As a business owner, you should be aware that you can save family income and payroll taxes by putting your child on the payroll.

Here are some considerations. 

Shifting business earnings

You can turn some of your high-taxed income into tax-free or low-taxed income by shifting some business earnings to a child as wages for services performed. In order for your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child’s salary must be reasonable.

For example, suppose you’re a sole proprietor in the 37% tax bracket. You hire your 16-year-old son to help with office work full-time in the summer and part-time in the fall. He earns $10,000 during the year (and doesn’t have other earnings). You can save $3,700 (37% of $10,000) in income taxes at no tax cost to your son, who can use his $12,550 standard deduction for 2021 to shelter his earnings.

Family taxes are cut even if your son’s earnings exceed his standard deduction. That’s because the unsheltered earnings will be taxed to him beginning at a 10% rate, instead of being taxed at your higher rate.

Income tax withholding

Your business likely will have to withhold federal income taxes on your child’s wages. Usually, an employee can claim exempt status if he or she had no federal income tax liability for last year and expects to have none this year.

However, exemption from withholding can’t be claimed if: 1) the employee’s income exceeds $1,100 for 2021 (and includes more than $350 of unearned income), and 2) the employee can be claimed as a dependent on someone else’s return.

Keep in mind that your child probably will get a refund for part or all of the withheld tax when filing a return for the year.

Social Security tax savings  

If your business isn’t incorporated, you can also save some Social Security tax by shifting some of your earnings to your child. That’s because services performed by a child under age 18 while employed by a parent isn’t considered employment for FICA tax purposes.

A similar but more liberal exemption applies for FUTA (unemployment) tax, which exempts earnings paid to a child under age 21 employed by a parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting only of his or her parents.

Note: There’s no FICA or FUTA exemption for employing a child if your business is incorporated or is a partnership that includes non-parent partners. However, there’s no extra cost to your business if you’re paying a child for work you’d pay someone else to do.

Retirement benefits

Your business also may be able to provide your child with retirement savings, depending on your plan and how it defines qualifying employees. For example, if you have a SEP plan, a contribution can be made for the child up to 25% of his or her earnings (not to exceed $58,000 for 2021).

Contact us if you have any questions about these rules in your situation. Keep in mind that some of the rules about employing children may change from year to year and may require your income-shifting strategies to change too.

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If you’re claiming deductions for business meals or auto expenses, expect the IRS to closely review them. In some cases, taxpayers have incomplete documentation or try to create records months (or years) later. In doing so, they fail to meet the strict substantiation requirements set forth under tax law. Tax auditors are adept at rooting out inconsistencies, omissions and errors in taxpayers’ records, as illustrated by one recent U.S. Tax Court case.

Facts of the case

In the case, the taxpayer ran a notary and paralegal business. She deducted business meals and vehicle expenses that she allegedly incurred in connection with her business.

The deductions were denied by the IRS and the court. Tax law “establishes higher substantiation requirements” for these and certain other expenses, the court noted. No deduction is generally allowed “unless the taxpayer substantiates the amount, time and place, business purpose, and business relationship to the taxpayer of the person receiving the benefit” for each expense with adequate records or sufficient evidence.

The taxpayer in this case didn’t provide adequate records or other sufficient evidence to prove the business purpose of her meal expenses. She gave vague testimony that she deducted expenses for meals where she “talked strategies” with people who “wanted her to do some work.” The court found this was insufficient to show the connection between the meals and her business.

When it came to the taxpayer’s vehicle expense deductions, she failed to offer credible evidence showing where she drove her vehicle, the purpose of each trip and her business relationship to the places visited. She also conceded that she used her car for both business and personal activities. (TC Memo 2021-50)

Best practices for business expenses

This case is an example of why it’s critical to maintain meticulous records to support business expenses for meals and vehicle deductions. Here’s a list of “DOs and DON’Ts” to help meet the strict IRS and tax law substantiation requirements for these items:

DO keep detailed, accurate records. For each expense, record the amount, the time and place, the business purpose, and the business relationship of any person to whom you provided a meal. If you have employees who you reimburse for meals and auto expenses, make sure they’re complying with all the rules.

DON’T reconstruct expense logs at year end or wait until you receive a notice from the IRS. Take a moment to record the details in a log or diary or on a receipt at the time of the event or soon after. Require employees to submit monthly expense reports.

DO respect the fine line between personal and business expenses. Be careful about combining business and pleasure. Your business checking account shouldn’t be used for personal expenses.

DON’T be surprised if the IRS asks you to prove your deductions. Meal and auto expenses are a magnet for attention. Be prepared for a challenge.

With organization and guidance from us, your tax records can stand up to scrutiny from the IRS. There may be ways to substantiate your deductions that you haven’t thought of, and there may be a way to estimate certain deductions (“the Cohan rule”), if your records are lost due to a fire, theft, flood or other disaster. 

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If you’re getting ready to retire, you’ll soon experience changes in your lifestyle and income sources that may have numerous tax implications.

Here’s a brief rundown of four tax and financial issues you may deal with when you retire:

Taking required minimum distributions. This is the minimum amount you must withdraw from your retirement accounts. You generally must start taking withdrawals from your IRA, SEP, SIMPLE and other retirement plan accounts when you reach age 72 (70½ before January 1, 2020). Roth IRAs don’t require withdrawals until after the death of the owner.
You can withdraw more than the minimum required amount. Your withdrawals will be included in your taxable income except for any part that was taxed before or that can be received tax-free (such as qualified distributions from Roth accounts).

Selling your principal residence. Many retirees want to downsize to smaller homes. If you’re one of them and you have a gain from the sale of your principal residence, you may be able to exclude up to $250,000 of that gain from your income. If you file a joint return, you may be able to exclude up to $500,000.

To claim the exclusion, you must meet certain requirements. During a five-year period ending on the date of the sale, you must have owned the home and lived in it as your main home for at least two years.

If you’re thinking of selling your home, make sure you’ve identified all items that should be included in its basis , which can save you tax.

Engaging in new work activities. After retirement, many people continue to work as consultants or start new businesses. Here are some tax-related questions to ask:

• Should the business be a sole proprietorship, S corporation, C corporation, partnership or limited liability company?
• Are you familiar with how to elect to amortize start-up expenditures and make payroll tax deposits?
• What expenses can you deduct and can you claim home office deductions?
• How should you finance the business?

Taking Social Security benefits. If you continue to work, it may have an impact on your Social Security benefits. If you retire before reaching full Social Security retirement age (65 years of age for people born before 1938, rising to 67 years of age for people born after 1959) and the sum of your wages plus self-employment income is over the Social Security annual exempt amount ($18,960 for 2021), you must give back $1 of Social Security benefits for each $2 of excess earnings.

If you reach full retirement age this year, your benefits will be reduced $1 for every $3 you earn over a different annual limit ($50,520 in 2021) until the month you reach full retirement age. Then, your earnings will no longer affect the amount of your monthly benefits, no matter how much you earn.

Speaking of Social Security, you may have to pay federal (and possibly state) tax on your benefits. Depending on how much income you have from other sources, you may have to report up to 85% of your benefits as income on your tax return and pay the resulting federal income tax.

Many decisions

As you can see, tax planning is still important after you retire. We can help maximize the tax breaks you’re entitled to so you can keep more of your hard-earned money.

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The IRS recently released guidance providing the 2022 inflation-adjusted amounts for Health Savings Accounts (HSAs).

Fundamentals of HSAs

An HSA is a trust created or organized exclusively for the purpose of paying the “qualified medical expenses” of an “account beneficiary.” An HSA can only be established for the benefit of an “eligible individual” who is covered under a “high deductible health plan.” In addition, a participant can’t be enrolled in Medicare or have other health coverage (exceptions include dental, vision, long-term care, accident and specific disease insurance).

A high deductible health plan (HDHP) is generally a plan with an annual deductible that isn’t less than $1,000 for self-only coverage and $2,000 for family coverage. In addition, the sum of the annual deductible and other annual out-of-pocket expenses required to be paid under the plan for covered benefits (but not for premiums) can’t exceed $5,000 for self-only coverage, and $10,000 for family coverage.

Within specified dollar limits, an above-the-line tax deduction is allowed for an individual’s contribution to an HSA. This annual contribution limitation and the annual deductible and out-of-pocket expenses under the tax code are adjusted annually for inflation.

Inflation adjustments for next year

In Revenue Procedure 2021-25, the IRS released the 2022 inflation-adjusted figures for contributions to HSAs, which are as follows:

Annual contribution limitation. For calendar year 2022, the annual contribution limitation for an individual with self-only coverage under a HDHP will be $3,650. For an individual with family coverage, the amount will be $7,300. This is up from $3,600 and $7,200, respectively, for 2021.

High deductible health plan defined. For calendar year 2022, an HDHP will be a health plan with an annual deductible that isn’t less than $1,400 for self-only coverage or $2,800 for family coverage (these amounts are unchanged from 2021). In addition, annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) won’t be able to exceed $7,050 for self-only coverage or $14,100 for family coverage (up from $7,000 and $14,000, respectively, for 2021).

Many advantages

There are a variety of benefits to HSAs. Contributions to the accounts are made on a pre-tax basis. The money can accumulate tax free year after year and be can be withdrawn tax free to pay for a variety of medical expenses such as doctor visits, prescriptions, chiropractic care and premiums for long-term care insurance. In addition, an HSA is “portable.” It stays with an account holder if he or she changes employers or leaves the workforce. If you have questions about HSAs at your business, contact your employee benefits and tax advisors.

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Are you age 65 and older and have basic Medicare insurance? You may need to pay additional premiums to get the level of coverage you want. The premiums can be expensive, especially if you’re married and both you and your spouse are paying them. But there may be a bright side: You may qualify for a tax break for paying the premiums.

Medicare premiums are medical expenses

You can combine premiums for Medicare health insurance with other qualifying medical expenses for purposes of claiming an itemized deduction for medical expenses on your tax return. This includes amounts for “Medigap” insurance and Medicare Advantage plans. Some people buy Medigap policies because Medicare Parts A and B don’t cover all their health care expenses. Coverage gaps include co-payments, coinsurance, deductibles and other costs. Medigap is private supplemental insurance that’s intended to cover some or all gaps.

Itemizing versus the standard deduction

Qualifying for a medical expense deduction is hard for many people for a couple of reasons. For 2021, you can deduct medical expenses only if you itemize deductions and only to the extent that total qualifying expenses exceeded 7.5% of AGI.

The Tax Cuts and Jobs Act nearly doubled the standard deduction amounts for 2018 through 2025. As a result, fewer individuals are claiming itemized deductions. For 2021, the standard deduction amounts are $12,550 for single filers, $25,100 for married couples filing jointly and $18,800 for heads of household. (For 2020, these amounts were $12,400, $24,800 and $18,650, respectively.)

However, if you have significant medical expenses, including Medicare health insurance premiums, you may itemize and collect some tax savings.

Note: Self-employed people and shareholder-employees of S corporations can generally claim an above-the-line deduction for their health insurance premiums, including Medicare premiums. So, they don’t need to itemize to get the tax savings from their premiums.

Medical expense deduction basics

In addition to Medicare premiums, you can deduct various medical expenses, including those for dental treatment, ambulance services, dentures, eyeglasses and contacts, hospital services, lab tests, qualified long-term care services, prescription medicines and others.

There are also many items that Medicare doesn’t cover that can be deducted for tax purposes, if you qualify. In addition, you can deduct transportation expenses to get to medical appointments. If you go by car, you can deduct a flat 16-cents-per-mile rate for 2021 (down from 17 cents for 2020), or you can keep track of your actual out-of-pocket expenses for gas, oil and repairs.

Claim all eligible deductions

Contact us if you have additional questions about claiming medical expense deductions on your tax return.

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If you’re a parent with a college-bound child, you may be concerned about being able to fund future tuition and other higher education costs. You want to take maximum advantage of tax benefits to minimize your expenses. Here are some possible options.

Savings bonds

Series EE U.S. savings bonds offer two tax-saving opportunities for eligible families when used to finance college:

• You don’t have to report the interest on the bonds for federal tax purposes until the bonds are cashed in, and
• Interest on “qualified” Series EE (and Series I) bonds may be exempt from federal tax if the bond proceeds are used for qualified education expenses.

To qualify for the tax exemption for college use, you must purchase the bonds in your name (not the child’s) or jointly with your spouse. The proceeds must be used for tuition, fees and certain other expenses — not room and board. If only part of the proceeds is used for qualified expenses, only that part of the interest is exempt.

The exemption is phased out if your adjusted gross income (AGI) exceeds certain amounts.

529 plans

A qualified tuition program (also known as a 529 plan) allows you to buy tuition credits for a child or make contributions to an account set up to meet a child’s future higher education expenses. Qualified tuition programs are established by state governments or private education institutions.

Contributions aren’t deductible. The contributions are treated as taxable gifts to the child, but they’re eligible for the annual gift tax exclusion ($15,000 for 2021). A donor who contributes more than the annual exclusion limit for the year can elect to treat the gift as if it were spread out over a five-year period.

The earnings on the contributions accumulate tax-free until college costs are paid from the funds. Distributions from 529 plans are tax-free to the extent the funds are used to pay “qualified higher education expenses.” Distributions of earnings that aren’t used for qualified expenses will be subject to income tax plus a 10% penalty tax.

Coverdell education savings accounts (ESAs)

You can establish a Coverdell ESA and make contributions of up to $2,000 annually for each child under age 18.

The right to make contributions begins to phase out once your AGI is over a certain amount. If the income limitation is a problem, a child can contribute to his or her own account.

Although the contributions aren’t deductible, income in the account isn’t taxed, and distributions are tax-free if used on qualified education expenses. If the child doesn’t attend college, the money must be withdrawn when he or she turns 30, and any earnings will be subject to tax and penalty. But unused funds can be transferred tax-free to a Coverdell ESA of another member of the child’s family who hasn’t reached age 30. (Some ESA requirements don’t apply to individuals with special needs.)

Plan ahead

These are just some of the tax-favored ways to build up a college fund for your children. Once your child is in college, you may qualify for tax breaks such as the American Opportunity Tax Credit or the Lifetime Learning Credit. Contact us if you’d like to discuss any of the options.

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Rob Cordasco’s new book “A Framework for Growth” becomes an Amazon #1 Best Seller.
The new book, on its initial launch, a #1 rating for Business Systems & Planning Books while currently maintaining a #2 ranking on the Entrepreneurship list and a #3 ranking in Strategic Business Planning.

We are excited to share our view of how to build successful financial & tax planning strategies throughout your entrepreneurial life cycle.

Thank you for helping us make this effort successful!

Eligible parents will soon begin receiving payments from the federal government. The IRS announced that the 2021 advance child tax credit (CTC) payments, which were created in the American Rescue Plan Act (ARPA), will begin being made on July 15, 2021.

How have child tax credits changed?

The ARPA temporarily expanded and made CTCs refundable for 2021. The law increased the maximum CTC — for 2021 only — to $3,600 for each qualifying child under age 6 and to $3,000 per child for children ages 6 to 17, provided their parents’ income is below a certain threshold.

Advance payments will receive up to $300 monthly for each child under 6, and up to $250 monthly for each child 6 and older. The increased credit amount will be reduced or phased out, for households with modified adjusted gross income above the following thresholds:

• $150,000 for married taxpayers filing jointly and qualifying widows and widowers;
• $112,500 for heads of household; and
• $75,000 for other taxpayers.

Under prior law, the maximum annual CTC for 2018 through 2025 was $2,000 per qualifying child but the income thresholds were higher and some of the qualification rules were different.

Important: If your income is too high to receive the increased advance CTC payments, you may still qualify to claim the $2,000 CTC on your tax return for 2021.

What is a qualifying child?

For 2021, a “qualifying child” with respect to a taxpayer is defined as one who is under age 18 and who the taxpayer can claim as a dependent. That means a child related to the taxpayer who, generally, lived with the taxpayer for at least six months during the year. The child also must be a U.S. citizen or national or a U.S. resident.

How and when will advance payments be sent out?

Under the ARPA, the IRS is required to establish a program to make periodic advance payments which in total equal 50% of IRS’s estimate of the eligible taxpayer’s 2021 CTCs, during the period July 2021 through December 2021. The payments will begin on July 15, 2021. After that, they’ll be made on the 15th of each month unless the 15th falls on a weekend or holiday. Parents will receive the monthly payments through direct deposit, paper check or debit card.

Who will benefit from these payments and do they have to do anything to receive them?

According to the IRS, about 39 million households covering 88% of children in the U.S. “are slated to begin receiving monthly payments without any further action required.” Contact us if you have questions about the child tax credit.

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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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Here are some of the key tax-related deadlines affecting businesses and other employers during the third quarter of 2021. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

Monday, August 2

• Employers report income tax withholding and FICA taxes for second quarter 2021 (Form 941) and pay any tax due.
• Employers file a 2020 calendar-year retirement plan report (Form 5500 or Form 5500-EZ) or request an extension.

Tuesday, August 10

• Employers report income tax withholding and FICA taxes for second quarter 2021 (Form 941), if you deposited all associated taxes that were due in full and on time.

Wednesday, September 15

• Individuals pay the third installment of 2021 estimated taxes, if not paying income tax through withholding (Form 1040-ES).
• If a calendar-year corporation, pay the third installment of 2021 estimated income taxes.
• If a calendar-year S corporation or partnership that filed an automatic extension:
  • File a 2020 income tax return (Form 1120S, Form 1065 or Form 1065-B) and pay any tax, interest and penalties due.
  • Make contributions for 2020 to certain employer-sponsored retirement plans.

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