Choosing the right accounting method for tax purposes

The Tax Cuts and Jobs Act (TCJA) liberalized the eligibility rules for using the cash method of accounting, making this method — which is simpler than the accrual method — available to more businesses. Now the IRS has provided procedures a small business taxpayer can use to obtain automatic consent to change its method of accounting under the TCJA. If you have the option to use either accounting method, it pays to consider whether switching methods would be beneficial.

Cash vs. accrual

Generally, cash-basis businesses recognize income when it’s received and deduct expenses when they’re paid. Accrual-basis businesses, on the other hand, recognize income when it’s earned and deduct expenses when they’re incurred, without regard to the timing of cash receipts or payments.

In most cases, a business is permitted to use the cash method of accounting for tax purposes unless it’s:

  1. Expressly prohibited from using the cash method, or
  2. Expressly required to use the accrual method.

Cash method advantages

The cash method offers several advantages, including:

Simplicity. It’s easier and cheaper to implement and maintain.

Tax-planning flexibility. It offers greater flexibility to control the timing of income and deductible expenses. For example, it allows you to defer income to next year by delaying invoices or to shift deductions into this year by accelerating the payment of expenses. An accrual-basis business doesn’t enjoy this flexibility. For example, to defer income, delaying invoices wouldn’t be enough; the business would have to put off shipping products or performing services.

Cash flow benefits. Because income is taxed in the year it’s received, the cash method does a better job of ensuring that a business has the funds it needs to pay its tax bill.

Accrual method advantages

In some cases, the accrual method may offer tax advantages. For example, accrual-basis businesses may be able to use certain tax-planning strategies that aren’t available to cash-basis businesses, such as deducting year-end bonuses that are paid within the first 2½ months of the following year and deferring income on certain advance payments.

The accrual method also does a better job of matching income and expenses, so it provides a more accurate picture of a business’s financial performance. That’s why it’s required under Generally Accepted Accounting Principles (GAAP).

If your business prepares GAAP-compliant financial statements, you can still use the cash method for tax purposes. But weigh the cost of maintaining two sets of books against the potential tax benefits.

Making a change

Keep in mind that cash and accrual are the two primary tax accounting methods, but they’re not the only ones. Some businesses may qualify for a different method, such as a hybrid of the cash and accrual methods.

If your business is eligible for more than one method, we can help you determine whether switching methods would make sense and can execute the change for you if appropriate.

Choosing the best business entity structure post-TCJA

For tax years beginning in 2018 and beyond, the Tax Cuts and Jobs Act (TCJA) created a flat 21% federal income tax rate for C corporations. Under prior law, C corporations were taxed at rates as high as 35%. The TCJA also reduced individual income tax rates, which apply to sole proprietorships and pass-through entities, including partnerships, S corporations, and, typically, limited liability companies (LLCs). The top rate, however, dropped only slightly, from 39.6% to 37%.

On the surface, that may make choosing C corporation structure seem like a no-brainer. But there are many other considerations involved.

Conventional wisdom

Under prior tax law, conventional wisdom was that most small businesses should be set up as sole proprietorships or pass-through entities to avoid the double taxation of C corporations: A C corporation pays entity-level income tax and then shareholders pay tax on dividends — and on capital gains when they sell the stock. For pass-through entities, there’s no federal income tax at the entity level.

Although C corporations are still potentially subject to double taxation under the TCJA, their new 21% tax rate helps make up for it. This issue is further complicated, however, by another provision of the TCJA that allows noncorporate owners of pass-through entities to take a deduction equal to as much as 20% of qualified business income (QBI), subject to various limits. But, unless Congress extends it, the break is available only for tax years beginning in 2018 through 2025.

There’s no one-size-fits-all answer when deciding how to structure a business. The best choice depends on your business’s unique situation and your situation as an owner.

3 common scenarios

Here are three common scenarios and the entity-choice implications:

  1. Business generates tax losses. For a business that consistently generates losses, there’s no tax advantage to operating as a C corporation. Losses from C corporations can’t be deducted by their owners. A pass-through entity will generally make more sense because losses pass through to the owners’ personal tax returns.
  2. Business distributes all profits to owners. For a profitable business that pays out all income to the owners, operating as a pass-through entity generally will be better if significant QBI deductions are available. If not, it’s probably a toss-up in terms of tax liability.
  3. Business retains all profits to finance growth. For a business that’s profitable but holds on to its profits to fund future growth strategies, operating as a C corporation generally will be advantageous if the corporation is a qualified small business (QSB). Why? A 100% gain exclusion may be available for QSB stock sale gains. If QSB status is unavailable, operating as a C corporation is still probably preferred — unless significant QBI deductions would be available at the owner level.

Many considerations

These are only some of the issues to consider when making the C corporation vs. pass-through entity choice. We can help you evaluate your options

 

C corp vs  S-Corp Launch Consulting

Two-income Families Should Check Withholding Amount

Two income families and those who work multiple jobs typically end up under-withheld. We recommend using the IRS Withholding Calculator to help navigate the complexities of multiple employer tax situations and to determine if the correct amount of tax for each employer is being withheld.

The passage of the Tax Cuts and Jobs Act (TCJA), which will affect 2018 tax returns that will be filed in early 2019, makes checking withholding amounts even more important. These tax law changes include:

  • Increased standard deduction
  • Eliminated personal exemptions
  • Increased Child Tax Credit
  • Limited or discontinued certain deductions
  • Changed the tax rates and brackets

Individuals with more complex tax profiles, such as two incomes or multiple jobs, may be more vulnerable to being under-withheld or over-withheld following these major law changes. We recommend performing check on your withholding as early as possible, as doing so gives more time for withholding to take place evenly throughout the year. Waiting means you could end up with a hefty tax bill come filing season.

The IRS calculator will recommend how to complete a new Form W-4 for any or all of your employers, if needed. Please contact us if you need assistance with a check up.

 

 

Law Change Affects Moving, Mileage and Travel Expenses

Changes to the deduction for move-related vehicle expenses

The passing of the Tax Cuts and Jobs Act  (“TCJA”) suspended the deduction for moving expenses for tax years beginning after Dec. 31, 2017, through Jan. 1, 2026. Previously, taxpayers were allowed to deduct the costs incurred for certain work related moves, given the requirements were met. Under the TCJA this deduction has been suspended for all moving expenses with the exception of those made by members of the Armed Forces of the United States on active duty who move pursuant to a military order related to a permanent change of station.

Changes to the deduction for un-reimbursed employee expenses

The TCJA at also suspended all miscellaneous itemized deductions that are subject to the 2 percent of adjusted gross income floor. This change affects unreimbursed employee expenses such as uniforms, union dues and the deduction for business-related meals, entertainment and travel.

Thus, the business standard mileage rate cannot be used to claim an itemized deduction for unreimbursed employee travel expenses in taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2026.

Standard mileage rates for 2018

The standard mileage rates for the use of a car, van, pickup or panel truck for 2018 are as follows:

  • 54.5 cents for every mile of business travel driven, a 1 cent increase from 2017.
  • 18 cents per mile driven for medical purposes, a 1 cent increase from 2017.
  • 14 cents per mile driven in service of charitable organizations, which is set by statute and remains unchanged.

 

 

Three Ways to Maximize Charitable Giving Under the New Tax Code

As many of you are aware by now, the Tax Cuts and Jobs Act (TCJA) almost doubled the standard deduction for many taxpayers, raising the limits to $12,000 for single filers and $24,000 for married joint taxpayers. Naturally, this makes it more difficult for taxpayers to write off charitable giving.

While there is a bi-partisan effort to push for charitable deductions for non-itemizing taxpayers (H.R. 5771), below are some steps you can take to maximize your charitable efforts in the meantime:

1. Bunching: Make the bulk of your charitable donations in the tax years you expect to itemize deductions and skip gift-giving in other years. For instance, if you’re already contemplating a large gift in 2018, you might be a little extra-generous toward the end of the year to include your donation goals for 2019, increasing the tax payoff for the 2018 tax year. In 2019, you can skip or reduce your gifting efforts, since you included these gifts in the 2018 tax year.

2. Donor-advised funds: With a donor-advised fund (DAF), you can make a large initial contribution this year and qualify a deduction. Then, the DAF distributes this money to your favorite charities over a period of time. This has the same practical effect as bunching.

3. Gifts of property: This is one of my favorite techniques. By giving capital gain property that has appreciated in value, like appreciated stock, art, or other collectibles, you can generally deduct the property’s current fair market value, instead of its initial cost. Thus, you increase your deduction while avoiding tax on the appreciation in value.

 

Year-End Business Checklist: 5 Steps To Get You Ready For Tax Season

As the year winds down, now is the best time to get your financials in order and prepare for filing season this spring. Here’s a few tips to ensure you are ready to file early this year:

  1. Reconcile your bank accounts: Whether you use QuickBooks, Xero, or another accounting information system, be sure that your bank and credit card statements have been reconciled to your financials. This will ensure the correct asset and liability ending balances on your balance sheet as well as ensure revenue or expenses are not overstated. Contact our office if you need assistance with this process.
  2. Review your profit & loss: Check your expense categories and ensure that you’ve properly categorized your expenses as best as possible. Any expenses you are unsure about, you can leave in a separate account, such as the “Ask my accountant” account, with a detailed description for us to review.
  3. Verify your vendor files: Since 1099-MISCs may be required for certain vendors or contractors, it’s important all this information as well as total payments to these vendors and contractors is correct. As a reminder, most 1099-MISC returns are due Jan 31, after the close of the year.
  4. Spot check your W-2: If you are an S-Corporation for tax purposes and are paying yourself as a greater than 2% shareholder employee, you need to ensure we are in compliance with the 2% shareholder rules. Contact our office if you have questions about these rules.
  5. Count Inventory: If you are an inventory business, be sure to take a count of your inventory at Dec 31 to ensure we properly calculate cost of goods sold.

If you have any questions about any of the tips above, feel free to reach out so we can make this filing season a breeze!

 

Why You Should Consider Moving your Traditional IRA Into Your Current Employer’s 401(k)

Over the weekend I had a friend call for some tax advice – he was planning to purchase a duplex to occupy and rent and was considering taking a distribution from his IRA (ROTH & Traditional) and a loan from his 401(k) in addition to the cash funds he was going to use as a down-payment to avoid PMI. His proposal was this:

  • $25k loan from 401(k) – the max given his $50k vested balance
  • $10k early distribution from his Traditional or ROTH IRA
  • $35k in cash for the remainder for a total down-payment of $70k.

Long story short, I had recommended he roll his Traditional IRA into his employer’s 401(k), a little known maneuver, to increase the the amount of loan he’d be eligible for through his 401(k) (typically a maximum of 50% of the account balance or $50,000). This move saves him from draining his IRAs and their future earnings, as well as the tax on a $10,000 early Traditional IRA distribution. As an added bonus, he will now be able to contribute to his ROTH IRA in future years using the “back-door” ROTH strategy that many high earner’s utilize to navigate the contribution limits typically associated with ROTHs.

Reuters assembled an article detailing additional benefits that come with rolling your Traditional IRA into an employers 401(k), check it out here.

Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

Ten Year-End Tax Moves To Minimize Your Tax Exposure

*Updated 12/28/17

With major tax reform looming, we compiled a list of year-end planning moves that can help you take advantage of the tax breaks that may be heading your way. While congress appears poised to enact tax reform this year, it’s by no means a sure bet. So keep a close eye on the news and don’t swing into action until the ink is dry on the President’s signature of the tax reform bill.

Both the tax bill passed the House of Representatives and the one before the Senate would reduce tax rates for many taxpayers, effective for the 2018 tax year. Additionally, businesses may see their tax bills cut, although the final form of the relief isn’t clear right now.

The general plan of action to take advantage of lower tax rates next year would be to defer income into next year. Here’s how:

  • If you are an employee who believes a bonus is coming your way before year end, consider asking your employer to delay payment of the bonus until next year.
  • If you are thinking of converting a regular IRA to a Roth IRA, consider postponing your ROTH conversion until next year. That way you’ll defer income from the conversion until next year and hopefully have it taxed at lower rates.
  • If you run a business that renders services and operates on the cash basis, the income you earn isn’t taxed until your clients or patients pay. So if you hold off on billings until next year—or until so late in the year that no payment can be received this year—you can defer income until next year.

Both the House-passed tax reform bill and the version before the Senate have provisions to repeal or reduce many popular tax deductions for 2018 in exchange for a larger standard deduction. You can maximize your tax benefit by accelerating these expenses. Here’s what you can do about this right now:

  • The House-passed tax reform bill would eliminate the deduction for nonbusiness state and local income or sales tax, but would allow an up-to-$10,000 deduction for real estate taxes on your home. The bill before the Senate would ban all nonbusiness deductions for state and local income, sales tax, and real estate tax. If you are an employee who expects to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding on those taxes. That way, additional amounts of state and local taxes withheld before the end of the year will be deductible in 2017. Similarly, pay the last installment of estimated state and local taxes for 2017 by Dec. 31 rather than on the 2018 due date, or prepay real estate taxes on your home.
  • Neither the House-passed bill nor the bill before the Senate would repeal the itemized deduction for charitable contributions. But because most other itemized deductions would be eliminated in exchange for a larger standard deduction (e.g., in both bills, $24,000 for joint filers), charitable contributions after 2017 may not yield a tax benefit for many. If you think you will fall in this category, consider accelerating some charitable giving into 2017.

Here are some other “last minute” moves that could wind up saving tax dollars in the event tax reform is passed:

  • The exercise of an incentive stock option (ISO) can result in AMT complications. But both the Senate and House versions of the tax reform bill call for the AMT to be repealed next year. So if you hold any ISOs, it may be wise to hold off exercising them until next year.
  • If you’ve got your eye on a plug-in electric vehicle, buying one before year-end could yield you an up-to-$7,500 discount in the form of a tax credit. The House-passed bill, but not the one before the Senate, would eliminate this credit after 2017.
  • If you’re in the process of selling your principal residence, wrap up the sale before year end. Up to $250,000 of your profit ($500,000 for certain joint filers) will be tax-free if you owned and used the property as your main home for at least two of the five years before the sale. However, under the House-passed bill and the bill before the Senate, the $250,000/$500,000 tax free amounts (“Section 121 exclusion”) would apply to post-2017 sales only if you own and use the property as your main home for five out of the previous eight years.  This proposal did not make the final cut
  • Under current rules, alimony payments generally are an above-the line deduction for the payor and included in the income of the payee. Under the House-passed tax bill but not the version before the Senate, alimony payments would not be deductible by the payor or includible in the income of the payee, generally effective for any divorce decree or separation agreement executed after 2017. So if you’re in the middle of a divorce or separation agreement, and you’ll wind up on the paying end, it would be worth your while to wrap things up before year end if the House-passed bill carries the day. On the other hand, if you’ll wind up on the receiving end, it would be worth your while to wrap things up next year.
  • Both the House-passed bill and the version before the Senate would repeal the deduction for moving expenses after 2017 (except for certain members of the Armed Forces), so if you’re about to embark on a job-related move, try to incur your deductible moving expenses before year-end.

Please keep in mind that some of the year-end moves that should be considered in regard to the tax reform package currently before Congress—which, may or may not actually become law. If you would like more details about any aspect of how the proposed legislation may affect you, please feel free to contact our office.

3 Tips For Making 1099-MISC Filing A Breeze This January

As the 2017 tax filing season approaches, it’s important to get organized to ensure timely filing of your informational returns. Since the Protecting Americans from Tax Hikes (PATH) Act, the due dates for Forms W-2 & W-3 and Form 1099-MISC issued for Non-Employee Compensation (Box 7) have been moved to January 31. This will be the second filing season under these new rules. Here’s three tips to help you get organized, avoid penalties, and ensure accuracy of your filings.

  1. Ensure you have a completed and signed Form W-9 from all contractors. If the W-9 you currently have on file is over a year old, I recommend verifying with your contractors that the information (specifically addresses) on this form is still accurate.
  2. Reconcile contractor payments inside of your accounting system. By using the vendor functions found in most accounting info systems, you can quickly arrive at the total amounts paid to specific individuals or businesses.
  3. Review the filing requirement rules. Two commonly overlooked provisions include:
    • The corporation exception: generally payments to corporations (including LLCs taxed as “C” or “S” Corporations) are not reportable payments for purposes of filing Form 1099. However, there are five exceptions to this rule, the most common exception is the mandatory reporting of attorney’s fees in Box 7, regardless of organizational or tax structure.
    • Other exceptions: payments for merchandise, telephone, freight, storage, and similar items typically do not require filing Form 1099-MISC

For assistance filing Form 1099, please contact our office.

 

Year-End Planning: Tax Strategies for Employee Stock Options

Stock options can be complex and costly if you don’t properly plan for taxes. Two common forms of non-cash employee incentives are Incentive Stock Options (ISOs) and Non-qualified Stock Options (NSOs). With tax reform on the horizon, hopefully this post will help you make a more informed decision about the opportunities that exist before the end of the year.

Incentive stock options: ISO’s are qualified stock options granted to an employee that allow the employee to buy stock or ownership in the employer at a specified price. Many ISO grants have vesting schedules that need to be met as a condition of receiving the options. With ISOs, there are no regular income tax consequences when granted or exercised. A taxable event does, however, occur if/when the employee sells the stock at a gain.

An ISO has certain requirements that must be met. For example, the option price cannot be less than the market value of the stock at the time of the grant, it must be exercised within ten years from the time of grant, and the market value of the stock for any ISOs exercisable in any year is limited to $100,000.

To avoid disqualified dispositions and lock in favorable capital gain treatment, ISO’s generally can’t be disposed of within two years after the option is granted or one year after the stock is transferred to the employee.

If there is a disqualifying disposition of a share of stock, you would recognize ordinary compensation income equal to the “bargain element”. This bargain element is the fair market value (FMV) of the stock on the date of sale less the exercise price.

For Alternative Minimum Tax (AMT) purposes, when an ISO is exercised, assuming the stock is fully vested on the exercise date, the amount of the bargain element is included as an adjustment for alternative minimum taxable income. If the stock is not substantially vested in the year of exercise (still subject to forfeiture), income is includible under the Code Sec. 83 rules for AMT purposes. In future years, a tax credit may be allowed against regular tax for AMT paid on account of the adjustment for ISO exercises.

Launch Consulting Insight: Since the Republican plan for tax reform has called for the AMT to be repealed, it may be worth holding off on exercising ISOs until 2018, if the current tax bill is passed.

Nonqualified stock options: NSOs, are taxable similar to an employee receiving compensation income equal to the FMV of the option. If a NSO isn’t tradeable and has no “ascertainable market value”, a taxable event would occur when stock is received upon exercise of the options rather than at the time of option receipt. The taxable amount would be the “bargain element”, the difference between the stock’s market price on the date of option exercise, less the exercise price under the option.

Launch Consulting Insight: NSOs pose a more difficult dilemma with year-end planning. If you have NSOs, you may want to consider waiting to exercise until 2018 if you believe tax reform will be enacted and lower tax rates will apply in 2018. I would recommend factoring in market conditions, since an increase in the stock value over the waiting period could increase the amount of income subject to taxation. Alternatively, if the bargain element now is small, and you think it could increase by next year, you may want to consider exercising in 2017 to minimize the amount of ordinary income recognized on your bargain element.