Author Archive: CCG

Business website costs: How to handle them for tax purposes

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The business use of websites is widespread. But surprisingly, the IRS hasn’t yet issued formal guidance on when Internet website costs can be deducted.

Fortunately, established rules that generally apply to the deductibility of business costs, and IRS guidance that applies to software costs, provide business taxpayers launching a website with some guidance as to the proper treatment of the costs.

Hardware or software?

Let’s start with the hardware you may need to operate a website. The costs involved fall under the standard rules for depreciable equipment. Specifically, once these assets are up and running, you can deduct 100% of the cost in the first year they’re placed in service (before 2023). This favorable treatment is allowed under the 100% first-year bonus depreciation break.

In later years, you can probably deduct 100% of these costs in the year the assets are placed in service under the Section 179 first-year depreciation deduction privilege. However, Sec. 179 deductions are subject to several limitations.

For tax years beginning in 2020, the maximum Sec. 179 deduction is $1.04 million, subject to a phaseout rule. Under the rule, the deduction is phased out if more than a specified amount of qualified property is placed in service during the year. The threshold amount for 2020 is $2.59 million.

There’s also a taxable income limit. Under it, your Sec. 179 deduction can’t exceed your business taxable income. In other words, Sec. 179 deductions can’t create or increase an overall tax loss. However, any Sec. 179 deduction amount that you can’t immediately deduct is carried forward and can be deducted in later years (to the extent permitted by the applicable limits).

Similar rules apply to purchased off-the-shelf software. However, software license fees are treated differently from purchased software costs for tax purposes. Payments for leased or licensed software used for your website are currently deductible as ordinary and necessary business expenses.

Was the software developed internally?

An alternative position is that your software development costs represent currently deductible research and development costs under the tax code. To qualify for this treatment, the costs must be paid or incurred by December 31, 2022.

A more conservative approach would be to capitalize the costs of internally developed software. Then you would depreciate them over 36 months.

If your website is primarily for advertising, you can also currently deduct internal website software development costs as ordinary and necessary business expenses.

Are you paying a third party?

Some companies hire third parties to set up and run their websites. In general, payments to third parties are currently deductible as ordinary and necessary business expenses.

What about before business begins?

Start-up expenses can include website development costs. Up to $5,000 of otherwise deductible expenses that are incurred before your business commences can generally be deducted in the year business commences. However, if your start-up expenses exceed $50,000, the $5,000 current deduction limit starts to be chipped away. Above this amount, you must capitalize some, or all, of your start-up expenses and amortize them over 60 months, starting with the month that business commences. 

Need Help?

We can determine the appropriate treatment of website costs for federal income tax purposes. Contact us if you have questions or want more information.

© 2020 Covenant CPA

A health care power of attorney is an essential element of any estate plan

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What happens if illness, injury or age-related dementia renders you unable to make decisions or communicate your wishes regarding your health care or financial affairs? Unless your estate plan addresses these situations, your family may be forced to seek a court-appointed guardian. Health care arrangements are particularly important because your wishes won’t necessarily coincide with someone else’s judgment about what’s “in your best interests.”

To help ensure that your wishes are carried out, create a health care power of attorney (HCPOA). Sometimes referred to as a “health care proxy” or “durable medical power of attorney,” an HCPOA appoints a representative to make medical decisions on your behalf if you’re unable to do so.

Choose a representative

Who should be your representative? The natural inclination may be to name your spouse or an adult child. This may be the right choice, but not always.

Consider whether the family member has a differing view on when to continue or terminate life-sustaining measures or would find it too difficult to make such decisions. Designate someone you trust to carry out your wishes.

Detail your health-care-related wishes

Your HCPOA should provide guidance on how to make health care decisions. Although it’s impossible to anticipate every potential scenario, the document can provide your representative with guiding principles.

For example: What are your desired health outcomes? Is your top priority to extend your life? Is artificial nutrition or hydration an option? Under what circumstances should life-sustaining treatment be withheld or terminated?

Additional documents

Another important document to have in place is a living will — which communicates your preferences regarding life-sustaining medical treatment in the event you are dying of a terminal condition or an end-stage condition. Also consider a revocable trust and durable power of attorney to provide for a trusted representative to manage your financial affairs in the event you’re unable to do so.

© 2020 Covenant CPA

Weighing the risks vs. rewards of a mezzanine loan

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To say that most small to midsize businesses have at least considered taking out a loan this year would probably be an understatement. The economic impact of the COVID-19 pandemic has lowered many companies’ revenue but may have also opened opportunities for others to expand or pivot into more profitable areas.

If your company needs working capital to grow, rather than simply survive, you might want to consider a mezzanine loan. These arrangements offer relatively quick access to substantial funding but with risks that you should fully understand before signing on the dotted line.

Equity on the table

Mezzanine financing works by layering a junior loan on top of a senior (or primary) loan. It combines aspects of senior secured debt from a bank and equity-based financing obtained from direct investors. Sources of mezzanine financing can include private equity groups, mutual funds, insurance companies and buyout firms.

Unlike bank loans, mezzanine debt typically is unsecured by the borrower’s assets or has liens subordinate to other lenders. So, the cost of obtaining financing is higher than that of a senior loan.

However, the cost generally is lower than what’s required to acquire funding purely from equity investment. Yet most mezzanine instruments do enable the lender to participate in the borrowing company’s success — or failure. Generally, the lower your interest rate, the more equity you must offer.

Flexibility at a price

The primary advantage of mezzanine financing is that it can provide capital when you can’t obtain it elsewhere or can’t qualify for the amount you’re looking for. That’s why it’s often referred to as a “bridge” to undertaking ambitious objectives such as a business acquisition or desirable piece of commercial property. But mezzanine loans aren’t necessarily an option of last resort; many companies prefer their flexibility when it comes to negotiating terms.

Naturally, there are drawbacks to consider. In addition to having higher interest rates, mezzanine financing carries with it several other potential disadvantages. Loan covenants can be restrictive. And though some lenders are relatively hands-off, they may retain the right to a significant say in company operations — particularly if you don’t repay the loan in a timely manner.

If you default on the loan, the lender may either sell its stake in your company or transfer that equity to another entity. This means you could suddenly find yourself with a co-owner who you’ve never met or intended to work with.

Mezzanine financing can also make an M&A deal more complicated. It introduces an extra interested party to the negotiation table and can make an already tricky deal that much harder.

Explore all options

Generally, mezzanine loans are best suited for businesses with clear and even aggressive growth plans. Our firm can help you fully explore the tax, financial and strategic implications of any lending arrangement, so you can make the right decision.

© 2020 Covenant CPA

Tax implications of working from home and collecting unemployment

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COVID-19 has changed our lives in many ways, and some of the changes have tax implications. Here is basic information about two common situations.

1. Working from home.

Many employees have been told not to come into their workplaces due to the pandemic. If you’re an employee who “telecommutes” — that is, you work at home, and communicate with your employer mainly by telephone, videoconferencing, email, etc. — you should know about the strict rules that govern whether you can deduct your home office expenses.

Unfortunately, employee home office expenses aren’t currently deductible, even if your employer requires you to work from home. Employee business expense deductions (including the expenses an employee incurs to maintain a home office) are miscellaneous itemized deductions and are disallowed from 2018 through 2025 under the Tax Cuts and Jobs Act.

However, if you’re self-employed and work out of an office in your home, you can be eligible to claim home office deductions for your related expenses if you satisfy the strict rules.

2. Collecting unemployment

Millions of Americans have lost their jobs due to COVID-19 and are collecting unemployment benefits. Some of these people don’t know that these benefits are taxable and must be reported on their federal income tax returns for the tax year they were received. Taxable benefits include the special unemployment compensation authorized under the Coronavirus Aid, Relief and Economic Security (CARES) Act.

In order to avoid a surprise tax bill when filing a 2020 income tax return next year, unemployment recipients can have taxes withheld from their benefits now. Under federal law, recipients can opt to have 10% withheld from their benefits to cover part or all their tax liability. To do this, complete Form W4-V, Voluntary Withholding Request, and give it to the agency paying benefits. (Don’t send it to the IRS.)

We can help

We can assist you with advice about whether you qualify for home office deductions, and how much of these expenses you can deduct. We can also answer any questions you have about the taxation of unemployment benefits as well as any other tax issues that you encounter as a result of COVID-19.

© 2020 Covenant CPA

2020 Q4 tax calendar: Key deadlines for businesses and other employers

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Here are some of the key tax-related deadlines affecting businesses and other employers during the fourth quarter of 2020. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

Thursday, October 15

  • If a calendar-year C corporation that filed an automatic six-month extension:
    • File a 2019 income tax return (Form 1120) and pay any tax, interest and penalties due.
    • Make contributions for 2019 to certain employer-sponsored retirement plans.

Monday, November 2

  • Report income tax withholding and FICA taxes for third quarter 2020 (Form 941) and pay any tax due. (See exception below under “November 10.”)

Tuesday, November 10

  • Report income tax withholding and FICA taxes for third quarter 2020 (Form 941), if you deposited on time (and in full) all of the associated taxes due.

Tuesday, December 15

  • If a calendar-year C corporation, pay the fourth installment of 2020 estimated income taxes.

Thursday, December 31

  • Establish a retirement plan for 2020 (generally other than a SIMPLE, a Safe-Harbor 401(k) or a SEP).

© 2020 Covenant CPA

Buy-sell agreements: A smart business decision also makes estate planning sense

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Do you own a business with one or more individuals? Undoubtedly, your interest in the business represents a substantial part of your net worth and is likely your “pride and joy.” So it’s normal if your fondest wish is for the business to continue long after you’re gone or for you to keep it running if a co-owner or partner dies.

However, if adequate provisions aren’t made, the business may flounder if a leadership void isn’t filled. Or bitter family disputes may tear the organization apart. In the end, a “distress sale” may leave your heirs with substantially less than the company’s current value.

Fortunately, disastrous results may be avoided if you have a buy-sell agreement drafted during your lifetime. The agreement can dictate how the business is sold, to whom and for how much. Life insurance policies are often used to fund the transaction.

Buy-sell agreements in a nutshell

A buy-sell agreement may be used for virtually every type of business entity, including C corporations, S corporations, partnerships and limited liability companies. Typically, it applies to the shares of stock and any business real estate held by respective owners.

Although variations exist, the agreement essentially provides for the sale of a business interest to other owners or partners, the business entity itself, or a hybrid. Alternatively, the agreement may cover a sale to one or more long-time employees.

The agreement, which is typically signed by all affected parties, imposes restrictions on the future sale of the business or property. For instance, if you intend to leave a business interest to your children, you may provide for each child to sell or transfer his or her interest to another party or parties named in the agreement, such as grandchildren or other relatives.

Significantly, a buy-sell agreement often establishes a formula for determining the sale price of the business and its components. The formula may be based on financial statement figures, such as book value, adjusted book value, or the weighted average of historical earnings, or a combination of variables.

Understanding the benefits

Having a valid buy-sell agreement in writing removes much of the uncertainty that can happen when a business owner passes away. It provides a “ready, willing and able” buyer who’s arranged to purchase shares under the formula or at a fixed price. There’s no argument about what the business is worth among co-owners, partners or family members.

The buy-sell agreement addresses a host of problems about co-ownership of assets. For instance, if you have one partner who dies first, the partnership shares might pass to a family member who has a different vision for the future than you do.

Work with us to design a buy-sell agreement that helps preserve the value of your business for your family.

© 2020 Covenant CPA

Prioritize customer service now more than ever

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You’d be hard-pressed to find a business that doesn’t value its customers, but tough times put many things into perspective. As companies have adjusted to operating during the COVID-19 pandemic and the resulting economic fallout, prioritizing customer service has become more important than ever.

Without a strong base of loyal buyers, and a concerted effort to win over more market share, your business could very well see diminished profit margins and an escalated risk of being surpassed by competitors. Here are some foundational ways to strengthen customer service during these difficult and uncertain times.

Get management involved

As is the case for many things in business, success starts at the top. Encourage your management team and fellow owners (if any) to regularly interact with customers. Doing so cements customer relationships and communicates to employees that cultivating these contacts is part of your company culture and a foundation of its profitability.

Moving down the organizational chart, cultivate customer-service heroes. Post articles about the latest customer service achievements on your internal website or distribute companywide emails celebrating successes. Champion these heroes in meetings. Public praise turns ordinary employees into stars and encourages future service excellence.

Just be sure to empower employees to make timely decisions. Don’t just talk about catering to customers unless your staff can really take the initiative to act accordingly.

Systemize your responsiveness

Like everyone in today’s data-driven world, customers want immediate information. So, strive to provide instant or at least timely feedback to customers with a highly visible, technologically advanced response system. This will let customers know that their input matters and you’ll reward them for speaking up.

The specifics of this system will depend on the size, shape and specialty of the business itself. It should encompass the right combination of instant, electronic responses to customer inquiries along with phone calls and, where appropriate, face-to-face (or direct virtual) interactions that reinforce how much you value their business.

Continue to adjust

By now, you’ve likely implemented a few adjustments to serving your customers during the COVID-19 pandemic. Many businesses have done so, with common measures including:

  • Explaining what you’re doing to cope with the crisis,
  • Being more flexible with payment plans and deadlines, and
  • Exercising greater patience and empathy.

As the months go on, don’t rest on your laurels. Continually reassess your approach to customer service and make adjustments that suit the changing circumstances of not only the pandemic, but also your industry and local economy. Seize opportunities to help customers and watch out for mistakes that could hurt your company’s reputation and revenue.

Don’t give up

This year has put everyone under unforeseen amounts of stress and, in turn, providing world-class customer services has become even more difficult. Keep at it — your extra efforts now could lay the groundwork for a much stronger customer base in the future. Our firm can help you assess your customer service and calculate its impact on revenue and profitability.

© 2020 Covenant CPA

Making lifetime gifts continues to be a smart estate planning strategy

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With the federal gift and estate tax exemption now at a record high $11.58 million for 2020, most estates aren’t taxable. But that doesn’t mean making lifetime gifts isn’t without significant benefits — even if your estate isn’t taxable under the current rules. Let’s examine reasons why gifting remains an important part of estate planning.

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 annually 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 — meaning 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.

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.

The good news is that the IRS issued final regulations in late 2019 that should provide comfort to taxpayers interested in making large gifts under the current gift and estate tax regime. The concern was that a taxpayer would make gifts during his or her lifetime based on the higher exemption, only to have their credit calculated based on the amount in effect at the time of death.

To address this fear, the final regs provide a special rule for such circumstances that allows the estate to compute its estate tax credit using the higher of the exemption amount applicable to gifts made during life or the amount applicable on the date of death.

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.

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.

© 2020 Covenant CPA

ESOPs offer businesses a variety of potential benefits

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Wouldn’t it be great if your employees worked as if they owned the company? An employee stock ownership plan (ESOP) could make this a reality.

Under an ESOP, employee participants take part ownership of the business through a retirement savings arrangement. Meanwhile, the business and its existing owner(s) can benefit from some tax breaks, an extra-motivated workforce and a clearer path to a smooth succession.

How they work

To implement an ESOP, you establish a trust fund and either:

  • Contribute shares of stock or money to buy the stock (an “unleveraged” ESOP), or
  • Borrow funds to initially buy the stock, and then contribute cash to the plan to enable it to repay the loan (a “leveraged” ESOP).

The shares in the trust are allocated to individual employees’ accounts, often using a formula based on their respective compensation. The business must formally adopt the plan and submit plan documents to the IRS, along with certain forms.

Tax impact

Among the biggest benefits of an ESOP is that contributions to qualified retirement plans (including ESOPs) are typically tax-deductible for employers. However, employer contributions to all defined contribution plans, including ESOPs, are generally limited to 25% of covered payroll. But C corporations with leveraged ESOPs can deduct contributions used to pay interest on the loans. That is, the interest isn’t counted toward the 25% limit.

Dividends paid on ESOP stock passed through to employees or used to repay an ESOP loan may be tax-deductible for C corporations, so long as they’re reasonable. Dividends voluntarily reinvested by employees in company stock in the ESOP also are usually deductible by the business. (Employees, however, should review the tax implications of dividends.)

In another potential benefit, shareholders in some closely held C corporations can sell stock to the ESOP and defer federal income taxes on any gains from the sales, with several stipulations. One is that the ESOP must own at least 30% of the company’s stock immediately after the sale. In addition, the sellers must reinvest the proceeds (or an equivalent amount) in qualified replacement property securities of domestic operation corporations within a set period.

Finally, when a business owner is ready to retire or otherwise depart the company, the business can make tax-deductible contributions to the ESOP to buy out the departing owner’s shares or have the ESOP borrow money to buy the shares.

Risks to consider

An ESOP’s tax impact for entity types other than C corporations varies somewhat from what we’ve discussed here. And while these plans do offer many potential benefits, they also present risks such as complexity of setup and administration and a strain on cash flow in some situations. Please contact us to discuss further. We can help you determine whether an ESOP would make sense for your business.

© 2020 Covenant CPA

Back-to-school tax breaks on the books

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Despite the COVID-19 pandemic, students are going back to school this fall, either remotely, in-person or under a hybrid schedule. In any event, parents may be eligible for certain tax breaks to help defray the cost of education.

Here is a summary of some of the tax breaks available for education.

1. Higher education tax credits. Generally, you may be able to claim either one of two tax credits for higher education expenses — but not both.

  • With the American Opportunity Tax Credit (AOTC), you can save a maximum of $2,500 from your tax bill for each full-time college or grad school student. This applies to qualified expenses including tuition, room and board, books and computer equipment and other supplies. But the credit is phased out for moderate-to-upper income taxpayers. No credit is allowed if your modified adjusted gross income (MAGI) is over $90,000 ($180,000 for joint filers).
  • The Lifetime Learning Credit (LLC) is similar to the AOTC, but there are a few important distinctions. In this case, the maximum credit is $2,000 instead of $2,500. Furthermore, this is the overall credit allowed to a taxpayer regardless of the number of students in the family. However, the LLC is also phased out under income ranges even lower than the AOTC. You can’t claim the credit if your MAGI is $68,000 or more ($136,000 or more if you file a joint return).

For these reasons, the AOTC is generally preferable to the LLC. But parents have still another option.

2. Tuition-and-fees deduction. As an alternative to either of the credits above, parents may claim an above-the-line deduction for tuition and related fees. This deduction is either $4,000 or $2,000, depending on the taxpayer’s MAGI, before it is phased out. No deduction is allowed for MAGI above $80,000 for single filers and $160,000 for joint filers.

The tuition-and-fees deduction, which has been extended numerous times, is currently scheduled to expire after 2020. However, it’s likely to be revived again by Congress.

In addition to these tax breaks, there are other ways to save and pay for college on a tax advantaged basis. These include using Section 529 plans and Coverdell Education Savings Accounts. There are limits on contributions to these saving vehicles.

Note: Thanks to a provision in the Tax Cuts and Jobs Act, a 529 plan can now be used to pay for up to $10,000 annually for a child’s tuition at a private or religious elementary or secondary school.

Final lesson

Typically, parents are able to take advantage of one or more of these tax breaks, even though some benefits are phased out above certain income levels. Contact us to maximize the tax breaks for your children’s education.

© 2020 Covenant CPA