Author Archive: Justine O'Sullivan

Tax planning for investments gets more complicated

Posted on by

For investors, fall is a good time to review year-to-date gains and losses. Not only can it help you assess your financial health, but it also can help you determine whether to buy or sell investments before year end to save taxes. This year, you also need to keep in mind the impact of the Tax Cuts and Jobs Act (TCJA). While the TCJA didn’t change long-term capital gains rates, it did change the tax brackets for long-term capital gains and qualified dividends.

For 2018 through 2025, these brackets are no longer linked to the ordinary-income tax brackets for individuals. So, for example, you could be subject to the top long-term capital gains rate even if you aren’t subject to the top ordinary-income tax rate.

Old rules

For the last several years, individual taxpayers faced three federal income tax rates on long-term capital gains and qualified dividends: 0%, 15% and 20%. The rate brackets were tied to the ordinary-income rate brackets.

Specifically, if the long-term capital gains and/or dividends fell within the 10% or 15% ordinary-income brackets, no federal income tax was owed. If they fell within the 25%, 28%, 33% or 35% ordinary-income brackets, they were taxed at 15%. And, if they fell within the maximum 39.6% ordinary-income bracket, they were taxed at the maximum 20% rate.

In addition, higher-income individuals with long-term capital gains and dividends were also hit with the 3.8% net investment income tax (NIIT). It kicked in when modified adjusted gross income exceeded $200,000 for singles and heads of households and $250,000 for married couples filing jointly. So, many people actually paid 18.8% (15% + 3.8%) or 23.8% (20% + 3.8%) on their long-term capital gains and qualified dividends.

New rules

The TCJA retains the 0%, 15% and 20% rates on long-term capital gains and qualified dividends for individual taxpayers. However, for 2018 through 2025, these rates have their own brackets. Here are the 2018 brackets:

  • Singles:
    • 0%: $0 – $38,600
    • 15%: $38,601 – $425,800
    • 20%: $425,801 and up
  • Heads of households:
    • 0%: $0 – $51,700
    • 15%: $51,701 – $452,400
    • 20%: $452,401 and up
  • Married couples filing jointly:
    • 0%: $0 – $77,200
    • 15%: $77,201 – $479,000
    • 20%: $479,001 and up

For 2018, the top ordinary-income rate of 37%, which also applies to short-term capital gains and nonqualified dividends, doesn’t go into effect until income exceeds $500,000 for singles and heads of households or $600,000 for joint filers. (Both the long-term capital gains brackets and the ordinary-income brackets will be indexed for inflation for 2019 through 2025.) The new tax law also retains the 3.8% NIIT and its $200,000 and $250,000 thresholds.

More thresholds, more complexity

With more tax rate thresholds to keep in mind, year-end tax planning for investments is especially complicated in 2018. If you have questions, please contact us at 205-345-9898.

© 2018 Covenant CPA

For unmarried couples, estate planning is indispensable

Posted on by

When married couples neglect to prepare an estate plan, state intestacy laws step in to help provide financial security for the surviving spouse. It may not be the plan they would have designed, but at least it offers some measure of financial security. Unmarried couples, however, have no such backup plan. Unless they carefully spell out how they wish to distribute their wealth, a surviving life partner may end up with nothing.

Marriage has its advantages

Because intestacy laws offer no protection to an unmarried person who wishes to provide for his or her partner, it’s essential for unmarried couples at minimum to employ a will or living trust. But marriage offers several additional estate planning advantages that unmarried couples must plan around, such as:

The marital deduction. Estate planning for wealthy married couples often centers around taxes and the marital deduction, which allows one spouse to make unlimited gifts to the other spouse free of gift or estate taxes. Unmarried couples don’t enjoy this advantage. Thus, lifetime gift planning is critical so they can make the most of the lifetime gift tax exemption and the $15,000 per recipient annual gift tax exclusion.

Tenancy by the entirety. Married and unmarried couples alike often hold real estate or other assets as joint tenants with rights of survivorship. When one owner dies, title automatically passes to the survivor. In many states, a special form of joint ownership — tenancy by the entirety — is available only to married couples.

Will contests. Married or not, anyone’s will is subject to challenge as improperly executed, or on grounds of lack of testamentary capacity, undue influence or fraud. For some unmarried couples, however, family members may be more likely to challenge a will simply because they disapprove of the relationship.

Here are steps unmarried couples should consider to reduce the risk of such challenges:

  • Be sure that a will is carefully worded and properly executed.
  • Use separate attorneys, which can help refute charges of undue influence or fraud.
  • Include a “no contest” clause, which disinherits anyone who challenges the will and loses.

Health care decisions. A married person generally can make health care decisions on behalf of a spouse who becomes incapacitated by illness or injury. Unmarried partners cannot do so without written authorization, such as a medical directive or health care power of attorney. A durable power of attorney for property may also be desirable, allowing a partner to manage the other’s assets during a period of incapacity.

Careful planning required

If you’re unmarried and wish to provide for a life partner, contact us to discuss potential strategies. You can achieve many of the same estate planning objectives as married couples, but only with careful planning and thorough documentation. Contact us at 205-345-9898 for details.

© 2018 Covenant CPA

Is a significant portion of your wealth concentrated in a single stock?

Posted on by

Estate planning and investment risk management go hand in hand. After all, an estate plan is effective only if you have some wealth to transfer to the next generation. One of the best ways to reduce your investment risk is to diversify your holdings. But it’s not unusual for affluent people to end up with a significant portion of their wealth concentrated in one or two stocks.

There are many ways this can happen, including the exercise of stock options, participation in equity-based compensation programs, or receipt of stock in a merger or acquisition.

Sell the stock

To reduce your investment risk, the simplest option is to sell some or most of the stock and reinvest in a more diversified portfolio. This may not be an option, however, if you’re not willing to pay the resulting capital gains taxes, if there are legal restrictions on the amount you can sell and the timing of a sale, or if you simply wish to hold on to the stock.

To soften the tax hit, consider selling the stock gradually over time to spread out the capital gains. Or, if you’re charitably inclined, contribute the stock to a charitable remainder trust (CRT). The trust can sell the stock tax-free, reinvest the proceeds in more diversified investments, and provide you with a current tax deduction and a regular income stream. (Be aware that CRT payouts are taxable — usually a combination of ordinary income, capital gains and tax-free amounts.)

Keep the stock

To reduce your risk without selling the stock:

  • Use a hedging technique. For example, purchase put options to sell your shares at a set price.
  • Buy other securities to rebalance your portfolio. Consider borrowing the funds you need, using the concentrated stock as collateral.
  • Invest in a stock protection fund. These funds allow investors who own concentrated stock positions in different industries to pool their risks, essentially insuring their holdings against catastrophic loss.

If you have questions about specific assets in your estate, contact us at 205-345-9898. We can help you preserve as much of your estate as possible so that you have more to pass on to your loved ones.

© 2018 Covenant CPA

Businesses aren’t immune to tax identity theft

Posted on by

Tax identity theft may seem like a problem only for individual taxpayers. But, according to the IRS, increasingly businesses are also becoming victims. And identity thieves have become more sophisticated, knowing filing practices, the tax code and the best ways to get valuable data.

How it works

In tax identity theft, a taxpayer’s identifying information (such as Social Security number) is used to fraudulently obtain a refund or commit other crimes. Business tax identity theft occurs when a criminal uses the identifying information of a business to obtain tax benefits or to enable individual tax identity theft schemes.

For example, a thief could use an Employer Identification Number (EIN) to file a fraudulent business tax return and claim a refund. Or a fraudster may report income and withholding for fake employees on false W-2 forms. Then, he or she can file fraudulent individual tax returns for these “employees” to claim refunds.

The consequences can include significant dollar amounts, lost time sorting out the mess and damage to your reputation.

Red flags

There are some red flags that indicate possible tax identity theft. For example, your business’s identity may have been compromised if:

  • Your business doesn’t receive expected or routine mailings from the IRS,
  • You receive an IRS notice that doesn’t relate to anything your business submitted, that’s about fictitious employees or that’s related to a defunct, closed or dormant business after all account balances have been paid,
  • The IRS rejects an e-filed return or an extension-to-file request, saying it already has a return with that identification number — or the IRS accepts it as an amended return,
  • You receive an IRS letter stating that more than one tax return has been filed in your business’s name, or
  • You receive a notice from the IRS that you have a balance due when you haven’t yet filed a return.

Keep in mind, though, that some of these could be the result of a simple error, such as an inadvertent transposition of numbers. Nevertheless, you should contact the IRS immediately if you receive any notices or letters from the agency that you believe might indicate that someone has fraudulently used your Employer Identification Number.

Prevention tips

Businesses should take steps such as the following to protect their own information as well as that of their employees:

  • Provide training to accounting, human resources and other employees to educate them on the latest tax fraud schemes and how to spot phishing emails.
  • Use secure methods to send W-2 forms to employees.
  • Implement risk management strategies designed to flag suspicious communications.

Of course identity theft can go beyond tax identity theft, so be sure to have a comprehensive plan in place to protect the data of your business, your employees and your customers. If you’re concerned your business has become a victim, or you have questions about prevention, please contact us at 205-345-9898.

© 2018 Covenant CPA

3 reasons you should continue making lifetime gifts

Posted on by

Now that the gift and estate tax exemption has reached a record high of $11.18 million (for 2018), it may seem that gifting assets to loved ones is less important than it was in previous years. However, lifetime gifts continue to provide significant benefits, whether your estate is taxable or not.

Let’s examine three reasons why making gifts remains an important part of estate planning:

1. Lifetime gifts reduce estate taxes. If your estate exceeds the exemption amount — or you believe it will in the future — regular lifetime gifts can substantially reduce your estate tax bill.

The annual gift tax exclusion allows you to give up to $15,000 per recipient ($30,000 if you “split” gifts with your spouse) tax-free without using up any of your gift and estate tax exemption. In addition, direct payments of tuition or medical expenses on behalf of your loved ones are excluded from gift tax.

Taxable gifts — that is, gifts beyond the annual exclusion amount and not eligible for the tuition and medical expense exclusion — can also reduce estate tax liability by removing future appreciation from your taxable estate. You may be better off paying gift tax on an asset’s current value rather than estate tax on its appreciated value down the road.

When gifting appreciable assets, however, be sure to consider the potential income tax implications. Property transferred at death receives a “stepped-up basis” equal to its date-of-death fair market value, which means the recipient can turn around and sell the property free of capital gains taxes. Property transferred during life retains your tax basis, so it’s important to weigh the estate tax savings against the potential income tax costs.

2. Tax laws aren’t permanent. Even if your estate is within the exemption amount now, it pays to make regular gifts. Why? Because even though the Tax Cuts and Jobs Act doubled the exemption amount, and that amount will be adjusted annually for inflation, the doubling expires after 2025. Without further legislation, the exemption will return to an inflation-adjusted $5 million in 2026.

Thus, taxpayers with estates in roughly the $6 million to $11 million range (twice that for married couples), whose estates would escape estate taxes if they were to die while the doubled exemption is in effect, still need to keep potential post-2025 estate tax liability in mind in their estate planning.

3. Gifts provide nontax benefits. Tax planning aside, there are other reasons to make lifetime gifts. For example, perhaps you wish to use gifting to shape your family members’ behavior — for example, by providing gifts to those who attend college. And if you own a business, gifts of interests in the business may be a key component of your ownership and management succession plan. Or you might simply wish to see your loved ones enjoy the gifts.

Regardless of the amount of your wealth, consider a program of regular lifetime giving. We can help you devise and incorporate a gifting program as part of your estate plan, call us today at 205-345-9898.

© 2018 Covenant CPA

At your own risk: The pitfalls of DIY estate planning

Posted on by

There’s no law that says you can’t prepare your own estate plan. And with an abundance of online services that automate the creation of wills and other documents, it’s easy to do. But unless your estate is small and your plan is exceedingly simple, the pitfalls of do-it-yourself (DIY) estate planning can be many.

Dotting the i’s and crossing the t’s

A common mistake people make with DIY estate planning is to neglect the formalities associated with the execution of wills and other documents. Rules vary from state to state regarding the number and type of witnesses who must attest to a will and what, specifically, they must attest to.

Also, states have different rules about interested parties (that is, beneficiaries) serving as witnesses to a will or trust. In many states, interested parties are ineligible to serve as witnesses. In others, an interested-party witness triggers an increase in the required number of witnesses (from two to three, for example).

Keeping abreast of tax law changes

Legislative developments during the last several years demonstrate how changes in the tax laws from one year to the next can have a dramatic impact on your estate planning strategies. DIY service providers don’t offer legal or tax advice — and provide lengthy disclaimers to prove it. Thus, they cannot be expected to warn users that tax law changes may adversely affect their plans.

Consider this example: A decade ago, in 2008, George used an online service to generate estate planning documents. At the time, his estate was worth $4 million and the federal estate tax exemption was $2 million.

George’s plan provided for the creation of a trust for the benefit of his children, funded with the maximum amount that could be transferred free of federal estate tax, with the remainder going to his wife, Ann. If George died in 2008, for example, $2 million would have gone into the trust and the remaining $2 million would have gone to Ann.

Suppose, however, that George dies in 2018, when the federal estate tax exemption has increased to $11.18 million and his estate has grown to $10 million. Under the terms of his plan, the entire $10 million — all of which can be transferred free of federal estate tax — will pass to the trust, leaving nothing for Ann.

While even a qualified professional couldn’t have predicted in 2008 what the estate tax exemption would be at George’s death, he or she could have structured a plan that would provide the flexibility needed to respond to tax law changes.

Don’t try this at home

These are just a few examples of the many pitfalls associated with DIY estate planning. To help ensure that you achieve your estate planning objectives, contact us to review your existing plan at 205-345-9898.

© 2018 Covenant CPA

2 ways to transfer a family business

Posted on by

For many people, a family-owned business is their primary source of wealth, so it’s critical to plan carefully for the transition of ownership from one generation to the next.

The best approach depends on your particular circumstances. If your net worth is well within the estate tax exemption ($11.18 million for 2018), for example, you might focus on reducing income taxes. But if you expect your estate to be significantly larger than the exemption amount, estate tax reduction may be a bigger concern.

Here are two techniques to transfer a family business — one if gift and estate taxes are a concern, and one if they aren’t:

1. IDGT. An intentionally defective grantor trust (IDGT) is an income defective trust. As such, it can be a highly effective tool for transferring business interests to the younger generation at a minimal gift and estate tax cost if your estate exceeds the gift and estate tax exemption.

An IDGT is designed so that contributions are completed gifts, removing the trust assets and all future appreciation in their value from your taxable estate. At the same time, it’s “defective” for income tax purposes; that is, it’s treated as a “grantor trust” whose income is taxable to you. This allows trust assets to grow without being eroded by income taxes, thus leaving a greater amount of wealth for your children or other beneficiaries.

The downside of an IDGT is that, when your beneficiaries inherit the business, they’ll also inherit yourtax basis, which may trigger a substantial capital gains tax liability if they sell the business. This result may be acceptable if the estate tax savings outweigh the income tax cost.

2. Estate defective trust. If the value of your business and other assets is less than the current estate tax exemption amount, so that estate taxes aren’t an issue, you might consider an estate defective trust. Essentially the opposite of an IDGT, an estate defective trust is designed so that beneficiaries are the owners for income tax purposes, while the assets remain in the estate for estate tax purposes.

This technique provides two significant income tax benefits. First, assuming your beneficiaries are in a lower tax bracket, this strategy will result in lower “familywide” taxes. Second, because the trust assets remain in your estate, the beneficiaries’ basis in the assets is “stepped up” to fair market value at your death, reducing or eliminating their potential capital gains tax liability.

Determining the right strategy to implement when transferring ownership of the business to heirs depends on the value of your business and other assets and the relative impact of estate and income taxes. Also keep in mind that the gift and estate tax exemption is scheduled to drop to an inflation-adjusted $5 million in 2026. Contact us with any questions at 205-345-9898.

© 2018 Covenant CPA

Keeping a king in the castle with a well-maintained cash reserve

Posted on by

You’ve no doubt heard the old business cliché “cash is king.” And it’s true: A company in a strong cash position stands a much better chance of obtaining the financing it needs, attracting outside investors or simply executing its own strategic plans.

One way to ensure that there’s always a king in the castle, so to speak, is to maintain a cash reserve. Granted, setting aside a substantial amount of dollars isn’t the easiest thing to do — particularly for start-ups and smaller companies. But once your reserve is in place, life can get a lot easier.

Common metrics

Now you may wonder: What’s the optimal amount of cash to keep in reserve? The right answer is different for every business and may change over time, given fluctuations in the economy or degree of competitiveness in your industry.

If you’ve already obtained financing, your bank’s liquidity covenants can give you a good idea of how much of a cash reserve is reasonable and expected of your company. To take it a step further, you can calculate various liquidity metrics and compare them to industry benchmarks. These might include:

  • Working capital = current assets − current liabilities,
  • Current ratio = current assets / current liabilities, and
  • Accounts payable turnover = cost of goods sold / accounts payable.

There may be other, more complex metrics that better apply to the nature and size of your business.

Financial forecasts

Believe it or not, many companies don’t suffer from a lack of cash reserves but rather a surplus. This often occurs because a business owner decides to start hoarding cash following a dip in the local or national economy.

What’s the problem? Substantial increases in liquidity — or metrics well above industry norms — can signal an inefficient deployment of capital.

To keep your cash reserve from getting too high, create financial forecasts for the next 12 to 18 months. For example, a monthly projected balance sheet might estimate seasonal ebbs and flows in the cash cycle. Or a projection of the worst-case scenario might be used to establish your optimal cash balance. Projections should consider future cash flows, capital expenditures, debt maturities and working capital requirements.

Formal financial forecasts provide a coherent method to building up cash reserves, which is infinitely better than relying on rough estimates or gut instinct. Be sure to compare actual performance to your projections regularly and adjust as necessary.

More isn’t always better

Just as individuals should set aside some money for a rainy day, so should businesses. But, when it comes to your company’s cash reserves, the notion that “more is better” isn’t necessarily correct. You’ve got to find the right balance. Contact us at 205-345-9898 to discuss your reserve and identify your ideal liquidity metrics.

© 2018 Covenant CPA

The tax deduction ins and outs of donating artwork to charity

Posted on by

If you’re charitably inclined and you collect art, appreciated artwork can make one of the best charitable gifts from a tax perspective. In general, donating appreciated property is doubly beneficial because you can both enjoy a valuable tax deduction and avoid the capital gains taxes you’d owe if you sold the property. The extra benefit from donating artwork comes from the fact that the top long-term capital gains rate for art and other “collectibles” is 28%, as opposed to 20% for most other appreciated property.

Requirements

The first thing to keep in mind if you’re considering a donation of artwork is that you must itemize deductions to deduct charitable contributions. Now that the Tax Cuts and Jobs Act has nearly doubled the standard deduction and put tighter limits on many itemized deductions (but not the charitable deduction), many taxpayers who have itemized in the past will no longer benefit from itemizing.

For 2018, the standard deduction is $12,000 for singles, $18,000 for heads of households and $24,000 for married couples filing jointly. Your total itemized deductions must exceed the applicable standard deduction for you to enjoy a tax benefit from donating artwork.

Something else to be aware of is that most artwork donations require a “qualified appraisal” by a “qualified appraiser.” IRS rules contain detailed requirements about the qualifications an appraiser must possess and the contents of an appraisal.

IRS auditors are required to refer all gifts of art valued at $20,000 or more to the IRS Art Advisory Panel. The panel’s findings are the IRS’s official position on the art’s value, so it’s critical to provide a solid appraisal to support your valuation.

Finally, note that, if you own both the work of art and the copyright to the work, you must assign the copyright to the charity to qualify for a charitable deduction.

Maximizing your deduction

The charity you choose and how the charity will use the artwork can have a significant impact on your tax deduction. Donations of artwork to a public charity, such as a museum or university with public charity status, can entitle you to deduct the artwork’s full fair market value. If you donate art to a private foundation, however, your deduction will be limited to your cost.

For your donation to a public charity to qualify for a full fair-market-value deduction, the charity’s use of the donated artwork must be related to its tax-exempt purpose. If, for example, you donate a painting to a museum for display or to a university’s art history department for use in its research, you’ll satisfy the related-use rule. But if you donate it to, say, a children’s hospital to auction off at its annual fundraising gala, you won’t satisfy the rule.

Plan carefully

Donating artwork is a great way to share enjoyment of the work with others. But to reap the maximum tax benefit, too, you must plan your gift carefully and follow all of the applicable rules. Contact us at 305-345-9898 to learn more.

© 2018 Covenant CPA

Be sure your employee travel expense reimbursements will pass muster with the IRS

Posted on by

Does your business reimburse employees’ work-related travel expenses? If you do, you know that it can help you attract and retain employees. If you don’t, you might want to start, because changes under the Tax Cuts and Jobs Act (TCJA) make such reimbursements even more attractive to employees. Travel reimbursements also come with tax benefits, but only if you follow a method that passes muster with the IRS.

The TCJA’s impact

Before the TCJA, unreimbursed work-related travel expenses generally were deductible on an employee’s individual tax return (subject to a 50% limit for meals and entertainment) as a miscellaneous itemized deduction. However, many employees weren’t able to benefit from the deduction because either they didn’t itemize deductions or they didn’t have enough miscellaneous itemized expenses to exceed the 2% of adjusted gross income (AGI) floor that applied.

For 2018 through 2025, the TCJA suspends miscellaneous itemized deductions subject to the 2% of AGI floor. That means even employees who itemize deductions and have enough expenses that they would exceed the floor won’t be able to enjoy a tax deduction for business travel. Therefore, business travel expense reimbursements are now more important to employees.

The potential tax benefits

Your business can deduct qualifying reimbursements, and they’re excluded from the employee’s taxable income. The deduction is subject to a 50% limit for meals. But, under the TCJA, entertainment expenses are no longer deductible.

To be deductible and excludable, travel expenses must be legitimate business expenses and the reimbursements must comply with IRS rules. You can use either an accountable plan or the per diem method to ensure compliance.

Reimbursing actual expenses

An accountable plan is a formal arrangement to advance, reimburse or provide allowances for business expenses. To qualify as “accountable,” your plan must meet the following criteria:

  • Payments must be for “ordinary and necessary” business expenses.
  • Employees must substantiate these expenses — including amounts, times and places — ideally at least monthly.
  • Employees must return any advances or allowances they can’t substantiate within a reasonable time, typically 120 days.

The IRS will treat plans that fail to meet these conditions as nonaccountable, transforming all reimbursements into wages taxable to the employee, subject to income taxes (employee) and employment taxes (employer and employee).

Keeping it simple

With the per diem method, instead of tracking actual expenses, you use IRS tables to determine reimbursements for lodging, meals and incidental expenses, or just for meals and incidental expenses, based on location. (If you don’t go with the per diem method for lodging, you’ll need receipts to substantiate those expenses.)

Be sure you don’t pay employees more than the appropriate per diem amount. The IRS imposes heavy penalties on businesses that routinely overpay per diems.

What’s right for your business?

To learn more about business travel expense deductions and reimbursements post-TCJA, contact us at 205-345-9898. We can help you determine whether you should reimburse such expenses and which reimbursement option is better for you.

© 2018 Covenant CPA