The housing market in many parts of the country is strong this spring. If you’re buying or selling a home, you should know how to determine your “basis.”

How it works

You can claim an itemized deduction on your tax return for real estate taxes and home mortgage interest. Most other home ownership costs can’t be deducted currently. However, these costs may increase your home’s “basis” (your cost for tax purposes). And a higher basis can save taxes when you sell.

The law allows an exclusion from income for all or part of the gain realized on the sale of your home. The general exclusion limit is $250,000 ($500,000 for married taxpayers). You may feel the exclusion amount makes keeping track of the basis relatively unimportant. Many homes today sell for less than $500,000. However, that reasoning doesn’t take into account what may happen in the future. If history is any indication, a home that’s owned for 20 or 30 years appreciates greatly. Thus, you want your basis to be as high as possible in order to avoid or reduce the tax that may result when you eventually sell.

Good recordkeeping

To prove the amount of your basis, keep accurate records of your purchase price, closing costs, and other expenses that increase your basis. Save receipts and other records for improvements and additions you make to the home. When you eventually sell, your basis will establish the amount of your gain. Keep the supporting documentation for at least three years after you file your return for the sale year.

Start with the purchase price

The main element in your home’s basis is the purchase price. This includes your down payment and any debt, such as a mortgage. It also includes certain settlement or closing costs. If you had your house built on land you own, your basis is the cost of the land plus certain costs to complete the house.

You add to the cost of your home expenses that you paid in connection with the purchase, including attorney’s fees, abstract fees, owner’s title insurance, recording fees and transfer taxes. The basis of your home is affected by expenses after a casualty to restore damaged property and depreciation if you used your home for business or rental purposes,

Over time, you may make additions and improvements to your home. Add the cost of these improvements to your basis. Improvements that add to your home’s basis include:

• A room addition,
• Finishing the basement,
• A fence,
• Storm windows or doors,
• A new heating or central air conditioning system,
• Flooring,
• A new roof, and
• Driveway paving.

Home expenses that don’t add much to the value or the property’s life are considered repairs, not improvements. Therefore, you can’t add them to the property’s basis. Repairs include painting, fixing gutters, repairing leaks and replacing broken windows. However, an entire job is considered an improvement if items that would otherwise be considered repairs are done as part of extensive remodeling.

The cost of appliances purchased for your home generally don’t add to your basis unless they are considered attached to the house. Thus, the cost of a built-in oven or range would increase basis. But an appliance that can be easily removed wouldn’t.

Plan for best results

Other rules and requirements may apply. We can help you plan for the best tax results involving your home’s basis.

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Do you play a major role in a closely held corporation and sometimes spend money on corporate expenses personally? These costs may wind up being nondeductible both by an officer and the corporation unless proper steps are taken. This issue is more likely to arise in connection with a financially troubled corporation.

Deductible vs. nondeductible expenses

In general, you can’t deduct an expense you incur on behalf of your corporation, even if it’s a legitimate “trade or business” expense and even if the corporation is financially troubled. This is because a taxpayer can only deduct expenses that are his own. And since your corporation’s legal existence as a separate entity must be respected, the corporation’s costs aren’t yours and thus can’t be deducted even if you pay them.

What’s more, the corporation won’t generally be able to deduct them either because it didn’t pay them itself. Accordingly, be advised that it shouldn’t be a practice of your corporation’s officers or major shareholders to cover corporate costs.

When expenses may be deductible

On the other hand, if a corporate executive incurs costs that relate to an essential part of his or her duties as an executive, they may be deductible as ordinary and necessary expenses related to his or her “trade or business” of being an executive. If you wish to set up an arrangement providing for payments to you and safeguarding their deductibility, a provision should be included in your employment contract with the corporation stating the types of expenses which are part of your duties and authorizing you to incur them. For example, you may be authorized to attend out-of-town business conferences on the corporation’s behalf at your personal expense.

Alternatively, to avoid the complete loss of any deductions by both yourself and the corporation, an arrangement should be in place under which the corporation reimburses you for the expenses you incur. Turn the receipts over to the corporation and use an expense reimbursement claim form or system. This will at least allow the corporation to deduct the amount of the reimbursement.

Contact us if you’d like assistance or would like to discuss these issues further.

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Are you eligible to take the deduction for qualified business income (QBI)? Here are 10 facts about this valuable tax break, referred to as the pass-through deduction, QBI deduction or Section 199A deduction. 

1. It’s available to owners of sole proprietorships, single member limited liability companies (LLCs), partnerships and S corporations. It may also be claimed by trusts and estates.
2. The deduction is intended to reduce the tax rate on QBI to a rate that’s closer to the corporate tax rate.
3. It’s taken “below the line.” That means it reduces your taxable income but not your adjusted gross income. But it’s available regardless of whether you itemize deductions or take the standard deduction.
4. The deduction has two components: 20% of QBI from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust or estate; and 20% of the taxpayer’s combined qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income.
5. QBI is the net amount of a taxpayer’s qualified items of income, gain, deduction and loss relating to any qualified trade or business. Items of income, gain, deduction and loss are qualified to the extent they’re effectively connected with the conduct of a trade or business in the U.S. and included in computing taxable income.
6. QBI doesn’t necessarily equal the net profit or loss from a business, even if it’s a qualified trade or business. In addition to the profit or loss from Schedule C, QBI must be adjusted by certain other gain or deduction items related to the business.
7. A qualified trade or business is any trade or business other than a specified service trade or business (SSTB). But an SSTB is treated as a qualified trade or business for taxpayers whose taxable income is under a threshold amount.
8. SSTBs include health, law, accounting, actuarial science, certain performing arts, consulting, athletics, financial services, brokerage services, investment, trading, dealing securities and any trade or business where the principal asset is the reputation or skill of its employees or owners.
9. There are limits based on W-2 wages. Inflation-adjusted threshold amounts also apply for purposes of applying the SSTB rules. For tax years beginning in 2021, the threshold amounts are $164,900 for singles and heads of household; $164,925 for married filing separately; and $329,800 for married filing jointly. The limits phase in over a $50,000 range ($100,000 for a joint return). This means that the deduction reduces ratably, so that by the time you reach the top of the range ($214,900 for singles and heads of household; $214,925 for married filing separately; and $429,800 for married filing jointly) the deduction is zero for income from an SSTB.
10. For businesses conducted as a partnership or S corporation, the pass-through deduction is calculated at the partner or shareholder level.

As you can see, this substantial deduction is complex, especially if your taxable income exceeds the thresholds discussed above. Other rules apply. Contact us if you have questions about your situation.

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The Employee Retention Tax Credit (ERTC) is a valuable tax break that was extended and modified by the American Rescue Plan Act (ARPA), enacted in March of 2021. Here’s a rundown of the rules.

Background

Back in March of 2020, Congress originally enacted the ERTC in the CARES Act to encourage employers to hire and retain employees during the pandemic. At that time, the ERTC applied to wages paid after March 12, 2020, and before January 1, 2021. However, Congress later modified and extended the ERTC to apply to wages paid before July 1, 2021.

The ARPA again extended and modified the ERTC to apply to wages paid after June 30, 2021, and before January 1, 2022. Thus, an eligible employer can claim the refundable ERTC against “applicable employment taxes” equal to 70% of the qualified wages it pays to employees in the third and fourth quarters of 2021. Except as discussed below, qualified wages are generally limited to $10,000 per employee per 2021 calendar quarter. Thus, the maximum ERTC amount available is generally $7,000 per employee per calendar quarter or $28,000 per employee in 2021.

For purposes of the ERTC, a qualified employer is eligible if it experiences a significant decline in gross receipts or a full or partial suspension of business due to a government order. Employers with up to 500 full-time employees can claim the credit without regard to whether the employees for whom the credit is claimed actually perform services. But, except as explained below, employers with more than 500 full-time employees can only claim the ERTC with respect to employees that don’t perform services.

Employers who got a Payroll Protection Program loan in 2020 can still claim the ERTC. But the same wages can’t be used both for seeking loan forgiveness or satisfying conditions of other COVID relief programs (such as the Restaurant Revitalization Fund program) in calculating the ERTC. 

Modifications

Beginning in the third quarter of 2021, the following modifications apply to the ERTC:

• Applicable employment taxes are the Medicare hospital taxes (1.45% of the wages) and the Railroad Retirement payroll tax that’s attributable to the Medicare hospital tax rate. For the first and second quarters of 2021, “applicable employment taxes” were defined as the employer’s share of Social Security or FICA tax (6.2% of the wages) and the Railroad Retirement Tax Act payroll tax that was attributable to the Social Security tax rate.
• Recovery startup businesses are qualified employers. These are generally defined as businesses that began operating after February 15, 2020, and that meet certain gross receipts requirements. These recovery startup businesses will be eligible for an increased maximum credit of $50,000 per quarter, even if they haven’t experienced a significant decline in gross receipts or been subject to a full or partial suspension under a government order.
• A “severely financially distressed” employer that has suffered a decline in quarterly gross receipts of 90% or more compared to the same quarter in 2019 can treat wages (up to $10,000) paid during those quarters as qualified wages. This allows an employer with over 500 employees under severe financial distress to treat those wages as qualified wages whether or not employees actually provide services.
• The statute of limitations for assessments relating to the ERTC won’t expire until five years after the date the original return claiming the credit is filed (or treated as filed). 

Contact us if you have any questions related to your business claiming the ERTC.

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The IRS just released its audit statistics for the 2020 fiscal year and fewer taxpayers had their returns examined as compared with prior years. But even though a small percentage of returns are being chosen for audit these days, that will be little consolation if yours is one of them.

Latest statistics

Overall, just 0.5% of individual tax returns were audited in 2020. However, as in the past, those with higher incomes were audited at higher rates. For example, in 2020, 2.2% of taxpayers with adjusted gross incomes (AGIs) of between $1 million and $5 million were audited. Among the richest taxpayers, those with AGIs of $10 million and more, 7% of returns were audited in 2020.

These are among the lowest percentages of audits conducted in recent years. However, the Biden administration has announced it would like to raise revenue by increasing tax compliance and enforcement. In other words, audits may be on the rise in coming years.

Prepare in advance

Even though fewer audits were performed in 2020, the IRS will still examine thousands of returns this year. With proper planning, you may fare well even if you’re one of the unlucky ones.

The easiest way to survive an IRS examination is to prepare in advance. On a regular basis, you should systematically maintain documentation — invoices, bills, canceled checks, receipts, or other proof — for all items reported on your tax returns.

It’s possible you didn’t do anything wrong. Just because a return is selected for audit doesn’t mean that an error was made. Some returns are randomly selected based on statistical formulas. For example, IRS computers compare income and deductions on returns with what other taxpayers report. If an individual deducts a charitable contribution that’s significantly higher than what others with similar incomes report, the IRS may want to know why.

Returns can also be selected if they involve issues or transactions with other taxpayers who were previously selected for audit, such as business partners or investors.

The government generally has three years within which to conduct an audit, and often the exam won’t begin until a year or more after you file your return.

Complex vs. simple returns

The scope of an audit depends on the tax return’s complexity. A return reflecting business or real estate income and expenses will obviously take longer to examine than a return with only salary income.

An audit may be conducted by mail or through an in-person interview and review of records. The interview may be conducted at an IRS office or may be a “field audit” at the taxpayer’s home, business, or accountant’s office.

Important: Even if you’re chosen for audit, an IRS examination may be nothing to lose sleep over. In many cases, the IRS asks for proof of certain items and routinely “closes” the audit after the documentation is presented.

Don’t go it alone

It’s advisable to have a tax professional represent you at an audit. A tax pro knows the issues that the IRS is likely to scrutinize and can prepare accordingly. In addition, a professional knows that in many instances IRS auditors will take a position (for example, to disallow certain deductions) even though courts and other guidance have expressed contrary opinions on the issues. Because pros can point to the proper authority, the IRS may be forced to concede on certain issues.

If you receive an IRS audit letter or simply want to improve your recordkeeping, we’re here to help. Contact us to discuss this or any other aspect of your taxes.

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If you’re planning your estate, or you’ve recently inherited assets, you may be unsure of the “cost” (or “basis”) for tax purposes.

The current rules

Under the current fair market value basis rules (also known as the “step-up and step-down” rules), an heir receives a basis in inherited property equal to its date-of-death value. So, for example, if your grandmother bought stock in 1935 for $500 and it’s worth $1 million at her death, the basis is stepped up to $1 million in the hands of your grandmother’s heirs — and all of that gain escapes federal income tax.

The fair market value basis rules apply to inherited property that’s includible in the deceased’s gross estate, and those rules also apply to property inherited from foreign persons who aren’t subject to U.S. estate tax. It doesn’t matter if a federal estate tax return is filed. The rules apply to the inherited portion of property owned by the inheriting taxpayer jointly with the deceased, but not the portion of jointly held property that the inheriting taxpayer owned before his or her inheritance. The fair market value basis rules also don’t apply to reinvestments of estate assets by fiduciaries.

Gifting before death

It’s crucial to understand the current fair market value basis rules so that you don’t pay more tax than you’re legally required to.

For example, in the above example, if your grandmother decides to make a gift of the stock during her lifetime (rather than passing it on when she dies), the “step-up” in basis (from $500 to $1 million) would be lost. Property that has gone up in value acquired by gift is subject to the “carryover” basis rules. That means the person receiving the gift takes the same basis the donor had in it ($500 in this example), plus a portion of any gift tax the donor pays on the gift.

A “step-down” occurs if someone dies owning property that has declined in value. In that case, the basis is lowered to the date-of-death value. Proper planning calls for seeking to avoid this loss of basis. Giving the property away before death won’t preserve the basis. That’s because when property that has gone down in value is the subject of a gift, the person receiving the gift must take the date of gift value as his basis (for purposes of determining his or her loss on a later sale). Therefore, a good strategy for property that has declined in value is for the owner to sell it before death so he or she can enjoy the tax benefits of the loss.

Change on the horizon?

Be aware that President Biden has proposed ending the ability to step-up the basis for gains in excess of $1 million. There would be exemptions for family-owned businesses and farms. Of course, any proposal must be approved by Congress in order to be enacted.

These are the basic rules. Other rules and limits may apply. For example, in some cases, a deceased person’s executor may be able to make an alternate valuation election. Contact us for tax assistance when estate planning or after receiving an inheritance. We’ll keep you up to date on any tax law changes.

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Working capital equals the difference between current assets and current liabilities. Organizations need a certain amount of working capital to run their operations smoothly. The optimal (or “target”) amount of working capital depends on the nature of operations and the industry. Inefficient working capital management can hinder growth and performance.

Benchmarks

The term “liquidity” refers to how quickly an item can be converted to cash. In general, receivables are considered more liquid than inventory. Working capital is often evaluated using the following liquidity metrics:

Current ratio. This is computed by dividing current assets by current liabilities. A current ratio of at least 1.0 means that the company has enough current assets on hand to cover liabilities that are due within 12 months.

Quick (or acid-test) ratio. This is a more conservative liquidity benchmark. It typically excludes prepaid assets and inventory from the calculation.

An alternative perspective on working capital is to compare it to total assets and annual revenues. From this angle, working capital becomes a measure of operating efficiency. Excessive amounts of cash tied up in working capital detract from other spending options, such as expanding to new markets, buying equipment and paying down debt.

Best practices

High liquidity generally equates with low financial risk. However, you can have too much of a good thing. If working capital is trending upward from year to year — or it’s significantly higher than your competitors — it may be time to take proactive measures to speed up cash inflows and delay cash outflows.

Lean operations require taking a closer look at each component of working capital and implementing these best practices:

1. Put cash to good use. Excessive cash balances encourage management to become complacent about working capital. If your organization has plenty of money in its checkbook, you might be less hungry to collect receivables and less disciplined when ordering inventory.

2. Expedite collections. Organizations that sell on credit effectively finance their customers’ operations. Stale receivables — typically any balance over 45 or 60 days outstanding, depending on the industry — are a red flag of inefficient working capital management.

Getting a handle on receivables starts by evaluating which items should be written off as bad debts. Then viable balances need to be “talked in the door” as soon as possible. Enhanced collections efforts might include early bird discounts, electronic invoices and collections-based sales compensation programs.

3. Carry less inventory. Inventory represents a huge investment for manufacturers, distributors, retailers and contractors. It’s also difficult to track and value. Enhanced forecasting and data sharing with suppliers can reduce the need for safety stock and result in smarter ordering practices. Computerized technology — such as barcodes, radio frequency identification and enterprise resource planning tools — also improve inventory tracking and ordering practices.

4. Postpone payments. Credit terms should be extended as long as possible — without losing out on early bird discounts. If you can stretch your organization’s average days in payables from, say, 45 to 60 days, it trains vendors and suppliers to accept the new terms, particularly if you’re a predictable, reliable payor.

Prioritize working capital

Some organizations are so focused on the income statement, including revenue and profits, that they lose sight of the strategic significance of the balance sheet — especially working capital accounts. We can benchmark your organization’s liquidity and asset efficiency over time and against competitors. If necessary, we also can help implement strategies to improve your performance, without exposing you to unnecessary risk.

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Most business owners would likely agree that strategic planning is important. Yet many companies rarely engage in active measures to gather and discuss strategy. Sometimes strategic planning is tacked on to a meeting about something else; other times it occurs only at the annual company retreat when employees may feel out of their element and perhaps not be fully focused.

Businesses should take strategic planning seriously. One way to do so is to hold meetings exclusively focused on discussing your company’s direction, establishing goals and identifying the resources you’ll need to achieve them. To get the most from strategy sessions, follow some of the best practices you’d use for any formal business meeting.

Set an agenda

Every strategy session should have an agenda that’s relevant to strategic planning — and only strategic planning. Allocate an appropriate amount of time for each agenda item so that the meeting is neither too long nor too short.

Before the meeting, distribute a document showing who’ll be presenting on each agenda topic. The idea is to create a “no surprises” atmosphere in which attendees know what to expect and can thereby think about the topics in advance and bring their best ideas and feedback.

Lay down rules (if necessary)

Depending on your workplace culture, you may want to state some upfront rules. Address the importance of timely attendance and professional decorum — either in writing or by announcement as the meeting begins.

Every business may not need to do this, but meetings that become hostile or chaotic with personal conflicts or “side chatter” can undermine the purpose of strategic planning. Consider whether to identify conflict resolution methods that participants must agree to follow.

Choose a facilitator

A facilitator should oversee the meeting. He or she is responsible for:

• Starting and ending on time,
• Transitioning from one agenda item to the next,
• Enforcing the rules as necessary,
• Motivating participation from everyone, and
• Encouraging a positive, productive atmosphere.

If no one at your company feels up to the task, you could engage an outside consultant. Although you’ll need to vet the person carefully and weigh the financial cost, a skilled professional facilitator can make a big difference.

Keep minutes

Recording the minutes of a strategic planning meeting is essential. An official record will document what took place and which decisions (if any) were made. It will also serve as a log of potentially valuable ideas or future agenda items.

In addition, accurate meeting minutes will curtail miscommunications and limit memory lapses of what was said and by whom. If no record is kept, people’s memories may differ about the conclusions reached and disagreements could later arise about where the business is striving to head.

Gather ’round

By gathering your best and brightest to discuss strategic planning, you’ll put your company in a stronger competitive position. Contact our firm for help laying out some of the tax, accounting and financial considerations you’ll need to talk about.

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Businesses need financial information that’s accurate, relevant and timely. The Securities and Exchange Commission requires publicly traded companies to follow U.S. Generally Accepted Accounting Principles (GAAP), often considered the “gold standard” in financial reporting in the United States. But privately held companies can use simplified alternative accounting methods. What’s right for your business depends on its size, regulatory and contractual requirements, management’s future plans and the needs of its stakeholders.

Menu of accounting methods

Here’s an overview of the accounting methods available for small and medium-sized entities (SMEs):

GAAP. This framework follows rules set forth by the Financial Accounting Standards Board (FASB). It’s based on the accrual method of accounting, where revenues and expenses are matched to the reporting period in which they’re earned and incurred, respectively. Under this method, companies report receivables for revenue that’s earned but not yet collected and payables for expenses that are incurred but not yet paid. Prepaid (and accrued) expenses are also reported on an accrual-basis balance sheet.

Financial Reporting Framework for SMEs. This framework is rooted in GAAP, but it’s adjusted to accommodate the needs of private businesses. Developed by the American Institute of Certified Public Accountants (AICPA), this simplified framework blends traditional accounting principles with accrual-basis income tax accounting methods.

This non-GAAP framework is based on historic cost, steering away from complex, fair-value-based standards that have been implemented in recent years. For example, it retains the familiar accounting for revenue recognition and leases. It also includes targeted disclosure requirements and provides a degree of optionality, enabling SMEs to customize their financial statements to meet the needs of stakeholders.

Tax-basis method. Under this method, companies use the same accounting principles for book and federal income tax purposes. The U.S. tax code provides the rules that apply under this method.

Cash-basis method. This is the simplest reporting method. Revenues are recognized when received from customers and expenses when the company pays them. But there’s a potential downside: Revenues for the period aren’t necessarily matched to the related expenses for the period. This can lead to fluctuations in profits and financial ratios when comparing performance over time.

Questionnaire

Discuss the following questions with your accounting professional to help select the right method for your business:

• How big is your business?
• How quickly is it growing?
• Who will use its financial statements and for what purpose?
• Do you plan to raise capital?
• Do you plan to apply for debt financing?
• Do you anticipate changes in the revenue your business generates, the products and services it offers, or the area it serves?
• Are you planning to sell the business or merge with another business?

For example, the cash- or tax-basis method may be appropriate for a single-owner business without any debt that uses its financial statements for internal purposes only. But larger private firms may decide it’s advantageous to comply with GAAP to attract outside investors, obtain loans, satisfy bonding and regulatory requirements, and evaluate strategic business decisions.

What’s right for you?

As your business grows in size, sophistication and complexity, it may be time to upgrade to a more complicated and consistent method of accounting. Contact us to help select a reporting framework that suits your current needs.

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As we continue to come out of the COVID-19 pandemic, you may be traveling again for business. Under tax law, there are a number of rules for deducting the cost of your out-of-town business travel within the United States. These rules apply if the business conducted out of town reasonably requires an overnight stay.

Note that under the Tax Cuts and Jobs Act, employees can’t deduct their unreimbursed travel expenses through 2025 on their own tax returns. That’s because unreimbursed employee business expenses are “miscellaneous itemized deductions” that aren’t deductible through 2025.

However, self-employed individuals can continue to deduct business expenses, including away-from-home travel expenses.

Here are some of the rules that come into play. 

Transportation and meals

The actual costs of travel (for example, plane fare and cabs to the airport) are deductible for out-of-town business trips. You’re also allowed to deduct the cost of meals and lodging. Your meals are deductible even if they’re not connected to a business conversation or other business function. The Consolidated Appropriations Act includes a provision that removes the 50% limit on deducting eligible business meals for 2021 and 2022. The law allows a 100% deduction for food and beverages provided by a restaurant. Takeout and delivery meals provided by a restaurant are also fully deductible.

Keep in mind that no deduction is allowed for meal or lodging expenses that are “lavish or extravagant,” a term that’s been interpreted to mean “unreasonable.”

Personal entertainment costs on the trip aren’t deductible, but business-related costs such as those for dry cleaning, phone calls and computer rentals can be written off. 

Combining business and pleasure

Some allocations may be required if the trip is a combined business/pleasure trip, for example, if you fly to a location for five days of business meetings and stay on for an additional period of vacation. Only the cost of meals, lodging, etc., incurred for the business days are deductible — not those incurred for the personal vacation days.

On the other hand, with respect to the cost of the travel itself (plane fare, etc.), if the trip is “primarily” business, the travel cost can be deducted in its entirety and no allocation is required. Conversely, if the trip is primarily personal, none of the travel costs are deductible. An important factor in determining if the trip is primarily business or personal is the amount of time spent on each (although this isn’’t the sole factor).

If the trip doesn’t involve the actual conduct of business but is for the purpose of attending a convention, seminar, etc., the IRS may check the nature of the meetings carefully to make sure they aren’t vacations in disguise. Retain all material helpful in establishing the business or professional nature of this travel.

Other expenses

The rules for deducting the costs of a spouse who accompanies you on a business trip are very restrictive. No deduction is allowed unless the spouse is an employee of you or your company, and the spouse’s travel is also for a business purpose.

Finally, note that personal expenses you incur at home as a result of taking the trip aren’t deductible. For example, the cost of boarding a pet while you’re away isn’t deductible. Contact us if you have questions about your small business deductions. 

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