years. This would be a major incentive for some businesses to make large purchases of equipment in late 2017.

• A corporation should consider deferring income until 2018 if it will be in a higher bracket this year than next. This could certainly be the case if Congress succeeds in dramatically reducing the corporate tax rate, beginning next year.

• A corporation should consider deferring income until next year if doing so will preserve the corporation’s qualification for the small-corporation AMT exemption for 2017. Note that there is never a reason to accelerate income for purposes of the small-corporation AMT exemption because, if a corporation doesn’t qualify for the exemption for any given tax year, it will not qualify for the exemption for any later tax year.

• A corporation (other than a ‘large’ corporation) that anticipates a small net operating loss for 2017 (and substantial net income in 2018) may find it worthwhile to accelerate just enough of its 2018 income (or to defer just enough of its 2017 deductions) to create a small amount of net income for 2017. This will permit the corporation to base its 2018 estimated tax installments on the relatively small amount of income shown on its 2017 return, rather than having to pay estimated taxes based on 100% of its much larger 2018 taxable income.

• If your business qualifies for the domestic production activities deduction (DPAD) for its 2017 tax year, consider whether the 50%-of-W-2 wages limitation on that deduction applies. If it does, consider ways to increase 2017 W-2 income, e.g., by bonuses to owner-shareholders whose compensation is allocable to domestic-production gross receipts. Note that the limitation applies to amounts paid with respect to employment in calendar year 2017, even if the business has a fiscal year. Keep in mind that the DPAD would be abolished under the tax-reform plan currently before Congress.

Year-End Tax-planning Moves for Individuals

• Higher-income earners must be wary of the 3.8% surtax on certain unearned income. The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).

As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than NII, and other individuals will need to consider ways to minimize both NII and other types of MAGI.

• The 0.9% additional Medicare tax also may require higher-income earners to take year-end actions. It applies to individuals for whom the sum of their wages received with respect to employment and their self-employment income is in excess of an unindexed threshold amount ($250,000 for joint filers, $125,000 for married couples filing separately, and $200,000 in any other case).

Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed individuals must take it into account in figuring estimated tax. There could be situations where an employee may need to have more withheld toward the end of the year to cover the tax. For example, if an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year, he would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don’t exceed $200,000.

• Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later. It may be advisable to discuss year-end trades with a qualified advisor.

• Postpone income until 2018 and accelerate deductions into 2017 to lower your 2017 tax bill. This strategy could enable you to claim larger deductions, credits, and other tax breaks for 2017 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher-education tax credits, and deductions for student-loan interest. Postponing income is also desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that, in some cases, it may pay to actually accelerate income into 2017.

• If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for 2017.

• It may be advantageous to try to arrange with your employer to defer, until early 2018, a bonus that may be coming your way. This could cut as well as defer your tax if Congress reduces tax rates beginning in 2018.

• Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2017 deductions even if you don’t pay your credit-card bill until after the end of the year.

• If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2017 if you won’t be subject to alternative minimum tax (AMT) in 2017. Pulling state and local tax deductions into 2017 would be especially beneficial if Congress eliminates such deductions beginning next year.

• Estimate the effect of any year-end planning moves on the AMT for 2017, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state property taxes on your residence, state income taxes, miscellaneous itemized deductions, and personal-exemption deductions. If you are subject to the AMT for 2017, or suspect you might be, these types of deductions should not be accelerated.

• You may be able to save taxes by applying a bunching strategy to pull ‘miscellaneous’ itemized deductions, medical expenses, and other itemized deductions into this year. This strategy would be especially beneficial if Congress eliminates such deductions beginning in 2018.

• Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retirement plan). RMDs from IRAs must begin by April 1 of the year following the year you reach age 70½. That start date also applies to company plans, but non-5% company owners who continue working may defer RMDs until April 1 following the year they retire. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn.

Although RMDs must begin no later than April 1 following the year in which the IRA owner attains age 70½, the first distribution calendar year is the year in which the IRA owner attains age 70½. Thus, if you turn age 70½ in 2017, you can delay the first required distribution to 2018, but if you do, you will have to take a double distribution in 2018 — the amount required for 2017 plus the amount required for 2018.

Think twice before delaying 2017 distributions to 2018, as bunching income into 2018 might push you into a higher tax bracket or have a detrimental impact on various income-tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2018 if you will be in a substantially lower bracket that year.

• Make gifts sheltered by the annual gift-tax exclusion before the end of the year and thereby save gift and estate taxes. The exclusion applies to gifts of up to $14,000 made in 2017 to each of an unlimited number of individuals. You can’t carry over unused exclusions from one year to the next. Such transfers may save family income taxes where income-earning property is given to family members in lower income-tax brackets who are not subject to the kiddie tax.

• If you were affected by Hurricane Harvey, Irma, or Maria, keep in mind that you may be entitled to special tax relief under recently passed legislation, such as relaxed casualty-loss rules and eased access to your retirement funds. In addition, qualifying charitable contributions related to relief efforts in the Hurricane Harvey, Irma, or Maria disaster areas aren’t subject to the usual charitable deduction limitations.

These are just some of the year-end steps that can be taken to save taxes. Consider meeting your tax advisor to discuss your unique tax situation so they can tailor a plan that will work best for you.


Kristina Drzal-Houghton, CPA, MST is the partner in charge of Taxation at Holyoke-based Meyers Brothers Kalicka, P.C.: (413) 536-8510.

Accounting and Tax Planning Sections

Tax Incentives for Business Owners

By Brenden Healy, CPA

Brenden Healy, CPA

Brenden Healy, CPA

Whether we like it or not, taxes are a part of any business strategy. From the federal level on down, tax obligations go side-by-side with running a business. And while the economy is getting better for much of the country, business owners need to continue to improve their bottom line. One good way to strengthen business cash flow is by taking advantage of tax credits or tax incentives. Business owners sometimes do not harvest these opportunities, most often because they don’t know about all the options available to them or because they don’t fully understand the requirements.

Capturing these benefits requires knowing to look for them, which can be an issue in the diverse tax rules of the IRS or state taxing authorities. Here are some tax opportunities that every business owner should know about:

• Research and Development Tax Credit: This credit was introduced as an incentive to encourage new innovation in the U.S., but remains one of the most overlooked tax opportunities out there. There’s a lot of misconception that a research-driven credit must be limited to modern, large tech firms that are putting out new products. However, the purpose of this credit is to fuel innovation and development, which is relevant to a variety of industries, of all sizes. Recent changes in IRS regulations have opened up this tax credit to many industries. Manufacturing, investment-management services, software development, and even construction are major industries that can take advantage of this tax-savings opportunity, but it can be applied to other industries in certain scenarios.

• Export Sales: The IRS allows companies that produce goods in the U.S. and then export them outside the border to take advantage of a reduced tax rate for some of the profits relating to those export sales. This is accomplished by converting the business income related to the exports into long-term capital-gain income, which is usually taxed at about half the normal business tax rate.

• Write-Off of Asset Purchases: This incentive is one of the most beneficial ones for small businesses. The IRS continues to allow generous write-offs for purchasing equipment, machines, computers, etc. through the Section 179 tax-expensing election with a 2017 deduction limit of about $500,000, or the 50% ‘bonus’ depreciation deduction, which could be used after that spending cap is reached.

• New IRS Capitalization-policy Rules: Just by making a special election on the tax return, a small business can adopt a policy of expensing items purchased during the year, up to $2,500 for each item. As an example, if a business buys 10 computers for $1,500 each, it could expense the full $15,000 of computers under this capitalization policy rule.

• Roof Repairs and Other Building Maintenance Costs: The IRS is also allowing real-estate owners to take advantage of writeoffs relating to building maintenance items. Under new IRS rules, certain roof repairs and other building maintenance items can be expensed in the year they are completed, instead of capitalizing those costs and depreciating them over a 39-year period of time, which was the old requirement.

• ‘Segregation’ of Building Costs for Tax Expensing: When a business owner buys a new building or makes significant improvements to a building, there can be ways to expense those costs faster than the normal, 39-year depreciation life that the tax law allows. By identifying certain costs such as non-structural items, wall coverings, or specialty lighting, the IRS allows the building owner to expense these costs at a faster rate. Thus, performing a ‘cost-segregation study’ can create large tax writeoffs up front instead of waiting 39 years to recover the investment.

• Compensation and Retirement Planning: The IRS also allows business owners to put away large amounts towards their retirement as well as the retirement of key employees of the business. By properly designing a compensation strategy and deferred-compensation planning options, business owners can take care of their key employees while saving tax money.

Leveraging tax incentives can greatly help buffer a company’s bottom line, but more often than not, business owners don’t know what’s available to them. It’s crucial that business owners have open conversations with their accountant about the work of the company to see if there are opportunities available. While these programs can be complex and difficult to navigate, they can save a business a significant amount of money.


Brenden Healy, CPA, is a partner at Whittlesey with significant experience in consulting with business owners to identify tax incentives and strategic planning for their future.

Accounting and Tax Planning Sections

A Different Kind of Number Crunching

sixsigmadpart3Since its introduction more than 30 years ago, the data-driven process-improvement methodology known as Six Sigma has been most closely associated with the manufacturing sector. But, as recent initiatives undertaken by the accounting firm Meyers Brothers Kalicka clearly show, this ‘lean’ concept can be utilized by companies in any business sector to improve efficiency and buy employees time — literally.

Melyssa Brown joked that when she earned her green belt in Six Sigma last year, she was disappointed when all that arrived in the mail confirming that accomplishment was a piece of paper, a certificate.

“I was thinking, hoping that maybe there would actually be a green belt — I could use an accessory like that,” she told BusinessWest, tongue firmly planted in cheek, adding quickly that just about everything else about Meyers Brothers Kalicka’s deep dive into this data-driven process-improvement methodology has been about what she and others at the Holyoke-based accounting firm expected.

And then some.

Our interaction with the client is better, and our delivery of services to the client is better. And internally, it has put everyone on the same page; it’s put everyone together behind a commitment to move forward and not stand still, because you can’t grow that way.”

Indeed, they were expecting that incorporation of this lean, quality-control program, developed by Motorola in 1986 and popular within the manufacturing sector, would be intense, time-consuming, and somewhat difficult because it constituted a significant change in how things were done.

They were right.

But they also expected it would achieve real results and provide powerful evidence that Six Sigma can work in the service sector as well as it does in the realm of manufacturing. And they were right again.

“Our interaction with the client is better, and our delivery of services to the client is better,” Brown, a senior manager in the auditing department at MBK, said of the net gains from the firm’s investments in Six Sigma. “And internally, it has put everyone on the same page; it’s put everyone together behind a commitment to move forward and not stand still, because you can’t grow that way.”

Elaborating, Brown said that, through Six Sigma, the company has been able to chart how the all-important time of partners, associates, and others at the firm is spent, with a critical eye toward making processes more efficient, thus essentially providing personnel with more time with which to better serve clients and serve more of them, critical elements in any company’s efforts to increase profits and improve market share.

Getting more specific, Brown said MBK has undertaken a few Six Sigma projects, both involving client interaction, the time spent accumulating needed information for tax and audit work, and efforts to bring more efficiency to those efforts.

Melyssa Brown

Melyssa Brown says MBK’s Six Sigma projects have effectively given employees at the firm more of that most precious commodity — time.

“To do audit and tax work, you clearly need to get information from the client — we need some numbers to work with,” she explained. “It comes down to, when you have that interaction, how it’s done, and how it’s followed up.”

In short, there were inefficiencies with all those steps in the process, she went on, and, therefore, some diligent work was undertaken to mitigate them.

“From these processes, we’ve put structures in place to help us monitor and conduct better interactions with the client, because that’s what’s important to them — and us,” she went on, adding that the goal was and is to make these interactions easier for the client and more productive for the firm.

Fast-forwarding a little, Brown said the firm has created an online portal, or drop box, if you will, for client information that can be accessed by all those servicing that particular client. This innovation has significantly reduced the time, trouble, and anxiety involved with collecting and accessing that data, as will be explained in more detail later.

As noted, the company’s experience shows how Six Sigma can be applied to businesses not traditionally associated with this methodology, said Brown, who was a member of a panel that delivered that very message to assembled members of the Employers Assoc. of the NorthEast several weeks ago.

“Everyone has a back office,” Brown explained. “And while people think of Six Sigma in terms of manufacturing processes, those back-office functions can be made more efficient as well.”

For this issue and its focus on accounting and tax planning, BusinessWest departs from more traditional discussions about taxes, audits, legislation, and compliance, and takes a hard look at a different form of number crunching.

Time Is of the Essence

Brown told BusinessWest she became the company’s point person on Six Sigma … well, because each senior manager at the firm has a ‘niche,’ as she called it, and at that moment in time, she didn’t have one.

So Six Sigma became her niche.

Backing up a little, Brown said she and others at the firm were in attendance for a presentation on Six Sigma presented by a consultant and hosted by CPA America, a trade organization the firm has belonged to for some time. That seminar came about just as the firm was aggressively exploring methods for achieving process improvement, thus bolstering the bottom line.

“We had tried several other ways to become better at improving efficiency,” she explained. “But we needed that outside person’s view of what the best course of action might be.”

Brown underwent green-belt training, which introduces an overview of the key concepts, in Ohio, and took on a project involving one of her clients to earn that aforementioned certificate in 2016.

Summing up what’s been happening at the firm since, Brown said MBK has essentially embraced ‘lean,’ a concept that, as noted earlier, is usually associated with manufacturing, but can be applied to virtually any business sector.

Lean is a transferable and systematic approach for discovering, analyzing, prioritizing, and correcting time-wasting activities that exist in business processes, Brown told BusinessWest — and her audience at the EANE roundtable in May.

Elaborating, she said ‘lean’ is a mindset, or a culture, to reduce waste, something that exists in every operation and can be reduced — but only, in most all cases, through careful analysis of data and development of new ways to do business.

And, as Brown noted, this approach can generate positive results not only on the factory floor, but also in back-room operations such as billing and accounts receivable, accounts payable, payroll, monthly reconciliations, and financial reporting.

With that, she returned to the projects undertaken by MBK, and specifically that online portal she discussed. It came about through the Six Sigma process of analyzing a specific process or method of doing business, taking it apart, and putting it back together again — without the wasted steps, energy, time, and profit.

To get her points across, she undertook an exercise in ‘before and after.’

“Before, we would send a list of needed information via e-mail, in Word or Excel, and the client would either send us documents via e-mail, save it to a jump drive, or find some other way to get it to us,” she explained. “But it was never really clear if we had a certain piece; we would say, ‘do we have an accounts-receivable list?’ and they would say, ‘yes, you have it,’ and someone here would say, ‘I don’t think I do.’”

Now, with the online portal, such exchanges are a thing of the past, she went on, and so is the time lost looking for information or trying to verify whether the firm has it or not.

The bottom line, as they say in this business, is that the firm can now serve clients better and more efficiently, and use the time saved to serve other clients or solicit new ones.

And all of these things can be measured.

“In the end, our goal in this is to issue financial statements to clients earlier or get tax returns done and out to the client sooner than we used to, and we can measure this,” she explained.

Meanwhile, the system improvements are enabling individual service providers to make better use of their time, she went on, adding that, in many cases, it is now possible to do some audit-preparation work in October or November, thus creating more time during the extremely hectic months and weeks prior to April 15.

“You’re getting a head start on the client,” she noted, “which frees us up during tax season, when we’re all a little stressed.”

The end result, she said, is the creation of more time.

“Before, we may have thought that we needed to hire more people to get the work done,” she noted. “Now, we can get the same amount of work done with fewer hours and the same amount of people — or more work, because you’re taking on new projects with the time that you’ve saved.”

Looking forward, Brown said the firm is looking at other ways to put Six Sigma to use.

Indeed, after projects involving the tax and audit functions, the company is looking at possible initiatives involving billing and administration and making them more efficient.

“There are lots of opportunities — you just have to crack open the shell,” said Brown, who told BusinessWest that this is her general advice to all those who own or manage service businesses.

She noted that too many businesses in this sector are not embracing Six Sigma, in part because they don’t fully understand how it can be applied to their sector. But once educated to the contrary, many are put off by what amounts to a considerable commitment to this culture in terms of time, expense (usually, a consultant must be hired and new technology acquired), and needed buy-in from everyone at the company.

Those willing to make such a commitment, she said, should take the dive.

“This can’t be the flavor of the month,” she explained. “The tone at the top has be, ‘we’re going to make this work — this is our new way of doing business and operating.’”

It All Adds Up

As noted, Brown doesn’t have an actual green belt, like the ones awarded to those engaged in the martial arts.

But through the firm’s implementation of Six Sigma principles, she and others at MBK have something far more meaningful — additional time, the most precious commodity that exists in business today.

It came about through hard work and a deep dive into processes and ways of doing business, with an eye toward continuous improvement.

Historically, such words, phrases, actions, and, yes, results have generally been restricted to the world of manufacturing. But as Brown noted and MBK has shown, any service business can generate the same types of positive outcomes.

They just have to crack open the shell.

George O’Brien can be reached at [email protected]

Accounting and Tax Planning Sections

The Best Time to Start Thinking About It Is … Now

By Thomas Wood, CPA

The retirement party. It’s a familiar sight these days.

We’ve all been to our fair share, given the aging of the Baby Boom generation, and they all summon a wide variety of emotions, especially for those left to carry on.

Thomas Wood

Thomas Wood

Indeed, once you get past the cake, balloons, and bittersweet nostalgia, you have to face the fact that you just lost a valued member of your management team. This is when many nonprofit organizations begin to address their succession planning. Even if it is only unspoken, there is a general consciousness that a retirement is coming, but when it comes to resignations, there is usually a lack of any advanced notice.

The effects of sudden turnover resonate strongest for nonprofit entities. For one, employees are driven by the mission and therefore tend to stay for a long time, making them unwritten resources. In addition, everyone wears more than one hat, so multiple aspects of the organization are affected.

A few unplanned departures can have a great impact on multiple facets of the organization, resulting in lost institutional knowledge. It also takes more time to replace a position because the skill set for many nonprofit organizations is program-specific, which limits the pool of potential candidates.

So when is the best time to start thinking about succession planning? Like everything else in life, an ounce of prevention is worth a pound of cure. As cliché as it sounds, the key is to address succession planning before it ever becomes an issue.

A process should be developed to identify and monitor management positions that are at risk. From there, you can take three simple steps to mitigate succession-related issues: 1) update your procedures manual annually, 2) cross-train staff, and 3) develop from within.

Every nonprofit has a handful of individuals who have been around forever. They are the ones who know everything. The first step to proper succession planning is to document what they do. It sounds simple, but how often does your organization update its employee handbook or procedures manual? Make sure the manual is reviewed by the person actually performing the duties. Having a current procedures manual will make sure that institutional knowledge isn’t lost.

Once your procedures are up to date, start cross-training your staff. Not only will it be helpful in the event of unforeseen turnover, but it is an important internal control. Cross-training is a temporary solution, but it can buy you time to find the perfect candidate.

Nonprofits have mission-specific programs, which can make it difficult to find qualified replacements for program leaders. Often times, very specific job requirements, including years of experience and advanced degrees, limit the candidate pool. Now, you could hire an expensive headhunter who might come up with a handful of so-so replacements, but there is another option, albeit more long-term: hire from within.

Identify potential leaders within your organization, and then create a long-term development plan. Unlike outside recruits, internal hires already understand the organization, fit in with the culture, and are passionate about the mission.

Senior management isn’t the only group that can benefit from succession planning. A healthy nonprofit is usually the result of an involved board of directors; a strong board takes time to develop and needs to be maintained. Typically, most nonprofit boards have a nominating or governance committee charged with finding and vetting future directors. Term limits and classes will keep the board fresh and prevent all the responsibility from falling on a few individuals.

So, the next time your nonprofit has a retirement party, enjoy a piece of cake and don’t worry — because you’ll be ready.

Tom Wood, a certified public accountant with Whittlesey & Hadley, P.C., has more than eight years of experience in public accounting, with a practice concentration in accounting and auditing services to nonprofits and foundations including preparation of consolidated financial statements and Form 990. He is a member of the American Institute of Certified Public Accountants and the Connecticut Society of Certified Public Accountants ; [email protected]

Accounting and Tax Planning Sections

Dollars-and-sense Fundamentals

By Kristina Drzal-Houghton, CPA MST

dolarssensetaxdpartTax planning can be a guessing game, especially in a year when new leadership in Washington could make significant changes to the tax code. But there are a number of basic strategies that businesses and individuals may put in play as year end approaches.

Tax planning for 2016 is significantly different than in recent years.

In late 2015, many tax provisions were made permanent, thus appearing to remove the many uncertainties that made tax planning much more of a guessing game in the past. This tax-planning article generally is oriented toward the time-honored approach of deferring income and accelerating deductions to minimize 2016 taxes.

Kristina Drzal-Houghton

Kristina Drzal-Houghton

Given that this is an election year, consideration should be given to the possibility of the new administration making changes to the tax code. Contrary to traditional thinking, in specific situations, you may decide it is most beneficial to pay more taxes now.

For individuals, deferring income also may help minimize or avoid AGI-based phaseouts of various tax breaks. Businesses, like individuals, should decide when and how to shift income and deductions between 2016 and 2017. Although C corporations will generally benefit from the deferral of income and the acceleration of deductions in the same way as individuals and pass-though entities, there are a number of special rules that should be taken into account.

Year-end tax planning for 2016 must take account of the many temporary ‘extender’ tax provisions still in the code. Extender provisions are business tax deductions, tax credits, and other tax-saving laws which have been on the books for years but which technically are temporary because they have a specific end date.

The majority of these extenders are in effect through 2016, presenting an opportunity to take advantage of them before year’s end when their continued renewal may be uncertain. However, some of these extender provisions are in effect through 2019. And, in a radical change from prior years, many of what were traditionally the most important extender provisions have been made permanent, allowing the opportunity for long-term planning in many cases. Most importantly, there are a number of these extender and other provisions that have been modified in various ways by late 2015 legislation that the taxpayer should be alert to.

Business Planning

Corporate rate planning. A C corporation is subject to the 39% ‘bubble.’ Corporate taxable income between $100,000 and $335,000 is taxed at the rate of 39% to phase out the benefits of the 15% and 25% brackets that apply to a corporation’s first $75,000 of taxable income.

Taxable income between $75,000 and $100,000, and between $335,000 and $10 million, is taxed at 34%. Taxable income over $10 million is taxed at 35%, except that there is also a 38% bubble that applies to corporate taxable income between $15 million and $18,333,333 to eliminate the benefit of the 34% rate.


List of Accounting Firms in Western Mass.


Many small C-corporation businesses utilize year-end bonus planning to maximize the benefit of the lower tax brackets. This can be a real balancing act with many items to consider, including the additional cost of Social Security and Medicare taxes, timing of the bonus payment to owners, and IRS rules on excessive compensation. When doing this planning, you must be careful to not run afoul of any bank-loan covenants.

Qualifying for the small-corporation AMT exception. The tentative minimum tax of a corporation is zero for any tax year that it qualifies as a small corporation meeting a ‘gross receipts test.’ A corporation will qualify if:

• The corporation’s average annual gross receipts for all three-tax-year periods beginning after Dec. 31, 1993 and ending before the tax year do not exceed $7.5 million; and

• The corporation’s average gross receipts do not exceed $5 million for the corporation’s first three-tax-year period taken into account above.

Thus, a corporation should consider deferring income to 2017 if necessary to keep average annual gross receipts for the three-tax-year period 2014 through 2016 at $7.5 million or less. This will preserve the AMT exemption for 2017.

Expensing deductions. Businesses that want to accelerate year-end deductions by buying machinery and equipment have a formidable array of tax tools to work with this year: generous expensing under Code Sec. 179, an expensing safe harbor under the capitalization regulations that has been liberalized for smaller businesses, and 50% bonus first-year depreciation for those eligible new assets that can’t be expensed under Code Sec. 179 or the regs’ safe harbor.

For qualified property placed in service in tax years beginning in 2016, the maximum amount that may be expensed under the Code Sec. 179 dollar limitation is $500,000, and the beginning-of-phaseout amount is $2,010,000. Besides taking advantage of the Code Sec. 179 rules, some businesses may be able to buy much-needed machinery and equipment at year-end and currently deduct the cost under a ‘de minimis’ safe-harbor election in the capitalization regs.

First-year depreciation deduction. Most new machinery and equipment bought and placed in service in 2016 qualifies for the 50% bonus first-year depreciation deduction. Bonus first-year depreciation has been extended through 2019 with a number of modifications, including a gradual reduction over that time (50% for qualified property placed in service in 2015 through 2017, 40% for 2018, and 30% for 2019).

Deduction for qualified production activities income. Taxpayers can claim a deduction, subject to limits, for 9% of the lesser of (1) the taxpayer’s ‘qualified production activities income’ for the tax year (i.e., net income from U.S. manufacturing, production or extraction activities, U.S. film production, U.S. construction activities, and U.S. engineering and architectural services), or (2) the taxpayer’s taxable income for that tax year (before taking this deduction into account). This deduction generally has the effect of a reduction in the taxpayer’s marginal rate and, thus, should be taken into account when making decisions regarding income-shifting strategies.

Net operating losses and debt-cancellation income. A business with a loss this year may be able to use that loss to generate cash in the form of a quick net-operating-loss-carryback refund. This type of refund may be of particular value to a financially troubled business that needs a fast cash transfusion to keep going. Also, a debtor who anticipates having the debt cancelled or reduced should consider steps to defer the resulting taxable income until 2017.

Accelerating or deferring income can save estimated tax requirements. Corporations (other than certain ‘large’ corporations, see below) can avoid being penalized for underpaying estimated taxes if they pay installments based on 100% of the tax shown on the return for the preceding year. Otherwise, they must pay estimated taxes based on 100% of the current year’s tax.

However, this 100%-of-last-year’s-tax safe harbor isn’t available unless the corporation filed a return for the preceding year that showed a liability for tax. A return showing a zero tax liability doesn’t satisfy this requirement; only a return that shows a positive tax liability for the preceding year makes the safe harbor available.

A corporation (other than a large corporation) that anticipates a small net operating loss (NOL) for 2016 and substantial net income in 2017 may find it worthwhile to accelerate just enough of its 2017 income (or to defer just enough of its 2016 deductions) to create a small amount of net income, and thus a small positive tax liability, for 2016. This will permit the corporation to base its 2017 estimated tax installments on the relatively small amount of tax shown on its 2016 return, rather than having to pay estimated taxes based on 100% of its much larger 2017 taxable income.

Also, by accelerating a small amount of income from 2017 to 2016, the corporation might be able to pay tax on that income at a lower rate — e.g., 15% instead of 25% or 34% — if doing so converts its 2016 NOL to a small amount of taxable income. However, where a 2016 NOL would result in a carryback that would eliminate tax in an earlier year, this income-acceleration strategy should be employed only if the value of the carryback is less than the value of having to pay only a small amount of estimated tax for 2017.

Individual Planning

Individuals who own pass-though entities such as S corporations, partnerships, or trusts should consider many of the above planning ideas in conjunction with provisions specifically applicable to the individual taxpayer.

Effective year-end tax planning also must take into account each taxpayer’s particular situation and planning goals, with the aim of minimizing taxes. For example, higher-income individuals must consider the effect of the 39.6% top tax bracket, the 20% tax rate on long-term capital gains and qualified dividends for taxpayers taxed at a rate of 39.6% on ordinary income, the phaseout of itemized deductions and personal exemptions when income is over specified thresholds, and the 3.8% surtax (Medicare contribution tax) on net investment income for taxpayers whose income exceeds specified thresholds.

While many taxpayers will come out ahead by following the traditional approach (deferring income and accelerating deductions), others, including those with special circumstances, should consider accelerating income and deferring deductions. Most traditional techniques for deferring income and accelerating expenses can be reversed to achieve the opposite effect.

For instance, a cash-method professional who wants to accelerate income can do so by speeding up his business’ billing and collection process instead of deferring income by slowing that process down. Or, a cash-method taxpayer who sells property in 2016 on the installment basis may realize a large long-term capital gain can accelerate income by electing out of the installment method.

Inflation adjustments to rate brackets, exemption amounts, etc. For both 2016 and 2017, some individuals will benefit from inflation adjustments in the thresholds for applying the income-tax rates, higher standard deduction amounts, and higher personal-exemption amounts.

Capital gains. Long-term capital gains are taxed at a rate of (a) 20% if they would be taxed at a rate of 39.6% if they were treated as ordinary income; (b) 15% if they would be taxed at above 15% but below 39.6% if they were treated as ordinary income; or (c) 0% if they would be taxed at a rate of 10% or 15% if they were treated as ordinary income. And the 3.8% surtax on net investment income may apply.

Strategies for matching capital gains and capital losses to make the most of these rules should be considered.

Low-taxed dividend income. Qualified dividend income is taxed at the same favorable tax rates that apply to long-term capital gains. Converting investment income taxable at regular rates into qualified dividend income can achieve tax savings and result in higher after-tax income. However, the 3.8% surtax on net investment income may apply.

Traditional IRA and Roth IRA year-end moves. One can convert traditional IRAs to Roth IRAs. And one can then ‘recharacterize’ (i.e., elect to treat a contribution made to one type of IRA as made to a different type of IRA) that conversion and can even, possibly, reconvert the recharacterized transaction.

Changes in an individual’s tax status may call for acceleration of income. Expected 2017 changes in an individual’s tax status, due, say, to divorce, marriage, or loss of head of household status, must be considered.

Alternative minimum tax (AMT). Watch out for the AMT, which applies to both individuals and many corporations. A decision to accelerate an expense or to defer an item of income to reduce taxable income for regular tax purposes may not save taxes if the taxpayer is subject to the AMT.

Time value of money. Any decision to save taxes by accelerating income must take into account the fact that this means paying taxes early and losing the use of money that could have been otherwise invested.

Obstacles to deferring taxable income. The code contains a number of rules that hinder the shifting of income and expenses. These include the passive activity loss rules, requirements that certain taxpayers use the accrual method, and limitations on the deduction of investment interest.

Charitable contributions. The timing of charitable contributions can have an important impact on year-end tax planning. Individual taxpayers who are at least 70½ years old can contribute to charities directly from their IRAs without having the amount of their contribution included in their gross income. By making this move, some taxpayers reduce their tax liability even more than they would have if they had received the distribution from their IRA and then contributed the amount distributed to charity. Some taxpayers, who could take advantage of this tax break for this year, should consider deferring until the end of the year their required minimum distributions (RMDs) for 2016.

Energy tax incentives. There are two different credits available for taxpayers who make qualifying energy-saving improvements to their homes. Tax credits are available for non-business energy property placed in service in 2016 (but not in 2017) and for residential, energy-efficient solar property placed in service before 2022 (but a gradual phaseout applies).

Bottom Line

Since tax planning can be vastly different from entity to entity or individual to individual, there is no standard checklist or formula that can be followed. Sometimes the benefits enjoyed today may not outweigh their effect on the future.  This is why careful consideration — in conjunction with your tax adviser — should be given to customizing your strategy.

Kristina Drzal-Houghton, CPA MST is the partner in charge of Taxation at Holyoke-based Meyers Brothers Kalicka, P.C.; (413) 536-8510.

Accounting and Tax Planning Sections

Driving Home Some Points About This Intriguing New Business

AccountingDPlayersARTThe rise of Uber and similar transportation services like Lyft have been a boon for people looking to make some extra money on their own schedule. But they have also given rise to a number of taxation issues. For anyone looking to turn their personal vehicle into a part-time taxi service, here’s a handy guide to IRS rules for tax filing, expense deductions, and more.

By Sean Wandrei

You know your city has arrived when a transportation network company is operating in town.

Uber has been in the Springfield area for some time now. Uber has been in major U.S. cities since 2011 and is now in 66 countries and 449 cities worldwide. New companies, such as Lyft, are also popping up in these markets (Lyft is now in Boston). With the casino arriving in 2018, it is safe to assume that this industry could be expanding locally.

For those of you who do not know what Uber is, here is a quick crash course. Uber is a transportation service that allows passengers to connect with drivers in the area via a smartphone app. Prices are predetermined before the transaction occurs, and all fares are paid via the app with a credit card. Generally, no cash is exchanged. Uber is basically a taxi service where the driver uses his or her own automobile.

Of course, since transactions are occurring, there are tax ramifications for the driver. An Uber or Lyft driver is not an employee of Uber or Lyft. The drivers are independent contractors who are considered self-employed individuals. Drivers have to calculate their taxable income and pay federal and state income and self-employment tax on the profits.

Generally, drivers report income and expenses on Schedule C of IRS Form 1040. While most taxpayers will file as a self-employed individual on Schedule C, some may want to think about limiting the liability that they could be exposed to.

The taxpayer could file paperwork to make the entity a single-member limited-liability corporation (SMLLC). While there are additional costs (that are deductible) to create and maintain the SMLLC, it could be worth it for the liability protection in case of an accident or lawsuit. The IRS does not recognize a SMLLC for tax purposes, so a self-employed taxpayer would file Schedule C if it was an SMLLC or not.

Uber drivers earn revenues from the fares they collect from driving passengers. All the fares that a driver receives have to be reported as revenue even if no tax documents (1099-Misc or 1099-K) are received. As of this writing, Uber issues tax documents to all drivers no matter the fares earned. Lyft only issues 1099-K if the total fares are $20,000 or greater and there are 200 or more transactions (the minimum threshold set by the IRS).

Since most of these transactions occur with a credit card, form 1099-Misc would not be issued since that form is for cash payments in excess of $600. Any cash tips that are received should also be reported as a part of gross income. Ordinary and necessary business expenses, which are defined as common and accepted in the general industry or type of activity in which the taxpayer is engaged, can be deducted from the revenues to arrive at the taxable net income which is subject to both income and self-employment tax.

Driver Deductions

Let’s take a look at some of those expenses that an Uber driver could deduct. The first, and most obvious, expense is for the automobile driven. There are two deduction methods available for automobile expenses — the standard mileage method (the easiest to calculate) and the actual vehicle expenses. The taxpayer has a choice of what method to use.

Generally with expenses, you are going to select the method that will generate the largest deduction. One thing to note about the method choice: if the taxpayer elects to use the standard mileage method, he or she must do so during the first year the automobile is placed in service.  Under the standard mileage method, the taxpayer determines the expense by multiplying the business miles driven during the year by the standard mileage rate (54 cents per mile for 2016). The tax form that Uber issues lists the miles driven while on fare, but those probably would not be the total business miles driven during the year. There are miles driven while not on fare that would be considered business miles, such as miles driven searching for the next fare, which could be deducted.


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Proof of these miles must be maintained in a daily log listing the business miles driven during the year. The other method for deducting automobile expenses, the actual vehicle expense, is more record-intensive. All actual business-use expenses incurred to operate the automobile during the year can be deducted. These expenses usually include gas, tires, repairs, maintenance, insurance, registration, and depreciation. Only the expenses directly related to the business can be deducted. The deductible costs are calculated by multiplying the actual costs incurred by the percentage of business use of the automobile.

Some other expenses that may be overlooked that could be deducted are car washes, USB and mobile-phone chargers, wireless plans, commissions paid, tolls, parking fees, floor mats, spare tire, flat-tire kit, jumper cables, AAA membership, supplies, music apps like Spotify, ice and snow scrapers, mobile routers such as a MiFi, and food and drink for passengers (limited to 50% deduction by law).

Only the portion of these expenses related to the driving business can be deducted. Any portion of an expense related to personal use is not deductible. Any expenses that are not listed above that are ordinary and necessary for the business could be deducted as well.

Some other expenses that could be deducted, which are not that common, include the home-office deduction and any health insurance paid for the driver and his or her family. The rule with deductions is that the taxpayer must prove the expenses were incurred, so all receipts from the expenses should be saved in case the IRS audits the tax return.

As sole proprietors, drivers are responsible for both income and self-employment tax on the profits. So it’s important to make sure all of the business deductions incurred are properly deducted.

While driving for Uber or Lyft can be a fun and easy way to make some extra cash, it is important to understand the tax issues that could arise from being a driver. As always, you should see your tax professional if you have any tax questions.

Sean Wandrei is a lecturer in Taxation at the Isenberg School of Management at UMass Amherst. He also practices at a local CPA firm; [email protected]

Accounting and Tax Planning Sections

Some Clear Math

By Amy Pitter

Now that all the mortarboards have been flipped in the air, college graduates are assessing their career prospects. Amid all the noise surrounding their choices, at least one trend is very clear: Much of the opportunity in the innovation economy goes to the mathematically inclined — research scientists, data analysts, and robotics engineers, to name a few. We just can’t get enough of them.

But let me suggest another high-demand, math-centric occupation that may surprise you: Accounting. It is, in fact, one of the hottest fields for young graduates in the Commonwealth. Why accountants? You can’t have an innovation economy, or anything resembling a healthy economy, without them. Accountants set up the financial controls and systems that help companies prosper. And they are in the middle of the new economy, by, for example, auditing companies for acquisition and providing the financial data for initial public offerings, among many other critical services.

In short, as Massachusetts grows, so does its accounting sector. And as we look to create more pathways for less-advantaged students to join the STEM (science, technology, engineering, and math) economy, accounting holds the potential to be a bridge to have them play a role in the innovation that’s driving Massachusetts’ growth.

Attractive Numbers

This year, many accounting graduates are quickly walking into jobs that pay $53,000. Colleges are seeing placement rates for grads of well over 90% — it’s a whopping 97% at UMass Amherst three months after graduation. And demand will increase as the retirement wave that is expected to drain many sectors also hits accounting. In fact, it’s estimated that 75% of certified public accounts, or CPAs, will retire in the next 15 years.

Despite the strong demand, and its clear-math orientation, accounting has not yet found a place in the roster of STEM occupations considered by students. That’s an avoidable loss for many young students who struggle imagining themselves in a research lab or calculating the algorithms in a computer-science class, but love numbers all the same.

We are going to need many new accountants over the next 10 years, an occupation that not only pays well, but also often leads to additional opportunities and greater earning potential. As Massachusetts business and government leaders look to connect students with the many possibilities in STEM careers, accounting should be part of the mix. Given the clear demand, an advanced-placement course in accounting deserves a place in the high-school curriculum.

As we consider addressing growing income inequality, we need to capture the imagination of students to see themselves in various fields well before they reach college. Here’s the conundrum: even though our fourth- and eighth-grade student test scores, including math, are the highest in the nation, the income gap in Massachusetts is the widest in the country.

As STEM-related occupations account for a larger percentage of the Massachusetts workforce, we risk letting the gap widen, leaving too many kids behind. Accounting beckons as a great opportunity to open more doors for students who come from disadvantaged backgrounds.

Accounting also holds potential to diversify math-oriented fields, which tend to be predominately white and male. That is why we at the Massachusetts Society of Certified Public Accountants hold workshops, focusing on diversity recruiting.

We are also working with the Massachusetts STEM Advisory Council to integrate accounting into their efforts to expand STEM opportunities, specifically through the Early College High School Program.

The society is hopeful the Massachusetts House and Senate will prioritize funding streams for these important programs in the FY17 budget to start building the pipeline of talent. Recognizing accounting as one of many high-growth segments of Massachusetts that often puts professionals on the front lines of innovation is a great place to start.

Amy Pitter is president and CEO of the Massachusetts Society of Certified Public Accountants.

Accounting and Tax Planning Sections

Inaction by Congress Leads to a Challenging Assignment

Kristina Drzal-Houghton

Kristina Drzal-Houghton

By KRISTINA DRZAL-HOUGHTON, CPA, MST

Year-end tax planning, which always brings its own challenges, has become even more burdensome this year due to  the inaction of Congress on extending a host of expiring tax breaks, among other issues. But there are still a host of tax strategies that businesses and individuals can enact now while they wait for lawmakers to do their part.

Year-end tax planning for 2015 is particularly challenging because Congress has not yet acted on a host of tax breaks that expired at the end of 2014.

It is uncertain at this time whether the extender provisions will be extended by Congress on a permanent or temporary basis (and whether any such extension would be made retroactive). These extender provisions may be dealt with as part of a broader tax-reform effort. These tax breaks include, for individuals:

• The option to deduct state and local sales and use taxes instead of state and local income taxes;
• Educator-expense deduction;
• Deduction for mortgage-insurance premiums;
• Exclusion of gains on sale of small-business stock;
• Energy-efficiency tax provisions;
• Above-the-line deduction for qualified higher-education expenses;
• Tax-free IRA distributions for charitable purposes by those age 70 1/2 or older; and
• Exclusion for up to $2 million of mortgage debt forgiveness on a principal residence.

For businesses, tax breaks that expired at the end of last year and may be retroactively reinstated and extended include:

• A 50% bonus first-year depreciation for most new machinery, equipment, and software;
• Expanded Section 179 deduction;
• R&D tax credit;
• Section 179D energy-efficiency deductions for commercial buildings;
• Section 45L energy-efficiency credits for multifamily and residential developers; and
• The 15-year write-off for qualified leasehold-improvement property, qualified restaurant property, and qualified retail-improvement property.

TaxPlanningDPartIt’s obvious that taxpayers across the spectrum are affected by these tax provisions. The delayed action on the part of Congress has left taxpayers with questions about how to proceed.

One might think we should be fully able to plan despite uncertainty. Remember, the tax cuts enacted in 2001 and 2003 included sunset provisions, so these cuts began to expire at the end of 2010. Since then, they have been extended for one or two years at a time. On Dec. 17, 2014, the cuts were extended for the tax year 2014 and expired on Dec. 31, 2014.

Although the Senate Finance Committee has voted to extend the provisions for 2015, Congress will not address possible legislation until later in the year. Such action is anticipated, but what exactly can be concluded for this year is unknown at this point. This is not an insignificant item since the tax impact of these expired provisions is significant for millions of taxpayers.

There are those in Congress who hear the voice of the taxpayer and are attempting to address these issues sooner rather than later. There is also a contingent in the House that would make the tax cuts permanent.

The best advice for taxpayers at this point is to:

• Make good business decisions, regardless of the tax implications;
• Reject a strategy that is dependent on Congress extending these provisions;
• Be ready to act if the cuts are extended; and
• Keep in close communication with their CPA to stay abreast of any late-breaking tax developments.

If the continued uncertainty of tax breaks doesn’t have you aggravated enough, contacting the IRS for guidance has become more difficult because budget cuts have resulted in personnel layoffs and reduction in services. On the bright side, your chances of facing an IRS audit are greatly reduced.

Meanwhile, the IRS continues to send out computer-generated notices, usually from document-matching processes. Since IRS notices generated in this way are sometimes incorrect, you should consult your tax professional about the appropriate response.

Business Planning

If you’re a business owner, you are facing another year-end with more tax questions than answers.

One 2015 inflation adjustment applies to the small-business healthcare tax credit. This year the maximum credit is phased out based on the employer’s number of full-time equivalent employees in excess of 10 and the employer’s average annual wages in excess of $25,800, which was $25,400 in 2014.

Of course, a major unknown right now is whether Congress will restore expired tax provisions noted above retroactively to the beginning of 2015, providing some tax relief. Or will extender legislation get trapped somewhere between the Senate, the House, and the Oval Office?

You can’t stake the welfare of your business on possibilities, but there’s some evidence that many of the business tax provisions will be extended.

While you’re waiting for the outcome of the extenders, you need to proceed with your standard tax filings, making sure they are properly filed in a timely manner.

Important guidance to keep in mind is the recently issued U.S. Department of Labor clarification of the definition of an independent contractor, as opposed to an employee. If you are classifying workers as independent contractors to reduce your health-insurance obligations, your share of Social Security and Medicare payments, and unemployment taxes, tread carefully.

If you classify some of your workers as independent contractors who are actually employees, your business could be required to pay unpaid payroll taxes and interest and penalties. It could also be obligated to pay for employee benefits that your company didn’t previously provide, as well as federal penalties.

The basic guidance is an ‘economic realities test.’ In other words, how much control does your company have over the way workers perform their jobs? For example:

• Do the workers in question determine how they accomplish their task, or do you closely supervise them?
• Do they have other clients, or do they work full-time for you?
• Do they receive payment for each job, or do you pay them on your schedule?
• Do they own their own equipment and facilities, or does your company provide equipment, supplies, and office space?

These and other considerations are important in determining a worker’s status. If you have any questions, consult with your CPA about the proper classification of your workers to avoid additional taxes and penalties.

Individual Planning

For 2015, the personal and dependency exemptions were increased to $4,000, from $3,950 in 2014. The standard deductions for all filing statuses received a small boost of between $100 and $200 above the 2014 amounts.

The annual health flexible spending account (FSA) contribution limit increased by $50 to $2,550. Both employee and employer may contribute to this account, but the combined contribution may not be greater than the annual limit.

Taxpayers who have a health savings account under a high-deductible health plan (HDHP) have higher contribution limits this year of $3,350 per individual and $6,650 for a family. The HDHP’s out-of-pocket maximums of $6,450 per individual and $12,900 for a family and minimum deductibles of $1,300 per individual and $2,600 for a family are up somewhat from 2014.

A good tax strategy is to participate in your employer’s 401(k) plan. You may elect to contribute up to $18,000 this year before taxes, and the additional catch-up contribution for employees who are age 50 and above is $6,000. Refer to your employer’s plan to confirm that the catch-up contribution is permitted. These increased contribution limits also apply to 403(b) plans, most 457 plans, and the Thrift Savings Plan.

The IRA contribution limit was not raised in 2015. It is still $5,500, with an additional $1,000 catch-up contribution allowed for people 50 years of age or older.

But rules governing IRA rollovers have changed. As of 2015, you may make only one IRA-to-IRA rollover per year. This does not limit direct rollovers from trustee to trustee.

Whether the estate tax will be repealed is an unknown at this point. Currently, the estate-tax exemption is $5.43 million. Together, a married couple can pass an estate valued at $10.86 million to their heirs without paying federal estate tax because of the portability provision. Taxpayers will have to see what awaits them in 2016.


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Estate-tax planning is incredibly complex. It should be done in concert with a qualified financial adviser or CPA who specializes in estate- and gift-tax planning. You don’t have to be wealthy to engage in estate-tax planning. Middle-income couples have made mistakes in estate planning costing them thousands of dollars. Additionally, for Massachusetts, the minimum taxable estate is considerably lower than the federal amount.

Another inflation adjustment applies to foreign earned income. U.S. citizens and U.S. resident aliens who live abroad are taxed on worldwide income. If you worked outside of the U.S. this year, you may qualify for the foreign earned income exclusion, which means you may qualify to exclude from income for 2015 up to $100,800 of foreign earnings. This amount is adjusted annually for inflation. You may also exclude or deduct certain foreign housing amounts.

As most taxpayers are aware, federal tax law allows a deduction for charitable contributions made to qualified IRS tax-exempt organizations. Before making such contributions, however, you should become familiar with some of the laws and limitations on contributions so you can maximize the tax benefit of the deduction.

The contribution must be made by Dec. 31. A check mailed with a Dec. 31 postmark is acceptable. The organization cannot ‘hold the books open’ for a few days after the end of the year and credit those contributions to the year just ended.

There are limitations on the amount of charitable contributions that you may deduct. For individuals, the limit is 50% of adjusted gross income (AGI) or 30% of AGI if the donation is capital-gain property. Any excess may be carried over to future years.

Corporations are limited to deducting 10% of the corporation’s pre-tax net income. An S corporation carries the contribution to the individual shareholders’ returns, so they are not subject to the 10% limitation.

Beyond the laws and limitations discussed above, some strategies may be employed to maximize the benefit of the deduction. If your itemized deductions are near the amount of the standard deduction, you may wish to bunch contributions in a year in which the standard deduction amount has been exceeded.

In addition, if your AGI exceeds a threshold amount — for example, $309,900 for married filing jointly — your charitable deduction amount will be phased out to not less than 80% of the contribution. If you have unusually large income in a particular year, you may wish to defer your giving to another year to receive a greater benefit.

It is a good strategy to keep a running list of your charitable contributions so you can be prepared to speed up or delay any contributions to maximize your deductions. Along this same line, keeping tabs on your total income for the year, in case you will be subject to the phaseout provisions, will enable you to plan properly.

If you plan to contribute appreciated capital-gain property, you will achieve the maximum benefit if the property is long-term — property held for more than 12 months. You can normally deduct the fair market value of the contribution rather than the cost basis. If held for 12 months or fewer, the deduction is limited to the basis in the property.

Before making such a contribution, you should ascertain that the property does qualify for deduction of the fair market value and is, in fact, appreciated property.

Timing income and expenses can be an important tax-reduction strategy. As you consider your tax plan, determine whether you are likely to be subject to the alternative minimum tax (AMT). The AMT’s function is to level taxes when income — adjusted for certain preference items — exceeds certain exemptions, but the tax rate applied to that income falls below the AMT rate.

Before deciding to accelerate or defer income and prepay or delay deductible expenses, you need to gauge the possible effect of the AMT on these tax-planning strategies. Having a number of miscellaneous itemized deductions, personal exemptions, medical expenses, and state and local taxes can trigger AMT. Our experience is that a vast number of taxpayers in Massachusetts and Connecticut pay the AMT tax as a result of the amount of real estate and state income tax they pay.

After analyzing your specific tax situation, if you anticipate that your income will be higher in 2016, you might benefit from accelerating income into 2015 and possibly postponing deductions, keeping the AMT threat in mind.

Individuals usually account for taxes using the cash method. As a cash-method taxpayer, you can deduct expenses when you pay them or charge them to your credit card. Expenses paid by credit card are considered paid in the year they are incurred.

In addition to charitable contributions discussed earlier, you should decide whether it would be beneficial for you to prepay the following expenses:

• State and local income taxes;
• Real-estate taxes;
• Mortgage interest;
• Margin interest; and
• Miscellaneous itemized deductions.

Taxpayers usually elect to itemize deductions only if total deductions exceed the standard deduction for the year. If itemized deductions are near the standard deduction amount, grouping these deductions in alternating years is often an effective tax-planning strategy. Bunching your deductions can be particularly advantageous for taxpayers with unreimbursed medical and dental expenses, who may deduct the amount in excess of 10% of AGI. For taxpayers age 65 or older, the percentage is 7.5%, but this exception is temporary, slated to expire after Dec. 31, 2016.

TaxPlanningGRAF1115BAlso deductible are unreimbursed employee business expenses, tax-return-preparation fees, investment expenses, and certain other miscellaneous itemized deductions that together are in excess of 2% of AGI

Keep in mind that not only AMT, but the amount of itemized deductions you can claim on your 2015 tax return is reduced by 3% of the amount by which your AGI exceeds the threshold amount.

Taxpayers cannot lose more than 80% of the itemized deductions subject to the phaseout. And deductions for medical expenses, investment interest, casualty and theft losses, and gambling losses are not subject to the limitation.

Conclusion

The U.S. tax code is incredibly complex and can change rapidly, even though it may sometimes seem to be moving along at a snail’s pace. This complexity has given rise to more calls for simplification. For now, taxpayers must still live with the complexity and the changes, as simplification appears to be only a dream.

Although a majority of taxpayers have their taxes prepared by a professional, they are turning in larger numbers to self-prepared returns. Since the online program does the calculations, it seems to be an economical approach to preparing and filing taxes.

However, the program is no substitute for a qualified tax professional such as a CPA. Programs can calculate tax liability, but they cannot substitute for professional advice and guidance. As a CPA, I would equate it to watching a how-to video on YouTube and embarking on repairing my car.

With such complexity in the tax code, a CPA is better able to keep abreast of the changes and can prepare taxes in a manner that determines a taxpayer’s minimum legal tax liability. But minimizing tax liability started last week, last month, last year. Tax planning is a constant in today’s complex world.

Kristina Drzal-Houghton, CPA MST is the partner in charge of Taxation at Holyoke-based Meyers Brothers Kalicka, P.C.; (413) 536-8510.

Accounting and Tax Planning Sections

Giving Advice

By HILLARY BURR, CPA, MST

Hillary Burr

Hillary Burr

While I can’t confirm the percentage of us that are procrastinators, I am comfortable assuming that, when it comes to year-end planning, that percentage skyrockets.
Understandably so, because this time of year is filled with travel, family, and holidays. For those reasons, now is the time to start thinking about year-end. This is particularly true if this will be a high-income year or if you are considering making larger charitable donations before year-end.
Here are some things to think about:

Get Your Advisors Talking
We often work with investment advisors, estate-planning attorneys and sometimes a client’s family office as a team. Each advisor brings a valuable piece to the table to assist in the decision-making process.  Having a handle on how the current year compares to the prior year and the impact on your upcoming tax liability allows your tax preparer to take a team approach with you and any of your other financial and legal professionals in deciding what makes sense for the remainder of the year.
It also allows this team to combine estate planning with income-tax planning.

A Focus on Philanthropy
When you have a high-income year, this is a natural time to consider the benefit that year-end charitable contributions can have.
This could be from selling a business or large holding in your portfolio, a stock-option exercise, or maybe a significant bonus. Often, clients know the amount they are comfortable donating. Your tax professional’s role is in educating you and your team to structure those donations in the most tax-efficient way and to confirm the desired outcome has been achieved.
If you are planning on donating or gifting appreciated securities, have a conversation with your custodian as to when they stop accepting transfer requests. The deadlines can vary by custodian, so having the conversation earlier allows you to ensure that it can be acted upon, as opposed to waiting until the end of the year, when it may be too late to request these transactions.
If you are planning on donating real estate or tangible property, you’ll need time to obtain the proper valuations and get the legal documents in order, so the earlier the better.


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Consider a Donor-advised Fund
An excellent planning tool for charitable giving is a donor-advised fund (DAF). This allows you to take the deduction on your return for the contribution in the current year while allowing you to be thoughtful in your giving. For example, if you are able to give a large amount to a DAF in a high-earning year, you can give smaller amounts away to your favorite charities, keeping annual donations at a level you are comfortable with and allowing you to give the same amount to the charity in your lower-income years. This approach is particularly useful in the last earning years before retirement.
Donor-advised funds can also be used to meet required distributions from a private foundation and can serve as a good opportunity to get younger members of the family involved in charitable giving with the funds in the DAF.

Review of Carry-forwards
If you have larger donations made in previous years that are coming up on their five-year expiration, you may be able to utilize the carry-forward and delay the contribution to January, effectively moving it into the next tax year.
Similarly, if income can fluctuate, as we saw with late capital-gain dividends in 2014, consider whether it makes sense to create a little bit of a carry-forward with your donations and make sure you’re achieving as much tax minimization benefit as you can.

Don’t Miss Out
Not taking action until Dec. 31 can leave you open to changes in the law but could also move a deduction or planning opportunity out another year, meaning April 2017 before you see the benefit. n

Hillary Burr is a CPA and principal with Wolf & Co., an accounting firm in Springfield and Boston; (617) 428-5460; [email protected]

Accounting and Tax Planning Sections
Stay on the Right Side of the IRS and Minimize Your Tax Liability

By JAMES BARRETT

TaxAccountingDPartTax planning for 2015 is a venture in uncertainty.

Last December, Congress passed legislation extending a number of expired tax provisions. Unfortunately, they were extended only until Dec. 31, 2014. At this point, we don’t know their status for 2015 and beyond.

There has been a great deal of talk about tax simplification, but currently, it appears to be all talk with no substance and little momentum for achieving true reform.

On April 16, the U.S. House of Representatives voted to repeal the estate tax, but this was seen as a largely symbolic gesture because the U.S. Senate does not appear to have enough votes to pass the legislation. Even if the bill were to survive the Senate, President Obama is likely to veto it. The House is apparently attempting to keep the issue in the forefront with an eye to repeal in 2017.

Rules regarding IRA rollovers have changed. As of 2015, taxpayers may make only one IRA-to-IRA rollover per year. This does not limit direct rollovers from trustee to trustee.

James Barrett

James Barrett

It should also be pointed out that the penalty for failure to maintain qualifying health insurance takes a big leap in 2015. The penalty is the greater of $325 for each adult and $162.50 for each child (but no more than $975) or 2% of household income minus the amount of the taxpayer’s tax-filing threshold.

Dealing with the IRS has become more difficult as a result of budget cuts that make it difficult to reach IRS personnel by phone or in person at most offices. On the flip side, the chances of being audited by the IRS are at the lowest they have been for years. However, the IRS remains quite proficient at sending out computer-generated notices, usually from document-matching processes.

Inflation Adjustments

As usual, there are some adjustments to a number of tax-related amounts for 2015.

The personal and dependency exemptions were increased by $50 per individual. The standard deduction for all filing statuses increased between $100 and $200, while the additional standard deduction for taxpayers who are age 65 and over or blind increased $50 for both married statuses but did not increase for head-of-household or single filers.

Tax brackets, along with phase-out ranges for itemized deductions, personal exemptions, the AMT exemption, IRAs, and several credits, were increased slightly for inflation.

The personal exemption and itemized deduction phase-out threshold for married filing jointly is now an adjusted gross income of $309,900. For single filers, it is $258,250.

The itemized-deduction phase-out reduces otherwise-allowable itemized deductions by 3% of the itemized deductions exceeding the threshold amount. The reduction cannot reduce itemized deductions below 80% of the otherwise deductible amount.

Certain itemized deductions are not subject to the phase-out — medical expenses, investment-interest expense, casualty and theft losses, and gambling losses.

Business mileage increased Jan. 14 to 57.5 cents a mile, while the deduction for medical or moving mileage dropped by a half-cent to 23 cents. The deduction for charitable mileage remains unchanged at 14 cents.

The new limits for some of the major items are outlined in the accompanying table.InflationAdjusted2015TaxProvisions

Timing of Deductions

As the standard deduction continues to increase each year, fewer and fewer taxpayers are finding that they can itemize deductions.

Statistically, only about one-third of all taxpayers use Schedule A, Itemized Deductions. In addition to the inflation factor, some other influences make itemizing a less attractive option.

First is the increase in the threshold for deducting medical expenses. This threshold had remained at 7.5% of adjusted gross income for a number of years. However, for most taxpayers, the threshold has increased to 10% under the Affordable Care Act.

Another factor affecting itemizing is the decrease in interest rates. As interest rates have declined, so has the amount of interest taxpayers are paying. As a result, the mortgage-interest deduction has declined. Many taxpayers are now finding they no longer have enough deductions to itemize.

When taxpayers find themselves in a situation where they are close to the itemization threshold, they can often decrease their tax liability through the timing of their deductions. This strategy simply involves speeding up or delaying certain deductions, bunching them as much as possible in a particular year.

For example, in a year in which the taxpayer has enough medical expenses to deduct, a good strategy is to pay as many of these bills as possible in that year to take advantage of greater medical deductions.

Another area open to the timing of the deduction is charitable contributions. By delaying or speeding up such contributions, taxpayers can bunch them into one year for maximum benefit. While regarding charitable giving, do not overlook the tax benefit to be derived from non-cash charitable contributions.

Depending on the local property tax laws, it may be possible to pay two years of property tax bills in one calendar year to get maximum benefit from the deduction. However, be aware of early-payment discounts and late-payment penalties that would wipe out the benefits from taking the itemized deduction.

Another related strategy is to consider if you are in the itemized-deduction phase-out area for the current year. If you have an unusually large amount of income in the current year, it may be beneficial to maximize itemized deductions in the following year, when you are not subject to the phase-out.

Keep in mind that the items in question can be deducted only in the year in which they are considered paid. You cannot choose which year to deduct the item if it has been paid.

Bills paid with a credit card can be deducted in the year in which the credit card is charged, not when the amount is paid to the credit-card company. If the provider of the goods or services has been paid, you may take the amount as an itemized deduction.

Non-cash Contributions Can Be Money in Your Pocket

We live in a throwaway society. We buy something, use it, and then discard it when it no longer suits our needs.

Frequently, these items are in good condition and can be useful to others. Making a contribution of these items to a qualified tax-exempt charitable organization is a win-win-win situation. The organization benefits from the revenues generated by the contribution, the donor gets a tax deduction, and someone gets a usable item at a good price.

The accompanying table illustrates the process of deducting the contribution on Form 1040. It is a fairly simple reporting model, with increasing requirements as the dollar value of the contribution increases.NonCashCharitableContributions

If the contribution exceeds $5,000 in value, an appraisal must be obtained. The cost of this appraisal is deductible as a miscellaneous itemized deduction subject to the 2% limitation. The appraisal requirement does not apply to registered securities.

If the donated item is a vehicle, boat, or airplane, the recipient organization is required to issue the donor a Form 1098-C, and the deduction amount will be the proceeds the organization received from the sale of the vehicle or the Blue Book value if it was retained for use in the organization.

Securities and certain other capital assets that have been held for more than 12 months can be donated, and the donor can take a deduction for the fair market value of the asset instead of the donor’s basis. This can yield a large deduction at little cost for assets that have significantly increased in value.

When donating household items, many people have a tendency to stuff their goods into a large garbage bag and tell the tax preparer that they donated “three bags of clothing and household goods, and here’s my receipt from the organization.” This haphazard approach will not stand up to an IRS audit. The taxpayer is required to have an itemized list of the items donated.

Valuing the items that are donated can be a problem and somewhat time-consuming. But a little time can pay significant rewards. Both the Salvation Army and Goodwill publish a valuation guide for donated items, which may be downloaded for free from their respective websites.

Another approach is to use computer programs. Intuit offers It’s Deductible, which is free online at www.itsdeductible.com.

There is also a mobile app for Apple. You simply input information about the charity, proceed to list your donated items, and let the program value them for you. The IRS generally accepts the values assigned by these guides or programs.

Using one of the above methods, a simple spreadsheet or some other system will help keep your donation records up to date and simplify your document gathering at tax time. An organized list may mean a larger deduction for you.

Capital-gain Rates and Net Investment Income Tax

If someone were to ask, “what is the capital-gain tax rate?” the best answer would have to be: “it depends.”

First, you should determine whether the sale is subject to taxation at the ordinary income rate or at the preferred capital-gain rate. A capital asset must be held for more than 12 months to qualify for capital-gain treatment. Otherwise, it is taxed at ordinary income rates, which vary from 10% to 39.6%.

Even if the sale of the asset meets the criteria for capital-gain treatment, the rate can be zero, 15%, 20%, 25%, or 28%. Then there may be an additional 3.8% net investment income tax levied on top of those rates.

It should be noted that the capital-gain rate is a rate that substitutes for the ordinary income rate. The sale is not subject to both regular income tax and the capital-gain tax.

Generally, a capital gain arises from the sale of investment property or real estate. In addition to gains from the sale of capital assets being subject to the capital-gain rate, qualified dividends are taxed at that rate but are not capital gains. The highest capital-gain rate is 28%, levied on gains from the sale of collectibles or qualified small-business stock. Next would be the tax on unrecaptured Section 1250 gains at 25%.

This brings us to the more common capital-gain rates, which are applied to most capital asset sales. This rate varies.

Taxpayers in the 39.6% (highest) bracket will be subject to a 20% capital-gain rate. Those not in the highest bracket but in the 25% or higher bracket must pay at the 15% rate. Taxpayers in the 10% or 15% brackets have a zero capital-gain rate applied.

These rates can be somewhat misleading since some taxpayers will be subject to the 3.8% net investment income tax. This is a surtax on taxpayers whose modified adjusted gross income exceeds $250,000 for married couples filing jointly ($125,000 for married filing single and $200,000 for everyone else).

Estates and trusts are subject to this tax, which can be significant. They will be subject to this tax on the lesser of:

• Undistributed net investment income; or
• Adjusted gross income over the amount at which the highest tax bracket for a trust or an estate begins (currently $12,300).

This tax makes the effective capital gain rate as high as 23.8%.

However, estates and trusts can avoid the tax by making income distributions to the beneficiaries. Since the threshold subject to the tax is significantly higher for individuals, this option could eliminate the tax altogether.

The net investment income tax is levied on income in addition to capital gains. Net investment income includes most dividends, interest, annuities, royalties, rents, and the taxable portion of gains from the sale of property. The regulations defining net investment income take 159 pages to define the term, so consult with your CPA regarding your liability for this tax.

A separate tax was enacted as a part of the Affordable Care Act that also applies to individuals with high incomes. The 0.9% additional Medicare tax is levied on earned income in excess of certain threshold amounts. The thresholds are the same as the ones for the net investment income tax.

However, collecting the tax is somewhat complex. If an individual has wages in excess of $200,000, the employer is required to withhold the tax on earnings in excess of that amount. If neither spouse exceeds the $200,000 threshold but they have a combined earned income in excess of $250,000, they must pay the tax when they file their Form 1040.

As with the additional Medicare tax, taxpayers are advised to consult with their CPA to take steps to mitigate this tax — or at least to be prepared for it.

Home-office Safe Harbor

If your business operates out of your home, the IRS will allow you to take a tax deduction for your home office.

To qualify for the deduction, you are required to:

• Have an area in your home that is exclusively and regularly used as a home office; and
• Use the home as your principal place of business.

If you are an employee, you are subject to these same two criteria. In addition, your home office must be for the convenience of the employer. An employee cannot rent a portion of the home to the employer, use the rented portion to perform services as an employee for that employer, and take a home-office deduction.

The home-office deduction is based on the portion of the home that is used for business. A percentage of many home expenditures can be allocated to the cost of the office. In addition, a depreciation deduction may be included in the cost.

The IRS now offers a simplified safe-harbor option for deducting home-office expenses. Rather than determining the actual expenses incurred in the home, taxpayers may simply deduct $5 per square foot used as an office for the deduction. Keep in mind that using the safe-harbor method means there will be no depreciation recapture when the home is sold.

A taxpayer may choose either deduction method each year. The election is made by filing the return using the method of choice for that year.

Home-office Deduction for a Corporation

The home-office deduction is designed for a sole proprietorship filing a Schedule C. Business owners who choose to incorporate their businesses will lose the advantage of deducting the expenses of a home office because the corporation and the taxpayer become two separate, distinct entities at the time of incorporation.

Three alternatives can be chosen that would allow a home-office deduction in these situations. First, assuming that corporation owners are also employees of their corporations, they could take the employee home-office deduction on their Schedule A as a miscellaneous itemized deduction.

However, this approach has two disadvantages. First, the deduction is subject to the 2% limitation on miscellaneous itemized deductions, potentially eliminating some or all of the deduction. Secondly, taxpayers who do not itemize cannot obtain a home-office deduction.

The second choice is for corporations to pay rent to their owners for use of a home office. This rent is deductible by the corporations, and the owners must report the rent on their Form 1040, Schedule E.

However, an owner can set the amount of rent equal to the expenses associated with the home office and show no gain or loss on the rental activity on the Form 1040. Using this method, the owner can create some personal cash flow since deducting depreciation on the office is an allowable expense.

The third alternative is to have the corporation pay the owner for any out-of-pocket costs of a home office under an accountable plan. Reimbursed expenses must be actual job-related expenses that the owner must substantiate by providing the corporation with receipts or other documentation.

These expenses can include a portion of mortgage interest, property taxes, utilities, insurance, security service, and repairs. They would be reimbursed based on the percentage of the home that is represented by the office area.

These last two methods require some rigorous record keeping. But the bottom line is that either of these approaches can yield benefits to the taxpayer and the corporation.

Tangible Property Regulations

New tangible property regulations went into effect on Jan. 1, 2014. These regulations are far-reaching and designed to guide taxpayers in determining whether an expenditure can be classified as an expense or must be capitalized and depreciated.

In many cases, the answer is clear. Routine ‘ordinary and necessary’ business expenses are normally expensed. These include supplies, payroll, purchased inventory (when sold), small tools, insurance, licenses and fees, and routine maintenance.

At the other extreme are items that are clearly long-lived assets and must be capitalized and depreciated — vehicles, machinery and equipment, buildings, etc. Companies may use a de minimis safe-harbor election to simplify accounting records. This amount is $5,000 if the company has an applicable financial statement (AFS), and $500 otherwise. Expenditures below these amounts may be expensed. An AFS is generally an audited statement filed with the SEC or with a government agency.

Where the major issues come into play is in considering whether a repair can be classified as an improvement to the asset. Under IRS regulations, property is improved if it undergoes a betterment, an adaptation, or a restoration. If it is an improvement, it should be depreciated.

Betterment:
• Fixes a ‘material condition or defect’ in the property that existed before acquisition of the asset;
• Results in a material addition to the property; or
• Results in a material increase in the property’s capacity.

Restoration:
• Returns a property to its normal, efficient operating condition after falling into disrepair;
• Rebuilds the property to like-new condition after the end of its economic life;
• Replaces a major component or substantial structural part of the property;
• Replaces a component of the property for which the owner has taken a loss; or
• Repairs damage to the property for which the owner has taken a basis adjustment for a casualty loss.

Adaptation:
• Fits a unit of property to a new or different use.

The definition of the unit of property (UOP) is critical. It helps determine whether an expenditure should be capitalized or expensed.

For example, a building may be defined as a UOP, or each of the enumerated building systems may be defined as a UOP. For non-buildings, the UOP is defined by the IRS as all components that are functionally interdependent, unless the taxpayer used a different depreciation method or recovery period for a component at the time it was placed into service.

There are two additional safe harbors — an election for small taxpayers and a routine-maintenance safe harbor.

Conclusion

Tax laws change at an amazing pace. It is estimated that more than 5,000 changes to federal tax laws have been made since 2001. That’s an average of more than one change per day. The Internal Revenue Code was 73,954 pages in 2013, which makes War and Peace look like a short story.

The information contained in this article was current at the time it was published. However, it is by no means certain that it will remain current for the rest of 2015.

Why bring this up? Simply to emphasize how incredibly complex our tax laws have become. Tax planning is necessary in today’s complex world so that you can stay on the right side of the IRS and minimize your tax liability.


James Barrett is managing partner of Meyers Brothers Kalicka in Holyoke; (413) 536-8510; [email protected]