All posts by Amanda Gabel

Keeping up with the net operating loss rules

When a trade or business’s deductible expenses exceed its income, a net operating loss (NOL) generally occurs. When filing your 2019 income tax return, you might find that your business has an NOL — and you may be able to turn it to your tax advantage. But the rules applying to NOLs have changed and changed again. Let’s review.

Pre-TCJA

Before 2017’s Tax Cuts and Jobs Act (TCJA), when a business incurred an NOL, the loss could be carried back up to two years. Any remaining amount could then be carried forward up to 20 years.

A carryback generates an immediate tax refund, boosting cash flow. A carryforward allows the company to apply the NOL to future years when its tax rate may be higher.

Post-TCJA

The changes made under the TCJA to the tax treatment of NOLs generally weren’t favorable to taxpayers. According to those rules, for NOLs arising in tax years ending after December 31, 2017, most businesses couldn’t carry back a qualifying NOL.

This was especially detrimental to trades or businesses that had been operating for only a few years. They tend to generate NOLs in those early years and greatly benefit from the cash-flow boost of a carryback. On the plus side, the TCJA allowed NOLs to be carried forward indefinitely, as opposed to the previous 20-year limit.

For NOLs arising in tax years beginning after December 31, 2017, the TCJA also stipulated that an NOL carryforward generally can’t be used to shelter more than 80% of taxable income in the carryforward year. (Under previous law, generally up to 100% could be sheltered.)

COVID-19 response

In response to the novel coronavirus (COVID-19) pandemic, the NOL rules were changed yet again under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. For NOLs arising in tax years beginning in 2018 through 2020, taxpayers are now eligible to carry back the NOLs to the previous five tax years. You may be able to file amended returns for carryback years to receive a tax refund now.

The CARES Act also modifies the treatment of NOL carryforwards. For tax years beginning before 2021, taxpayers can now potentially claim an NOL deduction equal to 100% of taxable income (rather than the 80% limitation under the TCJA) for prior-year NOLs carried forward into those years. For tax years beginning after 2020, taxpayers may be eligible for a 100% deduction for carryforwards of NOLs arising in tax years before 2018 plus a deduction equal to the lesser of 1) 100% of NOL carryforwards from post-2017 tax years, or 2) 80% of remaining taxable income (if any) after deducting NOL carryforwards from pre-2018 tax years.

Complicated rules

The NOL rules have always been complicated and multiple law changes have complicated them further. It’s also possible there could be more tax law changes this year affecting NOLs. Please contact us for further clarification and more information.

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Don’t forget about your 2019 tax return

Earlier this year, in response to the novel coronavirus (COVID-19) crisis, the IRS postponed numerous federal tax filing and payment deadlines. If you took advantage of the extra time, it’s important not to forget about your return or lose sight of any important details.

Recapping the relief

For taxpayers with a 2019 federal income tax return or payment that had been due on April 15, 2020, the due date for filing and paying has been automatically postponed to July 15, 2020, regardless of the size of any payment owed. The taxpayer doesn’t have to file Form 4868, which allows automatic extensions for individuals, or Form 7004, which should be used for certain business income tax, information and other returns.

The relief also applies to estimated income tax payments (including tax payments on self-employment income) previously due on April 15, 2020, and June 15, 2020, for the taxpayer’s 2020 tax year. The IRS has clarified that the postponed deadline also applies to numerous other federal tax filing and payment deadlines that had been on or after April 1, 2020, and before July 15, 2020, including gift and generation-skipping transfer tax filings and payments.

As a result of the return filing and tax payment postponements, the period from April 1, 2020, through July 15, 2020, is disregarded in calculating any interest, penalty or addition to tax for failure to file the postponed income tax returns or pay the postponed income taxes.

Filing an extension beyond July 15

It’s possible that, before July 15, deadlines could be postponed again or new extension relief could be made available. Otherwise, if you can’t file by July 15, as an individual, you can request an automatic extension until October 15, 2020.

As of this writing, you must request the automatic extension by July 15, 2020. To minimize interest and penalties when filing for an extension, you must properly estimate any 2019 tax liability due and pay that liability by July 15, 2020.

Contributing to accounts

The COVID-19 relief also applies to 2019 IRA contributions, so you can still make those contributions through July 15, 2020. Similarly, you can make a 2019 contribution to a Health Savings Account or Archer Medical Savings Account through July 15, 2020, as well.

Getting the optimal benefit

The COVID-19 crisis put unprecedented pressure on U.S. taxpayers. We can help ensure you get the relief offered by the federal government, as you’re eligible.

Sidebar: Relief doesn’t apply to 2019 estimated tax payments

If you’re a gig worker or independent contractor, be advised that the tax relief related to the novel coronavirus (COVID-19) outbreak doesn’t apply to 2019 estimated tax payments or penalties for failure to timely make 2019 estimated tax payments. In other words, if you failed to make the required installments of estimated tax in the required amounts, the COVID-19-related relief doesn’t apply. However, you may seek relief under the normal rules by filing Form 2210, “Underpayment of Estimated Tax by Individuals, Estates, and Trusts,” or Form 2220, “Underpayment of Estimated Tax by Corporations.”

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The marriage penalty still exists under the TCJA

One byproduct of the Internal Revenue Code is that the tax liability of married couples who file jointly may be more than their combined tax liabilities would be as single filers. This is “the marriage penalty.”

Unfortunately, this hasn’t gone away under the Tax Cuts and Jobs Act (TCJA). For example, through 2025, the TCJA imposes a $10,000 limit on itemized deductions for state and local taxes. The limit is the same for joint filers and single filers. That means unmarried couples can deduct $10,000 each, for a total of $20,000, while married couples can deduct only $10,000. (There have been proposals in Congress to eliminate the limit.)

There’s a similar marriage penalty on mortgage interest deductions. Through 2025, the TCJA reduced the amount of home acquisition debt that’s eligible for interest deductions from $1 million to $750,000 for debt incurred after Dec. 15, 2017. Again, the limit is the same for joint filers and singles filers, so while married couples may be able to deduct interest on only $750,000 in home acquisition debt, unmarried couples may be able to deduct interest on up to a combined $1.5 million.

If you’re getting married, we can help you crunch the numbers and see how your union will affect your tax bill. No one would suggest that a potential marriage penalty should influence your decision to tie the knot, but knowing the impact can help you make informed financial planning decisions.

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Should you digitize your tax and financial records?

Traditionally, important tax and financial records have been stored as hardcopies in desk drawers, filing cabinets and safe deposit boxes. Nowadays, it’s become increasingly popular and easy to digitize documents and store them electronically. Is this the right move for you?

Pluses of electronic storage

Perhaps the biggest advantage of digital documents is a drastic reduction in the amount of paper that you must sort, organize and store. Also, digital documents are generally more protected from damage than paper files — assuming they’re stored properly.

In addition, electronic documents can be digitally date-stamped, which helps ensure that you’re accessing the most recent versions. You can track edits to electronic files, monitor who’s been viewing them and restrict access to sensitive documents, too.

Self-host or the cloud

To digitize paper documents, you need only a scanner, which can be rented if you don’t have one and don’t wish to purchase one. You can shred many paper files after digitization, though you may need to retain paper versions of some legal documents. (Consult an attorney about which ones.)

When it comes to storage, you essentially have two options:

  1. A self-hosted system.Here, you buy a dedicated hard drive (or several high-quality thumb drives) to store your digital records. It’s best not to keep these files on your home computer because, if it crashes or gets hacked or stolen, your sensitive data may be lost permanently or exposed. Hackers can’t get to self-hosted files because they’re not on the Internet, and you can limit your drive’s exposure to natural disasters, accidental damage and theft risk by keeping it in a fire-proof safe.
  2. The cloud.You’ve likely heard of, and may even use, Internet-based storage for photos or other items. You can do this for tax and financial records as well, but you’ve got to be careful. Choose a reputable and stable provider that encrypts everything. The upside is you’ll have instant access to your files anywhere in the world — as long as you have a secure Internet connection. The downside: you’ll lose access during Internet outages and no cloud system is 100% guaranteed secure.

Organized and safe

For many people, the right approach might be “both.” Retain paper files of certain documents for a recommended period and digitize everything else. Our firm can help you find the best way to keep your tax and financial records organized and safe.

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Rolling over capital gains into a qualified opportunity fund

If you’re selling a business interest, real estate or other highly appreciated property, you could get hit with a substantial capital gains tax bill. One way to soften the blow — if you’re willing to tie up the funds long term — is to “roll over” the gain into a qualified opportunity fund (QOF).

What is a QOF?

A QOF is an investment fund, organized as a corporation or partnership, designed to invest in one or more Qualified Opportunity Zones (QOZs). A QOZ is a distressed area that meets certain low-income criteria, as designated by the U.S. Treasury Department.

Currently, there are more than 9,000 QOZs in the United States and its territories. QOFs can be structured as multi-investor funds or as single-investor funds established by an individual or business. To qualify for tax benefits, at least 90% of a QOF’s funds must be “QOZ property,” which includes:

QOZ business property. This is tangible property that’s used by a trade or business within a QOZ and that meets certain other requirements.

QOZ stock or partnership interests. These are equity interests in corporations or partnerships, with substantially all their assets in QOZ property.

Note: Final regulations define “substantially all” to mean at least 70%.

What are the benefits?

If you recognize capital gain by selling or exchanging property, and reinvest an amount up to the amount of gain in a QOF within 180 days, you’ll enjoy several tax benefits.

Taxes will be deferred on the reinvested gain until the earlier of December 31, 2026, or the date you dispose of your QOF investment. There will be a permanent reduction of the taxability of your gain by 10% if you hold the QOF investment for at least five years, and an additional 5% if you hold it for at least seven years. If you hold it for at least 10 years, you’ll incur tax-free capital gains attributable to appreciation of the QOF investment itself.

The only way to obtain these benefits is to first sell or exchange a capital asset in a transaction that results in gain recognition. You then would reinvest some or all of the gain in a QOF. You can’t simply invest cash.

You or your heirs will eventually be liable for taxes on some or all of the original gain. Consider ways to avoid those taxes, such as holding the original property for life or doing a tax-free exchange.

Who can help?

The rules surrounding these QOFs are complex. We can help you further explore the idea.

Sidebar: IRS addresses QOFs in 2020 guidance

In February 2020, the IRS issued guidance on reporting gains from qualified opportunity funds (QOFs). It gives instructions on how to report the deferral of eligible gains from Section 1231 property and the inclusion of those gains when the QOF investment is sold or exchanged.

Taxpayers who defer eligible gains from such property, including gains from installment sales and like-kind exchanges, by investing in a QOF must report the deferral election on Form 8949, “Sales and Other Dispositions of Capital Assets,” in the deferral tax year. And taxpayers selling or exchanging a QOF investment must report the inclusion of the eligible gain on the form.

© 2020

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Heed the lessons of your tax return and check your withholding

Every year’s tax return provides valuable lessons on the optimal amount that taxpayers should have withheld from their paychecks. Heeding these lessons is especially important if you end up owing a substantial amount of money.

Of course, even if you get a nice tax refund, that shouldn’t necessarily be your goal. It essentially means you’re giving the government an interest-free loan. Here’s a primer on why and how to review your withholding and change it, if necessary.

The TCJA’s impact

Following the passage of the Tax Cuts and Jobs Act (TCJA), the IRS updated the withholding tables that indicate how much employers should hold back from their employees’ paychecks. In general, the amount withheld was reduced. This was done to reflect changes under the TCJA — including the increase in the standard deduction, suspension of personal exemptions and changes in tax rates.

The new tables provided a reasonable amount of tax withholding for some individuals, but they caused other taxpayers to not have enough money withheld to pay their ultimate tax liabilities. Although many people have since adjusted to the TCJA’s impact, the IRS urges taxpayers to review their tax situations annually and adjust their withholding as appropriate.

The agency provides a withholding calculator to assist you. The calculator reflects tax law changes in areas such as available itemized deductions, the increased child credit, the dependent credit and the repeal of dependent exemptions. You can access the IRS calculator at https://bit.ly/2aLxK0A.

Circumstances that trigger change

There are a variety of specific circumstances that should trigger you to check your withholding. For example, if you adjusted your withholding in 2019 — especially in the middle or later part of the year — give it another look. Also, as mentioned, if you got hit by a bigger tax bill than you expected, or received a sizable refund, you may want to make an adjustment.

Certain life changes typically warrant adjusting withholding as well. These include getting married or divorced, having a child or adopting one, buying a home, or incurring notable changes in income.

You can modify your withholding at any time during the year, or even multiple times within a year. To do so, simply submit a new Form W-4 to your employer. Changes typically go into effect several weeks after a new Form W-4 is submitted. (For estimated tax payments, you can make adjustments each time quarterly estimated payments are due. The next payment is due on Monday, June 15.)

We can help

Contact us to discuss your situation and what you can do to remedy any shortfalls to minimize taxes due, as well as any penalties and interest. We can help you sort out whether to adjust your withholding.

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Benefit with a twist: The Roth 401(k)

Most everyone has heard of a 401(k) plan, and a sizable number of adults likely have at least a passing familiarity with the Roth IRA. What remains less well known among job candidates and employees is the Roth 401(k) plan. This retirement benefit with a twist might be worth offering to your staff, so long as you and they understand how it works.

Hybrid plan

As the name implies, Roth 401(k)s are hybrid plans that take some characteristics from employer-sponsored 401(k)s and others from Roth IRAs. Any employer with an existing 401(k), 403(b) or governmental 457(b) plan can offer designated Roth 401(k) accounts.

From there, eligible employees can elect to defer part of their salaries to Roth 401(k)s, subject to annual limits. The employer may choose to provide matching contributions. For 2020, a participating employee can contribute up to $19,500 ($26,000 if he or she is age 50 or older) to a Roth 401(k). The most you can contribute to a Roth IRA for 2020 is $6,000 ($7,000 for those age 50 or older).

Note: The ability to contribute to a Roth IRA is phased out for upper-income taxpayers, but there’s no such restriction for a Roth 401(k).

Pros and cons

Unlike with traditional 401(k)s, contributions to employees’ accounts are made with after-tax dollars, instead of pretax dollars. Therefore, employees forfeit a key 401(k) tax benefit. On the plus side, after an initial period of five years, “qualified distributions” are 100% exempt from federal income tax, just like qualified distributions from a Roth IRA. In contrast, regular 401(k) distributions are taxed at ordinary-income rates, which are currently up to 37%.

Generally, qualified distributions are those made after a participant reaches age 59½ or because of a death or disability. Therefore, you can take qualified Roth 401(k) distributions in retirement after age 59½ and pay no tax, as opposed to the hefty tax bill that may be due from traditional 401(k) payouts. Roth 401(k)s follow the same required minimum distribution rules as traditional 401(k)s, but employees can avoid mandated withdrawals by converting a Roth 401(k) to a Roth IRA.

Not for everyone

A Roth 401(k) is more beneficial than a traditional 401(k) for some participants, but not all. For example, it may be valuable for employees who expect to be in higher federal and state tax brackets in retirement than in their working years. Contact us if you have questions about adding a Roth 401(k) to your benefits lineup.

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A large unpaid tax bill could put your passport at risk

Most Americans aren’t using their passports right now. But it’s still important to remember that, if the IRS certifies that you have a seriously delinquent tax debt (SDTD), your passport application could be denied, or your current passport could be limited or revoked.

You have an SDTD if 1) you owe more than $53,000 (as indexed for inflation) in back taxes, penalties and interest, 2) the IRS has filed a Notice of Federal Tax Lien, and 3) the period to challenge the lien has expired or the IRS has issued a levy.

Should you find yourself in this situation, there are several steps to take to avoid losing your passport. First, obviously, you can pay your tax debt in full immediately. If that’s not possible, you may be able to pay your debt on a timely basis according to an approved installment agreement, accepted offer in compromise or settlement agreement with the Justice Department.

Requesting a collection due process hearing regarding a levy, or having collection suspended through a request for innocent spouse relief, may also enable you to retain your passport. More important, the IRS won’t likely notify the U.S. State Department of an SDTD during a federally declared disaster, such as the one we’ve experienced this year, or in the case of bankruptcy, identity theft or other hardships. Contact us for more info.

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Executive compensation requires informed decision-making

Business owners want to compensate themselves and their top executives fairly and competitively for their work, results and commitment. So, how do you achieve that goal without attracting undue IRS scrutiny and claims of inappropriate compensation? By making informed, astute decisions.

Start with the basics

Compensation is affected by the amount of cash in your company’s bank account. Just because your financial statements report a profit doesn’t necessarily mean you’ll have cash available to pay owners a salary or make annual distributions. Net income and cash on hand aren’t synonymous.

Other business objectives — for example, buying new equipment, repaying debt, and sprucing up your offices or facilities — will demand dollars as well. So, it’s a balancing act between owners’ compensation and dividends or distributions on the one hand, and capital expenditures, expansion plans and financing goals on the other.

C corporation challenges

If you operate as a C corporation, your business is generally taxed twice. First, its income is taxed at the corporate level, and then it’s taxed again at the personal level as the owners draw dividends. This is a long-running challenge to those who own C corporations.

In light of the situation, many owners have been tempted to classify all the money they take out as salaries or bonuses to avoid being double-taxed on dividends. But the IRS is wise to this strategy: It’s on the lookout for excessive compensation to owners and will reclassify above-market compensation as dividends, potentially resulting in additional income tax as well as interest and penalties.

The IRS also monitors a C corporation’s accumulated earnings. Much like retained earnings on your balance sheet, accumulated earnings measure the buildup of undistributed earnings. If these earnings get too high and can’t be justified as needed for things such as a planned expansion, the IRS will assess a tax on them.

Know your flow-through

Perhaps your business is structured as an S corporation, limited liability company or partnership. These are all examples of “flow-through” entities that aren’t taxed at the entity level. Instead, income flows through to the owners’ personal tax returns, where it’s taxed at the individual level.

Dividends (typically called “distributions” for flow-through entities) are tax-free to the extent that an owner has tax basis in the business. Simply put, basis is a function of capital contributions, net income and owners’ distributions.

So, the IRS has the opposite concern with flow-through entities: Agents are watchful of dealer-owners who underpay themselves to avoid payroll taxes on owners’ compensation. If the IRS finds you’re downplaying compensation in favor of payroll-tax-free distributions, it’ll reclassify some of your distributions as salaries. In turn, while your income taxes won’t change, you’ll owe more in payroll taxes than planned — plus, potentially, interest and penalties.

Beware of eyebrow-raisers

Above- or below-market compensation raises a red flag with the IRS, and that’s always undesirable. Not only will the agency evaluate your compensation expense — possibly imposing extra taxes, penalties and interest — but a zealous IRS agent might turn up other challenges in your records, such as nonsalary compensation or benefits.

What’s more, it might cause a domino effect, drawing attention in the states where you do business. Many state and local governments face budget shortages and are hot on the trail of the owners’ compensation issue; they’ll follow federal audits to assess additional taxes when possible.

Make sound decisions

Following the coronavirus (COVID-19) outbreak, some executives have considered lowering their salaries to help their companies’ cash flow. We can help you make sound and legally compliant compensation decisions.

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Reviewing business meal expenses under today’s tax rules

As the world battles coronavirus (COVID-19), companies aren’t doing much “wining and dining” of customers, prospects, vendors or employees. But someday you will again. With a hopeful eye on the future, let’s review the rules for deducting business meal expenses under the Tax Cuts and Jobs Act (TCJA).

3 basic rules

Among the biggest changes is that you can no longer deduct most business-related entertainment expenses. The TCJA disallows deductions for entertainment expenses, including those for sports events, theater productions, golf outings and fishing trips.

You can still deduct 50% of the cost of food and beverages for most meals conducted with business associates. However, you need to follow three basic rules in order to prove that your meal expenses are business related:

  1. The expenses must be “ordinary and necessary.” This means your food and beverage costs are customary and appropriate. They shouldn’t be lavish or extravagant.
  2. The expenses must be directly related or associated with your business. This means that you expect to receive a concrete business benefit from them. The principal purpose for the meal must be business. You can’t go out with a group of friends for the evening, discuss business with one of them for a few minutes, and then write off the check.
  3. You must be able to substantiate the expenses. There are requirements for proving that meal and beverage expenses qualify for a deduction. You must be able to establish the amount spent, the date and place where the meals took place, the business purpose and the business relationship of the people involved.

Set up detailed recordkeeping procedures to keep track of business meal costs. That way, you can prove them and the business connection in the event of an IRS audit.

Other considerations

What if you spend money on food and beverages at an entertainment event? The IRS clarified in guidance (Notice 2018-76) that taxpayers can still deduct 50% of food and drink expenses incurred at entertainment events, but only if business was conducted during the event or shortly before or after. The food-and-drink expenses should also be “stated separately from the cost of the entertainment on one or more bills, invoices or receipts,” according to the guidance.

Another related tax law change involves meals provided to employees on the business premises. Before the TCJA, these meals provided to an employee for the convenience of the employer were 100% deductible by the employer. Beginning in 2018, meals provided for the convenience of an employer in an on-premises cafeteria or elsewhere on the business property are only 50% deductible. After 2025, these meals won’t be deductible at all.

More complicated

The treatment of meal and entertainment expenses has become more complicated under the TCJA. We can keep you up to speed on the issues and suggest strategies to save taxes on your business meal bucks.

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