Category Archives: Investing

Will leasing equipment or buying it be more tax efficient for your business?

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Recent changes to federal tax law and accounting rules could affect whether you decide to lease or buy equipment or other fixed assets. Although there’s no universal “right” choice, many businesses that formerly leased assets are now deciding to buy them.

Pros and cons of leasing

From a cash flow perspective, leasing can be more attractive than buying. And leasing does provide some tax benefits: Lease payments generally are tax deductible as “ordinary and necessary” business expenses. (Annual deduction limits may apply.)

Leasing used to be advantageous from a financial reporting standpoint. But new accounting rules that bring leases to the lessee’s balance sheet go into effect in 2020 for calendar-year private companies. So, lease obligations will show up as liabilities, similar to purchased assets that are financed with traditional bank loans.

Leasing also has some potential drawbacks. Over the long run, leasing an asset may cost you more than buying it, and leasing doesn’t provide any buildup of equity. What’s more, you’re generally locked in for the entire lease term. So, you’re obligated to keep making lease payments even if you stop using the equipment. If the lease allows you to opt out before the term expires, you may have to pay an early-termination fee.

Pros and cons of buying

Historically, the primary advantage of buying over leasing has been that you’re free to use the assets as you see fit. But an advantage that has now come to the forefront is that Section 179 expensing and first-year bonus depreciation can provide big tax savings in the first year an asset is placed in service.

These two tax breaks were dramatically enhanced by the Tax Cuts and Jobs Act (TCJA) — enough so that you may be convinced to buy assets that your business might have leased in the past. Many businesses will be able to write off the full cost of most equipment in the year it’s purchased. Any remainder is eligible for regular depreciation deductions over IRS-prescribed schedules.

The primary downside of buying fixed assets is that you’re generally required to pay the full cost upfront or in installments, although the Sec. 179 and bonus depreciation tax benefits are still available for property that’s financed. If you finance a purchase through a bank, a down payment of at least 20% of the cost is usually required. This could tie up funds and affect your credit rating. If you decide to finance fixed asset purchases, be aware that the TCJA limits interest expense deductions (for businesses with more than $25 million in average annual gross receipts) to 30% of adjusted taxable income.

Decision time

When deciding whether to lease or buy a fixed asset, there are a multitude of factors to consider, including tax implications. We can help you determine the approach that best suits your circumstances. Call or email us today- 205-345-9898, [email protected].

© 2019 CovenantCPA

Careful tax planning required for incentive stock options

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Incentive stock options (ISOs) are a popular form of compensation for executives and other employees of corporations. They allow you to buy company stock in the future at a fixed price equal to or greater than the stock’s fair market value on the ISO grant date. If the stock appreciates, you can buy shares at a price below what they’re then trading for. But careful tax planning is required because of the complex rules that apply.

Tax advantages abound

Although ISOs must comply with many rules, they receive tax-favored treatment. You owe no tax when ISOs are granted. You also owe no regular income tax when you exercise ISOs. There could be alternative minimum tax (AMT) consequences, but the AMT is less of a risk now because of the high AMT exemption under the Tax Cuts and Jobs Act.

There are regular income tax consequences when you sell the stock. If you sell the stock after holding it at least one year from the exercise date and two years from the grant date, you pay tax on the sale at your long-term capital gains rate. You also may owe the 3.8% net investment income tax (NIIT).

If you sell the stock before long-term capital gains treatment applies, a “disqualifying disposition” occurs and any gain is taxed as compensation at ordinary-income rates.

Impact on your 2018 return

If you were granted ISOs in 2018, there likely isn’t any impact on your 2018 income tax return. But if in 2018 you exercised ISOs or you sold stock you’d acquired via exercising ISOs, then it could affect your 2018 tax liability.

It’s important to properly report the exercise or sale on your 2018 return to avoid potential interest and penalties for underpayment of tax.

Planning for the future 

If you receive ISOs in 2019 or already hold ISOs that you haven’t yet exercised, plan carefully when to exercise them. Waiting to exercise ISOs until just before the expiration date (when the stock value may be the highest, assuming the stock is appreciating) may make sense. But exercising ISOs earlier can be advantageous in some situations.

Once you’ve exercised ISOs, the question is whether to immediately sell the shares received or to hold on to them long enough to garner long-term capital gains treatment. The latter strategy often is beneficial from a tax perspective, but there’s also market risk to consider. For example, it may be better to sell the stock in a disqualifying disposition and pay the higher ordinary-income rate if it would avoid AMT on potentially disappearing appreciation.

The timing of the sale of stock acquired via an exercise could also positively or negatively affect your liability for higher ordinary-income tax rates, the top long-term capital gains rate and the NIIT.

If you need help tax planning for your ISOs, please contact us at 205-345-9898 or [email protected].

© 2019 CovenantCPA

Beware the Ides of March — if you own a pass-through entity

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Shakespeare’s words don’t apply just to Julius Caesar; they also apply to calendar-year partnerships, S corporations and limited liability companies (LLCs) treated as partnerships or S corporations for tax purposes. Why? The Ides of March, more commonly known as March 15, is the federal income tax filing deadline for these “pass-through” entities.

Not-so-ancient history

Until the 2016 tax year, the filing deadline for partnerships was the same as that for individual taxpayers: April 15 (or shortly thereafter if April 15 fell on a weekend or holiday). One of the primary reasons for moving up the partnership filing deadline was to make it easier for owners to file their personal returns by the April filing deadline. After all, partnership (and S corporation) income passes through to the owners. The earlier date allows owners to use the information contained in the pass-through entity forms to file their personal returns.

For partnerships with fiscal year ends, tax returns are now due the 15th day of the third month after the close of the tax year. The same deadline applies to fiscal-year S corporations. Under prior law, returns for fiscal-year partnerships were due the 15th day of the fourth month after the close of the fiscal tax year.

Avoiding a tragedy

If you haven’t filed your calendar-year partnership or S corporation return yet and are worried about having sufficient time to complete it, you can avoid the tragedy of a late return by filing for an extension. Under the current law, the maximum extension for calendar-year partnerships is six months (until September 16, 2019, for 2018 returns). This is up from five months under the old law. So the extension deadline is the same — only the length of the extension has changed. The extension deadline for calendar-year S corporations also is September 16, 2019, for 2018 returns.

Whether you’ll be filing a partnership or an S corporation return, you must file for the extension by March 15 if it’s a calendar-year entity.

Extending the drama

Filing for an extension can be tax-smart if you’re missing critical documents or you face unexpected life events that prevent you from devoting sufficient time to your return right now.

But to avoid potential interest and penalties, you still must (with a few exceptions) pay any tax due by the unextended deadline. There probably won’t be any tax liability from the partnership or S corporation return. But, if filing for an extension for the entity return causes you to also have to file an extension for your personal return, it could cause you to owe interest and penalties in relation to your personal return.

We can help you file your tax returns on a timely basis or determine whether filing for an extension is appropriate. Contact us today at 205-345-9898 or [email protected].

© 2019 CovenantCPA

Investment interest expense is still deductible, but that doesn’t necessarily mean you’ll benefit

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As you likely know by now, the Tax Cuts and Jobs Act (TCJA) reduced or eliminated many deductions for individuals. One itemized deduction the TCJA kept intact is for investment interest expense. This is interest on debt used to buy assets held for investment, such as margin debt used to buy securities. But if you have investment interest expense, you can’t count on benefiting from the deduction.

3 hurdles

There are a few hurdles you must pass to benefit from the investment interest deduction even if you have investment interest expense:

  1. You must itemize deductions. In the past this might not have been a hurdle, because you may have typically had enough itemized deductions to easily exceed the standard deduction. But the TCJA nearly doubled the standard deduction, to $24,000 (married couples filing jointly), $18,000 (heads of households) and $12,000 (singles and married couples filing separately) for 2018. Plus, some of your other itemized deductions, such as your state and local tax deduction, might be smaller on your 2018 return because of TCJA changes. So you might not have enough itemized deductions to exceed your standard deduction and benefit from itemizing.
  2. You can’t have incurred the interest to produce tax-exempt income. For example, if you borrow money to invest in municipal bonds, which are exempt from federal income tax, you can’t deduct the interest.
  3. You must have sufficient “net investment income.” The investment interest deduction is limited to your net investment income. For the purposes of this deduction, net investment income generally includes taxable interest, nonqualified dividends and net short-term capital gains, reduced by other investment expenses. In other words, long-term capital gains and qualified dividends aren’t included. However, any disallowed interest is carried forward. You can then deduct the disallowed interest in a later year if you have excess net investment income.

You may elect to treat net long-term capital gains or qualified dividends as investment income in order to deduct more of your investment interest. But if you do, that portion of the long-term capital gain or dividend will be taxed at ordinary-income rates.

Will interest expense save you tax?

As you can see, the answer to the question depends on multiple factors. We can review your situation and help you determine whether you can benefit from the investment interest expense deduction on your 2018 tax return. Call us today at 205-345-9898.

© 2019 Covenant CPA

Slam the door on home energy scams

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Deregulation of the energy industry was intended to give consumers a choice of electricity and natural gas providers — and an opportunity to save money. But many homeowners in deregulated states are receiving higher energy bills thanks to deceptive, and even fraudulent, door-to-door sales practices.

Deception and fraud

Not all states have deregulated. If yours has, you probably know it because you’ve received mailings, phone calls and sales rep visits from companies asking you to switch from your current provider. In most cases, traditional utilities continue to transmit the energy; the new providers, offering discounts and other incentives, deliver it to customers.

Many such offers are legitimate and can potentially save you money. But others are deceptive, designed to get you to agree to switching without a full understanding of the terms. For example, a company may offer an attractive introductory rate that becomes outrageously high after the introductory period ends. These companies usually ask you to sign a long-term contract, and getting out of one is likely to involve cancellation fees and a lot of hassle.

Then there are the cases of outright fraud. In the most common scam, slamming, a salesperson claims to represent your current utility company and tells you that there’s a problem with your account. The rep asks to see a current bill to “straighten out” the issue. Instead, the crooked rep copies down your account number and uses it to change your provider, claiming that you requested the switch. You may not even notice you’ve been conned until your bills suddenly skyrocket.

Prevention starts with knowledge

As with all consumer choices, a little knowledge can go a long way. First, find out what company currently delivers and provides energy to your home. Then learn which providers operate in your city by visiting the American Coalition of Competitive Energy Suppliers site at http://competitiveenergy.org or by contacting your state’s utility regulatory commission.

If someone comes to your door purporting to represent one of these companies, ask to see a business card and personal ID. Before inviting the rep into your home, call his or her office to confirm the individual’s identity.

Even if an offer seems above-board, never provide a door-to-door rep with:

  • A utility bill containing your account number,
  • Payment information such as credit card numbers, or
  • Personal information such as your Social Security number.

A legitimate alternative energy salesperson should be willing to leave materials so you can review them at your leisure and research your options. Be particularly suspicious of any high-pressure tactics such as special rates if you “sign today.” And, of course, if a rep makes threats or simply makes you uncomfortable, shut the door and call the police. Call us for more at 205-345-9898.

© 2019 Covenant CPA

Getting wise to the rise of “smart” buildings

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Nowadays, data drives everything — including the very buildings in which companies operate. If your business is considering upgrading its current facility, or moving to or constructing a new one, it’s important to be aware of “smart” buildings.

A smart building is one equipped with a variety of sensors that gather and track information about the structure’s energy usage and performance. With this data, the owners can better regulate the building’s energy consumption and, ultimately, save money.

Has this been the case in real life? The results of a 2018 Forbes Insights/Intel survey seem to indicate so. Of the 211 business leaders from around the world who responded, 66% answered affirmatively when asked whether smart building management technologies have produced a return on investment.

What’s out there

The name of the game with smart buildings is integration. Traditional building management and control systems don’t easily converge with today’s technology-driven and Internet-connected infrastructure. (This infrastructure is often referred to as “the Internet of Things.”) Sensor-collected data, however, flows directly to the management and control system of a building to automate everything from HVAC to lighting to security features.

Smart technology isn’t limited to new construction. When real estate developers renovate commercial space, it’s increasingly retrofitted with smart technology. By the same token, many large companies have renovated their own buildings to install data-gathering sensors. Doing so is an expensive undertaking but may be worthwhile if your business owns facilities in a prime location and doesn’t want to move.

At the same time, don’t assume every building will be completely automated. In the health care sector, for example, some facilities are finding that manual control of lighting and ventilation systems remains more effective because high traffic volume hampers computerized efforts to regulate energy usage.

Criteria to consider

The primary advantage of smart technology is simple. Over time, you should save money on energy costs by more accurately tracking and regulating usage — dollars that you can redirect toward more profitable activities. Any property you buy, however, must still fit a sensible budget and fulfill other functional criteria, such as being “right-sized” to your on-site workforce and perhaps coming with tax incentives.

When leasing, you’ll need to get specifics from the owner regarding the smart building in question. Was it built new with sensors or retrofitted? Are the sensors and data-processing equipment themselves up to date? You’ll also need to research local energy costs to ensure that the property owner is passing along the savings to you under a reasonable lease agreement.

Here to stay

Just as auto manufacturers no longer make cars without built-in computers, developers and contractors generally aren’t constructing buildings without smart technology. Bear this in mind as you shop for space. Whether you’re looking to lease, buy or build, we can help you weigh the pertinent factors and make the right decision. Call us today at 205-345-9898.

© 2019 Covenant CPA

Economic damages: Recovering what was lost

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A business can suffer economic damages arising from a variety of illegal conduct. Common examples include breach of contract, patent infringement and commercial negligence. If your company finds itself headed to court looking to recover lost profits, diminished business value or both, it’s important to know how the damages might be determined.

What methods are commonly used?

The goal of any economic damages case is to make your company, the plaintiff, “whole” again. In other words, one critical question must be answered: Where would your business be today “but for” the defendant’s alleged wrongdoing? When financial experts calculate economic damages, they generally rely on the following methods:

Before-and-after. Here, the expert assumes that, if it hadn’t been for the breach or other tortious act, the company’s operating trends would have continued in pace with past performance. In other words, damages equal the difference between expected and actual performance. A similar approach quantifies damages as the difference between the company’s value before and after the alleged “tort” (damaging incident) occurred.

Yardstick. Under this technique, the expert benchmarks a damaged company’s performance to external sources, such as publicly traded comparables or industry guidelines. The presumption is that the company’s performance would have mimicked that of its competitors if not for the tortious act.

Sales projection. Projections or forecasts of the company’s expected cash flow serve as the basis for damages under this method. Damages involving niche players and start-ups often call for the sales projection method, because they have limited operating history and few meaningful comparables.

An expert considers the specific circumstances of the case to determine the appropriate valuation method (or methods) for that situation.

What’s next?

After financial experts have estimated lost profits, they discount their estimates to present value. Some jurisdictions have prescribed discount rates, but, in many instances, experts subjectively determine the discount rate based on their professional opinions about risk. Small differences in the discount rate can generate large differences in final conclusions. As a result, the subjective discount rate is often a contentious issue.

The final step is to address mitigating factors. What could the damaged party have done to minimize its loss? Most jurisdictions hold plaintiffs at least partially responsible for mitigating their own damages. Like discount rates, this subjective adjustment often triggers widely divergent opinions among the parties involved.

Are you prepared?

You probably don’t relish the thought of heading to court to fight for economic damages. But these situations can occur — often quite unexpectedly — and it’s better to be prepared than surprised. Contact us for more information at 205-345-9898.

© 2019 Covenant CPA

Act soon to save 2018 taxes on your investments

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Do you have investments outside of tax-advantaged retirement plans? If so, you might still have time to shrink your 2018 tax bill by selling some investments • you just need to carefully select whichinvestments you sell.

Try balancing gains and losses

If you’ve sold investments at a gain this year, consider selling some losing investments to absorb the gains. This is commonly referred to as “harvesting” losses.

If, however, you’ve sold investments at a loss this year, consider selling other investments in your portfolio that have appreciated, to the extent the gains will be absorbed by the losses. If you believe those appreciated investments have peaked in value, essentially you’ll lock in the peak value and avoid tax on your gains.

Review your potential tax rates 

At the federal level, long-term capital gains (on investments held more than one year) are taxed at lower rates than short-term capital gains (on investments held one year or less). The Tax Cuts and Jobs Act (TCJA) retains the 0%, 15% and 20% rates on long-term capital gains. But, for 2018 through 2025, these rates have their own brackets, instead of aligning with various ordinary-income brackets.

For example, these are the thresholds for the top long-term gains rate for 2018:

  • Singles: $425,800
  • Heads of households: $452,400
  • Married couples filing jointly: $479,000

But the top ordinary-income rate of 37%, which also applies to short-term capital gains, doesn’t go into effect until income exceeds $500,000 for singles and heads of households or $600,000 for joint filers. The TCJA also retains the 3.8% net investment income tax (NIIT) and its $200,000 and $250,000 thresholds.

Don’t forget the netting rules

Before selling investments, consider the netting rules for gains and losses, which depend on whether gains and losses are long term or short term. To determine your net gain or loss for the year, long-term capital losses offset long-term capital gains before they offset short-term capital gains. In the same way, short-term capital losses offset short-term capital gains before they offset long-term capital gains.

You may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing your adjusted gross income. Any remaining net losses are carried forward to future years.

Time is running out

By reviewing your investment activity year-to-date and selling certain investments by year end, you may be able to substantially reduce your 2018 taxes. But act soon, because time is running out.

Keep in mind that tax considerations shouldn’t drive your investment decisions. You also need to consider other factors, such as your risk tolerance and investment goals.

We can help you determine what makes sense for you. Please contact us at 205-345-9898.

© 2018 Covenant CPA

Getting ahead of the curve on emerging technologies

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Turn on your computer or mobile device, scroll through Facebook or Twitter, or skim a business-oriented website, and you’ll likely come across the term “emerging technologies.” It has become so ubiquitous that you might be tempted to ignore it and move on to something else. That would be a mistake.

In today’s competitive business landscape, your ability to stay up to date — or, better yet, get ahead of the curve — on the emerging technologies in your industry could make or break your company.

Watch the competition

There’s a good chance that some of your competitors already are trying to adapt emerging technologies such as these:

Machine learning. A form of artificial intelligence, machine learning refers to the ability of machines to learn and improve at a specific task with little or no programming or human intervention. For instance, you could use machine learning to search through large amounts of consumer data and make predictions about future purchase patterns. Think of Amazon’s suggested products or Netflix’s recommended viewing.

Natural language processing (NLP). This technology employs algorithms to analyze unstructured human language in emails, texts, documents, conversation or otherwise. It could be used to find specific information in a document based on the other words around that information.

Internet of Things (IoT). The IoT is the networking of objects (for example, vehicles, building systems and household appliances) embedded with electronics, software, sensors and Internet connectivity. It allows the collection, sending and receiving of data about users and their interactions with their environments.

Robotic process automation (RPA). You can use RPA to automate repetitive manual tasks that eat up a lot of staff time but don’t require decision making. Relying on business rules and structured inputs, RPA can perform such tasks with greater speed and accuracy than any human possibly could.

Not so difficult

If you fall behind on these or other emerging technologies that your competitors may already be incorporating, you run the risk of never catching up. But how can you stay informed and know when to begin seriously pursuing an emerging technology? It’s not as difficult as you might think:

  • Schedule time to study emerging technologies, just as you would schedule time for doing market research or attending an industry convention.
  • Join relevant online communities. Follow and try to connect with the thought leaders in your industry, whether authors and writers, successful CEOs, bloggers or otherwise.
  • Check industry-focused publications and websites regularly.

Taking the time for these steps will reduce the odds that you’ll be caught by surprise and unable to catch up or break ahead.

When you’re ready to undertake the process of integrating an emerging technology into your business operation, forecasting both the implementation and maintenance costs will be critical. We can help you create a reasonable budget and manage the financial impact. Call us at 205-345-9898.

© 2018 Covenant CPA

Taxable vs. tax-advantaged: Where to hold investments

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When investing for retirement or other long-term goals, people usually prefer tax-advantaged accounts, such as IRAs, 401(k)s or 403(b)s. Certain assets are well suited to these accounts, but it may make more sense to hold other investments in traditional taxable accounts.

Know the rules

Some investments, such as fast-growing stocks, can generate substantial capital gains, which may occur when you sell a security for more than you paid for it.

If you’ve owned that position for over a year, you face long-term gains, taxed at a maximum rate of 20%. In contrast, short-term gains, assessed on holding periods of a year or less, are taxed at your ordinary-income tax rate — maxing out at 37%. (Note: These rates don’t account for the possibility of the 3.8% net investment income tax.)

Choose tax efficiency

Generally, the more tax efficient an investment, the more benefit you’ll get from owning it in a taxable account. Conversely, investments that lack tax efficiency normally are best suited to tax-advantaged vehicles.

Consider municipal bonds (“munis”), either held individually or through mutual funds. Munis are attractive to tax-sensitive investors because their income is exempt from federal income taxes and sometimes state and local income taxes. Because you don’t get a double benefit when you own an already tax-advantaged security in a tax-advantaged account, holding munis in your 401(k) or IRA would result in a lost opportunity.

Similarly, tax-efficient investments such as passively managed index mutual funds or exchange-traded funds, or long-term stock holdings, are generally appropriate for taxable accounts. These securities are more likely to generate long-term capital gains, which have more favorable tax treatment. Securities that generate more of their total return via capital appreciation or that pay qualified dividends are also better taxable account options.

Take advantage of income

What investments work best for tax-advantaged accounts? Taxable investments that tend to produce much of their return in income. This category includes corporate bonds, especially high-yield bonds, as well as real estate investment trusts (REITs), which are required to pass through most of their earnings as shareholder income. Most REIT dividends are nonqualified and therefore taxed at your ordinary-income rate.

Another tax-advantaged-appropriate investment may be an actively managed mutual fund. Funds with significant turnover — meaning their portfolio managers are actively buying and selling securities — have increased potential to generate short-term gains that ultimately get passed through to you. Because short-term gains are taxed at a higher rate than long-term gains, these funds would be less desirable in a taxable account.

Get specific advice

The above concepts are only general suggestions. Please contact our firm for specific advice on what may be best for you.

 

Sidebar: Doing due diligence on dividends

If you own a lot of income-generating investments, you’ll need to pay attention to the tax rules for dividends, which belong to one of two categories:

  1. Qualified.These dividends are paid by U.S. corporations or qualified foreign corporations. Qualified dividends are, like long-term gains, subject to a maximum tax rate of 20%, though many people are eligible for a 15% rate. (Note: These rates don’t account for the possibility of the 3.8% net investment income tax.)
  2. Nonqualified.These dividends — which include most distributions from real estate investment trusts and master limited partnerships — receive a less favorable tax treatment. Like short-term gains, nonqualified dividends are taxed at your ordinary-income tax rate.

© 2018 Covenant CPA