You’ve hit the jackpot! Now what?

When it comes to financial planning, most of us spend our time guarding against things that could go wrong. But what if something really good happens? Hitting the jackpot is obviously a nice problem to have. Yet an unexpected influx of cash can drive even savvy individuals to do regrettable things.

Your first impulse upon experiencing a financial windfall may be to shout about it from the rooftops. But it’s likely wiser to lie low and consider your options. A substantial sum of money could compel long-lost acquaintances and family to suddenly get in touch. And let’s not even get into the identity theft risks.

Naturally, you’ll need to consider the tax ramifications. There’s no shortage of cautionary tales about the suddenly rich who’ve gotten into trouble with the IRS.

There are also family issues to consider. If you have minor children, you may want to establish trusts so that, should something happen to you, their finances will be well managed. Likewise, you may need to establish or rethink your estate plan to preserve family harmony and ensure your wishes are fulfilled after you die.

Reassess your insurance needs, too. Your newfound wealth may make you a bigger target for lawsuits should an accident occur on your property or while you’re driving. Ask your insurance agent to review your existing coverage.

If good fortune has smiled upon you, please contact us. We can help ensure you don’t underestimate the amount of taxes you’ll have to pay, as well as assist you in planning your financial future.

© 2017

Identifying qualifying children for tax purposes

As you file your 2016 income tax return, you may be wondering whether you’re eligible for tax breaks related to a niece who lives with you, or perhaps a stepson who spends only part of the year in your home. It all depends on whether, for federal tax purposes, that person is your “qualifying child.”

Widely applicable

In an effort to simplify the tax code and eliminate confusion, Congress established a uniform definition of “qualifying child” as part of the Working Families Tax Relief Act of 2004. The definition applies for purposes of several child-related tax benefits, such as:

  • Dependency exemptions,
  • The child tax credit,
  • The child and dependent care credit, and
  • Head-of-household filing status.

The definition relies on residency rather than requiring that you have provided more than half of a dependent’s support, as was the case years ago.

4 tests to pass

More specifically, a qualifying child must meet four tests:

  1. Relationship. The definition applies to your child (including one who’s adopted or who’s an eligible foster child), stepchild, brother, sister, stepbrother or stepsister. It also includes any of their descendants. So, for example, your grandchildren, nieces and nephews also qualify.
  2. Age. A child must be under age 13 when the care was provided to qualify for the child and dependent care credit, under age 17 (as of the end of the year) for the child credit and under age 19 (age 24 for a full-time student) for the other tax benefits. Except for the child credit, there’s no age limit for a permanently disabled person.
  3. Residence. The child must share your principal place of abode for more than half the year, which includes time spent away from home because of school, military service or illness.
  4. Support. It’s no longer necessary for you to provide more than half of a child’s support. But the qualifying child generally can’t provide more than half of his or her own support.

Under the current definition, the child must be a citizen or resident of the United States, Canada or Mexico to qualify. However, if the child files a joint return, he or she won’t qualify. If more than one person claims a benefit with respect to the same child, the tax code specifies who’s entitled to tax benefits.

If two or more people are eligible to claim the same child as a dependent, they can decide among themselves who will claim the tax benefits. In the event that more than one person actually claims those benefits, there are a variety of rules in place to break the tie.

Further questions

As you can see, the Internal Revenue Code recognizes that families take care of each other and not every child claimed in relation to tax benefits will be a biological child. If you have further questions about this topic, please contact our firm.

© 2017

4 tips for donating artwork to charity

Individuals may want to donate artwork so it can be enjoyed by a wider audience or available for scholarly study or simply to make room for new artwork in their home. Here are four tips for donating artwork with an eye toward tax savings:

  1. Get an appraisal. Donations of artwork valued at over $5,000 require a “qualified appraisal” by a “qualified appraiser.” IRS rules detail the requirements. In addition, auditors are required to refer all gifts of art valued at $20,000 or more to the agency’s Art Advisory Panel. The panel’s findings are the IRS’s official position on the art’s value, so it’s critical to provide a solid appraisal to support your valuation.
  2. Donate to a public charity. Donations to a qualified public charity (such as a museum or university) potentially entitle you to deduct the artwork’s full fair market value. If you donate to a private foundation, your deduction will be limited to your cost. The total amount of charitable donations you may deduct in a given year is limited to a percentage of your adjusted gross income (50% for public charities, 30% for private foundations) with the excess carried forward for up to five years.
  3. Beware the related-use rule. To qualify for a full fair-market-value deduction, the charity’s use of the artwork must be related to its tax-exempt purpose. Even if the related-use rule is satisfied initially, you may lose some or all of your deductions if the artwork is worth more than $5,000 and the charity sells or otherwise disposes of it within three years of receipt. If that happens, you may be able to preserve your tax benefits via a certification process. (For further details, please contact us.)
  4. Consider a fractional donation. Donating a fractional interest allows you to save tax dollars without completely giving up the artwork. Say you donate a 25% interest in your art collection to a museum for it to display for three months annually. You could then deduct 25% of the collection’s fair market value and continue displaying the art in your home or business for most of the year.

The rules for fractional donations, and charitable contributions of artwork in general, can be tricky. Plus, tax law changes affecting deductions may occur in the coming year. Contact our firm for help.

© 2017

Got nexus? Find out before operating in multiple states

For many years, business owners had to ask themselves one question when it came to facing taxation in another state: Do we have “nexus”? This term indicates a business presence in a given state that’s substantial enough to trigger the state’s tax rules and obligations.

Well, the question still stands. And if you’re considering operating your business in multiple states, or are already doing so, it’s worth reviewing the concept of nexus and its tax impact on your company.

Common criteria

Precisely what activates nexus in a given state depends on that state’s chosen criteria. Triggers can vary but common criteria include:

  • Employing workers in the state,
  • Owning (or, in some cases, even leasing) property there,
  • Marketing your products or services in the state,
  • Maintaining a substantial amount of inventory there, and
  • Using a local telephone number.

Then again, one generally can’t say that nexus has a “hair trigger.” A minimal amount of business activity in a given state probably won’t create tax liability there.

For example, an HVAC company that makes a few tech calls a year across state lines probably wouldn’t be taxed in that state. Or let’s say you ask a salesperson to travel to another state to establish relationships or gauge interest. As long as he or she doesn’t close any sales, and you have no other activity in the state, you likely won’t have nexus.

Strategic moves

As with many tax issues, the totality of facts and circumstances will determine whether you have nexus in a state. So it’s important to make assumptions either way. The tax impact could be significant, and its specifics will vary widely depending on just how the state in question approaches taxation.

For starters, strongly consider conducting a nexus study. This is a systematic approach to identifying the out-of-state taxes to which your business activities may expose you. The results of a nexus study may not necessarily be negative. You may find that your company’s overall tax liability is lower in a neighboring state. In such cases, it may be advantageous to create nexus in that state by, say, setting up a small office there. If all goes well, you may be able to allocate some income to that state and lower your tax bill.

Taxation and profitability

“The grass is always greener on the other side of the fence,” so the saying goes. If profitability beckons in another state, please contact our firm for help projecting how setting up shop there might affect your tax liability.

Sidebar: Service companies, beware of market-based sourcing

Nexus has been and remains the primary focus of companies considering whether and how they’d be taxed across state lines. (See main article.) But, recently, many states have established “market-based sourcing” for determining the tax liability of service companies that operate within their borders.

Under this approach, if the benefits of a service occur and will be used in another state, that state will tax the revenue gained from said service. “Service revenue” generally is defined as revenue from intangible assets — not the sales of tangible personal property.

Thus, in market-based sourcing states, the destination state of a service is the relevant taxation factor rather than the state in which the income-producing activity is performed (also known as the “cost of performance” method).

© 2017

Phaseouts and reductions: A tax-filing reminder

As tax-filing season gets into full swing, there are many details to remember. One subject to keep in mind — especially if you’ve seen your income rise recently — is whether you’ll be able to reap the full value of tax breaks that you’ve claimed previously.

What could change? If your adjusted gross income (AGI) exceeds the applicable threshold, your personal exemptions will begin to be phased out and your itemized deductions reduced. For 2016, the thresholds are $259,400 (single), $285,350 (head of household), $311,300 (joint filer) and $155,650 (married filing separately). These are up from the 2015 thresholds, which were $258,250 (single), $284,050 (head of household), $309,900 (joint filer) and $154,950 (married filing separately).

The personal exemption phaseout reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer’s AGI exceeds the applicable threshold (2% for each $1,250 for married taxpayers filing separately). Meanwhile, the itemized deduction limitation reduces otherwise allowable deductions by 3% of the amount by which a taxpayer’s AGI exceeds the applicable threshold (not to exceed 80% of otherwise allowable deductions). It doesn’t apply, however, to deductions for medical expenses, investment interest, or casualty, theft or wagering losses.

If your AGI is close to the threshold, AGI-reduction strategies (such as making retirement plan and Health Savings Account contributions) may allow you to stay under it. If that’s not possible, consider the reduced tax benefit of the affected deductions before implementing strategies to accelerate or defer deductible expenses. Please contact our firm for specific strategies tailored to your situation.

© 2017

4 myths about managing your debt

Debt is a reality for many Americans. Median household debt was estimated at $2,300 as of May 2016, according to consumer information provider ValuePenguin. And debt isn’t limited to those earning lower incomes; households with a net worth of $500,000 and over had an estimated $8,139 in credit card debt, per the same source.

Underestimating or ignoring your obligations can delay or even prevent you from accomplishing many financial goals. Here are four myths about managing your debt.

1. My credit report is fine, and so am I

Many people glance at their credit reports, see a decent score and move on. But credit reports often contain inaccuracies that blur your true debt picture.

Review your report regularly and follow up with the issuing credit agency if there’s an inaccuracy. For example, make sure your report doesn’t reflect a lower credit limit than your actual one.

2. Shut it down … shut it down now

Closing out credit cards may seem like elementary debt management. But eliminating them isn’t necessarily the way to go. Instead, you should limit your number of open cards, pay them off or maintain low account balances, and avoid or renegotiate high interest rates.

The major credit-reporting agencies use a combination of metrics to establish your credit score, including credit history and debt utilization (ratio of debt to available credit). Closing out a card reduces your credit history, limiting the data by which you’re evaluated, and increases your debt utilization, which hurts your credit score.

3. I hold the golden ticket

The easiest way to deal with debt may seem a broad, sweeping strike to pay it down. Unfortunately, gathering the funds to make that move may only worsen the overall situation.

For instance, home equity loans typically offer lower interest rates than credit cards and large available balances. Plus, the interest paid on a home equity debt may be tax deductible, while credit card debt generally isn’t. But the greater obligation isn’t really wiped out — only transferred. And the borrower’s home is at risk.

Similarly, taking out a 401(k) loan offers easy, low-interest access to funds. But a significantly negative tax impact and marked reduction in one’s retirement savings are downsides. Also, interest paid on such a 401(k) loan wouldn’t be tax deductible.

4. Bankruptcy = failure

Well, it certainly doesn’t equal success. And a bankruptcy filing should undoubtedly form the last line of defense in any debt management plan. But, rather than considering it an outright failure, you might want to look at bankruptcy as a last-chance opportunity.

In many cases, a person’s credit score can recover surprisingly quickly — sometimes as soon as three to five years. In addition, some tax liabilities that meet certain requirements may be discharged in bankruptcy.

Ask for help

Sound, timely advice can help you avoid getting in over your head when it comes to debt. Please contact our firm for a detailed assessment of your situation.

© 2017

Facing the tax challenges of self-employment

Today’s technology makes self-employment easier than ever. But if you work for yourself, you’ll face some distinctive challenges when it comes to your taxes. Here are some important steps to take:

Learn your liability. Self-employed individuals are liable for self-employment tax, which means they must pay both the employee and employer portions of FICA taxes. The good news is that you may deduct the employer portion of these taxes. Plus, you might be able to make significantly larger retirement contributions than you would as an employee.

However, you’ll likely be required to make quarterly estimated tax payments, because income taxes aren’t withheld from your self-employment income as they are from wages. If you fail to fully make these payments, you could face an unexpectedly high tax bill and underpayment penalties.

Distinguish what’s deductible. Under IRS rules, deductible business expenses for the self-employed must be “ordinary” and “necessary.” Basically, these are costs that are commonly incurred by businesses similar to yours and readily justifiable as needed to run your operations.

The tax agency stipulates, “An expense does not have to be indispensable to be considered necessary.” But pushing this grey area too far can trigger an audit. Common examples of deductible business expenses for the self-employed include licenses, accounting fees, equipment, supplies, legal expenses and business-related software.

Don’t forget your home office! You may deduct many direct expenses (such as business-only phone and data lines, as well as office supplies) and indirect expenses (such as real estate taxes and maintenance) associated with your home office. The tax break for indirect expenses is based on just how much of your home is used for business purposes, which you can generally determine by either measuring the square footage of your workspace as a percentage of the home’s total area or using a fraction based on the number of rooms.

The IRS typically looks at two questions to determine whether a taxpayer qualifies for the home office deduction:

  1. Is the specific area of the home that’s used for business purposes used only for business purposes, not personal ones?
  2. Is the space used regularly and continuously for business?

If you can answer in the affirmative to these questions, you’ll likely qualify. But please contact our firm for specific assistance with the home office deduction or any other aspect of filing your taxes as a self-employed individual.

© 2017

Consider separating real estate assets from your business

Many companies choose not to combine real estate and other assets into a single entity. Perhaps the business fears liability for injuries suffered on the property. Or legal liabilities encountered by the company could affect property ownership. But there are valid and potentially beneficial tax reasons for holding real estate in a separate entity as well.

Avoiding costly mistakes

Many businesses operate as C corporations so they can buy and hold real estate just as they do equipment, inventory and other assets. The expenses of owning the property are treated as ordinary expenses on the company’s income statement. However, when the real estate is sold, any profit is subject to double taxation: first at the corporate level and then at the owner’s individual level when a distribution is made. As a result, putting real estate in a C corporation can be a costly mistake.

If the real estate were held instead by the business owner(s) or in a pass-through entity, such as a limited liability company (LLC) or limited partnership, and then leased to the corporation, the profit upon a sale of the property would be taxed only once — at the individual level.

Maximizing tax benefits

The most straightforward and seemingly least expensive way for a business owner to maximize the tax benefits is to buy the property outright. However, this could transfer liabilities related to the property directly to the owner, putting other assets — including the business — at risk. In essence, it would negate part of the rationale for organizing the business as a corporation in the first place.

So it’s generally best to hold real estate in its own limited liability entity. The LLC is most often the vehicle of choice for this, but limited partnerships can accomplish the same ends if there are multiple owners. No matter which structure is used, though, make sure all entities are adequately insured.

Tailoring the right strategy

There are many complexities to a company owning real estate. And there’s no one-size-fits-all solution to protecting yourself legally while minimizing your tax liability. But if you do nothing and treat real estate like any other business asset, you could be exposing your business to substantial risk. So please contact our firm for an assessment of your situation. We can help tailor a strategy that’s right for you.

Sidebar: The benefits of separation for family businesses

Family businesses face many distinctive challenges. One is that several family members may participate in the ownership of the company. Under such circumstances, separating real estate ownership from the business creates more options to meet the needs of multiple owners.

Let’s say that a family business is passing from one generation to the next. One child is very interested in owning and operating the business but doesn’t have the means to finance the purchase of both the business and its real estate.

If the two are separated, it’s possible for one sibling to take over the business while other siblings hold the real estate. In this case, everyone can benefit: The child who buys the business doesn’t have to share control with the other siblings, yet they can still reap benefits as property owners.

© 2017

Tax calendar

January 17

Individual taxpayers’ final 2016 estimated tax payment is due.

January 31

  • File 2016 Forms W-2 (“Wage and Tax Statement”) with the SSA and provide copies to your employees.
  • File 2016 Forms 1099-MISC (“Miscellaneous Income”) reporting nonemployee compensation payments in box 7 with the IRS and provide copies to recipients.
  • Most employers must file Form 941 (“Employer’s Quarterly Federal Tax Return”) to report Medicare, Social Security and income taxes withheld in the fourth quarter of 2016. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until February 10 to file the return. Employers who have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944 (“Employer’s Annual Federal Tax Return”).
  • File Form 940 (“Employer’s Annual Federal Unemployment [FUTA] Tax Return”) for 2016. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it is more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 10 to file the return.
  • File Form 943 (“Employer’s Annual Federal Tax Return for Agricultural Employees”) to report Social Security, Medicare and withheld income taxes for 2016. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 10 to file the return.
  • File Form 945 (“Annual Return of Withheld Federal Income Tax”) for 2016 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on accounts such as pensions, annuities and IRAs. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 10 to file the return.

February 28

File 2016 Forms 1099-MISC with the IRS and provide copies to recipients. (Note that Forms 1099-MISC reporting nonemployee compensation in box 7 must be filed by Jan. 31, beginning with 2016 forms filed in 2017.)

March 15

2016 tax returns must be filed or extended for calendar-year partnerships and S corporations. If the return is not extended, this is also the last day to make 2016 contributions to pension and profit-sharing plans.

© 2016