Are you considering transferring real estate, a family business or other assets you expect to appreciate dramatically in the future? If so, an installment sale may be a viable option. Its benefits include the ability to freeze asset values for estate tax purposes and remove future appreciation from your taxable estate.
Giving away vs. selling
From an estate planning perspective, if you have a taxable estate it’s usually more advantageous to give property to your children than to sell it to them. By gifting the asset you’ll be depleting your estate and thereby reducing potential estate tax liability, whereas in a sale the proceeds generally will be included in your taxable estate.
But an installment sale may be desirable if you’ve already used up your $11.18 million (for 2018) lifetime gift tax exemption or if your cash flow needs preclude you from giving the property away outright. When you sell property at fair market value to your children or other loved ones rather than gifting it, you avoid gift taxes on the transfer and freeze the property’s value for estate tax purposes as of the sale date. All future appreciation benefits the buyer and won’t be included in your taxable estate.
Because the transaction is structured as a sale rather than a gift, your buyer must have the financial resources to buy the property. But by using an installment note, the buyer can make the payments over time. Ideally, the purchased property will generate enough income to fund these payments.
Advantages and disadvantages
An advantage of an installment sale is that it gives you the flexibility to design a payment schedule that corresponds with the property’s cash flow, as well as with your and your buyer’s financial needs. You can arrange for the payments to increase or decrease over time, or even provide for interest-only payments with an end-of-term balloon payment of the principal.
One disadvantage of an installment sale over strategies that involve gifted property is that you’ll be subject to tax on any capital gains you recognize from the sale. Fortunately, you can spread this tax liability over the term of the installment note. As of this writing, the long-term capital gains rates are 0%, 15% or 20%, depending on the amount of your net long-term capital gains plus your ordinary income.
Also, you’ll have to charge interest on the note and pay ordinary income tax on the interest payments. IRS guidelines provide for a minimum rate of interest that must be paid on the note. On the bright side, any capital gains and ordinary income tax you pay further reduces the size of your taxable estate.
Simple technique, big benefits
An installment sale is an approach worth exploring for business owners, real estate investors and others who have gathered high-value assets. It can help keep a family-owned business in the family or otherwise play an important role in your estate plan.
Bear in mind, however, that this simple technique isn’t right for everyone. Our firm can review your situation and help you determine whether an installment sale is a wise move for you. Contact us at 205-345-9898.
© 2018 Covenant CPA
Prepaying property taxes related to the current year but due the following year has long been one of the most popular and effective year-end tax-planning strategies. But does it still make sense in 2018?
The answer, for some people, is yes — accelerating this expense will increase their itemized deductions, reducing their tax bills. But for many, particularly those in high-tax states, changes made by the Tax Cuts and Jobs Act (TCJA) eliminate the benefits.
The TCJA made two changes that affect the viability of this strategy. First, it nearly doubled the standard deduction to $24,000 for married couples filing jointly, $18,000 for heads of household, and $12,000 for singles and married couples filing separately, so fewer taxpayers will itemize. Second, it placed a $10,000 cap on state and local tax (SALT) deductions, including property taxes plus income or sales taxes.
For property tax prepayment to make sense, two things must happen:
- You must itemize (that is, your itemized deductions must exceed the standard deduction), and
- Your other SALT expenses for the year must be less than $10,000.
If you don’t itemize, or you’ve already used up your $10,000 limit (on income or sales taxes or on previous property tax installments), accelerating your next property tax installment will provide no benefit.
Joe and Mary, a married couple filing jointly, have incurred $5,000 in state income taxes, $5,000 in property taxes, $18,000 in qualified mortgage interest, and $4,000 in charitable donations, for itemized deductions totaling $32,000. Their next installment of 2018 property taxes, $5,000, is due in the spring of 2019. They’ve already reached the $10,000 SALT limit, so prepaying property taxes won’t reduce their tax bill.
Now suppose they live in a state with no income tax. In that case, prepayment would potentially make sense because it would be within the SALT limit and would increase their 2018 itemized deductions.
Look before you leap
Before you prepay property taxes, review your situation carefully to be sure it will provide a tax benefit. And keep in mind that, just because prepayment will increase your 2018 itemized deductions, it doesn’t necessarily mean that’s the best strategy. For example, if you expect to be in a higher tax bracket in 2019, paying property taxes when due will likely produce a greater benefit over the two-year period.
For help determining whether prepaying property taxes makes sense for you this year, contact us. We can also suggest other year-end tips for reducing your taxes. Call us today at 205-345-9898.
© 2018 Covenant CPA
As the year comes to a close, many businesses look for ways to save on taxes. Purveyors of abusive tax shelters know this and are ready to take advantage of unwitting owners.
Abusive tax shelters are complex transactions that have no legitimate business purpose and are used solely to reduce or eliminate tax liability. However tempting the tax savings may seem, you should avoid such tax shelters or you may face serious financial consequences.
Witting and unwitting victims
Unfortunately, abusive tax shelters aren’t always easy to identify. Even reputable companies may unwittingly market tax shelters the IRS deems abusive.
Some appear less innocent, though. For example, one company marketed products that functioned as loss generators, allowing buyers to offset paper losses against other income, sheltering that income from taxes. In such cases, not only is the seller of the products liable for penalties, but the taxpayers who use them generally are required to pay back taxes, interest and penalties.
As part of a comprehensive strategy to combat abusive tax shelters, the IRS requires that certain tax shelters be registered and that lists of investors be maintained by those who organize them. Individuals who participate in a “listed transaction” also must disclose their participation on their tax return. The list of transactions is available at irs.gov.
Avoid messy entanglements
How can you avoid becoming entangled in an abusive tax shelter? First apply the age-old rule that, if it seems too good to be true, it probably is. These products usually are unsolicited. So if someone approaches you with a proposal to make money through tax write-offs, it’s probably not a legitimate business investment.
Second, understand that legitimate tax advantages aren’t available as one-size-fits-all products. Tax liabilities vary according to a business’s financial situation, and no tax shelter is appropriate for every company.
Finally, look carefully at shelters that involve third parties such as foreign corporations, tax-exempt entities or entities with significant tax losses. If there’s no legitimate business purpose for entering into a transaction, there’s no legitimate tax shelter.
Shun the unknown
In short, if you receive an unsolicited offer to help you reduce your tax burden, look long and hard at the proposal, purveyor and participants. Contact us at 205-345-9898. We can help investigate any offer and steer you toward reliable and responsible tax-minimizing strategies.
© 2018 Covenant CPA
Estate planning typically focuses on what happens to your children and your assets when you die. But it’s equally important to have a plan for making critical financial and medical decisions if you’re unable to make those decisions yourself. A crucial component of this plan is the power of attorney (POA) • specifically, a nonspringing POA.
A POA is a document under which you, as “principal,” authorize a representative to be your “agent” or “attorney-in-fact” to act on your behalf. Typically, separate POAs are executed for health care and property.
A POA for health care authorizes your agent — often, a spouse, child or other family member — to make medical decisions on your behalf or consent to or discontinue medical treatment when you’re unable to do so.
A POA for property appoints an agent to manage your investments, pay your bills, file tax returns, continue your practice of making annual charitable and family gifts, and otherwise handle your finances, subject to limitations you establish.
Benefits of a nonspringing POA
A nonspringing or “durable” POA is effective immediately, regardless of the circumstances. Because it’s effective immediately, it allows your agent to act on your behalf for your convenience, not just when you’re incapacitated. A springing POA, on the other hand, becomes effective only when certain conditions are met.
In addition, a nonspringing POA avoids the need for a determination that you’ve become incapacitated, which can result in delays, disputes or even litigation. This allows your agents to act quickly in an emergency, making critical medical decisions or handling urgent financial matters without having to wait, for example, for one or more treating physicians to examine you and certify that you’re incapacitated.
Disadvantage of a nonspringing POA
A potential disadvantage of a nonspringing POA — and the main reason some people opt for a springing POA — is the concern that your agent may be tempted to abuse his or her authority or commit fraud. But consider this: If you don’t trust your agent enough to give him or her a POA that takes effect immediately, how does delaying its effect until you’re deemed incapacitated solve the problem? Arguably, the risk of fraud or abuse is even greater at that time because you’re unable to protect yourself.
Given the advantages of a nonspringing POA, and the potential delays associated with a springing POA, it’s usually preferable to use a nonspringing POA and to make sure the person you name as agent is someone you trust unconditionally.
If you’re still uncomfortable handing over a POA that takes effect immediately, consider signing a nonspringing POA but have your attorney or other trusted advisor hold it and deliver it to your agent when needed.
Contact us if you have questions regarding the use of POAs in your estate plan at 205-345-9898.
© 2018 Covenant CPA
As the year winds down, business owners can be thankful for the gift of perspective (among other things, we hope). Assuming you created a budget for the calendar year, you should now be able to accurately assess that budget by comparing its estimates to actual results. Your objective is to determine whether your budget was reasonable, and, if not, how to adjust it to be more accurate for 2019.
Identify notable changes
Your estimates, like those of many companies, probably start with historical financial statements. From there, you may simply apply an expected growth rate to annual revenues and let it flow through the remaining income statement and balance sheet items. For some businesses, this simplified approach works well. But future performance can’t always be expected to mirror historical results.
For example, suppose you renegotiated a contract with a major supplier during the year. The new contract may have affected direct costs and profit margins. So, what was reasonable at the beginning of the year may be less so now and require adjustments when you draft your 2019 budget.
Often, a business can’t maintain its current growth rate indefinitely without investing in additional assets or incurring further fixed costs. As you compare your 2018 estimates to actuals, and look at 2019, consider whether your company is planning to:
- Build a new plant,
- Buy a major piece of equipment,
- Hire more workers, or
- Rent additional space.
External and internal factors — such as regulatory changes, product obsolescence, and in-process research and development — also may require specialized adjustments to your 2019 budget to keep it reasonable.
Find the best way to track
The most analytical way to gauge reasonableness is to generate year-end financials and then compare the results to what was previously budgeted. Are you on track to meet those estimates? If not, identify the causes and factor them into a revised budget for next year.
If you discover that your actuals are significantly different from your estimates — and if this takes you by surprise — you should consider producing interim financials next year. Some businesses feel overwhelmed trying to prepare a complete set of financials every month. So, you might opt for short-term cash reports, which highlight the sources and uses of cash during the period. These cash forecasts can serve as an early warning system for “budget killers,” such as unexpected increases in direct costs or delinquent accounts.
Alternatively, many companies create 12-month rolling budgets — which typically mirror historical financial statements — and update them monthly to reflect the latest market conditions.
Do it all
The budgeting process is rarely easy, but it’s incredibly important. And that process doesn’t end when you create the budget; checking it regularly and performing a year-end assessment are key. We can help you not only generate a workable budget, but also identify the best ways to monitor your financials throughout the year. Call us today at 205-345-9898.
© 2018 Covenant CPA
Charities typically receive most of their donations during the holidays and at year end. It’s critical for these organizations to be on the lookout for fraud throughout the year, but even more so during the busy season. Here are some fraud schemes nonprofits should watch out for and how they can use internal controls to protect against financial losses.
Culture of trust
Charities generally are staffed by people who believe strongly in their missions, which contributes to a culture of trust. Unfortunately, such trust makes nonprofits vulnerable to certain types of fraud. For example, if managers don’t supervise staffers who accept cash donations, it provides an opportunity for them to skim cash. Skimming is even more likely to occur if a nonprofit doesn’t perform background checks on employees and volunteers who’ll be handling money.
However, skimming isn’t the most common type of fraud scheme in the nonprofit sector. According to the Association of Certified Fraud Examiners, religious, charitable and social services organizations are most likely to fall prey to billing schemes. Falsified expense reports and credit card abuse are also common in nonprofits.
Internal controls matter
Even small nonprofits that consider their employees and volunteers “family” need to establish and enforce internal controls. Such procedures must be followed regardless of how busy staffers are processing donations and completing year-end duties.
Possibly the most important control to prevent occupational fraud is segregation of duties. To reduce opportunities for any one person to steal, multiple employees should be involved in processing payables and receivables. For example, every incoming invoice should be reviewed by the staffer who instigated it to confirm the amount and that the goods or services were received. A different employee should be responsible for writing the check.
And don’t forget to protect electronic records that include data on donors, vendors and employees. Staff members should be given access only to the information and programs required for their job. And all sensitive information should be password-protected.
Caution with special events
Many nonprofits depend on money raised from a big annual gala or other special event at year end. During crowded, chaotic fundraisers, you’ll want to discourage supporters from making cash payments. Instead, presell or preregister event participants to limit access to cash on the day of the event. If you decide to accept cash at the door, try to assign cash-related duties to paid employees or board members, rather than unsupervised volunteers.
For more tips on preventing fraud in your nonprofit, contact us. We can help you reinforce internal controls, as well as investigate suspected theft. Call us today at 205-345-9898.
© 2018 Covenant CPA
Under the Tax Cuts and Jobs Act (TCJA), many more businesses are now eligible to use the cash method of accounting for federal tax purposes. The cash method offers greater tax-planning flexibility, allowing some businesses to defer taxable income. Newly eligible businesses should determine whether the cash method would be advantageous and, if so, consider switching methods.
Previously, the cash method was unavailable to certain businesses, including:
- C corporations — as well as partnerships (or limited liability companies taxed as partnerships) with C corporation partners — whose average annual gross receipts for the previous three tax years exceeded $5 million, and
- Businesses required to account for inventories, whose average annual gross receipts for the previous three tax years exceeded $1 million ($10 million for certain industries).
In addition, construction companies whose average annual gross receipts for the previous three tax years exceeded $10 million were required to use the percentage-of-completion method (PCM) to account for taxable income from long-term contracts (except for certain home construction contracts). Generally, the PCM method is less favorable, from a tax perspective, than the completed-contract method.
The TCJA raised all of these thresholds to $25 million, beginning with the 2018 tax year. In other words, if your business’s average gross receipts for the previous three tax years is $25 million or less, you generally now will be eligible for the cash method, regardless of how your business is structured, your industry or whether you have inventories. And construction firms under the threshold need not use PCM for jobs expected to be completed within two years.
You’re also eligible for streamlined inventory accounting rules. And you’re exempt from the complex uniform capitalization rules, which require certain expenses to be capitalized as inventory costs.
Should you switch?
If you’re eligible to switch to the cash method, you need to determine whether it’s the right method for you. Usually, if a business’s receivables exceed its payables, the cash method will allow more income to be deferred than will the accrual method. (Note, however, that the TCJA has a provision that limits the cash method’s advantages for businesses that prepare audited financial statements or file their financial statements with certain government entities.) It’s also important to consider the costs of switching, which may include maintaining two sets of books.
The IRS has established procedures for obtaining automatic consent to such a change, beginning with the 2018 tax year, by filing Form 3115 with your tax return. Contact us to learn more at 205-345-9898.
© 2018 Covenant CPA
An IRA is a popular vehicle to save for retirement, and it can also be a powerful estate planning tool. Some people designate a trust as beneficiary of their IRAs, but is that a good idea? The answer: possibly.
The benefit of an IRA is that your contributions can grow and compound on a tax-deferred basis for many years. The longer you leave the funds in the IRA, the greater the potential growth, because taxes aren’t taking a bite out of the account. If you don’t need to tap your IRA funds during your life — other than required minimum distributions (RMDs) — you can stretch out its benefits even longer by designating your spouse or child as beneficiary.
For traditional IRAs, you must begin taking annual RMDs by April 1 of the year following the year in which you reach age 70½ (your “required beginning date,” or RBD). The distribution amount is calculated by dividing your account balance by your remaining life expectancy.
If you name your spouse as beneficiary, he or she can transfer the funds to a spousal rollover IRA and delay distributions until his or her own RBD. If someone other than your spouse inherits your IRA, that person must take distributions even if he or she hasn’t reached age 70½ but can stretch them out over his or her own life expectancy.
If you designate multiple beneficiaries, distributions will be based on the oldest beneficiary’s — that is, the shortest — life expectancy.
One thing you shouldn’t do, unless you have a specific reason, is designate your estate as beneficiary or fail to name a beneficiary at all. Under those circumstances, the IRA must be distributed to your heirs within five years (if you die before your RBD) or over your remaining statistical life expectancy (if you die after your RBD).
Why use a trust?
One reason to name a trust as IRA beneficiary is to prevent a loved one from emptying the account too quickly and defeating your tax-deferral purposes. Another, if you have children from a previous marriage, is to ensure that they’ll benefit from an IRA you leave to your current spouse.
If you decide to use a trust, be sure it’s designed properly to meet the requirements of a “see-through” trust. Otherwise, distributions will be accelerated as if you’d failed to name a beneficiary. To qualify, the trust must be valid under state law, be irrevocable (or become irrevocable on your death) and name only identifiable individuals as beneficiaries.
In addition, the trustee must furnish the trust documentation to the IRA custodian by October 31 of the year following the year of death.
Under the right circumstances, naming a trust as IRA beneficiary can be a good strategy. However, contact us before taking action. We can help assess your circumstances and determine if this is the right move for you. Contact us at 205-345-9898.
© 2018 Covenant CPA
A strong economy leads some company owners to cut back on marketing. Why spend the money if business is so good? Others see it differently — a robust economy means more sales opportunities, so pouring dollars into marketing is the way to go.
The right approach for your company depends on many factors, but one thing is for sure: Few businesses can afford to cut back drastically on marketing or stop altogether, no matter how well the economy is doing. Yet spending recklessly may be dangerous as well. Here are three ways to creatively get more from your marketing dollars so you can cut back or ramp up as prudent:
1. Do more digitally. There are good reasons to remind yourself of digital marketing’s potential value: the affordable cost, the ability to communicate with customers directly, faster results and better tracking capabilities. Consider or re-evaluate strategies such as:
- Regularly updating your search engine optimization approaches so your website ranks higher in online searches and more prospective customers can find you,
- Refining your use of email, text message and social media to communicate with customers (for instance, using more dynamic messages to introduce new products or announce special offers), and
- Offering “flash sales” and Internet-only deals to test and tweak offers before making them via more expansive (and expensive) media.
2. Search for media deals. During boom times, you may feel at the mercy of high advertising rates. The good news is that there are many more marketing/advertising channels than there used to be and, therefore, much more competition among them. Finding a better deal is often a matter of knowing where to look.
Track your marketing efforts carefully and dedicate time to exploring new options. For example, podcasts remain enormously popular. Could a marketing initiative that exploits their reach pay dividends? Another possibility is shifting to smaller, less expensive ads posted in a wider variety of outlets over one massive campaign.
3. Don’t forget public relations (PR). These days, business owners tend to fear the news. When a company makes headlines, it’s all too often because of an accident, scandal or oversight. But you can turn this scenario on its head by using PR to your advantage.
Specifically, ask your marketing department to craft clear, concise but exciting press releases regarding your newest products or services. Then distribute these press releases via both traditional and online channels to complement your marketing efforts. In this manner, you can make the news, get information out to more people and even improve your search engine rankings — all typically at only the cost of your marketing team’s time.
These are just a few ideas to help ensure your marketing dollars play a winning role in your company’s investment in itself. We can provide further assistance in evaluating your spending in this area, as well as in developing a feasible budget for next year. Call us for more information at 205-345-9898.
© 2018 Covenant CPA
If most of your money is tied up in your business, retirement can be a challenge. So if you haven’t already set up a tax-advantaged retirement plan, consider doing so this year. There’s still time to set one up and make contributions that will be deductible on your 2018 tax return!
Not only are contributions tax deductible, but retirement plan funds can grow tax-deferred. If you might be subject to the 3.8% net investment income tax (NIIT), setting up and contributing to a retirement plan may be particularly beneficial because retirement plan contributions can reduce your modified adjusted gross income and thus help you reduce or avoid the NIIT.
If you have employees, they generally must be allowed to participate in the plan, provided they meet the qualification requirements. But this can help you attract and retain good employees.
And if you have 100 or fewer employees, you may be eligible for a credit for setting up a plan. The credit is for 50% of start-up costs, up to $500. Remember, credits reduce your tax liability dollar-for-dollar, unlike deductions, which only reduce the amount of income subject to tax.
3 options to consider
Many types of retirement plans are available, but here are three of the most attractive to business owners trying to build up their own retirement savings:
1. Profit-sharing plan. This is a defined contribution plan that allows discretionary employer contributions and flexibility in plan design. You can make deductible 2018 contributions as late as the due date of your 2018 tax return, including extensions — provided your plan exists on Dec. 31, 2018. For 2018, the maximum contribution is $55,000, or $61,000 if you are age 50 or older and your plan includes a 401(k) arrangement.
2. Simplified Employee Pension (SEP). This is also a defined contribution plan, and it provides benefits similar to those of a profit-sharing plan. But you can establish a SEP in 2019 and still make deductible 2018 contributions as late as the due date of your 2018 income tax return, including extensions. In addition, a SEP is easy to administer. For 2018, the maximum SEP contribution is $55,000.
3. Defined benefit plan. This plan sets a future pension benefit and then actuarially calculates the contributions needed to attain that benefit. The maximum annual benefit for 2018 is generally $220,000 or 100% of average earned income for the highest three consecutive years, if less. Because it’s actuarially driven, the contribution needed to attain the projected future annual benefit may exceed the maximum contributions allowed by other plans, depending on your age and the desired benefit.
You can make deductible 2018 defined benefit plan contributions until your tax return due date, including extensions, provided your plan exists on Dec. 31, 2018. Be aware that employer contributions generally are required.
If the benefits of setting up a retirement plan sound good, contact us. We can provide more information and help you choose the best retirement plan for your particular situation. Call us at 205-345-9898.
© 2018 Covenant CPA