If your investments have fluctuated wildly this year, you may have already recognized some significant gains and losses. But nothing is decided tax-wise until year end when the final results of your trades will reveal your 2023 tax situation. Here’s what you need to know to avoid tax surprises.
Tax-favored retirement accounts and taxable accounts
If you’ve had wild swings in the value of investments held in a tax-favored 401(k), traditional IRA, Roth IRA or self-employed SEP account, there’s no current tax impact. While these changes affect your account value, they have no tax consequences until you finally start taking withdrawals. At that point, the size of your balance(s) will affect your tax bills. If you have investments in a Roth IRA, qualified withdrawals taken after age 59½ can be federal-income-tax-free.
With taxable accounts, your cumulative gains and losses from executed trades during the year are what matter. Unrealized gains and losses don’t affect your tax bill.
Overall loss for 2023
If your losses for the year exceed your gains, you have a net capital loss. To determine and apply the loss:
- Divide your gains and losses into short-term gains and losses from investments held for one year or less and long-term gains and losses from investments held for more than one year.
- If your short-term losses exceed your short- and long-term gains, you have a net short-term capital loss for the year.
- If your long-term losses exceed the total of your long- and short-term gains, you have a net long-term capital loss for the year.
- Claim your allowable net capital loss deduction of up $3,000 ($1,500 if you use married filing separate status).
- Carry over any remaining net short-term or long-term capital loss after Step 2 to next year where it can be used to offset capital gains in 2024 and beyond.
Overall gain for 2023
If your gains for the year exceed your losses, you have a net capital gain. To figure out the gain:
- Divide your gains and losses into short-term gains and losses from investments held for one year or less and long-term gains and losses from investments held for more than one year.
- If your short-term gains exceed the total of your short- and long-term losses, you have a net short-term capital gain for the year.
- If your long-term gains exceed the total of your long- and short-term losses, you have a net long-term capital gain for the year.
Net short-term and long-term gain
A net short-term capital gain is taxed at your regular federal income tax rate, which can be up to 37%. You may also owe the 3.8% net investment income tax (NIIT) (see below) and state income tax, too.
A net long-term capital gain (LTCG) is taxed at the lower federal capital gain tax rates of 0%, 15%, and 20%. Most individuals pay 15%. High-income folks will owe the maximum 20% rate on the lesser of: 1) net LTCG or 2) the excess of taxable income, including any net LTCG, over the applicable threshold. For 2023, the thresholds are $553,850 for married joint-filers, $492,300 for singles and $523,050 for heads of households. You may also owe the NIIT and state income tax, too.
Watch out for the NIIT
The 3.8% NIIT hits the lesser of your net investment income, including capital gains, or the amount by which your modified adjusted gross income exceeds the applicable threshold. The thresholds are:
- $250,000 for married joint-filers,
- $200,000 for singles and heads of households, and
- $125,000 for married individuals filing separate.
Year end is still months away
As explained earlier, your tax results for 2023 are up in the air until all the gains and losses from trades executed during the year are tallied up. If you have questions or want more information, consult with us.
Are employees at your business traveling and frustrated about documenting expenses? Or perhaps you’re annoyed at the time and energy that goes into reviewing business travel expenses. There may be a way to simplify the reimbursement of these expenses. In Notice 2023-68, the IRS announced the fiscal 2024 special “per diem” rates that became effective October 1, 2023. Taxpayers can use these rates to substantiate the amount of expenses for lodging, meals and incidentals when traveling away from home. (Taxpayers in the transportation industry can use a special transportation industry rate.)
Basics of the method
A simplified alternative to tracking actual business travel expenses is to use the “high-low” per diem method. This method provides fixed travel per diems. The amounts, provided by the IRS, vary from locality to locality.
Under the high-low method, the IRS establishes an annual flat rate for certain areas with higher costs of living. All locations within the continental United States that aren’t listed as “high-cost” are automatically considered “low-cost.” The high-low method may be used in lieu of the specific per diem rates for business destinations. Examples of high-cost areas include Boston, and San Francisco. Other locations, such as resort areas, are considered high-cost during only part of the year.
Under some circumstances — for example, if an employer provides lodging or pays the hotel directly — employees may receive a per diem reimbursement only for their meals and incidental expenses. There’s also a $5 incidental-expenses-only rate for employees who don’t pay or incur meal expenses for a calendar day (or partial day) of travel.
If your company uses per diem rates, employees don’t have to meet the usual recordkeeping rules required by the IRS. Receipts of expenses generally aren’t required under the per diem method. But employees still must substantiate the time, place and business purpose of the travel. Per diem reimbursements generally aren’t subject to income or payroll tax withholding or reported on an employee’s Form W-2.
The FY2024 rates
For travel after September 30, 2023, the per diem rate for all high-cost areas within the continental United States is $309. This consists of $235 for lodging and $74 for meals and incidental expenses. For all other areas within the continental United States, the per diem rate is $214 for travel after September 30, 2023 ($150 for lodging and $64 for meals and incidental expenses). Compared to the FY2023 per diems, the high-cost area per diem increased $12, and the low-cost area per diem increased $10.
Important: This method is subject to various rules and restrictions. For example, companies that use the high-low method for an employee must continue using it for all reimbursement of business travel expenses within the continental United States during the calendar year. However, the company may use any permissible method to reimburse that employee for any travel outside the continental United States.
For travel during the last three months of a calendar year, employers must continue to use the same method (per diem or high-low method) for an employee as they used during the first nine months of the calendar year. Also, note that per diem rates can’t be paid to individuals who own 10% or more of the business.
If your employees are traveling, it may be a good time to review the rates and consider switching to the high-low method. It can reduce the time and frustration associated with traditional travel reimbursement. Contact us for more information or read the IRS notice here.
If you’re facing a serious cash shortfall, one possible solution is to take an early withdrawal from your traditional IRA. That means one before you’ve reached age 59½. For this purpose, traditional IRAs include simplified employee pension (SEP-IRA) and SIMPLE-IRA accounts.
Here’s what you need to know about the tax implications, including when the 10% early withdrawal penalty tax might apply.
Penalty may be avoided
In almost all cases, all or part of a withdrawal from a traditional IRA will constitute taxable income. The taxable percentage depends on whether you’ve made any nondeductible contributions to your traditional IRAs. If you have, each withdrawal from a traditional IRA consists of a proportionate amount of your total nondeductible contributions. That part is tax-free. The proportionate amount of each withdrawal that consists of deductible contributions and accumulated earnings is taxable. If you’ve never made any nondeductible contributions, 100% of a withdrawal is taxable.
Wide variety of exceptions
Unless one of these 11 exceptions applies, there will be a 10% early withdrawal penalty tax on the taxable portion of a traditional IRA withdrawal taken before age 59½.
1. Substantially equal periodic payments (SEPPs). These are annual annuity-like withdrawals that must be taken for at least five years or until the you reach age 59½, whichever comes later. Because the SEPP rules are complicated, consult with us to avoid pitfalls.
2. Withdrawals for medical expenses. If you have qualified medical expenses in excess of 7.5% of your adjusted gross income, the excess is exempt from the penalty tax.
3. Higher education expense withdrawals. Early withdrawals are penalty-free to the extent of qualified higher education expenses paid during the same year.
4. Withdrawals for health insurance premiums while unemployed. This exception is available to an IRA owner who has received unemployment compensation payments for 12 consecutive weeks under any federal or state unemployment compensation law during the year in question or the preceding year.
5. Birth or adoption withdrawals. Penalty-free treatment is available for qualified birth or adoption withdrawals of up to $5,000 for each eligible event.
6. Withdrawals for first-time home purchases. Penalty-free withdrawals are allowed to an account owner within 120 days to pay qualified principal residence acquisition costs, subject to a $10,000 lifetime limit.
7. Withdrawals by certain military reservists. Early withdrawals taken by military reserve members called to active duty for at least 180 days or for an indefinite period are exempt from the 10% penalty.
8. Withdrawals after disability. Early withdrawals taken by an IRA owner who is physically or mentally disabled to the extent that the owner cannot engage in his or her customary gainful activity or a comparable gainful activity are exempt from the penalty tax. The disability must be expected to lead to death or be of long or indefinite duration.
9. Withdrawals to satisfy certain IRS debts. This applies to early IRA withdrawals taken to pay IRS levies against the account.
10. Withdrawals after death. Withdrawals taken from an IRA after the account owner’s death are always exempt from the 10% penalty. However, this exemption isn’t available for funds rolled over into the surviving spouse’s IRA or if the surviving spouse elects to treat an IRA inherited from the deceased spouse as the spouse’s own account.
11. Penalty-free withdrawals for emergencies coming soon. The SECURE 2.0 law adds a new exception for certain distributions used for emergency expenses, which are defined as unforeseeable or immediate financial needs relating to personal or family emergencies. Only one distribution of up to $1,000 is permitted a year and a taxpayer has the option to repay it within three years. This provision is effective for distributions made after December 31, 2023.
Since most or all of an early traditional IRA withdrawal will probably be taxable, it could push you into a higher marginal federal income tax bracket. You may also owe the 10% early withdrawal penalty and possibly state income tax too. Note that the penalty tax exceptions generally have additional requirements that we haven’t covered here.
If you’re planning to start a business or thinking about changing your business entity, you need to determine what will work best for you. Should you operate as a C corporation or a pass-through entity such as a sole-proprietorship, partnership, limited liability company (LLC) or S corporation? There are many issues to consider.
Currently, the corporate federal income tax is imposed at a flat 21% rate, while individual federal income tax rates currently begin at 10% and go up to 37%. The difference in rates can be alleviated by the qualified business income (QBI) deduction that’s available to eligible pass-through entity owners that are individuals, and some estates and trusts.
Individual rate caveats: The QBI deduction is scheduled to end in 2026, unless Congress acts to extend it, while the 21% corporate rate is not scheduled to expire. Also, noncorporate taxpayers with modified adjusted gross incomes above certain levels are subject to an additional 3.8% tax on net investment income.
Organizing a business as a C corporation instead of a pass-through entity may reduce the current federal income tax on the business’s income. The corporation can still pay reasonable compensation to the shareholders and pay interest on loans from the shareholders. That income will be taxed at higher individual rates, but the overall rate on the corporation’s income can be lower than if the business was operated as a pass-through entity.
More to take into account
There are other tax-related factors to take into consideration. For example:
- If most of the business profits will be distributed to the owners, it may be preferable to operate the business as a pass-through entity rather than a C corporation, since the shareholders will be taxed on dividend distributions from the corporation (double taxation). In contrast, owners of a pass-through entity will only be taxed once, at the personal level, on business income. However, the impact of double taxation must be evaluated based on projected income levels for both the business and its owners.
- If the value of the assets is likely to appreciate, it’s generally preferable to conduct business as a pass-through entity to avoid a corporate tax when the assets are sold or the business is liquidated. Although corporate level tax will be avoided if the corporation’s shares, rather than its assets, are sold, the buyer may insist on a lower price because the tax basis of appreciated business assets cannot be stepped up to reflect the purchase price. That can result in much lower post-purchase depreciation and amortization deductions for the buyer.
- If the business is a pass-through entity, an owner’s basis in his or her interest in the entity is stepped-up by the entity income that’s allocated to the owner. That can result in less taxable gain for the owner when his or her interests in the entity are sold.
- If the business is expected to incur tax losses for a while, you may want to structure it as a pass-through entity so you can deduct the losses against other income. Conversely, if you have insufficient other income or the losses aren’t usable (for example, because they’re limited by the passive loss rules), it may be preferable for the business to be a C corporation, since it’ll be able to offset future income with the losses.
- If the owner of a business is subject to the alternative minimum tax (AMT), it may be preferable to organize as a C corporation, since corporations aren’t subject to the AMT. Affected individuals are subject to the AMT at 26% or 28% rates.
As you can see, there are many factors involved in operating a business as a certain type of entity. This only covers a few of them. For more details about how to proceed in your situation, consult with us.
If you’re fortunate to have an employer that offers a 401(k) plan, and you don’t contribute to it, you may wonder if you should participate. In general, it’s a great tax and retirement saving deal! These plans help an employee accumulate a retirement nest egg on a tax-advantaged basis. If you’re thinking about contributing to a plan at work, here are some of the advantages.
With a 401(k) plan, you can opt to set aside a certain amount of your wages in a qualified retirement plan. By electing to set cash aside in a 401(k) plan, you’ll reduce your gross income and defer tax on the amount until the cash (adjusted by earnings) is distributed to you in the future. It will either be distributed from the plan or from an IRA or other plan that you roll your proceeds into after leaving your job.
Your wages or other compensation will be reduced by the pre-tax contributions that you make, which will save you current income taxes. But the amounts will still be subject to Social Security and Medicare taxes. If your employer’s plan allows, you may instead make all, or some, contributions on an after-tax basis. These are Roth 401(k) contributions. With Roth 401(k) contributions, the amounts will be subject to current income taxation, but if you leave these funds in the plan for a required time, distributions (including earnings) will be tax-free.
Your elective contributions — either pre-tax or after-tax — are subject to annual IRS limits. In 2023, the maximum amount permitted is $22,500. When you reach age 50, if your employer’s plan allows, you can make additional “catch-up” contributions. In 2023, that additional amount is up to $7,500. So if you’re 50 or older, the total that you can contribute to all 401(k) plans in 2023 is $30,000. Total employer contributions, including your elective deferrals (but not catch-up contributions), can’t exceed 100% of compensation or, for 2023, $66,000, whichever is less.
In a typical plan, you’re permitted to invest the amount of your contributions (and any employer matching or other contributions) among available investment options that your employer has selected. Periodically review your plan investment performance to determine that each investment remains appropriate for your retirement planning goals and your risk specifications.
Another important characteristic of these plans is the limitation on withdrawals while you’re working. Amounts in the plan attributable to elective contributions aren’t available to you before one of the following events:
- Retirement (or other separation from service),
- Reaching age 59½,
- Plan termination, or
Eligibility rules for a hardship withdrawal are strict. A hardship distribution must be necessary to help deal with an immediate and heavy financial need.
As an alternative to taking a hardship or other plan withdrawal while employed, your employer’s plan may allow you to receive a loan, which you pay back to your account with interest.
Employers may opt to match 401(k) contributions up to a certain amount. Although matching is not required, surveys show that most employers offer some type of match. If your employer matches contributions, you should make sure to contribute enough to receive the full amount. Otherwise, you’ll lose out on free money!
These are just the basics of 401(k) plans for employees. For more information, contact your employer. Of course, we can answer any tax questions you may have.
The Social Security Administration recently announced that the wage base for computing Social Security tax will increase to $168,600 for 2024 (up from $160,200 for 2023). Wages and self-employment income above this threshold aren’t subject to Social Security tax.
The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees and self-employed workers — one for Old Age, Survivors and Disability Insurance, which is commonly known as the Social Security tax, and the other for Hospital Insurance, which is commonly known as the Medicare tax.
There’s a maximum amount of compensation subject to the Social Security tax, but no maximum for Medicare tax. For 2024, the FICA tax rate for employers will be 7.65% — 6.2% for Social Security and 1.45% for Medicare (the same as in 2023).
For 2024, an employee will pay:
- 6.2% Social Security tax on the first $168,600 of wages (6.2% x $168,600 makes the maximum tax $10,453.20), plus
- 1.45% Medicare tax on the first $200,000 of wages ($250,000 for joint returns, $125,000 for married taxpayers filing separate returns), plus
- 2.35% Medicare tax (regular 1.45% Medicare tax plus 0.9% additional Medicare tax) on all wages in excess of $200,000 ($250,000 for joint returns, $125,000 for married taxpayers filing separate returns).
For 2024, the self-employment tax imposed on self-employed people will be:
- 12.4% Soc
With the rising cost of college, many families are in search of scholarships to help pay the bills. If your child is awarded a scholarship, you may wonder about how it could affect your family’s taxes. Good news: Scholarships (and fellowships) are generally tax-free for students at elementary, middle and high schools, as well as those attending college, graduate school or an accredited vocational school. It doesn’t matter if the scholarship makes a direct payment to the individual or reduces tuition.
Requirements for tax-free treatment
Despite this generally favorable treatment, scholarships aren’t always tax-free. Certain requirements must be met. A scholarship is tax-free only if it’s used to pay for:
- Tuition and fees required to attend the school, and
- Fees, books, supplies and equipment required of all students in a particular course.
For example, expenses that don’t qualify include the cost of room and board, travel, research and clerical help.
A scholarship award is taxable to the extent it isn’t used for qualifying items. The recipient is responsible for establishing how much of an award is used to pay for tuition and eligible expenses. Therefore, you should maintain records (such as copies of bills, receipts and cancelled checks) that reflect the use of the scholarship money.
Taxable and nontaxable amounts
Subject to limited exceptions, a scholarship isn’t tax-free if the payments are linked to services that your child performs as a condition for receiving the award, even if the services are required of all degree candidates. Therefore, a stipend your child receives for required teaching, research or other services is taxable, even if the child uses the money for tuition or related expenses.
What if you, or a family member, are an employee of an educational institution that provides reduced or free tuition? A reduction in tuition provided to you, your spouse or your dependents by the school at which you work isn’t included in your income and isn’t subject to tax.
Payments reported and not reported on tax returns
If a scholarship is tax-free and your child has no other income, the award doesn’t have to be reported on a tax return. However, any portion of an award that’s taxable as payment for services is treated as wages. Estimated tax payments may have to be made if the payor doesn’t withhold enough tax. Your child should receive a Form W-2 showing the amount of these “wages” and the amount of tax withheld, and any portion of the award that’s taxable must be reported, even if no Form W-2 is received.
These are just the basic rules. Other rules and limitations may apply. For example, if your child’s scholarship is taxable, it may limit other higher education tax benefits to which you or your child are entitled. Contact us if you wish to discuss these or other tax matters further.
Ever wonder how IRS examiners know about different industries so they can audit various businesses? They generally do research about specific industries and issues on tax returns by using IRS Audit Techniques Guides (ATGs). A little-known fact is that these guides are available to the public on the IRS website. In other words, your business can use the same guides to gain insight into what the IRS is looking for in terms of compliance with tax laws and regulations.
Many ATGs target specific industries, such as construction, aerospace, art galleries, architecture and veterinary medicine. Other guides address issues that frequently arise in audits, such as executive compensation, passive activity losses and capitalization of tangible property.
Issues unique to certain taxpayers
IRS auditors need to examine all different types of businesses, as well as individual taxpayers and tax-exempt organizations. Each type of return might have unique industry issues, business practices and terminology. Before meeting with taxpayers and their advisors, auditors do their homework to understand various industries or issues, the accounting methods commonly used, how income is received, and areas where taxpayers might not be in compliance.
By using a specific ATG, an IRS auditor may be able to reconcile discrepancies when reported income or expenses aren’t consistent with what’s normal for the industry or to identify anomalies within the geographic area in which the business is located.
Updates and revisions
Some guides were written several years ago and others are relatively new. There isn’t a guide for every industry. Here are some of the guide titles that have been revised or added in recent years:
- Entertainment Audit Technique Guide (March 2023), which covers income and expenses for performers, producers, directors, technicians and others in the film and recording industries, as well as in live performances;
- Capitalization of Tangible Property Audit Technique Guide (September 2022), which addresses potential tax issues involved in capital expenditures and dispositions of property.
- Oil and Gas Audit Technique Guide (February 2023), which explains the complex tax issues involved in the exploration, development and production of crude oil and natural gas;
- Cost Segregation Audit Technique Guide (June 2022), which provides IRS examiners with an understanding of why and how cost segregation studies are performed in order for businesses to claim refunds related to depreciation deductions.
- Attorneys Audit Technique Guide (January 2022), which covers issues including retainers, contingent fees, client trust accounts, travel expenses and more;
- Child Care Provider Audit Technique Guide (January 2022), which enables IRS examiners to audit businesses that provide care in homes or day care centers; and
- Retail Audit Technique Guide (March 2021), which details tax issues unique to businesses that purchase items from a supplier or wholesaler and resell them at a profit.
Although ATGs were created to help IRS examiners uncover common methods of hiding income and inflating deductions, they also can help businesses ensure they aren’t engaging in practices that could raise audit red flags. For a complete list of ATGs, visit the IRS website.
This year, many Americans have been victimized by wildfires, severe storms, flooding, tornadoes and other disasters. No matter where you live, unexpected disasters may cause damage to your home or personal property. Before the Tax Cuts and Jobs Act (TCJA), eligible casualty loss victims could claim a deduction on their tax returns. But currently, there are restrictions that make these deductions harder to take.
What’s considered a casualty for tax purposes? It’s a sudden, unexpected or unusual event, such as a hurricane, tornado, flood, earthquake, fire, act of vandalism or a terrorist attack.
Many unable to claim a tax break
For losses incurred from 2018 through 2025, the TCJA generally eliminates deductions for personal casualty losses, except for losses due to federally declared disasters.
Note: There’s an exception to the general rule of allowing casualty loss deductions only in federally declared disaster areas. If you have personal casualty gains because your insurance proceeds exceed the tax basis of the damaged or destroyed property, you can deduct personal casualty losses that aren’t due to a federally declared disaster up to the amount of your personal casualty gains.
Claim a refund with a special election
If your casualty loss is due to a federally declared disaster, a special election allows you to deduct the loss on your tax return for the preceding year and claim a refund. If you’ve already filed your return for the preceding year, you can file an amended return to make the election and claim the deduction in the earlier year. This can potentially help you get extra cash when you need it.
This election must be made no later than six months after the due date (without considering extensions) for filing your tax return for the year in which the disaster occurs. However, the election itself must be made on an original or amended return for the preceding year.
Calculating the deduction
You must take the following three steps to calculate the casualty loss deduction for personal-use property in an area declared a federal disaster:
- Subtract any insurance proceeds.
- Subtract $100 per casualty event.
- Combine the results from the first two steps and then subtract 10% of your adjusted gross income (AGI) for the year you claim the loss deduction.
Important: Another factor that makes it harder to claim a casualty loss than it was years ago is that you must itemize deductions to claim one. Through 2025, fewer people will itemize because the TCJA significantly increased the standard deduction amounts. For 2023, they’re $13,850 for single filers, $20,800 for heads of households, and $27,700 for married joint-filing couples. So even if you qualify for a casualty deduction, you might not get any tax benefit because you don’t have enough itemized deductions.
Lawmakers debate the issue
Earlier this year, a bipartisan group of lawmakers in Washington introduced a bill that would make the deduction available to more taxpayers. The proposed Casualty Loss Deduction Restoration Act would reinstate the deduction to all taxpayers with a casualty loss — not just those located in a federal disaster declaration area. Passage of the bill is uncertain at this time.
We can help
The rules described above are for personal property. Keep in mind that the rules for business or income-producing property are different and other rules may apply. (It’s easier to get a deduction for a business property casualty loss.) If you’re a victim of a disaster, we can help you understand the complex tax deduction rules.
Here are some of the key tax-related deadlines affecting businesses and other employers during the fourth quarter of 2023. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
Note: Certain tax-filing and tax-payment deadlines may be postponed for taxpayers who reside in or have businesses in federally declared disaster areas.
Monday, October 2
- The last day you can initially set up a SIMPLE IRA plan, provided you (or any predecessor employer) didn’t previously maintain a SIMPLE IRA plan. If you’re a new employer that comes into existence after October 1 of the year, you can establish a SIMPLE IRA plan as soon as administratively feasible after your business comes into existence.
Monday, October 16
- If a calendar-year C corporation that filed an automatic six-month extension:
- File a 2022 income tax return (Form 1120) and pay any tax, interest and penalties due.
- Make contributions for 2022 to certain employer-sponsored retirement plans.
- Establish and contribute to a SEP for 2022, if an automatic six-month extension was filed.
Tuesday, October 31
- Report income tax withholding and FICA taxes for third quarter 2023 (Form 941) and pay any tax due. (See exception below under “November 13.”)
Monday, November 13
- Report income tax withholding and FICA taxes for third quarter 2023 (Form 941), if you deposited on time (and in full) all of the associated taxes due.
Friday, December 15
- If a calendar-year C corporation, pay the fourth installment of 2023 estimated income taxes.
In recent years, merger and acquisition activity has been strong in many industries. If your business is considering merging with or acquiring another business, it’s important to understand how the transaction will be taxed under current law.
Stocks vs. assets
From a tax standpoint, a transaction can basically be structured in two ways:
1. Stock (or ownership interest) sale. A buyer can directly purchase a seller’s ownership interest if the target business is operated as a C or S corporation, a partnership, or a limited liability company (LLC) that’s treated as a partnership for tax purposes.
The now-permanent 21% corporate federal income tax rate under the Tax Cuts and Jobs Act (TCJA) makes buying the stock of a C corporation somewhat more attractive. Reasons: The corporation will pay less tax and generate more after-tax income. Plus, any built-in gains from appreciated corporate assets will be taxed at a lower rate when they’re eventually sold.
The TCJA’s reduced individual federal tax rates may also make ownership interests in S corporations, partnerships and LLCs more attractive. Reason: The passed-through income from these entities also will be taxed at lower rates on a buyer’s personal tax return. However, the TCJA’s individual rate cuts are scheduled to expire at the end of 2025, and, depending on future changes in Washington, they could be eliminated earlier or extended.
2. Asset sale. A buyer can also purchase the assets of a business. This may happen if a buyer only wants specific assets or product lines. And it’s the only option if the target business is a sole proprietorship or a single-member LLC that’s treated as a sole proprietorship for tax purposes.
Note: In some circumstances, a corporate stock purchase can be treated as an asset purchase by making a “Section 338 election.” Ask us if this would be beneficial in your situation.
Buyer vs. seller preferences
For several reasons, buyers usually prefer to purchase assets rather than ownership interests. Generally, a buyer’s main objective is to generate enough cash flow from an acquired business to pay any acquisition debt and provide an acceptable return on the investment. Therefore, buyers are concerned about limiting exposure to undisclosed and unknown liabilities and minimizing taxes after the deal closes.
A buyer can step up (increase) the tax basis of purchased assets to reflect the purchase price. Stepped-up basis lowers taxable gains when certain assets, such as receivables and inventory, are sold or converted into cash. It also increases depreciation and amortization deductions for qualifying assets.
Meanwhile, sellers generally prefer stock sales for tax and nontax reasons. One of their main objectives is to minimize the tax bill from a sale. That can usually be achieved by selling their ownership interests in a business (corporate stock, or partnership or LLC interests) as opposed to selling business assets.
With a sale of stock or other ownership interest, liabilities generally transfer to the buyer and any gain on sale is generally treated as lower-taxed long-term capital gain (assuming the ownership interest has been held for more than one year).
Keep in mind that other areas, such as employee benefits, can also cause unexpected tax issues when merging with, or acquiring, a business.
Professional advice is critical
Buying or selling a business may be the most important transaction you make during your lifetime, so it’s important to seek professional tax advice as you negotiate. After a deal is done, it may be too late to get the best tax results.
Now that Labor Day has passed, the holidays are just around the corner. Many people may want to make gifts of cash or stock to their loved ones. By properly using the annual exclusion, gifts to family members and loved ones can reduce the size of your taxable estate, within generous limits, without triggering any estate or gift tax. The exclusion amount for 2023 is $17,000.
The exclusion covers gifts you make to each recipient each year. Therefore, a taxpayer with three children can transfer $51,000 to the children this year free of federal gift taxes. If the only gifts made during a year are excluded in this fashion, there’s no need to file a federal gift tax return. If annual gifts exceed $17,000, the exclusion covers the first $17,000 per recipient, and only the excess is taxable. In addition, even taxable gifts may result in no gift tax liability thanks to the unified credit (discussed below).
Note: This discussion isn’t relevant to gifts made to a spouse because these gifts are free of gift tax under separate marital deduction rules.
Married taxpayers can split gifts
If you’re married, a gift made during a year can be treated as split between you and your spouse, even if the cash or gift property is actually given by only one of you. Thus, by gift-splitting, up to $34,000 a year can be transferred to each recipient by a married couple because of their two annual exclusions. For example, a married couple with three married children can transfer a total of $204,000 each year to their children and to the children’s spouses ($34,000 for each of six recipients).
If gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return (or returns) that the spouses file. The IRS prefers that both spouses indicate their consent on each return filed. Because more than $17,000 is being transferred by a spouse, a gift tax return (or returns) will have to be filed, even if the $34,000 exclusion covers total gifts. We can prepare a gift tax return (or returns) for you, if more than $17,000 is being given to a single individual in any year.
“Unified” credit for taxable gifts
Even gifts that aren’t covered by the exclusion, and are thus taxable, may not result in a tax liability. This is because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $12.92 million for 2023. However, to the extent you use this credit against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death.
Be aware that gifts made directly to a financial institution to pay for tuition or to a health care provider to pay for medical expenses on behalf of someone else don’t count towards the exclusion. For example, you can pay $20,000 to your grandson’s college for his tuition this year, plus still give him up to $17,000 as a gift.
Annual gifts help reduce the taxable value of your estate. The estate and gift tax exemption amount is scheduled to be cut drastically in 2026 to the 2017 level when the related Tax Cuts and Jobs Act provisions expire (unless Congress acts to extend them). Making large tax-free gifts may be one way to recognize and address this potential threat. They could help insulate you against any later reduction in the unified federal estate and gift tax exemption.
The Tax Cuts and Jobs Act liberalized the rules for depreciating business assets. However, the amounts change every year due to inflation adjustments. And due to high inflation, the adjustments for 2023 were big. Here are the numbers that small business owners need to know.
Section 179 deductions
For qualifying assets placed in service in tax years beginning in 2023, the maximum Sec. 179 deduction is $1.16 million. But if your business puts in service more than $2.89 million of qualified assets, the maximum Sec. 179 deduction begins to be phased out.
Eligible assets include depreciable personal property such as equipment, computer hardware and peripherals, vehicles and commercially available software.
Sec. 179 deductions can also be claimed for real estate qualified improvement property (QIP), up to the maximum allowance of $1.16 million. QIP is defined as an improvement to an interior portion of a nonresidential building placed in service after the date the building was placed in service. However, expenditures attributable to the enlargement of a building, elevators or escalators, or the internal structural framework of a building don’t count as QIP and usually must be depreciated over 39 years. There’s no separate Sec. 179 deduction limit for QIP, so deductions reduce your maximum allowance dollar for dollar.
For nonresidential real property, Sec. 179 deductions are also allowed for qualified expenditures for roofs, HVAC equipment, fire protection and alarm systems, and security systems.
Finally, eligible assets include depreciable personal property used predominantly in connection with furnishing lodging, such as furniture and appliances in a property rented to transients.
Deduction for heavy SUVs
There’s a special limitation on Sec. 179 deductions for heavy SUVs, meaning those with gross vehicle weight ratings (GVWR) between 6,001 and 14,000 pounds. For tax years beginning in 2023, the maximum Sec. 179 deduction for heavy SUVs is $28,900.
First-year bonus depreciation has been cut
For qualified new and used assets that were placed in service in calendar year 2022, 100% first-year bonus depreciation percentage could be claimed.
However, for qualified assets placed in service in 2023, the first-year bonus depreciation percentage dropped to 80%. In 2024, it’s scheduled to drop to 60% (40% in 2025, 20% in 2026 and 0% in 2027 and beyond).
Eligible assets include depreciable personal property such as equipment, computer hardware and peripherals, vehicles and commercially available software. First-year bonus depreciation can also be claimed for real estate QIP.
Exception: For certain assets with longer production periods, these percentage cutbacks are delayed by one year. For example, the 80% depreciation rate will apply to long-production-period property placed in service in 2024.
Passenger auto limitations
For federal income tax depreciation purposes, passenger autos are defined as cars, light trucks and light vans. These vehicles are subject to special depreciation limits under the so-called luxury auto depreciation rules. For new and used passenger autos placed in service in 2023, the maximum luxury auto deductions are as follows:
- $12,200 for Year 1 ($20,200 if bonus depreciation is claimed),
- $19,500 for Year 2,
- $11,700 for Year 3, and
- $6,960 for Year 4 and thereafter until fully depreciated.
These allowances assume 100% business use. They’ll be further adjusted for inflation in future years.
Advantage for heavy vehicles
Heavy SUVs, pickups, and vans (those with GVWRs above 6,000 pounds) are exempt from the luxury auto depreciation limitations because they’re considered transportation equipment. As such, heavy vehicles are eligible for Sec. 179 deductions (subject to the special deduction limit explained earlier) and first-year bonus depreciation.
Here’s the catch: Heavy vehicles must be used over 50% for business. Otherwise, the business-use percentage of the vehicle’s cost must be depreciated using the straight-line method and it’ll take six tax years to fully depreciate the cost.
Consult with us for the maximum depreciation tax breaks in your situation.
Many homeowners across the country have seen their home values increase in recent years. According to the National Association of Realtors, the median price of existing homes sold in July of 2023 rose 1.9% over July of 2022 after a couple years of much higher increases. The median home price was $467,500 in the Northeast, $304,600 in the Midwest, $366,200 in the South and $610,500 in the West.
Be aware of the tax implications if you’re selling your home or you sold one in 2023. You may owe capital gains tax and net investment income tax (NIIT).
You can exclude a large chunk
If you’re selling your principal residence, and meet certain requirements, you can exclude from tax up to $250,000 ($500,000 for joint filers) of gain.
To qualify for the exclusion, you must meet these tests:
- You must have owned the property for at least two years during the five-year period ending on the sale date.
- You must have used the property as a principal residence for at least two years during the five-year period. (Periods of ownership and use don’t need to overlap.)
In addition, you can’t use the exclusion more than once every two years.
The gain above the exclusion amount
What if you have more than $250,000/$500,000 of profit? Any gain that doesn’t qualify for the exclusion generally will be taxed at your long-term capital gains rate, provided you owned the home for at least a year. If you didn’t, the gain will be considered short term and subject to your ordinary-income rate, which could be more than double your long-term rate.
If you’re selling a second home (such as a vacation home), it isn’t eligible for the gain exclusion. But if it qualifies as a rental property, it can be considered a business asset, and you may be able to defer tax on any gains through an installment sale or a Section 1031 like-kind exchange. In addition, you may be able to deduct a loss, which you can’t do on a principal residence.
The NIIT may be due for some taxpayers
How does the 3.8% NIIT apply to home sales? If you sell your main home, and you qualify to exclude up to $250,000/$500,000 of gain, the excluded gain isn’t subject to the NIIT.
However, gain that exceeds the exclusion limit is subject to the tax if your adjusted gross income is over a certain amount. Gain from the sale of a vacation home or other second residence, which doesn’t qualify for the exclusion, is also subject to the NIIT.
The NIIT applies only if your modified adjusted gross income (MAGI) exceeds: $250,000 for married taxpayers filing jointly and surviving spouses; $125,000 for married taxpayers filing separately; and $200,000 for unmarried taxpayers and heads of household.
Two other tax considerations
- Keep track of your basis. To support an accurate tax basis, be sure to maintain complete records, including information about your original cost and subsequent improvements, reduced by any casualty losses and depreciation claimed for business use.
- You can’t deduct a loss. If you sell your principal residence at a loss, it generally isn’t deductible. But if a portion of your home is rented out or used exclusively for business, the loss attributable to that part may be deductible.
As you can see, depending on your home sale profit and your income, some or all of the gain may be tax-free. But for higher-income people with pricey homes, there may be a tax bill. We can help you plan ahead to minimize taxes and answer any questions you have about home sales.
If your employer provides life insurance, you probably find it to be a desirable fringe benefit. However, if group term life insurance is part of your benefits package, and the coverage is higher than $50,000, there may be undesirable income tax implications.
You’re taxed on income you didn’t receive
The first $50,000 of group term life insurance coverage that your employer provides is excluded from taxable income and doesn’t add anything to your income tax bill. But the employer-paid cost of group term coverage in excess of $50,000 is taxable income to you. It’s included in the taxable wages reported on your Form W-2 — even though you never actually receive it. In other words, it’s “phantom income.”
What’s worse, the cost of group term insurance must be determined under a table prepared by the IRS even if the employer’s actual cost is less than the cost figured under the table. With these determinations, the amount of taxable phantom income attributed to an older employee is often higher than the premium the employee would pay for comparable coverage under an individual term policy. This tax trap gets worse as an employee gets older and as the amount of his or her compensation increases.
Look at your W-2
What should you do if you think the tax cost of employer-provided group term life insurance is higher than you’d like? First, you should establish if this is actually the case. If a specific dollar amount appears in Box 12 of your Form W-2 (with code “C”), that dollar amount represents your employer’s cost of providing you with group term life insurance coverage in excess of $50,000, less any amount you paid for the coverage. You’re responsible for federal, state and local taxes on the amount that appears in Box 12, and for the associated Social Security and Medicare taxes as well.
But keep in mind that the amount in Box 12 is already included as part of your total “Wages, tips and other compensation” in Box 1 of the W-2, and it’s the Box 1 amount that’s reported on your tax return.
What to do
If you decide that the tax cost is too high for the benefit you’re getting in return, find out whether your employer has a “carve-out” plan (a plan that carves out selected employees from group term coverage) or, if not, whether it would be willing to create one. There are different types of carve-out plans that employers can offer to their employees.
For example, the employer can continue to provide $50,000 of group term insurance (since there’s no tax cost for the first $50,000 of coverage). Then, the employer can provide the employee with an individual policy for the balance of the coverage. Alternatively, the employer can give the employee the amount the employer would have spent for the excess coverage as a cash bonus that the employee can use to pay the premiums on an individual policy.
If you have questions about group term coverage and how it affects your tax bill, contact us.
The SECURE 2.0 law, which was enacted last year, contains wide-ranging changes to retirement plans. One provision in the law is that eligible employers will soon be able to provide more help to staff members facing emergencies. This will be done through what the law calls “pension-linked emergency savings accounts.”
Effective for plan years beginning January 1, 2024, SECURE 2.0 permits a plan sponsor to amend its 401(k), 403(b) or government 457(b) plan to offer emergency savings accounts that are connected to the plan.
Basic distribution rules
If a retirement plan participant withdraws money from an employer plan before reaching age 59½, a 10% additional tax or penalty generally applies unless an exception exists. This is on top of the ordinary tax that may be due.
The goal of these emergency accounts is to encourage employees to save for retirement while still providing access to their savings if emergencies arise. Under current law, there are specific exceptions when employees can withdraw money from their accounts without paying the additional 10% penalty but they don’t include all of the emergencies that an individual may face. For example, while participants can take penalty-free distributions to pay eligible medical expenses, they can’t take them for car repairs.
Here are some features of pension-linked emergency savings accounts:
- The accounts can only be offered to employee-participants who aren’t highly compensated. In general, a highly compensated employee is one who is a 5% or more owner of a business or has compensation in the preceding year that exceeds an indexed limit (for 2024, $150,000 or more of compensation in 2023).
- Plan sponsors can automatically enroll employee-participants in these accounts at up to 3% of their salary. Plan participants may opt out of making these contributions or pick a different rate to be taken from their pay.
- Annual contributions are capped at the lesser of $2,500 (indexed for inflation) or an amount chosen by the plan sponsor.
- Contributions to pension-linked emergency savings accounts are made on a Roth after-tax basis. Contributions reduce an employee’s other retirement contributions that can be made to a plan.
- A participant must be allowed to make withdrawals from his or her account at least once per month. No reason needs to be provided and a participant must not be subject to any fees or charges for the first four withdrawals from the account each plan year. (However, subsequent withdrawals may be subject to reasonable fees and charges.)
Another option to help employees
In addition to these accounts, SECURE 2.0 adds a new exception for certain retirement plan distributions used for emergency expenses, which are defined as unforeseeable or immediate financial needs relating to personal or family emergencies. Only one distribution of up to $1,000 is permitted a year, and a taxpayer has the option to repay the distribution within three years. This provision is effective for distributions beginning January 1, 2024.
Determine whether there’s time
In addition to what is outlined here, other rules apply to pension-linked emergency savings accounts. The IRS is likely to issue additional guidance in the next few months. Be aware that plan sponsors don’t have to offer these accounts and many employers may find that they need more time to establish them before 2024. Or they may decide there are too many administrative hurdles to clear. Contact us with questions.
The federal student loan “pause” is coming to an end on August 31 after more than three years. If you have student loan debt, you may wonder whether you can deduct the interest you pay on your tax return. The answer may be yes, subject to certain limits. The deduction is phased out if your adjusted gross income exceeds certain levels — and they aren’t as high as the income levels for many other deductions.
If you’re eligible, the maximum amount of student loan interest you can deduct each year is $2,500. The interest must be for a “qualified education loan,” which means a debt incurred to pay tuition, room and board, and related expenses to attend a post-high school educational institution, including certain vocational schools. Post-graduate programs may also qualify. For example, an internship or residency program leading to a degree or certificate awarded by an institution of higher education, hospital, or health care facility offering post-graduate training can qualify.
It doesn’t matter when the loan was taken out or whether interest payments made in earlier years on the loan were deductible or not.
It’s not available to everyone
For 2023, the deduction is phased out for single taxpayers with adjusted gross income (AGI) between $75,000 and $90,000 ($155,000 and $185,000 for married couples filing jointly). The deduction is unavailable for single taxpayers with AGI of more than $90,000 ($185,000 for married couples filing jointly).
Married taxpayers must file jointly to claim this deduction.
The deduction is taken “above the line.” In other words, it’s subtracted from gross income to determine AGI. Therefore, it’s available even to taxpayers who don’t itemize deductions.
No deduction is allowed to a taxpayer who can be claimed as a dependent on another tax return. For example, let’s say a parent is paying for the college education of a child whom the parent is claiming as a dependent. In this case, the interest deduction is only available for interest the parent pays on a qualifying loan, not for any of the interest the child may pay on a student loan. The child will be able to deduct interest that’s paid in later years when he or she is no longer a dependent.
The interest paid must be on funds borrowed to cover qualified education costs of the taxpayer or his or her spouse or dependent. The student must be a degree candidate carrying at least half the normal full-time workload. Also, the education expenses must be paid or incurred within a reasonable time before or after the loan is taken out.
Taxpayers must keep records to verify qualifying expenditures. Documenting a tuition expense isn’t likely to pose a problem. However, care should be taken to document other qualifying education-related expenses including books, equipment, fees, and transportation.
Documenting room and board expenses should be straightforward for students living and dining on campus. Students who live off campus should maintain records of room and board expenses, especially when there are complicating factors such as roommates.
If you’d like help in determining whether you qualify for this deduction or if you have questions, contact us.