Services Archives - Page 40 of 86

Tax considerations when adding a new partner at your business

Management Advisory Services & Business Consulting|May 17, 2022

Adding a new partner in a partnership has several financial and legal implications. Let’s say you and your partners are planning to admit a new partner. The new partner will acquire a one-third interest in the partnership by making a cash contribution to it. Let’s further assume that your bases in your partnership interests are sufficient so that the decrease in your portions of the partnership’s liabilities because of the new partner’s entry won’t reduce your bases to zero.

Not as simple as it seems

Although the entry of a new partner appears to be a simple matter, it’s necessary to plan the new person’s entry properly in order to avoid various tax problems. Here are two issues to consider:

First, if there’s a change in the partners’ interests in unrealized receivables and substantially appreciated inventory items, the change is treated as a sale of those items, with the result that the current partners will recognize gain. For this purpose, unrealized receivables include not only accounts receivable, but also depreciation recapture and certain other ordinary income items. In order to avoid gain recognition on those items, it’s necessary that they be allocated to the current partners even after the entry of the new partner.

Second, the tax code requires that the “built-in gain or loss” on assets that were held by the partnership before the new partner was admitted be allocated to the current partners and not to the entering partner. Generally speaking, “built-in gain or loss” is the difference between the fair market value and basis of the partnership property at the time the new partner is admitted.

The most important effect of these rules is that the new partner must be allocated a portion of the depreciation equal to his share of the depreciable property based on current fair market value. This will reduce the amount of depreciation that can be taken by the current partners. The other effect is that the built-in gain or loss on the partnership assets must be allocated to the current partners when partnership assets are sold. The rules that apply here are complex and the partnership may have to adopt special accounting procedures to cope with the relevant requirements.

Keep track of your basis

When adding a partner or making other changes, a partner’s basis in his or her interest can undergo frequent adjustment. It’s imperative to keep proper track of your basis because it can have an impact in several areas: gain or loss on the sale of your interest, how partnership distributions to you are taxed and the maximum amount of partnership loss you can deduct.

Contact us if you’d like help in dealing with these issues or any other issues that may arise in connection with your partnership.

Undertaking a pay equity audit at your business

Management Advisory Services & Business Consulting|May 9, 2022

Pay equity is both required by law and a sound business practice. However, providing equitable compensation to employees who perform the same or similar jobs, while accounting for differences in experience and tenure, isn’t easy. That’s why every company should at least consider undertaking a pay equity audit to assess its compensation philosophy and approach.

Legal background

The federal Equal Pay Act requires employers to provide men and women with equal pay for equal work in the same establishment. The jobs don’t need to be identical, but they should be “substantially equal.” Moreover, it’s not job titles, but job content — including skill, effort and responsibility — that determines whether jobs are substantially equal.

Many states have enacted their own equal pay laws, some of which are more stringent than the federal legislation. California, for example, requires employers to pay employees the same wage rates for “substantially similar work,” a larger umbrella than “same or similar jobs.”

Some other countries have also introduced laws around pay equity. The United Kingdom, for instance, requires some public companies to annually disclose the ratio of their chief executive officers’ pay to the lower, median and upper quartile of their employees’ pay.

In addition to helping to prevent legal woes, pay equity can offer bottom-line benefits. A company’s commitment to equitable pay can enhance its employer brand, boost employee morale and performance, and reduce the risk of negative publicity.

An involved process

The purpose of a pay equity audit is to:

Uncover disparities in compensation,
Identify the drivers behind them, and
Develop ways to address the inequities.

Although the process can be quite involved, it’s typically worth the effort.

First, assemble participants from multiple departments — including HR, legal, and finance or accounting — to collect data on employee compensation, job classifications and demographics. This cross section of participants also will help ensure buy-in across the business.

The next step is determining how to group employees. That is, which ones will be considered to have substantially similar roles and, thus, should fall within the same pay range?

Some number crunching will come into play. For smaller employee groups, an analysis of, for example, differences in median pay between groups of employees might be enough to identify any unwarranted disparities. With larger groups, you may have to conduct more rigorous statistical analyses. For example, regression analysis can help control for variables, such as employees’ experience levels, when examining disparities.

Critical component

Over the past year, many workers have made it abundantly clear that they’ll leave a job if any of several employment components isn’t to their liking. Compensation is certainly one of these. Our firm can help support your efforts to conduct a pay equity audit.

Opening up to SLAT opportunities

Estate & Wealth Transfer Planning|May 4, 2022

Estate tax planning can become complicated when multiple parties are involved. For example, you may be concerned about providing assets to a surviving spouse of a second marriage, while also providing for your children from your first marriage. Of course, you also want to take advantage of favorable estate tax provisions in the law.

Fortunately, there’s a relatively simple way to meet your objectives with few dire tax consequences. It’s commonly called a spousal lifetime access trust (SLAT).

A SLAT in action

Essentially, a SLAT is an irrevocable trust established by a grantor spouse for the benefit of the other spouse — called the beneficiary spouse — plus other family members, such as children and grandchildren. The beneficiary spouse is granted limited access to the trust’s funds. As a result, the assets generally are protected from the reach of the beneficiary spouse’s creditors. This ensures that the remainder beneficiaries — namely, the children and grandchildren — will have a nest egg to rely on.

According to the SLAT terms, lifetime distributions are made to the beneficiary spouse to meet his or her needs. Preferably, if other funds are available to the beneficiary spouse outside of the trust, those funds are used first instead of making regular distributions to the spouse. Otherwise, distributions from the SLAT to the beneficiary spouse will reduce the trust’s effectiveness over time.

Favorable tax provisions

One of the primary attractions of a SLAT is that it’s designed to minimize federal tax liabilities. First, the transfer of assets is treated as a taxable gift, but it can be sheltered from gift tax by a combination of the annual gift tax exclusion ($16,000 for 2022) and the gift and estate tax exemption ($12.06 million for 2022). However, be aware that use of the exemption during the grantor spouse’s lifetime reduces the available estate tax shelter at death.

Second, assets transferred by the grantor spouse to a SLAT are removed from his or her taxable estate. Thus, estate taxes aren’t a concern, thereby allowing the remaining estate tax exemption to be used for other assets.

Third, a SLAT is considered to be a “grantor trust” for income tax purposes. In other words, when a grantor spouse establishes a SLAT for the benefit of the beneficiary spouse, the trust’s taxable income is reported on the grantor’s personal tax return, but the trust entity pays zero tax. This may be advantageous because the assets can compound inside the trust without any income tax erosion. On the death of the grantor spouse, the trust is required to pay income tax.

Other planning considerations

As mentioned above, the transfer of assets to a SLAT is a gift, so the grantor must file a federal gift tax return. Finally, don’t forget that a SLAT is an irrevocable trust. Thus, once the grantor spouse transfers assets to the trust, he or she can’t get them back.

If you’re considering using a SLAT, contact us for additional details.

Power up your trust with Crummey powers

Estate & Wealth Transfer Planning|May 2, 2022

The unified gift and estate tax exemption is set at an inflation-adjusted $12.06 million for 2022, up from $11.7 million for 2021. This means that for many families, estate tax liability isn’t a factor. However, for others, the annual gift tax exclusion continues to be an important estate planning strategy — especially since future tax law changes could lower the gift and estate tax exemption. For this reason, using a Crummey trust in your estate plan remains an important estate planning strategy. Here’s why.

Using the annual exclusion

Under the annual gift tax exclusion, you can give gifts to each recipient, valued up to a specific limit, without incurring any gift tax. The limit for 2022 is $16,000 per recipient. (This amount is indexed for inflation, but only in $1,000 increments.)

Therefore, if you have, for example, three adult children and seven grandchildren, you can give each one $16,000 this year, for a total of $160,000, and pay zero gift tax. The exclusion is per donor, meaning that for a married couple the amount is doubled.

If you give outright gifts, however, you run the risk that the money or property could be squandered, especially if the recipient is young or irresponsible. Alternatively, you can transfer assets to a trust and name a child as a beneficiary. With this setup, the designated trustee manages the assets until the child reaches a specified age.

But there’s a catch. To qualify for the annual exclusion, a gift must be a transfer of a “present interest.” This is defined as an unrestricted right to the immediate use, possession or enjoyment of the property or the income from it. Without certain provisions in the trust language, a gift to the trust doesn’t qualify as a gift of a present interest. Instead, it’s treated as a gift of a “future interest” that’s not eligible for the annual gift tax exclusion.

Giving Crummey powers to a trust

This is where a Crummey trust can come to the rescue. It satisfies the rules for gifts of a present interest without requiring the trustee to distribute the assets to the beneficiary.

Typically, periodic contributions of assets to the trust are coordinated with an immediate power giving the beneficiary the right to withdraw the contribution for a limited time. However, the expectation of the donor is that the power won’t be exercised. (The trust document cannot expressly provide this.)

As a result, the beneficiary’s limited withdrawal right allows the gift to the trust to be treated as a gift of a present interest. Thus, it qualifies for the annual gift tax exclusion. Note that it’s the existence of the legal power — not the exercise of it — that determines the tax outcome.

Avoiding pitfalls

To pass muster with the IRS, the beneficiary must be given actual notice of the withdrawal right, along with a reasonable period to exercise it. Generally, at least 30 days is required. Contact us with additional questions regarding the use of a Crummey trust.

Eyes on related parties

Management Advisory Services & Business Consulting|April 27, 2022

Business transactions with related parties — such as friends, relatives, parent companies, subsidiaries and affiliated entities — may sometimes happen at above- or below-market rates. This can be misleading to people who rely on your company’s financial statements, because undisclosed related-party transactions may skew the company’s true financial results.

The hunt for related parties

Given the potential for double-dealing with related parties, auditors spend significant time hunting for undisclosed related-party transactions. Examples of documents and data sources that can help uncover these transactions are:

A list of the company’s current related parties and associated transactions,
Minutes from board of directors’ meetings, particularly when the board discusses significant business transactions,
Disclosures from board members and senior executives regarding their ownership of other entities, participation on additional boards and previous employment history,
Bank statements, especially transactions involving intercompany wires, automated clearing house (ACH) transfers, and check payments, and
Press releases announcing significant business transactions with related parties.

Specifically, auditors look for contracts for goods or services that are priced at less (or more) favorable terms than those in similar arm’s-length transactions between unrelated third parties.

For example, a spinoff business might lease office space from its parent company at below-market rates. A manufacturer might buy goods at artificially high prices from its subsidiary in a low-tax country to reduce its taxable income in the United States. Or an auto dealership might pay the owner’s daughter an above-market salary and various perks that aren’t available to unrelated employees.

Audit procedures

Audit procedures designed to target related-party transactions include:

Testing how related-party transactions are identified and coded in the company’s enterprise resource planning (ERP) system,
Interviewing accounting personnel responsible for reporting related-party transactions in the company’s financial statements, and
Analyzing presentation of related-party transactions in financial statements.

Accurate, complete reporting of these transactions requires robust internal controls. A company’s vendor approval process should provide guidelines to help accounting personnel determine whether a supplier qualifies as a related party and mark it accordingly in the ERP system. Without the right mechanisms in place, a company may inadvertently omit a disclosure about a related-party transaction.

Let’s talk about it

With related-party transactions, communication is key. Always tell your auditors about known related-party transactions and ask for help disclosing and reporting these transactions in a transparent manner that complies with U.S. Generally Accepted Accounting Principles.

Classify your nonprofit’s workers correctly — or risk repercussions

Management Advisory Services & Business Consulting|April 25, 2022

Many not-for-profits are understaffed in 2022, thanks to a labor shortage and pandemic-related budget shortfalls. Some organizations are filling the gaps with freelancers and contractors. However, such decisions can lead to trouble if these workers should really be classified as employees according to the Department of Labor (DOL) or the IRS. To ensure your workers are correctly classified, review the rules.

The DOL and FLSA

The Fair Labor Standards Act (FLSA) doesn’t define the term “independent contractor.” But courts generally have focused on several factors related to the “economic reality” of relationships between employers and workers.

The DOL leans on U.S. Supreme Court rulings for guidance. The Court has repeatedly stated that no single rule or test applies to determine employment status under the FLSA. Rather, the totality of circumstances determines a worker’s status, including how integral the worker’s services are to your operations, the permanency of the relationship and the nature and degree of control you have over the worker. The DOL has identified other factors it deems relevant, including:

Where the work is performed (remotely or on-site),
The absence or existence of a formal written employment contract, and
Whether the work is licensed by the state or local government.

Some states have even more restrictive tests. Moreover, the fact that workers qualify as independent contractors under another federal law doesn’t guarantee they qualify under the FLSA. For example, the IRS applies a different test.

The IRS

Providing your workers with IRS Form 1099, “Miscellaneous Information” instead of Form W-2, “Wage and Tax Statement,” won’t automatically make them independent contractors. When assessing worker classification, the IRS typically looks at a variety of factors, as well as the totality of facts and circumstances. But in general, these factors are important:

Level of behavioral control. The more control you exercise over the worker, the more likely the worker is an employee. The IRS might look at the extent to which you instruct a worker on when, where and how to work, what tools or equipment to use and where to purchase supplies.

Extent of financial control. Contractors are more likely to invest in their own equipment or facilities, incur unreimbursed business expenses, market their services to other clients and be paid with a flat fee. Employees are more likely to be paid hourly, weekly or bimonthly.

Relationship of the parties. Contractors are often engaged for a specific project while employees are typically hired permanently (or for an indefinite period). Also, workers who serve a key business function are more likely to be classified as employees.

Difference in pay, benefits and taxes

If your workers don’t qualify as independent contractors, you must properly treat them as employees:

Pay and benefits. You generally must pay covered, nonexempt employees at least the federal minimum wage of $7.25 an hour. When an employee’s hours within a workweek exceed 40, you must pay at least 1½ times the employee’s regular pay rate. If the DOL reclassifies an independent contractor as an employee, in addition to having to make up the unpaid wages, you may owe workers’ compensation premiums and unpaid leave and other benefits. Fines and penalties are also possible.

Taxes. For employees, you must withhold federal income and payroll taxes, and pay the employer’s share of FICA taxes on the wages, plus FUTA tax. If the IRS reclassifies one of your independent contractors, you may be liable for back taxes that you should have paid and payroll and income taxes you should have withheld. In some cases, interest and penalties are levied.

Resolving issues

If budget shortfalls are preventing you from hiring the staffers you need or you aren’t sure if you’re accurately classifying the workers you have, contact us. We can help your nonprofit resolve financial and compliance issues.

Tax issues to assess when converting from a C corporation to an S corporation

Management Advisory Services & Business Consulting|April 20, 2022

Operating as an S corporation may help reduce federal employment taxes for small businesses in the right circumstances. Although S corporations may provide tax advantages over C corporations, there are some potentially costly tax issues that you should assess before making a decision to switch.

Here’s a quick rundown of the most important issues to consider when converting from a C corporation to an S corporation:

Built-in gains tax

Although S corporations generally aren’t subject to tax, those that were formerly C corporations are taxed on built-in gains (such as appreciated property) that the C corporation has when the S election becomes effective, if those gains are recognized within 5 years after the corporation becomes an S corporation. This is generally unfavorable, although there are situations where the S election still can produce a better tax result despite the built-in gains tax.

Passive income

S corporations that were formerly C corporations are subject to a special tax if their passive investment income (such as dividends, interest, rents, royalties and stock sale gains) exceeds 25% of their gross receipts, and the S corporation has accumulated earnings and profits carried over from its C corporation years. If that tax is owed for three consecutive years, the corporation’s election to be an S corporation terminates. You can avoid the tax by distributing the accumulated earnings and profits, which would be taxable to shareholders. Or you might want to avoid the tax by limiting the amount of passive income.

LIFO inventories

C corporations that use LIFO inventories have to pay tax on the benefits they derived by using LIFO if they convert to S corporations. The tax can be spread over four years. This cost must be weighed against the potential tax gains from converting to S status.

Unused losses

If your C corporation has unused net operating losses, the losses can’t be used to offset its income as an S corporation and can’t be passed through to shareholders. If the losses can’t be carried back to an earlier C corporation year, it will be necessary to weigh the cost of giving up the losses against the tax savings expected to be generated by the switch to S status.

There are other factors to consider in switching from C to S status. Shareholder-employees of S corporations can’t get the full range of tax-free fringe benefits that are available with a C corporation. And there may be complications for shareholders who have outstanding loans from their qualified plans. All of these factors have to be considered to understand the full effect of converting from C to S status.

There are strategies for eliminating or minimizing some of these tax problems and for avoiding unnecessary pitfalls related to them. But a lot depends upon your company’s particular circumstances. Contact us to discuss the effect of these and other potential problems, along with possible strategies for dealing with them.

Once you file your tax return, consider these 3 issues

Tax Prep, Planning & Strategy|April 18, 2022

The tax filing deadline for 2021 tax returns is April 18 this year. After your 2021 tax return has been successfully filed with the IRS, there may still be some issues to bear in mind. Here are three considerations:

1. You can throw some tax records away now

You should hang onto tax records related to your return for as long as the IRS can audit your return or assess additional taxes. The statute of limitations is generally three years after you file your return. So you can generally get rid of most records related to tax returns for 2018 and earlier years. (If you filed an extension for your 2018 return, hold on to your records until at least three years from when you filed the extended return.)

However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.

You should keep certain tax-related records longer. For example, keep the actual tax returns indefinitely, so you can prove to the IRS that you filed a legitimate return. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)

What about your retirement account paperwork? Keep records associated with a retirement account until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset, plus at least three years after you sell it and report the sale on your tax return. (You can keep these records for six years if you want to be extra safe.)

2. Waiting for your refund? You can check on it

The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Get Your Refund Status” to find out about yours. You’ll need your Social Security number, filing status and the exact refund amount.

3. If you forgot to report something, you can file an amended return

In general, you can file an amended tax return and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later. So for a 2021 tax return that you file on April 15, 2022, you can generally file an amended return until April 15, 2025.

However, there are a few opportunities when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.

We’re here year round

If you have questions about tax record retention, your refund or filing an amended return, contact us. We’re not just available at tax filing time — we’re here all year!

Establish a tax-favored retirement plan

Management Advisory Services & Business Consulting|April 14, 2022

If your business doesn’t already have a retirement plan, now might be a good time to take the plunge. Current retirement plan rules allow for significant tax-deductible contributions.

For example, if you’re self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $61,000 for 2022. If you’re employed by your own corporation, up to 25% of your salary can be contributed to your account, with a maximum contribution of $61,000. If you’re in the 32% federal income tax bracket, making a maximum contribution could cut what you owe Uncle Sam for 2022 by a whopping $19,520 (32% times $61,000).

More options

Other small business retirement plan options include:

401(k) plans, which can even be set up for just one person (also called solo 401(k)s),
Defined benefit pension plans, and
SIMPLE-IRAs.

Depending on your circumstances, these other types of plans may allow bigger deductible contributions.

Deadlines to establish and contribute

Thanks to a change made by the 2019 SECURE Act, tax-favored qualified employee retirement plans, except for SIMPLE-IRA plans, can now be adopted by the due date (including any extension) of the employer’s federal income tax return for the adoption year. The plan can then receive deductible employer contributions that are made by the due date (including any extension), and the employer can deduct those contributions on the return for the adoption year.

Important: The SECURE Act provision didn’t change the deadline to establish a SIMPLE-IRA plan. It remains October 1 of the year for which the plan is to take effect. Also, the SECURE Act change doesn’t override rules that require certain plan provisions to be in effect during the plan year, such as the provisions that cover employee elective deferral contributions (salary-reduction contributions) under a 401(k) plan. The plan must be in existence before such employee elective deferral contributions can be made.

For example, the deadline for the 2021 tax year for setting up a SEP-IRA for a sole proprietorship business that uses the calendar year for tax purposes is October 17, 2022, if you extend your 2021 tax return. The deadline for making the contribution for the 2021 tax year is also October 17, 2022. However, to make a SIMPLE-IRA contribution for the 2021 tax year, you must have set up the plan by October 1, 2021. So, it’s too late to set up a plan for last year.

While you can delay until next year establishing a tax-favored retirement plan for this year (except for a SIMPLE-IRA plan), why wait? Get it done this year as part of your tax planning and start saving for retirement. We can provide more information on small business retirement plan alternatives. Be aware that, if your business has employees, you may have to make contributions for them, too.

Clarity counts when it comes to estate planning documents

Estate & Wealth Transfer Planning|April 12, 2022

Precise language is critical in wills, trusts and other estate planning documents. A lack of clarity may be an invitation to litigation. An example of this is the dispute that arose after Tom Petty’s death, between his widow and his two daughters from a previous marriage. (The two parties have since resolved their differences and dismissed all litigation matters.)

Interpreting “equal participation”

Details of the musician’s estate plan aren’t entirely clear. But it appears that his trust appointed his widow as a “directing trustee,” while providing that she and his daughters were entitled to “participate equally” in the management of his extensive music catalog and other assets. Unfortunately, the trust failed to spell out the meaning of “equal participation,” resulting in litigation between Petty’s widow and daughters over control of his assets.

There are several plausible interpretations of “equal participation.” One interpretation is that each of the three women has an equal vote, giving the daughters the ability to rule by majority.

Another interpretation is that each has an opportunity to participate in the decision-making process, but Petty’s widow has the final say as the directing trustee. Yet another possibility is that Petty intended for the women to make decisions by unanimous consent.

Determining intent

If the two parties hadn’t settled their differences out of court, it would have been up to the court to provide an answer based on evidence of Petty’s intent. But the time, expense and emotional strain of litigation may have been avoided by including language in the trust that made that intent clear.

If you’re planning your estate, the Petty case illustrates the importance of using unambiguous language to ensure that your wishes are carried out. And if you anticipate that one or more of your beneficiaries will perceive your plan as unfair, sit down with them to explain your reasoning. This discussion can go a long way toward avoiding future disputes.

Review and revise to make your intent crystal clear

If your estate plan has already been drafted and you have concerns regarding the language used, contact your attorney. He or she can review your documents to determine if more precise wording is necessary to make your intentions crystal clear for your family after your death.

Tax considerations when adding a new partner at your business

Undertaking a pay equity audit at your business

Opening up to SLAT opportunities

Power up your trust with Crummey powers

Eyes on related parties

Classify your nonprofit’s workers correctly — or risk repercussions

Tax issues to assess when converting from a C corporation to an S corporation

Once you file your tax return, consider these 3 issues

Establish a tax-favored retirement plan

Clarity counts when it comes to estate planning documents

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