Author Archive: Justine O'Sullivan

Add spendthrift language to a trust to safeguard assets

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Protecting assets from creditors is a critical aspect of estate planning, but you need to think about more than just your own creditors: You also need to consider your heirs’ creditors. Adding spendthrift language to a trust benefiting your heirs can help safeguard assets.

Spendthrift language explained

Despite its name, the purpose of a spendthrift trust isn’t just to protect profligate heirs from themselves. Although that’s one use for this trust type, even the most financially responsible heirs can be exposed to frivolous lawsuits, dishonest business partners or unscrupulous creditors. A properly designed spendthrift trust can protect assets against such attacks.

It can also protect your loved ones in the event of relationship changes. If one of your children divorces, your child’s spouse generally can’t claim a share of the trust property in the divorce settlement.

Also, if your child predeceases his or her spouse, the spouse generally is entitled by law to a significant portion of your child’s estate, including property you left the child outright. In some cases, that may be a desirable outcome. But in others, such as second marriages when there are children from a prior marriage, a spendthrift trust can prevent your child’s inheritance from ending up in the hands of his or her spouse rather than in those of your grandchildren.

A variety of trusts can be spendthrift trusts. It’s just a matter of including a spendthrift clause, which restricts a beneficiary’s ability to assign or transfer his or her interest in the trust and restricts the rights of creditors to reach the trust assets.

Additional considerations

It’s important to recognize that the protection offered by a spendthrift trust isn’t absolute. Depending on applicable law, it may be possible for government agencies to reach the trust assets — to satisfy a tax obligation, for example.

Generally, the more discretion you give the trustee over distributions from the trust, the greater the protection against creditors’ claims. If the trust requires the trustee to make distributions for a beneficiary’s support, for example, a court may rule that a creditor can reach the trust assets to satisfy support-related debts. For increased protection, it’s preferable to give the trustee full discretion over whether and when to make distributions.

Protect wealth after transfer

Protecting your wealth after you’ve transferred it to your family is just as important as other estate planning strategies such as reducing tax liability on the transfer. One way to do this is to include spendthrift language in a trust. Contact us to learn whether a spendthrift trust is right for your estate plan at 205-345-9898 or [email protected].

© 2019 CovenantCPA

Responding to the nightmare of a data breach

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It’s every business owner’s nightmare. Should hackers gain access to your customers’ or employees’ sensitive data, the very reputation of your company could be compromised. And lawsuits might soon follow.

No business owner wants to think about such a crisis, yet it’s imperative that you do. Suffering a data breach without an emergency response plan leaves you vulnerable to not only the damage of the attack itself, but also the potential fallout from your own panicked decisions.

5 steps to take

A comprehensive plan generally follows five steps once a data breach occurs:

1. Call your attorney. He or she should be able to advise you on the potential legal ramifications of the incident and what you should do or not do (or say) in response. Involve your attorney in the creation of your response plan, so all this won’t come out of the blue.

2. Engage a digital forensics investigator. Contact us for help identifying a forensic investigator that you can turn to in the event of a data breach. The preliminary goal will be to answer two fundamental questions: How were the systems breached? What data did the hackers access? Once these questions have been answered, experts can evaluate the extent of the damage.

3. Fortify your IT systems. While investigative and response procedures are underway, you need to proactively prevent another breach and strengthen controls. Doing so will obviously involve changing passwords, but you may also need to add firewalls, create deeper layers of user authentication or restrict some employees from certain systems.

4. Communicate strategically. No matter the size of the company, the communications goal following a data breach is essentially the same: Provide accurate information about the incident in a reasonably timely manner that preserves the trust of customers, employees, investors, creditors and other stakeholders.

Note that “in a reasonably timely manner” doesn’t mean “immediately.” Often, it’s best to acknowledge an incident occurred but hold off on a detailed statement until you know precisely what happened and can reassure those affected that you’re taking specific measures to control the damage.

5. Activate or adjust credit and IT monitoring services. You may want to initiate an early warning system against future breaches by setting up a credit monitoring service and engaging an IT consultant to periodically check your systems for unauthorized or suspicious activity. Of course, you don’t have to wait for a breach to do these things, but you could increase their intensity or frequency following an incident.

Inevitable risk

Data breaches are an inevitable risk of running a business in today’s networked, technology-driven world. Should this nightmare become a reality, a well-conceived emergency response plan can preserve your company’s goodwill and minimize the negative impact on profitability. We can help you budget for such a plan and establish internal controls to prevent and detect fraud related to (and not related to) data breaches. Call or email us today at 205-345-9898 or [email protected].

© 2019 CovenantCPA

Seniors: Medicare premiums could lower your tax bill

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Americans who are 65 and older qualify for basic Medicare insurance, and they may need to pay additional premiums to get the level of coverage they desire. The premiums can be expensive, especially if you’re married and both you and your spouse are paying them. But one aspect of paying premiums might be positive: If you qualify, they may help lower your tax bill.

Medicare premium tax deductions

Premiums for Medicare health insurance can be combined with other qualifying health care expenses for purposes of claiming an itemized deduction for medical expenses on your individual tax return. This includes amounts for “Medigap” insurance and Medicare Advantage plans. Some people buy Medigap policies because Medicare Parts A and B don’t cover all their health care expenses. Coverage gaps include co-payments, co-insurance, deductibles and other costs. Medigap is private supplemental insurance that’s intended to cover some or all gaps.

Fewer people now itemize

Qualifying for a medical expense deduction can be difficult for a couple of reasons. For 2019, you can deduct medical expenses only if you itemize deductions and only to the extent that total qualifying expenses exceeded 10% of AGI. (This threshold was 7.5% for the 2018 tax year.)

The Tax Cuts and Jobs Act nearly doubled the standard deduction amounts for 2018 through 2025. For 2019, the standard deduction amounts are $12,200 for single filers, $24,400 for married joint-filing couples and $18,350 for heads of households. So, fewer individuals are claiming itemized deductions.

However, if you have significant medical expenses (including Medicare health insurance premiums), you may itemize and collect some tax savings.

Important note: Self-employed people and shareholder-employees of S corporations can generally claim an above-the-line deduction for their health insurance premiums, including Medicare premiums. So, they don’t need to itemize to get the tax savings from their premiums.

Other deductible medical expenses

In addition to Medicare premiums, you can deduct a variety of medical expenses, including those for ambulance services, dental treatment, dentures, eyeglasses and contacts, hospital services, lab tests, qualified long-term care services, prescription medicines and others.

Keep in mind that many items that Medicare doesn’t cover can be written off for tax purposes, if you qualify. You can also deduct transportation expenses to get to medical appointments. If you go by car, you can deduct a flat 20-cents-per-mile rate for 2019, or you can keep track of your actual out-of-pocket expenses for gas, oil and repairs.

Need more information?

Contact us if you have additional questions about Medicare coverage options or claiming medical expense deductions on your personal tax return. Your advisor can help determine the optimal overall tax-planning strategy based on your personal circumstances. 205-345-9898 or [email protected].

© 2019 CovenantCPA

Divorcing business owners need to pay attention to tax implications

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If you’re getting a divorce, you know it’s a highly stressful time. But if you’re a business owner, tax issues can complicate matters even more. Your business ownership interest is one of your biggest personal assets and your marital property will include all or part of it.

Transferring property tax-free 

You can generally divide most assets, including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).

For example, let’s say that, under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding periods for the home and the stock would carry over to the person who receives them.

Tax-free transfers can occur before the divorce or at the time it becomes final. Tax-free treatment also applies to postdivorce transfers so long as they’re made “incident to divorce.” This means transfers that occur within:

  • A year after the date the marriage ends, or
  • Six years after the date the marriage ends if the transfers are made pursuant to your divorce agreement.

Future tax implications

Eventually, there will be tax implications for assets received tax-free in a divorce settlement. The ex-spouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies).

What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.

Note that the person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement.

In addition, the IRS now extends the beneficial tax-free transfer rule to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in divorce, these types of ordinary-income assets can also be transferred tax-free. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.

Avoid adverse tax consequences

Like many major life events, divorce can have major tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher. Your tax advisor can help you minimize the adverse tax consequences of settling your divorce under today’s laws. Contact us at 205-345-9898 or [email protected] for more info.

© 2019 CovenantCPA

Prevent hackers from wiping out your employees’ 401(k) accounts

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News of commercial database hackings may seem commonplace in 2019. But while many of these stories focus on hacked bank and credit card accounts, 401(k) plan sponsors and participants probably don’t realize that their plan assets also are at risk.

Employers who offer 401(k) plans to their employees need to take precautions against identity theft. Part of this is educating participants.

Role of sponsors

If your organization sponsors a 401(k) plan, it’s essential that you assess plan service providers’ protection systems and policies. Most providers carry cyberfraud insurance that they extend to plan participants. But there may be limits to this protection if, for example, the provider determines that you (the sponsor) or employees (participants) opened the door to a security breach.

Your plan’s documents may say that participants must adopt the provider’s recommended security practices. These could include checking account information “frequently” and reviewing correspondence from the administrator “promptly.” Make sure you and your employees understand what these terms mean — and follow them.

What participants can do

Traditionally, 401(k) plan participants have been discouraged from worrying about short-term fluctuations and volatility in their accounts, and instead encouraged to focus on the long run. However, lack of regular monitoring can make these accounts vulnerable. Instruct employees to periodically check their account balances and look for signs of unauthorized activity.

Employees also should take the same steps they follow to protect other online accounts. For example:

  • Use strong passwords and change them regularly.
  • Take advantage of two-factor authentication.
  • Don’t use the same login ID and passwords for multiple sites.
  • Don’t allow a browser to store login information.
  • Never share login information.

Such precautions can foil some of the most common retirement plan thieves — relatives and friends — from using their knowledge to gain account access. In one real-life case, a plan participant divorced his wife and moved out of the house. However, he didn’t update his address with his plan provider, change his password or review his balance regularly. His ex-wife cleaned out his more than $40,000 balance.

A few clicks

Without adequate vigilance, anybody can be a few clicks away from cleaning out your employees’ 401(k) accounts. Review your plan documents carefully and educate participants about their responsibilities for monitoring their accounts. Contact us for more information on identity theft at 205-345-9898 or [email protected].

© 2019 CovenantCPA

If art donations are part of your estate plan, consider these four tips

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Charitable giving is a key part of estate planning for many people. If you have a collection of valuable art and are charitably minded, consider donating one or more pieces to receive tax deductions. Generally, it’s advantageous to donate appreciated property to avoid capital gains taxes. Because the top federal capital gains rate for art and other “collectibles” is 28%, donating art is particularly effective.

Considerations before donating

If you’re considering a donation of art, here are four tips to keep in mind:

1. Get an appraisal. Given the subjective nature of art valuation and the potential for abuse, the IRS scrutinizes charitable donations and other transactions involving valuable artwork. Most art 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.

2. Donate to a public charity. To maximize your charitable deduction, donate artwork to a public charity, such as a museum or university with public charity status. These donations generally entitle you to deduct the artwork’s full fair market value. If you donate art to a private foundation, your deduction will be limited to your cost. Keep in mind that the amount you may deduct in a given year is limited to a percentage of your adjusted gross income (30% for public charities, 50% for private charities) with the excess carried over to future years.

3. Beware the related-use rule. To qualify for a full fair-market-value deduction, the charity’s use of the artwork must be related to its tax-exempt purpose. So, for example, if you donate a painting to a museum for display or to a university for use in art classes, you’ll satisfy the related-use rule.

Even if the related-use rule is satisfied initially, you may lose some or all of your deductions if the artwork is worth more than $5,000 and the charity sells or otherwise disposes of it within three years after receiving it.

4. Transfer the copyright. 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.

Fractional donations

At one time, it was possible to give art away gradually using a series of fractional gifts, and claim increasing deductions if the art continued to appreciate. Under current rules, however, the deduction for future fractional gifts is limited to the value of the initial fractional gift (or, if lower, the fair market value of the later fractional gift).

The rules surrounding donations of art can be complex. We can help you achieve your charitable giving goals while maximizing your tax benefits. Contact us today at 205-345-9898 or [email protected].

© 2019 CovenantCPA

Present yet unaccounted for: The problem of presenteeism

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Absenteeism has typically been a thorn in the side of many companies. But there’s a flip side to employees failing to show up to work: “presenteeism.” This is when employees come in to work unwell or put in excessive overtime.

Now you probably appreciate and respect workers who are team players and go the extra mile. But employees who come to work when they aren’t operating at full physical or mental capacity may make mistakes, cause accidents, create confusion and ultimately hurt productivity. In other words, presenteeism can slowly and silently erode your bottom line unless you recognize and deal with it.

Address mental health

A common response to presenteeism is, “But we offer paid sick days.” Although paid sick days do generally help resolve incidences of a physical ailment or injury, they may not adequately address struggles with mental illness or extreme personal stress (such as a divorce or financial crisis). Some managers may raise an eyebrow at those taking a “mental health day,” so sufferers end up coming in to work when they really may need the day off.

How can you help? If you sponsor a health care plan, it likely offers coverage for mental health and substance use disorder services, including behavioral health treatment. Be sure employees are aware of this. Also, reinforce with employees that you’ll honor the sick-day provisions spelled out in your employee manual for all types of ailments (physical, mental and psychological). Train supervisors to support employees’ well-being and encourage those who need to take time off to do so if they need it.

Discourage excessive overtime

Another common cause of presenteeism is the perceived notion among many workers that they must work excessive overtime to prove themselves. Many companies still operate under an “old school” culture that says putting in extra overtime will make the boss happy and lead to quicker raises and promotions.

Generally, many managers assume that, if an employee is absent, his or her productivity must be suffering. Conversely, if that same employee is putting in extra time and skipping vacations, he or she must be highly productive. But these assumptions aren’t always true — they must be supported by a thorough, objective and analytical performance evaluation process.

You can prevent this type of presenteeism by strongly encouraging, if not strictly enforcing, vacation time. Communicate to employees your concerns about overworking and remind them to take advantage of the time off that they’ve earned. (Doing so can also deter fraud.)

Find the balance

Having a workforce full of dedicated, hard-working employees is still a goal that every business should strive for. But, at the same time, work-life balance is a concept that benefits both employers and employees. Our firm can help you analyze the numbers related to productivity that can help you make optimal decisions regarding staffing and workflow. Call us or email us today at 205-345-9898/ [email protected].

© 2019CovenantCPA

Make a deductible IRA contribution for 2018. It’s not too late!

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Do you want to save more for retirement on a tax-favored basis? If so, and if you qualify, you can make a deductible traditional IRA contribution for the 2018 tax year between now and the tax filing deadline and claim the write-off on your 2018 return. Or you can contribute to a Roth IRA and avoid paying taxes on future withdrawals.

You can potentially make a contribution of up to $5,500 (or $6,500 if you were age 50 or older as of December 31, 2018). If you’re married, your spouse can potentially do the same, thereby doubling your tax benefits.

The deadline for 2018 traditional and Roth contributions for most taxpayers is April 15, 2019 (April 17 for those in Maine and Massachusetts).

There are some ground rules. You must have enough 2018 earned income (from jobs, self-employment or alimony) to equal or exceed your IRA contributions for the tax year. If you’re married, either spouse can provide the necessary earned income. And you can’t make a deductible contribution to a traditional IRA if you were 70½ or older as of December 31, 2018. (But you can make one to a Roth IRA after that age.)

Finally, deductible IRA contributions are phased out (reduced or eliminated) if last year’s modified adjusted gross income (MAGI) is too high.

Types of contributions

If you haven’t already maxed out your 2018 IRA contribution limit, consider making one of these three types of contributions by the April deadline:

1. Deductible traditional. With traditional IRAs, account growth is tax-deferred and distributions are subject to income tax. If you and your spouse don’t participate in an employer-sponsored plan such as a 401(k), the contribution is fully deductible on your 2018 tax return. If you or your spouse doparticipate in an employer-sponsored plan, your deduction is subject to the following MAGI phaseout:

  • For married taxpayers filing jointly, the phaseout range is specific to each spouse based on whether he or she is a participant in an employer-sponsored plan: 
    • For a spouse who participated in 2018: $101,000–$121,000.
    • For a spouse who didn’t participate in 2018: $186,000–$196,000.
  • For single and head-of-household taxpayers participating in an employer-sponsored plan: $63,000–$73,000.

Taxpayers with MAGIs within the applicable range can deduct a partial contribution. But those with MAGIs exceeding the applicable range can’t deduct any IRA contribution.

2. Roth. Roth IRA contributions aren’t deductible, but qualified distributions — including growth — are tax-free, if you satisfy certain requirements.

Your ability to contribute, however, is subject to a MAGI-based phaseout:

  • For married taxpayers filing jointly: $189,000–$199,000.
  • For single and head-of-household taxpayers: $120,000–$135,000.

You can make a partial contribution if your 2018 MAGI is within the applicable range, but no contribution if it exceeds the top of the range.

3. Nondeductible traditional. If your income is too high for you to fully benefit from a deductible traditional or a Roth contribution, you may benefit from a nondeductible contribution to a traditional IRA. The account can still grow tax-deferred, and when you take qualified distributions, you’ll only be taxed on the growth.

Act fast

Traditional and Roth IRAs provide a powerful way to save for retirement on a tax-advantaged basis. Contact us to learn more about making 2018 contributions and making the most of IRAs in 2019 and beyond. 205-345-9898 or [email protected].

© 2019 CovenantCPA

Understanding how taxes factor into an M&A transaction

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Merger and acquisition activity has been brisk in recent years. If your business is considering merging with or acquiring another business, it’s important to understand how the transaction will be taxed under current law.

Stocks vs. assets

From a tax standpoint, a transaction can basically be structured in two ways:

1. Stock (or ownership interest). A buyer can directly purchase a seller’s ownership interest if the target business is operated as a C or S corporation, a partnership, or a limited liability company (LLC) that’s treated as a partnership for tax purposes.

The now-permanent 21% corporate federal income tax rate under the Tax Cuts and Jobs Act (TCJA) makes buying the stock of a C corporation somewhat more attractive. Reasons: The corporation will pay less tax and generate more after-tax income. Plus, any built-in gains from appreciated corporate assets will be taxed at a lower rate when they’re eventually sold.

The TCJA’s reduced individual federal tax rates may also make ownership interests in S corporations, partnerships and LLCs more attractive. Reason: The passed-through income from these entities also will be taxed at lower rates on a buyer’s personal tax return. However, the TCJA’s individual rate cuts are scheduled to expire at the end of 2025, and, depending on future changes in Washington, they could be eliminated earlier or extended.

2. Assets. A buyer can also purchase the assets of a business. This may happen if a buyer only wants specific assets or product lines. And it’s the only option if the target business is a sole proprietorship or a single-member LLC that’s treated as a sole proprietorship for tax purposes.

Note: In some circumstances, a corporate stock purchase can be treated as an asset purchase by making a “Section 338 election.” Ask your tax advisor for details.

Buyer vs. seller preferences 

For several reasons, buyers usually prefer to purchase assets rather than ownership interests. Generally, a buyer’s main objective is to generate enough cash flow from an acquired business to pay any acquisition debt and provide an acceptable return on the investment. Therefore, buyers are concerned about limiting exposure to undisclosed and unknown liabilities and minimizing taxes after the deal closes.

A buyer can step up (increase) the tax basis of purchased assets to reflect the purchase price. Stepped-up basis lowers taxable gains when certain assets, such as receivables and inventory, are sold or converted into cash. It also increases depreciation and amortization deductions for qualifying assets.

Meanwhile, sellers generally prefer stock sales for tax and nontax reasons. One of their main objectives is to minimize the tax bill from a sale. That can usually be achieved by selling their ownership interests in a business (corporate stock or partnership or LLC interests) as opposed to selling business assets.

With a sale of stock or other ownership interest, liabilities generally transfer to the buyer and any gain on sale is generally treated as lower-taxed long-term capital gain (assuming the ownership interest has been held for more than one year).

Keep in mind that other issues, such as employee benefits, can also cause unexpected tax issues when merging with, or acquiring, a business.

Professional advice is critical

Buying or selling a business may be the most important transaction you make during your lifetime, so it’s important to seek professional tax advice as you negotiate. After a deal is done, it may be too late to get the best tax results. Contact us for the best way to proceed in your situation. 205-345-9898 or [email protected].

© 2019 CovenantCPA

Fraud fact: Crooks prefer cash

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It should come as no surprise that cash is the most popular target of fraud perpetrators. After all, once stolen, cash itself is virtually untraceable. But that doesn’t mean forensic accounting professionals can’t unearth cash fraud schemes — and the crooks behind them.

3 categories

According to the Association of Certified Fraud Examiners, there are three main categories of cash fraud (which includes checks because they’re easily converted to cash):

  1. Theft of cash on hand,
  2. Theft of cash receipts, and
  3. Fraudulent disbursements.

The last category comprises many of the most frequently executed schemes, such as overbilling and “ghost” vendor or employee schemes. For example, overbilling vendors usually submit inflated invoices by overstating the price per unit or the quantity delivered. A dishonest vendor also might submit a legitimate invoice multiple times. Overbilling may involve collusion with employees of the victim organization, who typically receive kickbacks for their assistance.

Employees also can conduct billing fraud on their own, submitting bogus invoices payable to a fictitious vendor and diverting the payments to themselves. Similarly, an employee might set up payroll disbursements to nonexistent ghost employees.

Tracing schemes

Cash can be difficult to trace once it’s in the hands of a thief. But forensic experts usually are able to trace the path that stolen cash took before the fraudster pocketed it. This includes who “touched” the cash and what prompted its flow out of the organization.

Inflated invoices, for example, often leave a trail of red flags. Experts look for invoices that bill for “extra” or “special” charges with no explanation. Other suspicious signs include round dollar amounts, or amounts just below the threshold that requires management’s signoff, and discrepancies between invoice amounts and purchase orders, contracts or inventory counts.

If forensic experts suspect that fictitious billing has occurred, they often investigate accounts with no tangible deliverables — such as those for consulting, commissions and advertising — and check vendor addresses against employee addresses. Invoices with consecutive numbers or payable to post office boxes receive extra scrutiny.

Returned checks can supply useful information, too. Fraud perpetrators are more likely to cash checks, whereas legitimate businesses typically deposit them and rarely endorse checks to third parties.

To trace ghost employee schemes, experts examine payroll lists, withholding forms, employment applications, personnel files and other documents. The information collected from these sources may provide vital links between actual and ghost employees that wouldn’t otherwise be apparent.

To catch a thief

Strong internal controls are instrumental in preventing cash-type schemes. But even the strongest controls sometimes fail to prevent a determined fraudster. If that happens, we can help your business ferret out the fraud and track down the perp. Call or email us today for help– 205-345-9898 or [email protected].

© 2019CovenantCPA