Summer is just around the corner. If you’re fortunate enough to own a vacation home, you may wonder about the tax consequences of renting it out for part of the year.

The tax treatment depends on how many days it’s rented and your level of personal use. Personal use includes vacation use by your relatives (even if you charge them market rate rent) and use by nonrelatives if a market rate rent isn’t charged.

If you rent the property out for less than 15 days during the year, it’s not treated as “rental property” at all. In the right circumstances, this can produce significant tax benefits. Any rent you receive isn’t included in your income for tax purposes (no matter how substantial). On the other hand, you can only deduct property taxes and mortgage interest — no other operating costs and no depreciation. (Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.)

If you rent the property out for more than 14 days, you must include the rent you receive in income. However, you can deduct part of your operating expenses and depreciation, subject to several rules. First, you must allocate your expenses between the personal use days and the rental days. For example, if the house is rented for 90 days and used personally for 30 days, then 75% of the use is rental (90 days out of 120 total days). You would allocate 75% of your maintenance, utilities, insurance, etc., costs to rental. You would allocate 75% of your depreciation allowance, interest, and taxes for the property to rental as well. The personal use portion of taxes is separately deductible. The personal use portion of interest on a second home is also deductible if the personal use exceeds the greater of 14 days or 10% of the rental days. However, depreciation on the personal use portion isn’t allowed.

If the rental income exceeds these allocable deductions, you report the rent and deductions to determine the amount of rental income to add to your other income. If the expenses exceed the income, you may be able to claim a rental loss. This depends on how many days you use the house personally.

Here’s the test: if you use it personally for more than the greater of 1) 14 days, or 2) 10% of the rental days, you’re using it “too much,” and you can’t claim your loss. In this case, you can still use your deductions to wipe out rental income, but you can’t go beyond that to create a loss. Any unused deductions are carried forward and may be usable in future years. If you’re limited to using deductions only up to the amount of rental income, you must use the deductions allocated to the rental portion in the following order: 1) interest and taxes, 2) operating costs, 3) depreciation.

If you “pass” the personal use test (i.e., you don’t use the property personally more than the greater of the figures listed above), you must still allocate your expenses between the personal and rental portions. In this case, however, if your rental deductions exceed rental income, you can claim the loss. (The loss is “passive,” however, and may be limited under the passive loss rules.)

As you can see, the rules are complex. Contact us if you have questions or would like to plan ahead to maximize deductions in your situation.

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Typically, businesses want to delay recognition of taxable income into future years and accelerate deductions into the current year. But when is it prudent to do the opposite? And why would you want to?

One reason might be tax law changes that raise tax rates. There have been discussions in Washington about raising the corporate federal income tax rate from its current flat 21%. Another reason may be because you expect your noncorporate pass-through entity business to pay taxes at higher rates in the future, because the pass-through income will be taxed on your personal return. There have also been discussions in Washington about raising individual federal income tax rates.

If you believe your business income could be subject to tax rate increases, you might want to accelerate income recognition into the current tax year to benefit from the current lower tax rates. At the same time, you may want to postpone deductions into a later tax year, when rates are higher, and when the deductions will do more tax-saving good.

To accelerate income

Consider these options if you want to accelerate revenue recognition into the current tax year:

• Sell appreciated assets that have capital gains in the current year, rather than waiting until a later year.
• Review the company’s list of depreciable assets to determine if any fully depreciated assets are in need of replacement. If fully depreciated assets are sold, taxable gains will be triggered in the year of sale.
• For installment sales of appreciated assets, elect out of installment sale treatment to recognize gain in the year of sale.
• Instead of using a tax-deferred like-kind Section 1031 exchange, sell real property in a taxable transaction.
• Consider converting your S corporation into a partnership or LLC treated as a partnership for tax purposes. That will trigger gains from the company’s appreciated assets because the conversion is treated as a taxable liquidation of the S corp. The partnership will have an increased tax basis in the assets.
• For a construction company, do you have long-term construction contracts previously exempt from the percentage-of-completion method of accounting for long-term contracts? Consider using the percentage-of-completion method to recognize income sooner as compared to the completed contract method, which defers recognition of income until the long-term construction is completed.

To defer deductions

Consider the following actions to postpone deductions into a higher-rate tax year, which will maximize their value:

• Delay purchasing capital equipment and fixed assets, which would give rise to depreciation deductions.
• Forego claiming big first-year Section 179 deductions or bonus depreciation deductions on new depreciable assets and instead depreciate the assets over a number of years.
• Determine whether professional fees and employee salaries associated with a long-term project could be capitalized, which would spread out the costs over time and push the related deductions forward into a higher rate tax year.
• Purchase bonds at a discount this year to increase interest income in future years.
• If allowed, put off inventory shrinkage or other write-downs until a year with a higher tax rate.
• Delay charitable contributions into a year with a higher tax rate.
• If allowed, delay accounts receivable charge-offs to a year with a higher rate.
• Delay payment of liabilities where the related deduction is based on when the amount is paid.

Contact us to discuss the best tax planning actions in light of your business’s unique tax situation.

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Spring is the time of year that calendar-year-end businesses issue financial statements and prepare tax returns. This year, take your financial data beyond compliance. Here’s how financial statements can be used to be proactive, not reactive, to changes in the marketplace.

Perform a benchmarking study

Financial statements can be used to evaluate the company’s current performance vs. past performance or against industry norms. A comprehensive benchmarking study includes the following elements:

Size. This is usually in terms of annual revenue, total assets or market share.

Growth. How much the company’s size has changed from previous periods.

Profitability. This section evaluates whether the business is making money from operations — before considering changes in working capital accounts, investments in capital expenditures and financing activities.

Liquidity. Working capital ratios help assess how easily assets can be converted into cash and whether current assets are sufficient to cover current liabilities.

Asset management. Such ratios as total asset turnover (revenue divided by total assets) or inventory turnover (cost of sales divided by inventory) show how well the company manages its assets.

Leverage. This identifies how the company finances its operations — through debt or equity. There are pros and cons of both.

No universal benchmarks apply to all types of businesses. It’s important to seek data sorted by industry, size and geographic location, if possible.

Forecast the future

Financial statements also may be used to plan for the future. Historical results are often the starting point for forecasted balance sheets, income statements and statements of cash flows.

For example, variable expenses and working capital accounts are often assumed to grow in tandem with revenue. Other items, such as rent and management salaries, are fixed over the short run. These items may need to increase in steps over the long run. For instance, your company may eventually need to expand its factory or purchase equipment to grow if it’s currently at (or near) full capacity.

By tracking sources and uses of cash on the forecasted statement of cash flows, you can identify when cash shortfalls are likely to happen and plan how to make up the difference. For example, you might need to draw on the company’s line of credit, request additional capital contributions, lay off workers, reduce inventory levels or improve collections. In turn, these changes will flow through to the company’s forecasted balance sheet.

We can help

When your year-end financial statements are delivered, consider asking for guidance on how to put them to work for you. We can help you benchmark your results over time or against industry norms and plan for the future. Contact us for more information.

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In today’s economy, many small businesses are strapped for cash. They may find it beneficial to barter or trade for goods and services instead of paying cash for them. Bartering is the oldest form of trade and the internet has made it easier to engage with other businesses. But if your business gets involved in bartering, be aware that the fair market value of goods that you receive in bartering is taxable income. And if you exchange services with another business, the transaction results in taxable income for both parties.

How it works

Here are some examples:

• A computer consultant agrees to exchange services with an advertising agency.
• A plumber does repair work for a dentist in exchange for dental services.

In these cases, both parties are taxed on the fair market value of the services received. This is the amount they would normally charge for the same services. If the parties agree to the value of the services in advance, that will be considered the fair market value unless there’s contrary evidence.

In addition, if services are exchanged for property, income is realized. For example,

• If a construction firm does work for a retail business in exchange for unsold inventory, it will have income equal to the fair market value of the inventory.
• If an architectural firm does work for a corporation in exchange for shares of the corporation’s stock, it will have income equal to the fair market value of the stock.

Barter clubs

Many businesses join barter clubs that facilitate barter exchanges. These clubs generally use a system of “credit units,” which are awarded to members who provide goods and services. The credits can be redeemed for goods and services from other members.

In general, bartering is taxable in the year it occurs. But if you participate in a barter club, you may be taxed on the value of credit units at the time they’re added to your account, even if you don’t redeem them for actual goods and services until a later year. For example, let’s say that you earn 2,500 credit units one year, and that each unit is redeemable for $2 in goods and services. In that year, you’ll have $5,000 of income. You won’t pay additional tax if you redeem the units the next year, since you’ve already been taxed once on that income.

If you join a barter club, you’ll be asked to provide your Social Security number or Employer Identification Number. You’ll also be asked to certify that you aren’t subject to backup withholding. Unless you make this certification, the club is required to withhold tax from your bartering income at a 24% rate.

Reporting to the IRS

By January 31 of each year, a barter club will send participants a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” which shows the value of cash, property, services and credits that you received from exchanges during the previous year. This information will also be reported to the IRS.

Conserve cash, reap benefits

By bartering, you can trade away excess inventory or provide services during slow times, all while hanging onto your cash. You may also find yourself bartering when a customer doesn’t have the money on hand to complete a transaction. As long as you’re aware of the federal and state tax consequences, these transactions can benefit all parties. If you need assistance or would like more information, contact us.

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Despite the robust job market, there are still some people losing their jobs. If you’re laid off or terminated from employment, taxes are probably the last thing on your mind. However, there are tax implications due to your changed personal and professional circumstances. Depending on your situation, the tax aspects can be complex and require you to make decisions that may affect your tax picture this year and for years to come.

Unemployment and severance pay

Unemployment compensation is taxable, as are payments for any accumulated vacation or sick time. Although severance pay is also taxable and subject to federal income tax withholding, some elements of a severance package may be specially treated. For example:

• If you sell stock acquired by way of an incentive stock option (ISO), part or all of your gain may be taxed at lower long-term capital gain rates rather than at ordinary income tax rates, depending on whether you meet a special dual holding period.
• If you received — or will receive — what’s commonly referred to as a “golden parachute payment,” you may be subject to an excise tax equal to 20% of the portion of the payment that’s treated as an “excess parachute payment” under very complex rules, along with the excess parachute payment also being subject to ordinary income tax.
• The value of job placement assistance you receive from your former employer usually is tax-free. However, the assistance is taxable if you had a choice between receiving cash or outplacement help.

Health insurance

Also, be aware that under the COBRA rules, most employers that offer group health coverage must provide continuation coverage to most terminated employees and their families. While the cost of COBRA coverage may be expensive, the cost of any premium you pay for insurance that covers medical care is a medical expense, which is deductible if you itemize deductions and if your total medical expenses exceed 7.5% of your adjusted gross income.

If your ex-employer pays for some of your medical coverage for a period of time following termination, you won’t be taxed on the value of this benefit. And if you lost your job as a result of a foreign-trade-related circumstance, you may qualify for a refundable credit for 72.5% of your qualifying health insurance costs.

Retirement plans

Employees whose employment is terminated may also need tax planning help to determine the best option for amounts they’ve accumulated in retirement plans sponsored by former employers. For most, a tax-free rollover to an IRA is the best move, if the terms of the plan allow a pre-retirement payout.

If the distribution from the retirement plan includes employer securities in a lump sum, the distribution is taxed under the lump-sum rules except that “net unrealized appreciation” in the value of the stock isn’t taxed until the securities are sold or otherwise disposed of in a later transaction. If you’re under age 59½, and must make withdrawals from your company plan or IRA to supplement your income, there may be an additional 10% penalty tax to pay unless you qualify for an exception.

Further, any loans you’ve taken out from your employer’s retirement plan, such as a 401(k)-plan loan, may be required to be repaid immediately, or within a specified period. If they aren’t, they may be treated as if the loan is in default. If the balance of the loan isn’t repaid within the required period, it will typically be treated as a taxable deemed distribution.

Contact us so that we can chart the best tax course for you during this transition period.

© 2022

The credit for increasing research activities, often referred to as the research and development (R&D) credit, is a valuable tax break available to eligible businesses. Claiming the credit involves complex calculations, which we can take care of for you. But in addition to the credit itself, be aware that the credit also has two features that are especially favorable to small businesses:

1. Eligible small businesses ($50 million or less in gross receipts) may claim the credit against alternative minimum tax (AMT) liability.
2. The credit can be used by certain even smaller startup businesses against the employer’s Social Security payroll tax liability.

Let’s take a look at the second feature. Subject to limits, you can elect to apply all or some of any research tax credit that you earn against your payroll taxes instead of your income tax. This payroll tax election may influence you to undertake or increase your research activities. On the other hand, if you’re engaged in — or are planning to undertake — research activities without regard to tax consequences, be aware that you could receive some tax relief.

Why the election is important

Many new businesses, even if they have some cash flow, or even net positive cash flow and/or a book profit, pay no income taxes and won’t for some time. Thus, there’s no amount against which business credits, including the research credit, can be applied. On the other hand, any wage-paying business, even a new one, has payroll tax liabilities. Therefore, the payroll tax election is an opportunity to get immediate use out of the research credits that you earn. Because every dollar of credit-eligible expenditure can result in as much as a 10-cent tax credit, that’s a big help in the start-up phase of a business — the time when help is most needed.

Eligible businesses

To qualify for the election a taxpayer must:

• Have gross receipts for the election year of less than $5 million and
• Be no more than five years past the period for which it had no receipts (the start-up period).

In making these determinations, the only gross receipts that an individual taxpayer takes into account are from the individual’s businesses. An individual’s salary, investment income or other income aren’t taken into account. Also, note that an entity or individual can’t make the election for more than six years in a row.

Limits on the election

The research credit for which the taxpayer makes the payroll tax election can be applied only against the Social Security portion of FICA taxes. It can’t be used to lower the employer’s lability for the “Medicare” portion of FICA taxes or any FICA taxes that the employer withholds and remits to the government on behalf of employees.

The amount of research credit for which the election can be made can’t annually exceed $250,000. Note, too, that an individual or C corporation can make the election only for those research credits which, in the absence of an election, would have to be carried forward. In other words, a C corporation can’t make the election for the research credit that the taxpayer can use to reduce current or past income tax liabilities.

The above are just the basics of the payroll tax election. Keep in mind that identifying and substantiating expenses eligible for the research credit itself is a complex area. Contact us about whether you can benefit from the payroll tax election and the research tax credit. 

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