Author Archive: CCG

How business owners may be able to reduce tax by using an S corporation

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Do you conduct your business as a sole proprietorship or as a wholly owned limited liability company (LLC)? If so, you’re subject to both income tax and self-employment tax. There may be a way to cut your tax bill by using an S corporation.

Self-employment tax basics

The self-employment tax is imposed on 92.35% of self-employment income at a 12.4% rate for Social Security up to a certain maximum ($137,700 for 2020) and at a 2.9% rate for Medicare. No maximum tax limit applies to the Medicare tax. An additional 0.9% Medicare tax is imposed on income exceeding $250,000 for married couples ($125,000 for married persons filing separately) and $200,000 in all other cases.

Similarly, if you conduct your business as a partnership in which you’re a general partner, in addition to income tax you are subject to the self-employment tax on your distributive share of the partnership’s income. On the other hand, if you conduct your business as an S corporation, you’ll be subject to income tax, but not self-employment tax, on your share of the S corporation’s income.

An S corporation isn’t subject to tax at the corporate level. Instead, the corporation’s items of income, gain, loss and deduction are passed through to the shareholders. However, the income passed through to the shareholder isn’t treated as self-employment income. Thus, by using an S corporation, you may be able to avoid self-employment income tax.

Salary must be reasonable

However, be aware that the IRS requires that the S corporation pay you reasonable compensation for your services to the business. The compensation is treated as wages subject to employment tax (split evenly between the corporation and the employee), which is equivalent to the self-employment tax. If the S corporation doesn’t pay you reasonable compensation for your services, the IRS may treat a portion of the S corporation’s distributions to you as wages and impose Social Security taxes on the amount it considers wages.

There’s no simple formula regarding what is considered reasonable compensation. Presumably, reasonable compensation is the amount that unrelated employers would pay for comparable services under similar circumstances. There are many factors that should be taken into account in making this determination.

Converting from a C to an S corp

There can be complications if you convert a C corporation to an S corporation. A “built-in gains tax” may apply when appreciated assets held by the C corporation at the time of the conversion are subsequently disposed of. However, there may be ways to minimize its impact.

As explained above, an S corporation isn’t normally subject to tax, but when a C corporation converts to S corporation status, the tax law imposes a tax at the highest corporate rate (21%) on the net built-in gains of the corporation. The idea is to prevent the use of an S election to escape tax at the corporate level on the appreciation that occurred while the corporation was a C corporation. This tax is imposed when the built-in gains are recognized (in other words, when the appreciated assets are sold or otherwise disposed of) during the five-year period after the S election takes effect (referred to as the “recognition period”).

Consider all issues

Contact us if you’d like to discuss the factors involved in conducting your business as an S corporation, including the built-in gains tax and how much the business should pay you as compensation.

© 2020 Covenant CPA

Reasons why married couples might want to file separate tax returns

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Married couples often wonder whether they should file joint or separate tax returns. The answer depends on your individual tax situation.

It generally depends on which filing status results in the lowest tax. But keep in mind that, if you and your spouse file a joint return, each of you is “jointly and severally” liable for the tax on your combined income. And you’re both equally liable for any additional tax the IRS assesses, plus interest and most penalties. This means that the IRS can come after either of you to collect the full amount.

Although there are provisions in the law that offer relief, they have limitations. Therefore, even if a joint return results in less tax, you may want to file separately if you want to only be responsible for your own tax.

In most cases, filing jointly offers the most tax savings, especially when the spouses have different income levels. Combining two incomes can bring some of it out of a higher tax bracket. For example, if one spouse has $75,000 of taxable income and the other has just $15,000, filing jointly instead of separately can save $2,512.50 for 2020.

Filing separately doesn’t mean you go back to using the “single” rates that applied before you were married. Instead, each spouse must use “married filing separately” rates. They’re less favorable than the single rates.

However, there are cases when people save tax by filing separately. For example:

One spouse has significant medical expenses. For 2019 and 2020, medical expenses are deductible only to the extent they exceed 7.5% of adjusted gross income (AGI). If a medical expense deduction is claimed on a spouse’s separate return, that spouse’s lower separate AGI, as compared to the higher joint AGI, can result in larger total deductions.

Some tax breaks are only available on a joint return. The child and dependent care credit, adoption expense credit, American Opportunity tax credit and Lifetime Learning credit are only available to married couples on joint returns. And you can’t take the credit for the elderly or the disabled if you file separately unless you and your spouse lived apart for the entire year. You also may not be able to deduct IRA contributions if you or your spouse were covered by an employer retirement plan and you file separate returns. You also can’t exclude adoption assistance payments or interest income from series EE or Series I savings bonds used for higher education expenses.

Social Security benefits may be taxed more. Benefits are tax-free if your “provisional income” (AGI with certain modifications plus half of your Social Security benefits) doesn’t exceed a “base amount.” The base amount is $32,000 on a joint return, but zero on separate return (or $25,000 if the spouses didn’t live together for the whole year).

No hard and fast rules

The decision you make on your federal tax return may affect your state or local income tax bill, so the total tax impact should be compared. There’s often no simple answer to whether a couple should file separate returns. A number of factors must be examined. We can look at your tax bill jointly and separately. Contact us to prepare your return or if you have any questions.

© 2020 Covenant CPA

Take steps to curb power of attorney abuse

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A financial power of attorney can be a valuable planning tool. The most common type is the durable power of attorney, which allows someone (the agent) to act on the behalf of another person (the principal) even if the person becomes mentally incompetent or otherwise incapacitated. It authorizes the agent to manage the principal’s investments, pay bills, file tax returns and handle other financial matters if the principal is unable to do so as a result of illness, injury, advancing age or other circumstances.

However, a disadvantage of a power of attorney is that it may be susceptible to abuse by scam artists, dishonest caretakers or greedy relatives.

Watch out for your loved ones

A broadly written power of attorney gives an agent unfettered access to the principal’s bank and brokerage accounts, real estate, and other assets. In the right hands, this can be a huge help in managing a person’s financial affairs when the person isn’t able to do so him- or herself. But in the wrong hands, it provides an ample opportunity for financial harm.

Many people believe that, once an agent has been given a power of attorney, there’s little that can be done to stop the agent from misappropriating money or property. Fortunately, that’s not the case.

If you suspect that an elderly family member is a victim of financial abuse by the holder of a power of attorney, contact an attorney as soon as possible. An agent has a fiduciary duty to the principal, requiring him or her to act with the utmost good faith and loyalty when acting on the principal’s behalf. So your relative may be able to sue the agent for breach of fiduciary duty and obtain injunctive relief, damages (including punitive damages) and attorneys’ fees.

Take steps to prevent abuse

If you or a family member plans to execute a power of attorney, there are steps you can take to minimize the risk of abuse:

  • Make sure the agent is someone you know and trust.
  • Consider using a “springing” power of attorney, which doesn’t take effect until certain conditions are met, such as a physician’s certification that the principal has become incapacitated.
  • Use a “special” or “limited” power of attorney that details the agent’s specific powers. (The drawback of this approach is that it limits the agent’s ability to deal with unanticipated circumstances.)
  • Appoint a “monitor” or other third party to review transactions executed by the agent and require the monitor’s approval of transactions over a certain dollar amount.
  • Provide that the appointment of a guardian automatically revokes the power of attorney.

Some state laws contain special requirements, such as a separate rider, to authorize an agent to make large gifts or conduct other major transactions.

Act now

If you’re pursuing legal remedies against an agent, the sooner you proceed, the greater your chances of recovery. And if you wish to execute or revoke a power of attorney for yourself, you need to do so while you’re mentally competent. Contact us with questions.

© 2020 Covenant CPA

How to make the most of your multigenerational workforce

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Many of today’s businesses employ workers from across the generational spectrum. Employees may range from Baby Boomers to members of Generation X to Millennials to the newest group, Generation Z.

Managing a workforce with a wide age range requires flexibility and skill. If you’re successful, you’ll likely see higher employee morale, stronger productivity and a more positive work environment for everyone.

Generational definitions

Definitions of the generations vary slightly, but the U.S. Chamber of Commerce Foundation defines them as follows:

  • Members of the Baby Boomer generation were born from 1946 to 1964,
  • Members of Generation X were born from 1965 to 1979,
  • Members of the Millennial generation were born from 1980 to 1999, and
  • Members of Generation Z were born after 1999.

Certain stereotypes have long been associated with each generation. Baby Boomers are assumed to be grumbling curmudgeons. Gen Xers were originally consigned to being “slackers.” Millennials are often thought of as needy approval-seekers. And many presume that a Gen Zer is helpless without his or her mobile device.

But successfully managing employees across generations requires setting aside stereotypes. Don’t assume that employees fit a certain personality profile based simply on age. Instead, you or a direct supervisor should get to know each one individually to better determine what makes him or her tick.

Best practices

Here are just a couple best practices for managing diverse generations:

Recognize and respect value differences. Misunderstandings and conflicts often arise because of value differences between managers and employees of different generations. For example, many older supervisors expect employees to do “whatever it takes” to get the job done, including working long hours. However, some younger employees place a high value on maintaining a healthy work-life balance.

Be sure everyone is on the same page about these expectations. This doesn’t mean younger employees shouldn’t have to work hard. The key is to find the right balance so that work is accomplished satisfactorily and on time, and employees feel like their values are being respected.

Maximize each generation’s strengths. Different generations tend to bring their own strengths to the workplace. For instance, older employees likely have valuable industry experience and important historical business insights to share. Meanwhile, younger employees — especially Generation Z — have grown up with high-powered mobile technology and social media.

Consider initiatives such as company retreats and mentoring programs in which employees from diverse generations can work together and share their knowledge, experiences and strengths. Encourage them to communicate openly and honestly and to be willing to learn from, rather than compete with, one another.

A competitive advantage

Having a multigenerational workforce can be a competitive advantage. Your competitors may not have the hard-fought experience of your older workers nor the fresh energy and ideas of your younger ones. Our firm can help you develop cost-effective strategies for hiring, retaining and maximizing the productivity of employees.

© 2020 Covenant CPA

Do you want to go into business for yourself?

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Many people who launch small businesses start out as sole proprietors. Here are nine tax rules and considerations involved in operating as that entity.

1. You may qualify for the pass-through deduction. To the extent your business generates qualified business income, you are eligible to claim the 20% pass-through deduction, subject to limitations. The deduction is taken “below the line,” meaning it reduces taxable income, rather than being taken “above the line” against your gross income. However, you can take the deduction even if you don’t itemize deductions and instead claim the standard deduction.

2. Report income and expenses on Schedule C of Form 1040. The net income will be taxable to you regardless of whether you withdraw cash from the business. Your business expenses are deductible against gross income and not as itemized deductions. If you have losses, they will generally be deductible against your other income, subject to special rules related to hobby losses, passive activity losses and losses in activities in which you weren’t “at risk.”

3. Pay self-employment taxes. For 2020, you pay self-employment tax (Social Security and Medicare) at a 15.3% rate on your net earnings from self-employment of up to $137,700, and Medicare tax only at a 2.9% rate on the excess. An additional 0.9% Medicare tax (for a total of 3.8%) is imposed on self-employment income in excess of $250,000 for joint returns; $125,000 for married taxpayers filing separate returns; and $200,000 in all other cases. Self-employment tax is imposed in addition to income tax, but you can deduct half of your self-employment tax as an adjustment to income.

4. Make quarterly estimated tax payments. For 2019, these are due April 15, June 15, September 15 and January 15, 2021.

5. You may be able to deduct home office expenses. If you work from a home office, perform management or administrative tasks there, or store product samples or inventory at home, you may be entitled to deduct an allocable portion of some costs of maintaining your home. And if you have a home office, you may be able to deduct expenses of traveling from there to another work location.

6. You can deduct 100% of your health insurance costs as a business expense. This means your deduction for medical care insurance won’t be subject to the rule that limits medical expense deductions.

7. Keep complete records of your income and expenses. Specifically, you should carefully record your expenses in order to claim all the tax breaks to which you’re entitled. Certain expenses, such as automobile, travel, meals, and office-at-home expenses, require special attention because they’re subject to special recordkeeping rules or deductibility limits.

8. If you hire employees, you need to get a taxpayer identification number and withhold and pay employment taxes.

9. Consider establishing a qualified retirement plan. The advantage is that amounts contributed to the plan are deductible at the time of the contribution and aren’t taken into income until they’re are withdrawn. Because many qualified plans can be complex, you might consider a SEP plan, which requires less paperwork. A SIMPLE plan is also available to sole proprietors that offers tax advantages with fewer restrictions and administrative requirements. If you don’t establish a retirement plan, you may still be able to contribute to an IRA.

Seek assistance

If you want additional information regarding the tax aspects of your new business, or if you have questions about reporting or recordkeeping requirements, please contact us.

© 2020 Covenant CPA

Wait! Don’t approve that office supply invoice yet

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When Dan received a large shipment of highlighter markers, he was confused. He didn’t remember ordering them — and he was the company’s sole office supplies buyer. Yet when he received an invoice for the markers a week later, he approved it for payment. After all, employees were already using the highlighters.

Dan fell for a typical office supply scam — and his company paid for the mistake. Here’s how to protect your business from this type of fraud.

Common features

Office supply scams typically begin as telemarketing fraud, with someone calling your business to obtain your street address and the name of an employee. Callers may ask for the person in charge, claim to need information to complete an order or pretend to verify an office machine’s serial number. The goal is to get a name that will lend legitimacy to bogus shipments and invoices.

The fraudster then attempts to perpetrate an office supply scheme, including one of the following:

Phony invoices. A supplier ships poor quality products and then, a week or two later, sends a pricey invoice. The delay is intentional: The fraudster hopes you won’t notice that the final price is much higher than you’d pay for better quality products. The person is also hoping you’ve used some of the products and feel obligated to pay for them.

Promotional items. Some pretenders offer to send you a promotional item. Before they hang up, however, they’ll mention in passing that they’re going to throw some ink cartridges in with the free coffee mug. What they don’t mention is that they’ll also throw in a bill for the ink.

Gift horses. A perpetrator sends a promotional item to an employee and follows up by sending unordered merchandise to you. When you receive the bill with the employee’s name on it, you question the employee. The scammer is hoping the employee will be so nervous about accepting the promotional item that you’ll end up believing the worker mistakenly ordered the merchandise.

Stop supply fraud

To keep your business safe from office supply fraud:

  • Tell employees to transfer all telemarketing calls to one or two designated buyers.
  • Provide buyers with procedures for documenting and approving purchases.
  • Set up a system for generating purchase order or internal reference numbers.
  • Instruct vendors to include those numbers on their shipment documents.
  • When you receive merchandise, inspect it and verify that you ordered it and that the packing list matches the box’s contents.

If everything’s in order, receiving employees should send copies of the bills of lading to accounts payable for reconciliation with the order.

Legal rights

Know that you aren’t legally required to pay for anything you didn’t order. Unless there’s a legitimate mistake on an order, you may treat any unrequested merchandise as a gift and use it as you like. If suppliers hassle you, discuss the matter with your legal and accounting advisors.

© 2020 Covenant CPA

Inheriting property? Be aware of the basis consistency rules

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If you’re in line to inherit property from a parent or other loved one, it’s critical to understand the basis consistency rules. Current tax law, passed in 2015, provides that the income tax basis of property received from a deceased person can’t exceed the property’s fair market value (FMV) as finally determined for estate tax purposes.

Prior law

Before the 2015 tax law change, estates and their beneficiaries had conflicting incentives when it came to the valuation of a deceased person’s property. Executors had an incentive to value property as low as possible to minimize estate taxes, while beneficiaries had an incentive to value property as high as possible to minimize capital gains, if they decided to sell the property.

Current law

The 2015 law requires consistency between a property’s basis reflected on an estate tax return and the basis used to calculate gain when it’s sold by the person who inherits it. It provides that the basis of property in the hands of a beneficiary may not exceed its value as finally determined for estate tax purposes.

Generally, a property’s value is finally determined when:

  • Its value is reported on a federal estate tax return and the IRS doesn’t challenge it before the limitations period expires,
  • The IRS determines its value and the executor doesn’t challenge it before the limitations period expires, or
  • Its value is determined according to a court order or agreement.

But the basis consistency rule isn’t a factor in all situations. The rule doesn’t apply to property unless its inclusion in the deceased’s estate increased the liability for estate taxes. So, for example, the rule doesn’t apply if the value of the deceased’s estate is less than his or her unused exemption amount.

Beware of failure-to-file penalties

Current law also requires estates to furnish information about the value of inherited property to the IRS and the person who inherits it. Estates that fail to comply with these reporting requirements are subject to failure-to-file penalties.

An accurate valuation is key

The basis consistency rules can be complex. The bottom line is that if you inherit property from a person whose estate is liable for estate tax, it’s important that the property’s value be accurately reported on the deceased’s estate tax return. Contact us with any questions.

© 2020 Covenant CPA

5 best practices when investigating an employee complaint

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All complaints will be swiftly and thoroughly investigated.” No doubt this sentence, or something similar, appears in your company’s employee handbook. Unfortunately, there will likely be a time when you’ll have to put those words into action. Whether an employee alleges discrimination or harassment, or reports a coworker for theft or fraud, you’ll need to handle the complaint appropriately.

Keep these five best practices in mind to avoid unnecessary legal complications:

1. Maintain confidentiality. Take every precaution to keep details of the allegation private — especially the identities of the accused and the accuser. Remind managers that they need to have all conversations behind closed doors, store all meeting notes securely and speak only to those people who are necessary to the investigation. Assure workers involved in the investigation that it will be held in strict confidence and inform them that they aren’t free to talk about any part of the process.

2. Conduct productive interviews. Be prepared with an opening statement that describes what’s being investigated, then ask open-ended questions that encourage employees to say more than “yes” or “no.” Ask all interviewees the same questions so that you can compare answers, identify patterns and uncover discrepancies. Also, have a witness present to verify what occurred during the interviews.

3. Avoid bias. Keep an open mind while gathering facts. Just because an employee has a reputation around the office as a “troublemaker” or “crank,” doesn’t mean that person is lying or guilty of an impropriety. Consider hiring a third-party investigator, such as a fraud expert, to handle interviews. This can help preserve impartiality and show all parties that the investigation is being taken seriously.

4. Document activities. Make detailed notes on all the steps of your investigation. Include the dates and times of workspace searches, computer forensic activity and conversations. After every interview or action taken, review your notes to ensure they capture all relevant information.

5. Close the loops. Even if an investigation turns up no evidence of misconduct or criminal behavior, you need to follow up and close the loop with those involved. When complaints are found to have merit, take appropriate action as quickly as possible. You may be able to handle some minor issues with in-house personnel. But consult your legal and financial advisors — and possibly law enforcement — in more serious cases.

Contact us if you need help investigating a fraud allegation.

© 2020 Covenant CPA

Cents-per-mile rate for business miles decreases slightly for 2020

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This year, the optional standard mileage rate used to calculate the deductible costs of operating an automobile for business decreased by one-half cent, to 57.5 cents per mile. As a result, you might claim a lower deduction for vehicle-related expense for 2020 than you can for 2019.

Calculating your deduction

Businesses can generally deduct the actual expenses attributable to business use of vehicles. This includes gas, oil, tires, insurance, repairs, licenses and vehicle registration fees. In addition, you can claim a depreciation allowance for the vehicle. However, in many cases depreciation write-offs on vehicles are subject to certain limits that don’t apply to other types of business assets.

The cents-per-mile rate comes into play if you don’t want to keep track of actual vehicle-related expenses. With this approach, you don’t have to account for all your actual expenses, although you still must record certain information, such as the mileage for each business trip, the date and the destination.

Using the mileage rate is also popular with businesses that reimburse employees for business use of their personal vehicles. Such reimbursements can help attract and retain employees who drive their personal vehicles extensively for business purposes. Why? Under the Tax Cuts and Jobs Act, employees can no longer deduct unreimbursed employee business expenses, such as business mileage, on their own income tax returns.

If you do use the cents-per-mile rate, be aware that you must comply with various rules. If you don’t, the reimbursements could be considered taxable wages to the employees.

The rate for 2020

Beginning on January 1, 2020, the standard mileage rate for the business use of a car (van, pickup or panel truck) is 57.5 cents per mile. It was 58 cents for 2019 and 54.5 cents for 2018.

The business cents-per-mile rate is adjusted annually. It’s based on an annual study commissioned by the IRS about the fixed and variable costs of operating a vehicle, such as gas, maintenance, repair and depreciation. Occasionally, if there’s a substantial change in average gas prices, the IRS will change the mileage rate midyear.

Factors to consider

There are some situations when you can’t use the cents-per-mile rate. In some cases, it partly depends on how you’ve claimed deductions for the same vehicle in the past. In other cases, it depends on if the vehicle is new to your business this year or whether you want to take advantage of certain first-year depreciation tax breaks on it.

As you can see, there are many factors to consider in deciding whether to use the mileage rate to deduct vehicle expenses. We can help if you have questions about tracking and claiming such expenses in 2020 — or claiming them on your 2019 income tax return.

© 2019 Covenant CPA

Can you deduct charitable gifts on your tax return?

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Many taxpayers make charitable gifts — because they’re generous and they want to save money on their federal tax bills. But with the tax law changes that went into effect a couple years ago and the many rules that apply to charitable deductions, you may no longer get a tax break for your generosity.

Are you going to itemize?

The Tax Cuts and Jobs Act (TCJA), signed into law in 2017, didn’t put new limits on or suspend the charitable deduction, like it did with many other itemized deductions. Nevertheless, it reduces or eliminates the tax benefits of charitable giving for many taxpayers.

Itemizing saves tax only if itemized deductions exceed the standard deduction. Through 2025, the TCJA significantly increases the standard deduction. For 2020, it is $24,800 for married couples filing jointly (up from $24,400 for 2019), $18,650 for heads of households (up from $18,350 for 2019), and $12,400 for singles and married couples filing separately (up from $12,200 for 2019).

Back in 2017, these amounts were $12,700, $9,350, $6,350 respectively. The much higher standard deduction combined with limits or suspensions on some common itemized deductions means you may no longer have enough itemized deductions to exceed the standard deduction. And if that’s the case, your charitable donations won’t save you tax.

To find out if you get a tax break for your generosity, add up potential itemized deductions for the year. If the total is less than your standard deduction, your charitable donations won’t provide a tax benefit.

You might, however, be able to preserve your charitable deduction by “bunching” donations into alternating years. This can allow you to exceed the standard deduction and claim a charitable deduction (and other itemized deductions) every other year.

What is the donation deadline?

To be deductible on your 2019 return, a charitable gift must have been made by December 31, 2019. According to the IRS, a donation generally is “made” at the time of its “unconditional delivery.” The delivery date depends in part on what you donate and how you donate it. For example, for a check, the delivery date is the date you mailed it. For a credit card donation, it’s the date you make the charge.

Are there other requirements?

If you do meet the rules for itemizing, there are still other requirements. To be deductible, a donation must be made to a “qualified charity” — one that’s eligible to receive tax-deductible contributions.

And there are substantiation rules to prove you made a charitable gift. For a contribution of cash, check, or other monetary gift, regardless of amount, you must maintain a bank record or a written communication from the organization you donated to that shows its name, plus the date and amount of the contribution. If you make a charitable contribution by text message, a bill from your cell provider containing the required information is an acceptable substantiation. Any other type of written record, such as a log of contributions, isn’t sufficient.

Do you have questions?

We can answer any questions you may have about the deductibility of charitable gifts or changes to the standard deduction and itemized deductions.

© 2020 Covenant CPA