How entity type affects tax planning for owner-employees

Come tax time, owner-employees face a variety of distinctive tax planning challenges, depending on whether their business is structured as a partnership, limited liability company (LLC) or corporation. Whether you’re thinking about your 2016 filing or planning for 2017, it’s important to be aware of the challenges that apply to your particular situation.

Partnerships and LLCs

If you’re a partner in a partnership or a member of an LLC that has elected to be disregarded or treated as a partnership, the entity’s income flows through to you (as does its deductions). And this income likely will be subject to self-employment taxes — even if the income isn’t actually distributed to you. This means your employment tax liability typically doubles, because you must pay both the employee and employer portions of these taxes.

The employer portion of self-employment taxes paid (6.2% for Social Security tax and 1.45% for Medicare tax) is deductible above the line. Above-the-line deductions are particularly valuable because they reduce your adjusted gross income and modified adjusted gross income, which are the triggers for certain additional taxes and phaseouts of many tax breaks.

But flow-through income may not be subject to self-employment taxes if you’re a limited partner or the LLC member equivalent. And be aware that flow-through income might be subject to the additional 0.9% Medicare tax on earned income or the 3.8% net investment income tax (NIIT), depending on the situation.

S and C corporations

For S corporations, even though the entity’s income flows through to you for income tax purposes, only income you receive as salary is subject to employment taxes and, if applicable, the 0.9% Medicare tax. Keeping your salary relatively — but not unreasonably — low and increasing your distributions of company income (which generally isn’t taxed at the corporate level or subject to employment taxes) can reduce these taxes. The 3.8% NIIT may also apply.

In the case of C corporations, the entity’s income is taxed at the corporate level and only income you receive as salary is subject to employment taxes, and, if applicable, the 0.9% Medicare tax. Nevertheless, if the overall tax paid by both the corporation and you would be less, you may prefer to take more income as salary (which is deductible at the corporate level) as opposed to dividends (which aren’t deductible at the corporate level, are taxed at the shareholder level and could be subject to the 3.8% NIIT).

Whether your entity is an S or a C corporation, tread carefully, however. The IRS remains on the lookout for misclassification of corporate payments to shareholder-employees. The penalties and additional tax liability can be costly.

As you can see, tax planning is extra important for owner-employees.  Plus, tax law changes proposed by the President-elect and the Republican majority in Congress could affect tax treatment of  your income in 2017. Please contact us for help identifying the ideal strategies for your situation.

©2016

Data analytics can help solve your nonprofit’s biggest challenges

If your not-for-profit wants to improve its budgeting, forecasting, fundraising or other functions but is having a hard time identifying both problems and solutions, data analytics can help. This form of business intelligence is already considered invaluable in the for-profit world. But it can be just as useful to nonprofits.

Informed decision making

Data analytics is the science of collecting and analyzing sets of data to develop useful insights, connections and patterns that can lead to more informed decision making. It produces such metrics as program efficacy, outcomes vs. efforts, and membership renewal that can reflect past and current performance and, in turn, predict and guide future performance.

The data usually comes from two sources:

1. Internal. Examples include your organization’s databases of detailed information on donors, beneficiaries or members.

2. External. This type of information can be obtained from government databases, social media and other organizations, both non- and for-profit.

Applied advantages

Data analytics can help your organization validate trends, uncover root causes and improve transparency. For example, analysis of certain fundraising data makes it easier to target those individuals most likely to contribute to your nonprofit.

It typically facilitates fact-based discussions and planning, which is helpful when considering new initiatives or cost-cutting measures that stir political or emotional waters. The ability to predict outcomes can support sensitive programming decisions by considering data on a wide range of factors — such as at-risk populations, funding restrictions, offerings available from other organizations and grantmaker priorities.

Needs dictate your purchase

Your organization’s informational needs should dictate the data analytics package you buy. Thousands of potential performance metrics can be produced, but not all of them will be useful. So keeping in mind your most important programs, identify those metrics that matter most to stakeholders and that truly drive decisions. Also ensure that the technology solution you choose complies with any applicable privacy and security regulations, as well as your organization’s ethical standards.

You can adopt the most cutting-edge software, but if your staff aren’t on board, data analytics will be of little benefit. Note that you may need to hire or develop qualified staff to conduct data analytics and convert the results into actionable intelligence.

Make the most of it

Before you choose a technology, make sure your organization, including your staff, is ready to make the most of it. We can help steer you in the right direction.

© 2018

Be aware of the tax consequences before selling your home

In many parts of the country, summer is peak season for selling a home. If you’re planning to put your home on the market soon, you’re probably thinking about things like how quickly it will sell and how much you’ll get for it. But don’t neglect to consider the tax consequences.

Home sale gain exclusion

The U.S. House of Representatives’ original version of the Tax Cuts and Jobs Act included a provision tightening the rules for the home sale gain exclusion. Fortunately, that provision didn’t make it into the final version that was signed into law.

As a result, if you’re selling your principal residence, there’s still a good chance you’ll be able to exclude up to $250,000 ($500,000 for joint filers) of gain. Gain that qualifies for exclusion also is excluded from the 3.8% net investment income tax.

To qualify for the exclusion, you must meet certain tests. For example, you generally must own and use the home as your principal residence for at least two years during the five-year period preceding the sale. (Gain allocable to a period of “nonqualified” use generally isn’t excludable.) In addition, you can’t use the exclusion more than once every two years.

More tax considerations

Any gain that doesn’t qualify for the exclusion generally will be taxed at your long-term capital gains rate, as long as you owned the home for at least a year. If you didn’t, the gain will be considered short-term and subject to your ordinary-income rate, which could be more than double your long-term rate.

Here are some additional tax considerations when selling a home:

Tax basis. To support an accurate tax basis, be sure to maintain thorough records, including information on your original cost and subsequent improvements, reduced by any casualty losses and depreciation claimed based on business use.

Losses. A loss on the sale of your principal residence generally isn’t deductible. But if part of your home is rented out or used exclusively for your business, the loss attributable to that portion may be deductible.

Second homes. If you’re selling a second home, be aware that it won’t be eligible for the gain exclusion. But if it qualifies as a rental property, it can be considered a business asset, and you may be able to defer tax on any gains through an installment sale or a Section 1031 exchange. Or you may be able to deduct a loss.

A big investment

Your home is likely one of your biggest investments, so it’s important to consider the tax consequences before selling it. If you’re planning to put your home on the market, we can help you assess the potential tax impact. Contact us to learn more.

© 2018

Is it time to adopt the new hedge accounting principles?

Implementing changes in accounting rules can be a real drag. But the new hedge accounting standard may be an exception to this generality. Many companies welcome this update and may even want to adopt it early, because the new rules are more flexible and attempt to make hedging strategies easier to report on financial statements.

Hedging strategies today

Hedging strategies protect earnings from unexpected price jumps in raw materials, changes in interest rates or fluctuations in foreign currencies. How? A business purchases futures, options or swaps and then designates these derivative instruments to a hedged item. Gains and losses from both items are then recognized in the same period, which, in turn, stabilizes earnings.

The existing rules require hedging transactions to be documented at inception and to be “highly effective.” After purchasing hedging instruments, businesses must periodically assess the transactions for their effectiveness.

The existing guidance on hedging is one of the most complex areas of U.S. Generally Accepted Accounting Principles (GAAP). So, companies have historically shied away from applying these rules to avoid errors and restatements.

In turn, investors complain that, when a business opts not to use the hedge accounting rules, it prevents stakeholders from truly understanding how the business operates. The new standard tries to address these potential shortcomings.

Future of hedge accounting

Accounting Standards Update (ASU) No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, expands the strategies that are eligible for hedge accounting to include 1) hedges of the benchmark rate component of the contractual coupon cash flows of fixed-rate assets or liabilities, 2) hedges of the portion of a closed portfolio of prepayable assets not expected to prepay, and 3) partial-term hedges of fixed-rate assets or liabilities.

In addition, the updated standard:

• Allows for hedging of nonfinancial components, such as corrugated material in a cardboard box or rubber in a tire,


• Eliminates an onerous penalty in the “shortcut” method of hedge accounting for interest rate swaps that meet specific criteria,


• Eliminates the concept of recording hedge “ineffectiveness,”


• Adds the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate to a list of acceptable benchmark interest rates for hedges of fixed-interest-rate items, and


• Revises the presentation and disclosure requirements for hedging to be more user-friendly.

ASU 2017-12 also provides practical expedients to make it easier for private businesses to apply the hedge accounting guidance.

Early adoption

The update will be effective for public companies for reporting periods starting after December 15, 2018. Private companies and other organizations will have an extra year to comply with the changes. But many companies are expected to adopt the amended standard for hedge accounting ahead of the effective date.

If you use hedging strategies, contact us to discuss how to report these complex transactions — and whether it makes sense to adopt the updated rules sooner rather than later. While many companies expect to adopt the amendments early, the transition process calls for more work than just picking up a calculator and applying the new guidance.

© 2018

What businesses need to know about the tax treatment of bitcoin and other virtual currencies

Over the last several years, virtual currency has become increasingly popular. Bitcoin is the most widely recognized form of virtual currency, also commonly referred to as digital, electronic or crypto currency.

While most smaller businesses aren’t yet accepting bitcoin or other virtual currency payments from their customers, more and more larger businesses are. And the trend may trickle down to smaller businesses. Businesses also can pay employees or independent contractors with virtual currency. But what are the tax consequences of these transactions?

Bitcoin 101

Bitcoin has an equivalent value in real currency and can be digitally traded between users. It also can be purchased with real currencies or exchanged for real currencies. Bitcoin is most commonly obtained through virtual currency ATMs or online exchanges.

Goods or services can be paid for using “bitcoin wallet” software. When a purchase is made, the software digitally posts the transaction to a global public ledger. This prevents the same unit of virtual currency from being used multiple times.

Tax impact

Questions about the tax impact of virtual currency abound. And the IRS has yet to offer much guidance.

The IRS did establish in a 2014 ruling that bitcoin and other convertible virtual currency should be treated as property, not currency, for federal income tax purposes. This means that businesses accepting bitcoin payments for goods and services must report gross income based on the fair market value of the virtual currency when it was received, measured in equivalent U.S. dollars.

When a business uses virtual currency to pay wages, the wages are taxable to the employees to the extent any other wage payment would be. You must, for example, report such wages on your employees’ W-2 forms. And they’re subject to federal income tax withholding and payroll taxes, based on the fair market value of the virtual currency on the date received by the employee.

When a business uses virtual currency to pay independent contractors or other service providers, those payments are also taxable to the recipient. The self-employment tax rules generally apply, based on the fair market value of the virtual currency on the date received. Payers generally must issue 1099-MISC forms to recipients.

Finally, payments made with virtual currency are subject to information reporting to the same extent as any other payment made in property.

Deciding whether to go virtual

Accepting bitcoin can be beneficial because it may avoid transaction fees charged by credit card companies and online payment providers (such as PayPal) and attract customers who want to use virtual currency. But the IRS is targeting virtual currency transactions in an effort to raise tax revenue, and it hasn’t issued much guidance on the tax treatment or reporting requirements. So bitcoin can also be a bit risky from a tax perspective.

To learn more about tax considerations when deciding whether your business should accept bitcoin or other virtual currencies — or use them to pay employees, independent contractors or other service providers — contact us.

© 2018

Financial sustainability and your nonprofit

If your not-for-profit relies heavily on a few funding sources — for example, an annual government or foundation grant — what happens if you suddenly lose that support? The risk may be compounded if you generally spend every penny that comes in the door and fail to build adequate reserves. Bottom line: If your nonprofit hopes to serve its community many years into the future, you need to think about financial sustainability now.

Information, please

No organization can accurately evaluate its sustainability without timely, comprehensive and accurate financial reporting. In addition to providing a current picture of your standing, financial reports should compare actual figures with historical and projected numbers. Some nonprofits use “dashboards” that give real-time financial data, ratios and trends in easily understood graphic form.

It’s not enough for the board to review financial statements. Board members must provide true fiscal oversight and not leave major financial decisions to staff, no matter how trusted and loyal. The finance committee should report regularly to the full board and engage in dialogue about their reports and the organization’s financial health. Most importantly, your board shouldn’t merely take a backward-looking view but should also consider the future — for example, how current trends and developments might affect future plans for funding your nonprofit’s mission.

Lower costs, more revenue

Holding expenses down and continually searching for new revenue sources are critical to long-term financial sustainability. Many nonprofits forge formal partnerships with other organizations to share costs. Look into partnering with organizations that share your missions and serve similar populations. Such collaboration may enable you to make better use of limited resources while reducing competition for funding. By joining forces, you can more quickly scale up high-demand programs or services.

If you’re seeking new revenue ideas, consider expanding fee-based service offerings to new locations or populations. For example, an organization that provides services to children with disabilities in schools also could offer the services to children with disabilities in foster homes.

Funds in reserve

Finally, maintaining adequate reserves is a key component of financial sustainability. If you don’t have a reserve fund — or have one but no formal policy for determining the appropriate amount, maintaining it and allocating funds when necessary — make developing such a policy a priority. Contact us for help.

© 2018

Do you need to adjust your withholding?

 
If you received a large refund after filing your 2017 income tax return, you’re probably enjoying the influx of cash. But a large refund isn’t all positive. It also means you were essentially giving the government an interest-free loan.

That’s why a large refund for the previous tax year would usually indicate that you should consider reducing the amounts you’re having withheld (and/or what estimated tax payments you’re making) for the current year. But 2018 is a little different.

TCJA and withholding

To reflect changes under the Tax Cuts and Jobs Act (TCJA) — such as the increase in the standard deduction, suspension of personal exemptions and changes in tax rates and brackets —the IRS updated the withholding tables that indicate how much employers should hold back from their employees’ paychecks, generally reducing the amount withheld.

The new tables may provide the correct amount of tax withholding for individuals with simple tax situations, but they might cause other taxpayers to not have enough withheld to pay their ultimate tax liabilities under the TCJA. So even if you received a large refund this year, you could end up owing a significant amount of tax when you file your 2018 return next year.

Perils of the new tables

The IRS itself cautions that people with more complex tax situations face the possibility of having their income taxes underwithheld. If, for example, you itemize deductions, have dependents age 17 or older, are in a two-income household or have more than one job, you should review your tax situation and adjust your withholding if appropriate.

The IRS has updated its withholding calculator (available at irs.gov) to assist taxpayers in reviewing their situations. The calculator reflects changes in available itemized deductions, the increased child tax credit, the new dependent credit and repeal of dependent exemptions.

More considerations

Tax law changes aren’t the only reason to check your withholding. Additional reviews during the year are a good idea if:

• You get married or divorced,

• You add or lose a dependent,

• You purchase a home,

• You start or lose a job, or

• Your investment income changes significantly.

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

The TCJA and your tax situation

If you rely solely on the new withholding tables, you could run the risk of significantly underwithholding your federal income taxes. As a result, you might face an unexpectedly high tax bill when you file your 2018 tax return next year. Contact us for help determining whether you should adjust your withholding. We can also answer any questions you have about how the TCJA may affect your particular situation.  

© 2018