Tax and Accounting Thoughts From the Trail:
A NH CPA's Blog
As 2015 draws to a close, there is still time to reduce your 2015 tax bill and plan ahead for 2016.
Deferring Income into 2016
Deferring income to the next taxable year is a time-honored year-end planning tool. If you expect your taxable income to be higher in 2015 than in 2016, or if you anticipate being in the same or a higher tax bracket in 2015 than in 2016, you may benefit by deferring income into 2016. Some ways to defer income include:
Use of Cash Method of Accounting: By adopting the cash method of accounting, you can generally put yourself in a better position for accelerating deductions and deferring income.
Delay Billing: If you are on the cash method, delay year-end billing to clients so that payments are not received until 2016.
Accelerating Income into 2015
You may benefit from accelerating income into 2015. For example, you may anticipate being in a higher tax bracket in 2016 or perhaps you need additional income in 2015 to take advantage of an offsetting deduction or credit that will not be available to you in future tax years.
If you report your business income and expenses on a cash basis, issue bills and pursue collection before the end of 2015. Also, see if some of your clients or customers are willing to pay for January 2016 goods or services in advance. Any income received using these steps will shift income from 2016 to 2015.
Accelerating Business Deductions
Bad Debts: If you use the accrual method, you can accelerate deductions into 2015 by analyzing your business accounts receivable and writing off those receivables that are totally or partially worthless. By identifying specific bad debts, you should be entitled to a deduction.
2015 Bonuses: In general, if you are paying a bonus to employees, you may accrue that liability and deduct that amount if all the events are satisfied that fix that liability even though you pay the bonus next year. Any compensation arrangement that defers payment will be currently deductible only if paid within 2 ½ months after the employer's year-end.
General Business Considerations
Self-Employed Health Insurance Premiums: Self-employed individuals are allowed to claim 100% of the amount paid during the taxable year for insurance that constitutes medical care for themselves, their spouses, and their dependents as an above-the-line deduction, without regard to the general 10%-of-AGI floor. Self Employed Health Insurance includes eligible long term health care premiums.
Equipment Purchases: If you purchase equipment, you may make a “Section 179 election,” which allows you to expense (i.e., currently deduct) otherwise depreciable business property. For 2015, you may elect to expense up to $25,000 of equipment costs (with a phase-out for purchases in excess of $200,000) if the asset was placed in service during 2015. Although the amount eligible to be expensed and the phase-out amount were significantly greater in prior years, there is a chance the 2015 figures will go up if Congress acts soon. However, it is uncertain whether any such legislation will be passed and if so whether that legislation would have retroactive application.
Vehicles Weighing Over 6,000 Pounds: A popular strategy in recent years is to purchase a vehicle for business purposes that exceeds the depreciation limits set by statute (i.e., a vehicle rated over 6,000 pounds). Doing so would not subject the purchase to the statutory dollar limit for depreciation: $3,160 for 2015; $3,460 in the case of vans and trucks. Therefore, the vehicle would qualify for the full equipment expensing dollar amount. However, for SUVs (rated between 6,000 and 14,000 pounds gross vehicle weight) the expensing amount is limited to $25,000.
Capitalization of Tangible Property: Recent rules clarify whether certain items you purchase for use in your business (i.e. copiers, computers) can be expensed in the year purchased, or must be capitalized and deducted over several years. The rules include certain elections that may simplify your recordkeeping and/or increase your current deductions.
Home Office Deduction: Expenses attributable to using the home office as a business office are deductible if the home office is used regularly and exclusively: (1) as a taxpayer's principal place of business for any trade or business; (2) as a place where patients, clients, or customers regularly meet or deal with the taxpayer in the normal course of business; or (3) in the case of a separate structure not attached to the residence, in connection with a trade or business. If you have been using part of your home as a business office, we should talk about the amount of any deduction you would like to take because an IRS safe harbor could be used to minimize audit risk.
Recently I published a LinkedIn post entitled “Ensuring a Smooth Family Business Transition”. It briefly addressed the topic of succession planning for a family business. As I wrote it, I knew that there was more I needed to say. In my practice, I work with family businesses of various sizes, stages of development, operating in various industries, but no matter what their situation succession planning is a critical component of their success.
Succession planning is one of the most important considerations facing any small business owner but unfortunately also one of the most overlooked. Throw in the added complications of family dynamics and the effects of a poorly executed transaction are compounded. Sadly, in PWC’s 2014 Family Business Survey they reported that “only 16% of family firms have a discussed and documented succession plan in place”. It is therefore unsurprising that the UNH Center for Family Business reported that “two-thirds of successful first-generation businesses don’t survive to the second generation – and fewer than 15% survive to the third generation.”
Having said all of this, I know there are some of you who would still argue that this does not apply to you. Perhaps you and your business are young and you have years ahead of you to figure all of that out. Perhaps the next generation seems hesitant to take the reins. Maybe you just don’t like to golf and the thought of retirement seems repulsive to you. Whatever the reason, the fact is that none of us will be working forever and this business that you have worked hard to build is an investment that can only be realized fully through careful planning.
Now, an effective succession plan is a complex matter. According to an article published in New Hampshire Business Review entitled “Family Business Succession: A Strategic Planning Model”, there are five distinct areas of transition:
It is important that your CPA fully understand and be experienced in each of these areas in order to guide you in developing a comprehensive plan. Furthermore, it is critical to continue to work with him or her to implement it and reevaluate it as the business grows. Here is an example of a plan that I assisted in creating and implementing that successfully combined all five areas:
The company (we’ll call them Smith & Sons) was an S-Corporation, established legally as a corporation and solely owned by the father, Smith. Smith had 2 sons who both worked with him in the business. Smith knew that he eventually wanted to pass Smith & Sons on to his sons equally.
The first step was to have the corporation sell stock to the sons and take back an installment note receivable for the appraised value of the stock. At this point Smith owned 51% of the stock and the sons owned 49% of the stock. The sons made annual installment payments for their stock purchase which was funded through year-end bonuses. When Smith finally decided to retire, he gifted the balance of the stock to the sons using part of his life time gift tax exemption, creating no gift tax liability. The sons now each owned 50% of the outstanding stock.
The S-Corp. had significant accumulated earnings in its accumulated adjustments account (previously taxed income not distributed to the shareholders of an S-Corp.). The next step was to convert the legal corporation to a limited liability company while maintaining the company’s S-Corp. election. After the conversion, the sons were able to take tax free distributions from the accumulated earnings of the S-Corp. and pay off the balance of their installment notes. The tax free distribution totaled into hundreds of thousands of dollars. Because of the legal conversion of the company, there was no state income tax liability on the distributions to the sons.
Through careful planning over a number of years we were able to ensure that Smith & Sons would pass smoothly from one generation to the next. Smith was able to retire when he was ready, financially secure thanks to the nest egg he had built through his business. He had the added satisfaction of seeing the company he built continue on and his sons well provided for. We were able to structure the plan in such a way that there was only a minimal financial liability related to the bonuses used to pay the annual installment payments. The balance of the transactions created no tax liability to the family members or to the S-Corporation and resulted in the elimination of a substantial amount of debt due from the sons.
If you do not have a comprehensive and well-documented succession plan in place it’s time to create one. Make sure that you consult legal and accounting professionals that are knowledgeable and experienced in each transition area in order to maximize the benefits to everyone involved. If you’ve already done so do not forget to reevaluate the plan from time to time as your business grows or your goals change. If you have questions about succession planning, or if you would like help creating or reevaluating one, please do not hesitate to contact us.
In its efforts to combat identity theft, the IRS is stopping suspicious tax returns that have indications of being identity theft, but contain a real taxpayer’s name and/or Social Security number, and sending out Letter 5071C to request that the taxpayer verify his or her identity.
Letter 5071C is mailed through the U.S. Postal Service to the address on the return. It asks taxpayers to verify their identities in order for the IRS to complete processing of the returns if the taxpayers did file it or reject the returns if the taxpayers did not file it.
It is important to understand that the IRS does not request such information via e-mail; nor will the IRS call you directly to ask this information without first sending you a Letter 5071C. The letter number can be found in the upper corner of the page.
Letter 5071C gives you two options to contact the IRS and confirm whether or not you filed the return: You can (1) use the www.idverify.irs.gov site or (2) call a toll-free number on the letter. However, the IRS says that, because of the high volume on its toll-free numbers, the IRS-sponsored website, www.idverify.irs.gov, is the safest, fastest option for taxpayers with Web access.
Before accessing the website, be sure to have your prior-year and current-year tax returns available, including supporting documents, such as Forms W-2 and 1099. You will be asked a series of questions that only the real taxpayer can answer.
Once your identity is verified, you can confirm whether or not you filed the return in question. If you did not file the return, the IRS will take steps at that time to assist you. If you did file the return, it will take approximately six weeks to process it and issue a refund.
You should always be aware of tax scams, efforts to solicit personally identifiable information, and IRS impersonations. However, www.idverify.irs.gov is a secure, IRS-supported site that allows taxpayers to verify their identities quickly and safely. IRS.gov is the official IRS website. Always look for a URL ending with “.gov” — not “.com,” “.org,” “.net,” or other nongovernmental URLs.
There are many instances in which self-employed individuals might desire to establish a §401(k) plan. For example, an individual who has severed employment from an employer and has established his or her own business could use a §401(k) plan to receive an eligible rollover distribution from the former employer's pension plan. An employee also could have a business on the side from which he or she earns income and a §401(k) plan may be used to defer some earned income.
Self-employed individuals include sole proprietors and partners in a partnership. Both are considered employees for purposes of participating in a qualified §401(k) plan.
In general, a self-employed individual is someone who:
- has earned income for the taxable year;
- would have had earned income for the taxable year except that the trade or business carried on
- has been a self-employed individual for any prior taxable year.
by the individual had no net profits for the taxable year; or
The self-employed individual does not need to carry on a regular full-time business to be self-employed, but the individual must have earned income. Earned income means the individual's net earnings from self-employment, which are: the gross income from the trade or business which the individual carries on, less any
- related deductions; plus
- the individual's distributive share of taxable income or loss from a partnership.
The trade or business must be one in which the individual's personal services are a material income-producing factor. This means that an individual who derives only investment income from the trade or business cannot participate in the plan.
Plan contributions on behalf of the self-employed individual only can be made from the earned income that is derived from the trade or business for which the plan is established and cannot exceed the individual's earned income from that trade or business. Otherwise, the plan will fail to be qualified with respect to such contributions. Thus, any other earned income from another trade or business cannot be contributed to the plan.
In general, the same qualification rules that apply to regular §401(k) plans, also apply to §401(k) plans for self-employed individuals (sometimes referred to as “single-participant §401(k) plans”). The only significant differences are in the definition of compensation and the deduction adjustments for self-employed individuals for determining contributions and deductions.
A self-employed individual can contribute up to the maximum annual elective deferral limit applicable to regular §401(k) plans. As in regular §401(k) plans, employer matching contributions are not counted as employee elective deferral contributions for this purpose. In addition, the catch-up rules apply. Plan loans also can be made to self-employed individuals without violating the prohibited transaction rules.
Other rules applicable to §401(k) plans include the required minimum distribution rules, the top heavy rules, and the nondiscrimination rules.
A self-employed individual can maximize retirement savings by using a §401(k) plan. Because a §401(k) plan is subject to the same dollar limit on deductible annual contributions ($18,000 for 2015, plus the employer match) as other defined contribution plans, a §401(k) plan can be a supplement to other defined contribution plans to take full advantage of the deductible contribution limit ($53,000 for 2015). However, contributions to another §401(k) plan in addition to the self-employed individual's §401(k) plan would reduce the elective deferral limit to the self-employed individual's §401(k) plan because this limit on deductible contributions applies per person instead of per plan.
Generally, an employer is allowed a deduction for contributions to a §401(k) plan of up to 25% of all participants’ compensation. Because earned income (as defined above) is used in place of compensation for a self-employed individual, the percentage limit on the contribution is reduced to 20% of earned income after the self-employment tax deduction but before the plan contribution deduction.
If you have any questions concerning the matters discussed in this article or would like more information about establishing a §401(k) plan for a self-employed individual, please give us a call.
One day in the course of doing some professional reading I came across two articles related to college education costs. The Journal of Accountancy stated that 68% of adults surveyed with college loans or whose children have loans said they regret how they financed their own or their children’s education. The second, published the same day by Bloomberg, reported that college savings in 2014 had dropped by 25% making it the lowest savings level in 3 years.
So it seems people are saving less for college while those who paid with loans regret doing so. Well this struck me as a pretty significant problem. After all, it’s not like the cost of education is going down. On the contrary, JP Morgan Asset Management estimates that college costs will inflate at about 5% each year, more than doubling by 2032. And in January, NPR announced that tuition has now outstripped state funding as source of revenue for public colleges. As state funding has fallen, tuition has risen 55% across all public colleges between 2003 and 2012.
The approximate cost of tuition, fees, room and board, books, etc. for a full-time student at UNH for the 2014-2015 school year is $31,412. Now multiply that by 4 years – or more if you have more than one child. With these kinds of figures you may feel destined to join that regretful 68% but do not despair, I am here with encouragement and advice.
First, it is never too late to start. If you have considered a 529 plan but thought that ship had sailed, think again. There are no age restrictions on a 529 plan so even if your child is a senior in high school it is not too late. These plans also offer some flexibility. If you child’s plans should change it may be possible to use the funds to pay for vocational schools, graduate programs, or even change the beneficiary to another student should they chose not to continue with school.
Next, when forming an approach for financing a college education it is very likely that student loans will be a component. This doesn’t mean that you or your child will necessarily end up an unhappy survey statistic. The key is not to borrow more that you need. Also consider the repayment plans offered. Do they offer flexibility during times of financial difficulty?
Finally, keep in mind that your first savings priority should always be…retirement. Was that answer unexpected given everything I’ve just told you? Well then look at it this way, there are many more sources of funding available to college students than retirees. Ideally, your financial plan includes saving for both. College costs may prolong retirement for a few years but do not risk ending up in a financial crisis because you forgot to take care of yourself.
Tis the season to be shopping – and not just for the perfect gift for that special someone. This is also the period of health insurance open enrollment. A time of year to reflect on the insurance coverage of the past and look forward to the options offered for the future. So why is it that so many people let this occasion go by without a second thought? Simple: health insurance is complicated and expensive. In fact most of us would rather risk life and limb trying to score a hot deal at Best Buy in the predawn hours of Black Friday.
No matter how much you dread it however, ignore the urge to forgo the opportunity that open enrollment provides. Carefully consider your options to make the choice that will best protect both your physical and your financial well-being. One item in particular I would urge you to bear in mind: Health Saving Accounts.
Health Savings Accounts, or HSAs, can be a powerful tool in offsetting the steep costs connected with healthcare. They are trust or custodial accounts subject to rules similar to IRAs. The funds in the account are used to cover out of pocket medical expenses. They carry over from year to year and can be rolled over to another HSA or to an Archer MSA.
HSAs are available to individuals under the age of 65 who are covered by a “high deductible” health plan, or HDHP. In general, an HDHP is a plan with an annual deductible above a certain amount that is adjusted annually for inflation. For 2014 the amount is $1,250 for individual coverage or $2,500 for family coverage.
The contributions to an HSA are pretax under an employer sponsored plan or tax deductible under individual plans. The maximum contribution for 2014 is $3,300 for individual plans or $6,550 for family coverage. These limits are also adjusted annually. Contributions may be made on behalf of account holders and employers may offer to do this as part of their benefits package.
Now the best part: the triple tax advantage. As the pretax or tax deductible funds remain in an HSA they will grow. Those earnings are not taxable. When the funds are withdrawn, so long as they are used to pay for qualified medical expenses, they are also not taxable. Keep in mind that if those funds are not used to pay for medical expenses they will be subject to income tax and possibly an additional 20% penalty if the distribution is made prior to age 65.
Of course this is only a general overview of what HSAs are all about and we would be happy to discuss them in greater detail to determine if this might be a good option for you. The important thing to remember is not to miss out on the health insurance “deals” that may be offered to you during open enrollment. While less dramatic than a Wal-Mart doorbuster, cost-effective options such as HSAs are available if you shop carefully.