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The SECURE Act – What You Need to Know

Congress recently passed—and the President signed into law—the SECURE Act, landmark legislation that affects the rules for creating and maintaining employer-provided retirement plans. Whether you currently offer your employees a retirement plan, or are planning to do so, you should consider how these new rules may affect your current retirement plan (or your decision to create a new one).

Here is a look at some of the more important elements of the SECURE Act that have an impact on employer-sponsors of retirement plans. The changes in the law apply to both large employers and small employers, but some of the changes are especially beneficial to small employers. However, not all of the changes are favorable, and there may be steps you could take to minimize their impact. Please give me a call if you would like to discuss these matters.

It is easier for unrelated employers to band together to create a single retirement plan. A multiple employer plan (MEP) is a single plan maintained by two or more unrelated employers. Starting in 2021, the new rules reduce the barriers to creating and maintaining MEPs, which will help increase opportunities for small employers to band together to obtain more favorable investment results, while allowing for more efficient and less expensive management services.

New small employer automatic plan enrollment credit. Automatic enrollment is shown to increase employee participation and retirement savings. Starting in 2020, the new rules create a new tax credit of up to $500 per year to employers to defray start-up costs for new 401(k) plans and SIMPLE IRA plans that include automatic enrollment. The credit is in addition to an existing plan start-up credit, and is available for three years. The new credit is also available to employers who convert an existing plan to a plan with an automatic enrollment design.

Increased credit for small employer pension plan start-up costs. The new rules increase the credit for plan start-up costs to make it more affordable for small businesses to set up retirement plans. Starting in 2020, the credit is increased by changing the calculation of the flat dollar amount limit on the credit to the greater of

  1. $500, or
  2. The lesser of:
    1. $250 multiplied by the number of nonhighly compensated employees of the eligible employer who are eligible to participate in the plan, or
    2. $5,000.

The credit applies for up to three years.

Expand retirement savings by increasing the auto enrollment safe harbor cap. An annual nondiscrimination test called the actual deferral percentage (ADP) test applies to elective deferrals under a 401(k) plan. The ADP test is deemed to be satisfied if a 401(k) plan includes certain minimum matching or non-elective contributions under either of two safe harbor plan designs and meets certain other requirements. One of the safe harbor plans is an automatic enrollment safe harbor plan.

Starting in 2020, the new rules increase the cap on the default rate under an automatic enrollment safe harbor plan from 10% to 15%, but only for years after the participant’s first deemed election year. For the participant’s first deemed election year, the cap on the default rate is 10%.

Allow long-term part-time employees to participate in 401(k) plans. Currently, employers are generally allowed to exclude part-time employees (i.e., employees who work less than 1,000 hours per year) when providing certain types of retirement plans—like a 401(k) plan—to their employees. As women are more likely than men to work part-time, these rules can be especially harmful for women in preparing for retirement.

However, starting in 2021, the new rules will require most employers maintaining a 401(k) plan to have a dual eligibility requirement under which an employee must complete either a one-year-of-service requirement (with the 1,000-hour rule), or three consecutive years of service where the employee completes at least 500 hours of service per year. For employees who are eligible solely by reason of the new 500-hour rule, the employer will be allowed to exclude those employees from testing under the nondiscrimination and coverage rules, and from the application of the top-heavy rules.

Looser notice requirements and amendment timing rules to facilitate adoption of nonelective contribution 401(k) safe harbor plans. The actual deferral percentage nondiscrimination test is deemed to be satisfied if a 401(k) plan includes certain minimum matching or nonelective contributions under either of two plan designs (referred to as a “401(k) safe harbor plan”), as well as certain required rights and features, and satisfies a notice requirement. Under one type of 401(k) safe harbor plan, the plan either

  1. Satisfies a matching contribution requirement, or
  2. Provides for a nonelective contribution to a defined contribution plan of at least 3% of an employee’s compensation on behalf of each nonhighly compensated employee who is eligible to participate in the plan.

For plan years beginning after Dec. 31, 2019, the new rules change the nonelective contribution 401(k) safe harbor to provide greater flexibility, improve employee protection, and facilitate plan adoption. The new rules eliminate the safe harbor notice requirement, but maintain the requirement to allow employees to make or change an election at least once per year. The rules also permit amendments to nonelective status at any time before the 30th day before the close of the plan year. Amendments after that time are allowed if the amendment provides

  1. A nonelective contribution of at least 4% of compensation (rather than at least 3%) for all eligible employees for that plan year, and
  2. The plan is amended no later than the last day for distributing excess contributions for the plan year (i.e., by the close of following plan year).

Expanded portability of lifetime income options. Starting in 2020, the new rules permit certain retirement plans to make a direct trustee-to-trustee transfer to another employer-sponsored retirement plan, or IRA, of a lifetime income investment or distributions of a lifetime income investment in the form of a qualified plan distribution annuity, if a lifetime income investment is no longer authorized to be held as an investment option under the plan. This change permits participants to preserve their lifetime income investments and avoid surrender charges and fees.

Qualified employer plans barred from making loans through credit cards and similar arrangements. For loans made after Dec. 20, 2019, plan loans may no longer be distributed through credit cards or similar arrangements. This change is intended to ensure that plan loans are not used for routine or small purchases, thereby helping to preserve retirement savings.

Nondiscrimination rules modified to protect older, longer service participants in closed plans. Starting in 2020, the nondiscrimination rules as they pertain to closed pension plans (i.e., plans closed to new entrants) are being changed to permit existing participants to continue to accrue benefits. The modification will protect the benefits for older, longer-service employees as they near retirement.

Plans adopted by filing due date for year may be treated as in effect as of close of year. Starting in 2020, employers can elect to treat qualified retirement plans adopted after the close of a tax year, but before the due date (including extensions) of the tax return, as having been adopted as of the last day of the year. The additional time to establish a plan provides flexibility for employers who are considering adopting a plan, and the opportunity for employees to receive contributions for that earlier year.

New annual disclosures required for estimated lifetime income streams. The new rules (starting at a to-be-determined future date) will require that plan participants’ benefit statements include a lifetime income disclosure at least once during any 12-month period. The disclosure will have to illustrate the monthly payments the participant would receive if the total account balance were used to provide lifetime income streams, including a qualified joint and survivor annuity for the participant and the participant s surviving spouse and a single life annuity.

Fiduciary safe harbor added for selection of annuity providers. When a plan sponsor selects an annuity provider for the plan, the sponsor is considered a plan “fiduciary,” which generally means that the sponsor must discharge his or her duties with respect to the plan solely in the interests of plan participants and beneficiaries (this is known as the “prudence requirement”).

Starting on Dec. 20, 2019 (the date the SECURE Act was signed into law), fiduciaries have an optional safe harbor to satisfy the prudence requirement in their selection of an insurer for a guaranteed retirement income contract, and are protected from liability for any losses that may result to participants or beneficiaries due to an insurer’s future inability to satisfy its financial obligations under the terms of the contract. Removing ambiguity about the applicable fiduciary standard eliminates a roadblock to offering lifetime income benefit options under a plan.

Increased penalties for failure-to-file retirement plan returns. Starting in 2020, the new rules modify the failure-to-file penalties for retirement plan returns.

The penalty for failing to file a Form 5500 (for annual plan reporting) is changed to $250 per day, not to exceed $150,000.

A taxpayer’s failure to file a registration statement incurs a penalty of $10 per participant per day, not to exceed $50,000.

The failure to file a required notification of change results in a penalty of $10 per day, not to exceed $10,000.

The failure to provide a required withholding notice results in a penalty of $100 for each failure, not to exceed $50,000 for all failures during any calendar year.

Accelerate depreciation deductions with a cost segregation study

Is your business depreciating over a 39-year period the entire cost of constructing the building that houses your operation? If so, you should consider a cost segregation study. It may allow you to accelerate depreciation deductions on certain items, thereby reducing taxes and boosting cash flow. And under current law, the potential benefits of a cost segregation study are now even greater than they were a few years ago due to enhancements to certain depreciation-related tax breaks.

Depreciation basics

Business buildings generally have a 39-year depreciation period (27.5 years for residential rental properties). Most times, you depreciate a building’s structural components, including walls, windows, HVAC systems, elevators, plumbing and wiring, along with the building. Personal property — such as equipment, machinery, furniture and fixtures — is eligible for accelerated depreciation, usually over five or seven years. And land improvements, such as fences, outdoor lighting and parking lots, are depreciable over 15 years.

Often, businesses allocate all or most of their buildings’ acquisition or construction costs to real property, overlooking opportunities to allocate costs to shorter-lived personal property or land improvements. In some cases — computers or furniture, for example — the distinction between real and personal property is obvious. But the line between the two is frequently less clear. Items that appear to be “part of a building” may in fact be personal property, like removable wall and floor coverings, removable partitions, awnings and canopies, window treatments, signs and decorative lighting.

In addition, certain items that otherwise would be treated as real property may qualify as personal property if they serve more of a business function than a structural purpose. This includes reinforced flooring to support heavy manufacturing equipment, electrical or plumbing installations required to operate specialized equipment, or dedicated cooling systems for data processing rooms.

Identifying and substantiating costs

A cost segregation study combines accounting and engineering techniques to identify building costs that are properly allocable to tangible personal property rather than real property. Although the relative costs and benefits of a cost segregation study depend on your particular facts and circumstances, it can be a valuable investment.

Speedier depreciation tax breaks

The Tax Cuts and Jobs Act (TCJA) enhances certain depreciation-related tax breaks, which may also enhance the benefits of a cost segregation study. Among other things, the act permanently increased limits on Section 179 expensing, which allows you to immediately deduct the entire cost of qualifying equipment or other fixed assets up to specified thresholds.

The TCJA also expanded 15-year-property treatment to apply to qualified improvement property. Previously this break was limited to qualified leasehold-improvement, retail-improvement and restaurant property. And it temporarily increased first-year bonus depreciation to 100% (from 50%).

Making favorable depreciation changes

Fortunately, it isn’t too late to get the benefit of speedier depreciation for items that were incorrectly assumed to be part of your building for depreciation purposes. You don’t have to amend your past returns (or meet a deadline for claiming tax refunds) to claim the depreciation that you could have already claimed. Instead, you can claim that depreciation by following procedures, in connection with the next tax return that you file, that will result in “automatic” IRS consent to a change in your accounting for depreciation.

Cost segregation studies can yield substantial benefits, but they’re not right for every business. We must judge whether a study will result in overall tax savings greater than the costs of the study itself. To find out whether this would be worthwhile for you, contact us

The tax implications of a company car

The use of a company vehicle is a valuable fringe benefit for owners and employees of small businesses. This benefit results in tax deductions for the employer as well as tax breaks for the owners and employees using the cars. (And of course, they get the nontax benefits of driving the cars!) Even better, recent tax law changes and IRS rules make the perk more valuable than before.

Here’s an example

Let’s say you’re the owner-employee of a corporation that’s going to provide you with a company car. You need the car to visit customers, meet with vendors and check on suppliers. You expect to drive the car 8,500 miles a year for business. You also expect to use the car for about 7,000 miles of personal driving, including commuting, running errands and weekend trips with your family. Therefore, your usage of the vehicle will be approximately 55% for business and 45% for personal purposes. You want a nice car to reflect positively on your business, so the corporation buys a new luxury $50,000 sedan.

Your cost for personal use of the vehicle will be equal to the tax you pay on the fringe benefit value of your 45% personal mileage. By contrast, if you bought the car yourself to be able to drive the personal miles, you’d be out-of-pocket for the entire purchase cost of the car.

Your personal use will be treated as fringe benefit income. For tax purposes, your corporation will treat the car much the same way it would any other business asset, subject to depreciation deduction restrictions if the auto is purchased. Out-of-pocket expenses related to the car (including insurance, gas, oil and maintenance) are deductible, including the portion that relates to your personal use. If the corporation finances the car, the interest it pays on the loan would be deductible as a business expense (unless the business is subject to business-interest limitation under the tax code).

In contrast, if you bought the auto yourself, you wouldn’t be entitled to any deductions. Your outlays for the business-related portion of your driving would be unreimbursed employee business expenses that are nondeductible from 2018 to 2025 due to the suspension of miscellaneous itemized deductions under the Tax Cuts and Jobs Act. And if you financed the car yourself, the interest payments would be nondeductible.

And finally, the purchase of the car by your corporation will have no effect on your credit rating.

Administrative tasks

Providing an auto for an owner’s or key employee’s business and personal use comes with complications and paperwork. Personal use will have to be tracked and valued under the fringe benefit tax rules and treated as income. This article only explains the basics.

Despite the necessary valuation and paperwork, a company-provided car is still a valuable fringe benefit for business owners and key employees. It can provide them with the use of a vehicle at a low tax cost while generating tax deductions for their businesses. We can help you stay in compliance with the rules and explain more about this prized perk.

Please contact our office if you are interested in the pros and cons of a company car for your business.

The IRS is targeting business transactions in bitcoin and other virtual currencies

Cryptocurrency and blockchain. Platform creation of digital currency. Web business, analytics and management.

Bitcoin and other forms of virtual currency are gaining popularity. But many businesses, consumers, employees and investors are still confused about how they work and how to report transactions on their federal tax returns. And the IRS just announced that it is targeting virtual currency users in a new “educational letter” campaign. 

The nuts and bolts

Unlike cash or credit cards, small businesses generally don’t accept bitcoin payments for routine transactions. However, a growing number of larger retailers — and online businesses — now accept payments. Businesses can also pay employees or independent contractors with virtual currency. The trend is expected to continue, so more small businesses may soon get on board.

Bitcoin has an equivalent value in real currency. It can be digitally traded between users. You can also purchase and exchange bitcoin with real currencies (such as U.S. dollars). The most common ways to obtain bitcoin are through virtual currency ATMs or online exchanges, which typically charge nominal transaction fees.

Once you (or your customers) obtain bitcoin, it can be used to pay for goods or services using “bitcoin wallet” software installed on your computer or mobile device. Some merchants accept bitcoin to avoid transaction fees charged by credit card companies and online payment providers (such as PayPal).

Tax reporting

Virtual currency has triggered many tax-related questions. The IRS has issued limited guidance to address them. In a 2014 guidance, the IRS established that virtual currency should be treated as property, not currency, for federal tax purposes.

As a result, businesses that accept bitcoin payments for goods and services must report gross income based on the fair market value of the virtual currency when it was received. This is measured in equivalent U.S. dollars.

From the buyer’s perspective, purchases made using bitcoin result in a taxable gain if the fair market value of the property received exceeds the buyer’s adjusted basis in the currency exchanged. Conversely, a tax loss is incurred if the fair market value of the property received is less than its adjusted tax basis.

Wages paid using virtual currency are taxable to employees and must be reported by employers on W-2 forms. They’re subject to federal income tax withholding and payroll taxes, based on the fair market value of the virtual currency on the date of receipt.

Virtual currency payments made to independent contractors and other service providers are also taxable. In general, the rules for self-employment tax apply and payers must issue 1099-MISC forms.

IRS campaign

The IRS announced it is sending letters to taxpayers who potentially failed to report income and pay tax on virtual currency transactions or didn’t report them properly. The letters urge taxpayers to review their tax filings and, if appropriate, amend past returns to pay back taxes, interest and penalties.

By the end of August, more than 10,000 taxpayers will receive these letters. The names of the taxpayers were obtained through compliance efforts undertaken by the IRS. The IRS Commissioner warned, “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics.”

Last year, the tax agency also began an audit initiative to address virtual currency noncompliance and has stated that it’s an ongoing focus area for criminal cases.

Implications of going virtual

Contact us if you have questions about the tax considerations of accepting virtual currency or using it to make payments for your business. And if you receive a letter from the IRS about possible noncompliance, consult with us before responding.

Businesses can utilize the same information IRS auditors use to examine tax returns

The IRS uses Audit Techniques Guides (ATGs) to help IRS examiners get ready for audits. 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 or businesses, such as construction, aerospace, art galleries, child care providers and veterinary medicine. Others address issues that frequently arise in audits, such as executive compensation, passive activity losses and capitalization of tangible property.

How they’re used

IRS auditors need to examine all 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 may not be in compliance.

By using a specific ATG, an 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.

For example, one ATG focuses specifically on businesses that deal in cash, such as auto repair shops, car washes, check-cashing operations, gas stations, laundromats, liquor stores, restaurants., bars, and salons. The “Cash Intensive Businesses” ATG tells auditors “a financial status analysis including both business and personal financial activities should be done.” It explains techniques such as:

  • How to examine businesses with and without cash registers,
  • What a company’s books and records may reveal,
  • How to analyze bank deposits and checks written from known bank accounts,
  • What to look for when touring a business,
  • Ways to uncover hidden family transactions,
  • How cash invoices found in an audit of one business may lead to another business trying to hide income by dealing mainly in cash.

Auditors are obviously looking for cash-intensive businesses that underreport their cash receipts but how this is uncovered varies. For example, when examining a restaurants or bar, auditors are told to ask about net profits compared to the industry average, spillage, pouring averages and tipping.

Learn the red flags

Although ATGs were created to help IRS examiners ferret out 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. Contact us if you have questions about your business. For a complete list of ATGs, visit the IRS website here.

Tax-smart domestic travel: Combining business with pleasure

Summer is just around the corner, so you might be thinking about getting some vacation time. If you’re self-employed or a business owner, you have a golden opportunity to combine a business trip with a few extra days of vacation and offset some of the cost with a tax deduction. But be careful, or you might not qualify for the write-offs you’re expecting.

Basic rules

Business travel expenses can potentially be deducted if the travel is within the United States and the expenses are:

  • “Ordinary and necessary” and
  • Directly related to the business.

Note: The tax rules for foreign business travel are different from those for domestic travel.

Business owners and the self-employed are generally eligible to deduct business travel expenses if they meet the tests described above. However, under the Tax Cuts and Jobs Act, employees can no longer deduct such expenses. The potential deductions discussed in this article assume that you’re a business owner or self-employed.

A business-vacation trip

Transportation costs to and from the location of your business activity may be 100% deductible if the primary reason for the trip is business rather than pleasure. But if vacation is the primary reason for your travel, generally no transportation costs are deductible. These costs include plane or train tickets, the cost of getting to and from the airport, luggage handling tips and car expenses if you drive. Costs for driving your personal car are also eligible.

The key factor in determining whether the primary reason for domestic travel is business is the number of days you spend conducting business vs. enjoying vacation days. Any day principally devoted to business activities during normal business hours counts as a business day. In addition:

  • Your travel days count as business days, as do weekends and holidays — if they fall between days devoted to business and it wouldn’t be practical to return home.
  • Standby days (days when your physical presence might be required) also count as business days, even if you aren’t ultimately called upon to work on those days.

Bottom line: If your business days exceed your personal days, you should be able to claim business was the primary reason for a domestic trip and deduct your transportation costs.

What else can you deduct?

Once at the destination, your out-of-pocket expenses for business days are fully deductible. Examples of these expenses include lodging, meals (subject to the 50% disallowance rule), seminar and convention fees, and cab fare. Expenses for personal days aren’t deductible.

Keep in mind that only expenses for yourself are deductible. You can’t deduct expenses for family members traveling with you, including your spouse — unless they’re employees of your business and traveling for a bona fide business purpose.

Keep good records

Be sure to retain proof of the business nature of your trip. You must properly substantiate all of the expenses you’re deducting. If you get audited, the IRS will want to see records during travel you claim was for business. Good records are your best defense. Additional rules and limits apply to travel expense deductions. Please contact us if you have questions.

PRESS RELEASE: Paul Glantz, CPA Appointed to Intuit’s Accountant Council

PRESS RELEASE


Contacts:           

Paul Glantz, CPA
Launch Consulting, Inc
512-666-0729
Paul@launchconsultinginc.com

Kim Amsbaugh, Intuit, Inc
650-944-6649
kim_amsbaugh@intuit.com

Paul Glantz, CPA Appointed to Intuit’s Accountant Council

Select Panel Advises on Products and Services that Accountants and Their Clients Want Most

            AUSTIN, TX – June 3, 2019 – Today, Intuit, Inc (Nasdaq: INTU) announced that Paul Glantz, CPA has been named to the company’s U.S. Accountant Council advisory board. Intuit’s mission is to power prosperity around the world, and it accomplishes this through its innovative ecosystem of financial management solutions that serve more than 50 million accounting professionals, small businesses and consumers worldwide.

As President of Launch Consulting, Inc., Glantz is one of 16 council members who will share their insights, experience and expertise to help Intuit develop new products and services for accounting professionals and small businesses worldwide. Glantz has more than 10 years of experience in providing advisory and accounting services that help small businesses thrive.

“We are excited to have Paul on our Council,” said Ariege Misherghi, leader of the Accountant Segment, Small Business and Self-Employed Group at Intuit. “As an accounting professional who embraces new technology and forward-thinking practices, Paul will be a critical member of our advisory board. He will be instrumental in helping us develop, enhance and deliver products and services that meet the needs of accounting professionals across the globe, ultimately allowing them to better serve their small business and self-employed clients.”

Glantz said he is looking forward to participating on council, “I’m honored and excited to be a part of this council. This is an opportunity for Launch Consulting to drive innovation for the future of accounting and the next generation of Intuit products. As an innovative CPA with a growing client base, I’ve immersed myself in becoming an expert in cloud-based accounting solutions and industry best practices, always putting the needs of our clients first. QuickBooks Online is a great solution for the entrepreneurs, technology businesses, and start-ups for which Launch Consulting provides strategic tax guidance and virtual accounting services. I hope that my contribution to this council helps drive product innovation at Intuit, providing valuable feedback addressing real world customer needs.”

Intuit’s Accountant Council meets periodically at Intuit’s Silicon Valley headquarters to get an inside look at the company’s strategy and product development. Members participate for up to two years, sharing their thoughts and insights on critical accountant and small business tools.

About Intuit Inc.

Intuit’s mission is to Power Prosperity Around the World. Our global products and platforms, including TurboTaxQuickBooksMint and Turbo, are designed to empower consumers, self-employed and small businesses to improve their financial lives, finding them more money with the least amount of work, while giving them complete confidence in their actions and decisions. Our innovative ecosystem of financial management solutions serves approximately 50 million customers worldwide, unleashing the power of many for the prosperity of one. Please visit us for the latest news and in-depth information about Intuit and its brands and find us on social.

Taxpayers should include tax plans in their wedding plans

Couples getting married this year know there are a lot of details in planning a wedding. Along with the cake and gift registry, their first tax return as a married couple should be on their checklist. The IRS has tips and tools to help newlyweds consider how marriage may affect their taxes.

Here are five simple steps that can make filing their first tax return as newlyweds less stressful.

Step 1: Taxpayers should check their withholding at the beginning of each year, or when their personal circumstances change — like after getting married. Using the IRS Withholding Calculator is a good way for taxpayers to check their withholding. Taxpayers who need to change their withholding should complete and submit a new Form W-4, Employee’s Withholding Allowance Certificate, to their employer.

Step 2: Marriage may mean a change in name. If either – or both – of the newlyweds legally change their name, it’s important to report that change to the Social Security Administration. The names on the taxpayers’ tax return must match the names on file at the SSA. If it doesn’t, it could delay any refund.

Step 3: If a marriage means a change in address, the IRS and the U.S. Postal Service need to know. Newlyweds can file Form 8822, Change of Address, to update their mailing address with the IRS. They should notify the postal service to forward their mail by going online at USPS.com or by visiting their local post office.

Step 4: Taxpayers who receive advance payments of the premium tax credit should report changes in circumstances to their Health Insurance Marketplace as they happen. Certain changes to household, income or family size may affect the amount of the premium tax credit. This can affect a tax refund or the amount of tax owed. Taxpayers should also notify the Marketplace when they move out of the area covered by their current Marketplace plan.

Step 5: Newlyweds should consider their filing status. A taxpayer’s marital status on December 31 determines whether they’re considered married for that full year. Generally, the tax law allows married couples to file their federal income tax return either jointly or separately in any given year. Taxpayers can use the Interactive Tax Assistant to determine which status is best for them.

Source: IRS Tax Tip 2019-68

Hire your children this summer: Everyone wins

If you’re a business owner and you hire your children (or grandchildren) this summer, you can obtain tax breaks and other nontax benefits. The kids can gain on-the-job experience, save for college and learn how to manage money. And you may be able to:

  • Shift your high-taxed income into tax-free or low-taxed income,
  • Realize payroll tax savings (depending on the child’s age and how your business is organized), and
  • Enable retirement plan contributions for the children.

It must be a real job

When you hire your child, you get a business tax deduction for employee wage expenses. In turn, the deduction reduces your federal income tax bill, your self-employment tax bill (if applicable), and your state income tax bill (if applicable). However, in order for your business to deduct the wages as a business expense, the work performed by the child must be legitimate and the child’s salary must be reasonable.

For example, let’s say a business owner operates as a sole proprietor and is in the 37% tax bracket. He hires his 16-year-old son to help with office work on a full-time basis during the summer and part-time into the fall. The son earns $10,000 during 2019 and doesn’t have any other earnings.

The business owner saves $3,700 (37% of $10,000) in income taxes at no tax cost to his son, who can use his 2019 $12,200 standard deduction to completely shelter his earnings.

The family’s taxes are cut even if the son’s earnings exceed his or her standard deduction. The reason is that the unsheltered earnings will be taxed to the son beginning at a rate of 10%, instead of being taxed at his father’s higher rate.

How payroll taxes might be saved

If your business isn’t incorporated, your child’s wages are exempt from Social Security, Medicare and FUTA taxes if certain conditions are met. Your child must be under age 18 for this to apply (or under age 21 in the case of the FUTA tax exemption). Contact us for how this works.

Be aware that there’s no FICA or FUTA exemption for employing a child if your business is incorporated or a partnership that includes nonparent partners.

Start saving for retirement early

Your business also may be able to provide your child with retirement benefits, depending on the type of plan you have and how it defines qualifying employees. And because your child has earnings from his or her job, he can contribute to a traditional IRA or Roth IRA. For the 2018 tax year, a working child can contribute the lesser of his or her earned income, or $6,000 to an IRA or a Roth.

Raising tax-smart children

As you can see, hiring your child can be a tax-smart idea. Be sure to keep the same records as you would for other employees to substantiate the hours worked and duties performed (such as timesheets and job descriptions). Issue your child a Form W-2. If you have any questions about how these rules apply to your situation, don’t hesitate to contact us.

What type of expenses can’t be written off by your business?

If you read the Internal Revenue Code (and you probably don’t want to!), you may be surprised to find that most business deductions aren’t specifically listed. It doesn’t explicitly state that you can deduct office supplies and certain other expenses.

Some expenses are detailed in the tax code, but the general rule is contained in the first sentence of Section 162, which states you can write off “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

Basic definitions

In general, an expense is ordinary if it’s considered common or customary in the particular trade or business. For example, insurance premiums to protect a store would be an ordinary business expense in the retail industry.

A necessary expense is defined as one that’s helpful or appropriate. For example, let’s say a car dealership purchases an automatic defibrillator. It may not be necessary for the operation of the business, but it might be helpful and appropriate if an employee or customer suffers a heart attack.

It’s possible for an ordinary expense to be unnecessary — but, in order to be deductible, an expense must be ordinary and necessary.

In addition, a deductible amount must be reasonable in relation to the benefit expected. For example, if you’re attempting to land a $3,000 deal, a $65 lunch with a potential client should be OK with the IRS. (Keep in mind that the Tax Cuts and Jobs Act eliminated most deductions for entertainment expenses but retains the 50% deduction for business meals.)

Examples of not ordinary and unnecessary

Not surprisingly, the IRS and courts don’t always agree with taxpayers about what qualifies as ordinary and necessary expenditures.

In one case, a man engaged in a business with his brother was denied deductions for his private airplane expenses. The U.S. Tax Court noted that the taxpayer had failed to prove the expenses were ordinary and necessary to the business. In addition, only one brother used the plane and the flights were to places that the taxpayer could have driven to or flown to on a commercial airline. And, in any event, the stated expenses including depreciation expenses, weren’t adequately substantiated, the court added. (TC Memo 2018-108)

In another case, the Tax Court ruled that a business owner wasn’t entitled to deduct legal and professional fees he’d incurred in divorce proceedings defending his ex-wife’s claims to his interest in, or portion of, distributions he received from his LLC. The IRS and the court ruled the divorce legal fees were nondeductible personal expenses and weren’t ordinary and necessary. (TC Memo 2018-80)

Proceed with caution

The deductibility of some expenses is clear. But for other expenses, it can get more complicated. Generally, if an expense seems like it’s not normal in your industry — or if it could be considered fun, personal or extravagant in nature — you should proceed with caution. And keep records to substantiate the expenses you’re deducting. Consult with us for guidance.