If you own a valuable piece of art, or other property, you may wonder how much of a tax deduction you could get by donating it to charity.

The answer to that question can be complex because several different tax rules may come into play with such contributions. A charitable contribution of a work of art is subject to reduction if the charity’s use of the work of art is unrelated to the purpose or function that’s the basis for its qualification as a tax-exempt organization. The reduction equals the amount of capital gain you’d have realized had you sold the property instead of giving it to charity.

For example, let’s say you bought a painting years ago for $10,000 that’s now worth $20,000. You contribute it to a hospital. Your deduction is limited to $10,000 because the hospital’s use of the painting is unrelated to its charitable function, and you’d have a $10,000 long-term capital gain if you sold it. What if you donate the painting to an art museum? In that case, your deduction is $20,000.

Substantiation requirements

One or more substantiation rules may apply when donating art. First, if you claim a deduction of less than $250, you must get and keep a receipt from the organization and keep written records for each item contributed.

If you claim a deduction of $250 to $500, you must get and keep an acknowledgment of your contribution from the charity. It must state whether the organization gave you any goods or services in return for your contribution and include a description and good faith estimate of the value of any goods or services given.

If you claim a deduction in excess of $500, but not over $5,000, in addition to getting an acknowledgment, you must maintain written records that include information about how and when you obtained the property and its cost basis. You must also complete an IRS form and attach it to your tax return.

If the claimed value of the property exceeds $5,000, in addition to an acknowledgment, you must also have a qualified appraisal of the property. This is an appraisal that was done by a qualified appraiser no more than 60 days before the contribution date and meets numerous other requirements. You include information about these donations on an IRS form filed with your tax return.

If your total deduction for art is $20,000 or more, you must attach a copy of the signed appraisal. If an item is valued at $20,000 or more, the IRS may request a photo. If an art item has been appraised at $50,000 or more, you can ask the IRS to issue a “Statement of Value” that can be used to substantiate the value.

Percentage limitations

In addition, your deduction may be limited to 20%, 30%, 50%, or 60% of your contribution base, which usually is your adjusted gross income. The percentage varies depending on the year the contribution is made, the type of organization, and whether the deduction of the artwork had to be reduced because of the unrelated use rule explained above. The amount not deductible on account of a ceiling may be deductible in a later year under carryover rules.

Other rules may apply

Donors sometimes make gifts of partial interests in a work of art. Special requirements apply to these donations. If you’d like to discuss any of these rules, please contact us.

© 2021

Employers offer 401(k) plans for many reasons, including to attract and retain talent. These plans help an employee accumulate a retirement nest egg on a tax-advantaged basis. If you’re thinking about participating in a plan at work, here are some of the features.

Under a 401(k) plan, you have the option of setting aside a certain amount of your wages in a qualified retirement plan. By electing to set cash aside in a 401(k) plan, you’ll reduce your gross income, and defer tax on the amount until the cash (adjusted by earnings) is distributed to you. It will either be distributed from the plan or from an IRA or other plan that you roll your proceeds into after leaving your job.

Tax advantages

Your wages or other compensation will be reduced by the amount of pre-tax contributions that you make — saving you current income taxes. But the amounts will still be subject to Social Security and Medicare taxes. If your employer’s plan allows, you may instead make all, or some, contributions on an after-tax basis (these are Roth 401(k) contributions). With Roth 401(k) contributions, the amounts will be subject to current income taxation, but if you leave these funds in the plan for a required time, distributions (including earnings) will be tax-free.

Your elective contributions — either pre-tax or after-tax — are subject to annual IRS limits. For 2021, the maximum amount permitted is $19,500. When you reach age 50, if your employer’s plan allows, you can make additional “catch-up” contributions. For 2021, that additional amount is $6,500. So if you’re 50 or older, the total that you can contribute to all 401(k) plans in 2021 is $26,000. Total employer contributions, including your elective deferrals (but not catch-up contributions), can’t exceed 100% of compensation or, for 2021, $58,000, whichever is less.

Typically, you’ll be permitted to invest the amount of your contributions (and any employer matching or other contributions) among available investment options that your employer has selected. Periodically review your plan investment performance to determine that each investment remains appropriate for your retirement planning goals and your risk specifications.

Getting money out

Another important aspect of these plans is the limitation on distributions while you’re working. First, amounts in the plan attributable to elective contributions aren’t available to you before one of the following events: retirement (or other separation from service), disability, reaching age 59½, hardship, or plan termination. And eligibility rules for a hardship withdrawal are very stringent. A hardship distribution must be necessary to satisfy an immediate and heavy financial need.

As an alternative to taking a hardship or other plan withdrawal while employed, your employer’s 401(k) plan may allow you to receive a plan loan, which you pay back to your account, with interest. Any distribution that you do take can be rolled into another employer’s plan (if that plan permits) or to an IRA. This allows you to continue deferral of tax on the amount rolled over. Taxable distributions are generally subject to 20% federal tax withholding, if not rolled over.

Employers may opt to match contributions up to a certain amount. If your employer matches contributions, you should make sure to contribute enough to receive the full match. Otherwise, you’ll miss out on free money!

These are just the basics of 401(k) plans for employees. For more information, contact your employer. Of course, we can answer any tax questions you may have.

© 2021

Are employees at your business traveling again after months of virtual meetings? In Notice 2021-52, the IRS announced the fiscal 2022 “per diem” rates that became effective October 1, 2021. Taxpayers can use these rates to substantiate the amount of expenses for lodging, meals and incidental expenses when traveling away from home. (Taxpayers in the transportation industry can use a special transportation industry rate.)

Background information

A simplified alternative to tracking actual business travel expenses is to use the high-low per diem method. This method provides fixed travel per diems. The amounts are based on rates set by the IRS that vary from locality to locality.

Under the high-low method, the IRS establishes an annual flat rate for certain areas with higher costs of living. All locations within the continental United States that aren’t listed as “high-cost” are automatically considered “low-cost.” The high-low method may be used in lieu of the specific per diem rates for business destinations. Examples of high-cost areas include Boston, San Francisco and Seattle.

Under some circumstances — for example, if an employer provides lodging or pays the hotel directly — employees may receive a per diem reimbursement only for their meals and incidental expenses. There’s also a $5 incidental-expenses-only rate for employees who don’t pay or incur meal expenses for a calendar day (or partial day) of travel.

Less recordkeeping

If your company uses per diem rates, employees don’t have to meet the usual recordkeeping rules required by the IRS. Receipts of expenses generally aren’t required under the per diem method. But employees still must substantiate the time, place and business purpose of the travel. Per diem reimbursements generally aren’t subject to income or payroll tax withholding or reported on an employee’s Form W-2.

The FY2022 rates

For travel after September 30, 2021, the per diem rate for all high-cost areas within the continental United States is $296. This consists of $222 for lodging and $74 for meals and incidental expenses. For all other areas within the continental United States, the per diem rate is $202 for travel after September 30, 2021 ($138 for lodging and $64 for meals and incidental expenses). Compared to the FY2021 per diems, both the high and low-cost area per diems increased $4.

Important: This method is subject to various rules and restrictions. For example, companies that use the high-low method for an employee must continue using it for all reimbursement of business travel expenses within the continental United States during the calendar year. However, the company may use any permissible method to reimburse that employee for any travel outside the continental United States.

For travel during the last three months of a calendar year, employers must continue to use the same method (per diem or high-low method) for an employee as they used during the first nine months of the calendar year. Also, note that per diem rates can’t be paid to individuals who own 10% or more of the business.

If your employees are traveling, it may be a good time to review the rates and consider switching to the high-low method. It can reduce the time and frustration associated with traditional travel reimbursement. Contact us for more information.

© 2021

When creating or updating your strategic plan, you might be tempted to focus on innovative products or services, new geographic locations, or technological upgrades. But, what about your customers? Particularly if you’re a small to midsize business, focusing your strategic planning efforts on them may be the most direct route to a better bottom line.

Do your ABCs

To get started, pick a period — perhaps one, three or five years — and calculate the profitability contribution level of each major customer or customer unit based on sales numbers and both direct and indirect costs. (We can help you choose the ideal metrics and run the numbers.)

Once you’ve determined the profitability contribution level of each customer or customer unit, divide them into three groups: 1) an A group consisting of highly profitable customers whose business you’d like to expand, 2) a B group comprising customers who aren’t extremely profitable, but still positively contribute to your bottom line, and 3) a C group that includes customers who are dragging down your profitability, perhaps because of constant late payments or unreasonably high-maintenance relationships. These are the ones you can’t afford to keep.

Devise strategies

Your objective with A customers should be to strengthen your rapport with them. Identify what motivates them to buy, so you can continue to meet their needs. Is it something specific about your products or services? Is it your customer service? Developing a good understanding of this group will help you not only build your relationships with these critical customers, but also target sales and marketing efforts to attract other, similar ones.

As mentioned, Category B customers have some profit value. However, just by virtue of sitting in the middle, they can slide either way. There’s a good chance that, with the right mix of sales, marketing and customer service efforts, some of them can be turned into A customers. Determine which ones have the most in common with your best customers, then focus your efforts on them and track the results.

Finally, take a hard look at the C group. You could spend a nominal amount of time determining whether any of them might move up the ladder. It’s likely, though, that most of your C customers simply aren’t a good fit for your company. Fortunately, firing your least desirable customers won’t require much effort. Simply curtail your sales and marketing efforts, or stop them entirely, and most will wander off on their own.

Brighten your future

As the calendar year winds down, examine how your customer base has changed over the past months. Ask questions such as: Have the evolving economic changes triggered (at least in part) by the pandemic affected who buys from us and how much? Then tailor your strategic plan for 2022 accordingly.

Please contact our firm for help reviewing the pertinent data and developing a customer-focused strategic plan that brightens your company’s future.

© 2021

The Build Back Better Act is far from  being a done deal, so by time you read this the legislative landscape may have already changed.

On Thursday, October 28, the House Rules Committee released draft text of the modified Build Back Better Act. The modified text includes a substantial number of changes to the tax-related provisions included in the bill released in September 2021. 

The bill does not include many of the increased tax rates originally planned. Below are some of the items not included in the revised bill:

• Increase in corporate income tax rate
• Increase in individual ordinary income tax rates (with exception of a surcharge for certain taxpayers discussed below)
• Increase in capital gains and qualified dividend rates
• Carried interest modifications
• Grantor trust modifications
• Gift and Estate lifetime exemption reduction
• Limit on deduction of qualified business income for certain “high income” individuals

New tax provisions have been added to the prior version of the bill, including, but not limited:

• Imposes a 5% surtax on individual taxpayer’s modified adjusted gross income (MAGI) in excess of $10 million and an additional 3% (total 8% surtax) of MAGI in excess of $25 million. The 5% and 3% surtax will apply to estates and trusts at $200,000 and $500,000, respectively.
• Imposes 3.8% net investment income tax on trade or business income for individual taxpayers earning $400,000 ($500,000 if filing a joint return).
• Imposes new limitation on excess business losses.
• Imposes a 15% minimum tax on adjusted financial statement income for corporations with a three-year average of such income over $1 billion.
• Increases global intangible low-taxed income (GILTI) from 10.5% to 15% and assesses the tax on a country-by-country basis.
• Adjusts the Base Erosion Anti-Abuse Tax and other international tax provisions.
• Limits the gain exclusion on the sale of qualified small business stock to taxpayers with adjusted gross income under $400,000.
• Introduces green energy credits.

These are only some of the high-level items currently included in the bill. There could be additional changes before the bill is brought to the floor for a vote in the House and Senate. The timing of a vote is still unclear.

We will keep you up to date as the Bill continues to evolve and make its way through Congress. If you have any questions in the meantime, please do not hesitate to contact us.

As Congress vacillates over its spending Bill, it gives us a lot of time to speculate on what we would do if certain proposals come to light. Please keep in mind that everything is up in the air at the moment, so we are not recommending any action. We just need to explore options so we are ready for a potential late in the year Tax Bill.

Under the House Ways & Means Committee mark up, the Democrats proposed language that would make assets in a grantor trust includable in the grantor’s estate, eliminating the ability to set up “intentionally defective trusts”. This will eliminate a grantors’ ability to pay income taxes on behalf of the trust without triggering taxable gifts. The legislation would also make it so that transactions with an existing grantor trust, such as sale of a business or other assets, would not be ignored for tax purposes and would become taxable.

This change would significantly diminish, if not eliminate, the use of these type of arrangements which have been a cornerstone of estate planning

If that comes to pass, what would the estate planning landscape look like?

The current proposals have grandfather provisions for existing grantor trusts and transactions, but once that is exhausted, we believe we will see a shift towards non-grantor trusts. Non-grantor trusts are treated as separate taxpayers which can create some tax advantages.

Depending on the final law passed, there a variety of advantages that could be gained from a non-grantor trust. For instance, we may be able to shift income to low-income taxed states. Unlike grantor trusts, which share the grantor’s residency, non-grantor trusts are treated as separate taxpayers and can often be located in a different, low-tax state.

Another tax planning opportunity with non-grantor trusts involves qualified small business stock (QSBS), which House Democrats want to scale back. Taxpayers now can generally claim up to a 100 percent tax exclusion equal to the greater of $10 million or 10 times the tax basis upon the disposition of QSBS. The House proposal, would limit the exclusion to 50 percent of gain for any trust or estate, or for individuals with an adjusted gross income above $400,000.

Even under the proposed regime, the exclusion limitation would apply on a per-issuer basis, and because non-grantor trusts are treated as separate taxpayers for purposes of this limitation, the exclusion might be multiplied for gifted stock.

Another potential opportunity offered by non-grantor trusts is the ability of the taxpayer to control the timing of gain recognition, either to accelerate gains in anticipation of a tax rate increase or to defer income taxes. If a client sells an asset to a non-grantor trust and elects the installment sale method, the client may have better control over the timing of the gain that is recognized compared with the sale of that same asset to a third party in which there is no installment method available.

It is still too early to know which direction the final legislation will take, but it is important to have a rough game plan for how we would respond to the significant changes being discussed in Congress.

We will continue to monitor the development of this legislation and develop taxpayer friendly strategies to help mitigate the impact of these changes.

If your business is depreciating over a 30-year period the entire cost of constructing the building that houses your operation, you should consider a cost segregation study. It might allow you to accelerate depreciation deductions on certain items, thereby reducing taxes and boosting cash flow. And under current law, the potential benefits of a cost segregation study are now even greater than they were a few years ago due to enhancements to certain depreciation-related tax breaks.

Fundamentals of depreciation

Generally, business buildings have a 39-year depreciation period (27.5 years for residential rental properties). Usually, you depreciate a building’s structural components, including walls, windows, HVAC systems, elevators, plumbing and wiring, along with the building. Personal property — such as equipment, machinery, furniture and fixtures — is eligible for accelerated depreciation, usually over five or seven years. And land improvements, such as fences, outdoor lighting and parking lots, are depreciable over 15 years.

Often, businesses allocate all or most of their buildings’ acquisition or construction costs to real property, overlooking opportunities to allocate costs to shorter-lived personal property or land improvements. In some cases — computers or furniture, for example — the distinction between real and personal property is obvious. But the line between the two is frequently less clear. Items that appear to be “part of a building” may in fact be personal property, like removable wall and floor coverings, removable partitions, awnings and canopies, window treatments, signs and decorative lighting.

In addition, certain items that otherwise would be treated as real property may qualify as personal property if they serve more of a business function than a structural purpose. This includes reinforced flooring to support heavy manufacturing equipment, electrical or plumbing installations required to operate specialized equipment, or dedicated cooling systems for data processing rooms.

Classify property into the appropriate asset classes

A cost segregation study combines accounting and engineering techniques to identify building costs that are properly allocable to tangible personal property rather than real property. Although the relative costs and benefits of a cost segregation study depend on your particular facts and circumstances, it can be a valuable investment.

The Tax Cuts and Jobs Act (TCJA) enhances certain depreciation-related tax breaks, which may also enhance the benefits of a cost segregation study. Among other things, the act permanently increased limits on Section 179 expensing, which allows you to immediately deduct the entire cost of qualifying equipment or other fixed assets up to specified thresholds.

The TCJA also expanded 15-year-property treatment to apply to qualified improvement property. Previously this break was limited to qualified leasehold improvement, retail improvement and restaurant property. And it temporarily increased first-year bonus depreciation to 100% (from 50%).

The savings can be substantial

Fortunately, it isn’t too late to get the benefit of speedier depreciation for items that were incorrectly assumed to be part of your building for depreciation purposes. You don’t have to amend your past returns (or meet a deadline for claiming tax refunds) to claim the depreciation that you could have already claimed. Instead, you can claim that depreciation by following procedures, in connection with the next tax return that you file, that will result in “automatic” IRS consent to a change in your accounting for depreciation.

Cost segregation studies can yield substantial benefits, but they’re not right for every business. We can judge whether a study will result in overall tax savings greater than the costs of the study itself. Contact us to find out whether this would be worthwhile for you.

© 2021

If you’re fortunate enough to own a vacation home, you may want to rent it out for part of the year. What are the tax consequences?

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

Less than 15 days

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 revenue and significant tax benefits. Any rent you receive isn’t included in your income for tax purposes. On the other hand, you can only deduct property taxes and mortgage interest — no other operating costs or 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 received in income. However, you can deduct part of your operating expenses and depreciation, subject to certain 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, 75% of the use is rental (90 out of 120 total use days). You’d allocate 75% of your costs such as maintenance, utilities and insurance to rental. You’d also allocate 75% of your depreciation allowance, interest and taxes for the property to rental. The personal use portion of taxes is separately deductible. The personal use part of interest on a second home is also deductible (if eligible) where 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.

Claiming a loss

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 for personal purposes.

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

If you “pass” the personal use test, 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 passive loss rules.)

Planning ahead

These are only the basic rules. There may be other rules if you’re considered a small landlord or real estate professional. Contact us if you have questions. We can help plan your vacation home use to achieve optimal tax results.

© 2021

When choosing health care benefits, many businesses opt for a self-insured (self-funded) plan rather than a fully insured one. Why? Among various reasons, self-insured plans tend to offer greater flexibility and potentially lower fixed costs.

When implementing a self-insured plan, stop-loss insurance is typically recommended. Although buying such a policy isn’t required, many small to midsize companies find it a beneficial risk-management tool.

Purpose of coverage

Specifically, stop-loss insurance protects the business against the risk that health care plan claims greatly exceed the amount budgeted to cover costs. Plan administration costs generally are fixed in advance, and an actuary can estimate claims costs. This information allows a company to budget for the estimated overall plan cost. However, exceptionally large — that is, catastrophic — claims can bust the budget.

To be clear, stop-loss insurance doesn’t pay participants’ health care benefits. Rather, it reimburses the business for certain claims properly paid by the plan above a stated amount. A less common approach for single-employer plans is to buy a stop-loss policy as a plan asset, in which case the coverage reimburses the plan, rather than the employer.

The threshold for stop-loss insurance is referred to as the “stop-loss attachment point.” A policy may have a specific attachment point (which applies to claims for individual participants or beneficiaries), an aggregate attachment point (which applies to total covered claims for participants and beneficiaries) or both.

Aligning plan and coverage terms

If you choose to buy stop-loss insurance, it’s critical to line up the terms of the coverage with the terms of your health care plan. Otherwise, some claims paid by the plan that you might expect to be reimbursed by the insurance might not be — and would instead remain your responsibility.

Properly lining up coverage terms isn’t always straightforward, so consider having legal counsel familiar with the terms of your health care plan review any proposed or existing stop-loss policy. In particular, watch out for discrepancies between the eligibility provisions, definitions, limits and exclusions of your plan and those same elements of the stop-loss policy.

Because stop-loss insurance isn’t health care coverage, insurers may impose limits and exclusions that are impermissible for group health plans. For example, a stop-loss policy can exclude coverage of specified individuals or services. Or it can impose an annual or lifetime dollar limit per individual.

You’ll also need to look carefully at the stop-loss policy’s coverage period. This is the period during which claims must be incurred by individuals or paid by the health care plan to be covered by the insurance. Specifically, determine whether it lines up with your plan year.

Cost-effective coverage

After buying stop-loss insurance, be extra sure to administer your health care plan in accordance with its written plan document. Any departures from the plan document could render the stop-loss coverage inapplicable. We can help you determine whether stop-loss insurance is right for your business or whether your current coverage is cost-effective.

© 2021

Have you heard of the “nanny tax?” Even if you don’t employ a nanny, it may apply to you. Hiring a house cleaner, gardener or other household employee (who isn’t an independent contractor) may make you liable for federal income and other taxes. You may also have state tax obligations.

If you employ a household worker, you aren’t required to withhold federal income taxes from pay. But you can choose to withhold if the worker requests it. In that case, ask the worker to fill out a Form W-4. However, you may be required to withhold Social Security and Medicare (FICA) taxes and to pay federal unemployment (FUTA) tax.

2021 and 2022 thresholds

In 2021, you must withhold and pay FICA taxes if your household worker earns cash wages of $2,300 or more (excluding the value of food and lodging). The Social Security Administration recently announced that this amount would increase to $2,400 in 2022. If you reach the threshold, all the wages (not just the excess) are subject to FICA.

However, if a nanny is under age 18 and childcare isn’t his or her principal occupation, you don’t have to withhold FICA taxes. So, if you have a part-time student babysitter, there’s no FICA tax liability.

Both an employer and a household worker may have FICA tax obligations. As an employer, you’re responsible for withholding your worker’s FICA share. In addition, you must pay a matching amount. FICA tax is divided between Social Security and Medicare. The Social Security tax rate is 6.2% for the employer and 6.2% for the worker (12.4% total). Medicare tax is 1.45% each for the employer and the worker (2.9% total).

If you want, you can pay your worker’s share of Social Security and Medicare taxes. If you do, your payments aren’t counted as additional cash wages for Social Security and Medicare purposes. However, your payments are treated as additional income to the worker for federal tax purposes, so you must include them as wages on the W-2 form that you must provide.

You also must pay FUTA tax if you pay $1,000 or more in cash wages (excluding food and lodging) to your worker in any calendar quarter. FUTA tax applies to the first $7,000 of wages paid and is only paid by the employer.

Paperwork and payments

You pay household worker obligations by increasing your quarterly estimated tax payments or increasing withholding from wages, rather than making an annual lump-sum payment.

As an employer of a household worker, you don’t have to file employment tax returns, even if you’re required to withhold or pay tax (unless you own your own business). Instead, employment taxes are reported on your tax return on Schedule H.

When you report the taxes on your return, include your employer identification number (not the same as your Social Security number). You must file Form SS-4 to get one.

However, if you own a business as a sole proprietor, you include the taxes for a household worker on the FUTA and FICA forms (940 and 941) that you file for the business. And you use your sole proprietorship EIN to report the taxes.

Recordkeeping is important

Keep related tax records for at least four years from the later of the due date of the return or the date the tax was paid. Records should include the worker’s name, address, Social Security number, employment dates, dates and amount of wages paid and taxes withheld, and copies of forms filed.

Contact us for assistance or questions about how to comply with these requirements.

© 2021