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Accounting and Tax Planning

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.