Since the recent signing into law of the Tax Cuts and Jobs Act on December 22, 2017, the CK team has received many inquiries about its effect on future tax burdens. According to a recent survey from HubSpot, 88.5% of small businesses don’t understand the full impact of the tax bill. It’s apparent that business owners are seeking more clarity. As your trusted business advisors, we hear you loud and clear. To help you get through this transition, we will be posting our latest insights into the effects of the new law. You can subscribe here to receive our weekly email updates.

This week we are examining a provision in the new law that could cause a tax increase – the new limitation on business interest.

Let’s start with businesses NOT subject to these new provisions:

• Any business with average gross receipts over the prior three years of less than $25 million. Keep in mind that IRS rules will require you to aggregate businesses with similar ownership for purposes of determining if this limitation has been met.
• An employee
• Any business which furnishes or sells certain types of energy
• An electing farming business
• An electing real property trade or business

What is an electing real property trade or business?

A real property trade or business is “any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.” The IRS will allow these real property businesses to elect out of the interest deduction limitation via an annual irrevocable election. The cost for doing so? The real property business must apply ADS depreciation rather than the usual MACRS methods, which means longer depreciable lives and limitations on bonus depreciation.

If your business is subject to the interest deduction limitation, the interest deduction cannot exceed the sum of:

• The business interest income for the tax year; plus
• 30% of the business’ adjusted taxable income for the tax year; plus
• Business floor plan financing interest for the tax year

Adjusted taxable income generally means the business’ taxable income without regard to:

• Business interest income or business interest expense
• Any net operating loss
• The qualified business income deduction
• For tax years beginning before January 1, 2022, any deduction allowable for depreciation, amortization or depletion.

Any business interest not deductible due to these limitations will carry forward to the following tax year.

Who does this effect?

We expect these provisions will impact our clients with multiple entities and large amounts of financed capital expenditures the most. Given that interest rates are expected to rise, this valuable interest deduction will need to be looked at in terms of how companies decide to finance and capitalize their operations.

Keep in mind that these rules apply for tax years beginning after December 31, 2017. If you have questions in the interim, please call us at 630-953-4900.

It’s not fun to think about, but there’s no way to be completely immune from the possibility of an IRS audit. But if thinking about it isn’t pleasant, going through an audit can be even worse. If you do get audited, you’ll have a better chance of an easy audit experience if you start planning for it now. Since we’re in tax season, it’s wise to prepare for a potential audit while your tax information for the previous year is at hand. Here’s how to prepare for an IRS audit:

Use Your Tax Return as a Checklist

Use your current tax return to guide you in gathering all the components of your tax return and putting them together in one file. That way, if the state or federal tax authorities decide to review your return, you’ll have the right documents readily available.

Categorize Your Records

It’s a good idea to organize your documents by year, as well as income and expense type. Including a summary of transactions for each year as a quick guide for yourself and the auditors will also be helpful.

Prepare for Questions

You can anticipate by looking over anything that could potentially trigger an audit. Anything that looks out of the ordinary like foreign bank accounts, large tax losses, or significant business tax deductions are all flags for auditors. It’s best to have explanations for those items in advance. It’s an auditor’s job to ask tough questions, so be prepared!

Audits aren’t known for being enjoyable, but there are ways you can make them stress free by being proactive. If you do get audited, Cray Kaiser is here to help you through the entire process. Please don’t hesitate to contact us if you have questions on how to prepare for an IRS audit or how to avoid an audit.

Since the recent signing into law of the Tax Cuts and Jobs Act on December 22, 2017, the CK team has received many inquiries about its effect on future tax burdens. According to a recent survey from HubSpot, 88.5% of small businesses don’t understand the full impact of the tax bill. It’s apparent that business owners are seeking more clarity. As your trusted business advisors, we hear you loud and clear. To help you get through this transition, we will be posting our latest insights into the effects of the new law. You can subscribe here to receive our weekly email updates.

Last week, we discussed the Qualified Business Income (QBI) deduction for “specified service” businesses. For those businesses, the phaseout of the QBI deduction is aggressive – phasing out completely at taxable incomes above $415,000 for married filing jointly taxpayers and $207,500 for all other taxpayers. But what happens if your business is not a “specified service”?

Qualified Property

Although the computation is more challenging in this case, the good news is that the phaseouts are not as aggressive as for specified service businesses. As we spelled out in a prior blog, QBI is the lesser of:

• 20% of the taxpayer’s QBI or
• The greater of:
  1. 50% of the W-2 wages paid by the business, or
  2. 25% of the W-2 wages paid by the business plus 2.5% of the unadjusted basis of all qualified property.

What is the “unadjusted basis of all qualified property”? Qualified property is defined as tangible property subject to depreciation (inventory does not qualify) that is used in the production of qualified business income. The unadjusted basis means tax basis before tax depreciation. However, there is a special rule that excludes property where the depreciable period ended before the last day of the tax year. Further discussion of this point is beyond the scope of this article. Please contact us directly for more information.

Here’s an example:

A manufacturing company that is 100% owned by one married individual has: QBI of $500,000; paid company wages of $1,000,000; $100,000 of unadjusted basis in qualified property; and the individual has taxable income of $550,000. QBI is the lesser of:

• 20% of the taxpayer’s QBI ($500,000 * 20%) = $100,000 or
• The greater of:
  1. 50% of W-2 wages paid ($1,000,000 * .5) = $500,000, or
  2. 25% of W-2 wages paid ($1,000,000 * .25) = $250,000 plus 2.5% of unadjusted basis ($100,000 * .025) = $2,500 yields $252,500

In this case, the QBI is $100,000 as the manufacturing company’s wage limitation was much more than 20% of the QBI. The individual receives the full 20% QBI deduction despite having taxable income over the thresholds.

The key takeaways for all businesses considering the QBI are:

• For married individuals with taxable income less than $315,000 (or $157,500 for all other filing statuses), the 20% QBI deduction is not subject to the wage/asset threshold regardless of the type of business.
• For married individuals in “specified service” businesses, if taxable income exceeds $315,000 (or $157,500 for all other filing statuses), the 20% QBI deduction is phased out based on the amount of taxable income above the thresholds; the deduction is fully phased out at taxable income of $415,000 (married) or $207,500 (all others).
• For married individuals NOT in “specified service” businesses, if taxable income exceeds $315,000 (or $157,500 for all other filing statuses), the 20% QBI deduction is phased out based on the wage/asset thresholds discussed above. Even if taxable income thresholds are exceeded, the full QBI deduction may be allowable in a labor-intensive business.
• Allowing companies NOT in “specified service” businesses to use their unadjusted basis of assets as part of the QBI threshold computation will allow real estate ventures to qualify for the QBI, despite these generally not being labor-intensive businesses.
• Once the QBI deduction is computed, the individual taxpayer must still make sure that the QBI cannot exceed 20% of the excess of taxable income over the sum of any net capital gain. In other words, if there is no taxable income, there is no QBI.

As you can see, the provisions of the QBI are complex. We eagerly await regulations that will help define some of the terms of the deduction. Cray Kaiser will keep you informed as we learn more. If you would like to discuss the QBI deduction in more detail, please call us at 630-953-4900.

Since the recent signing into law of the Tax Cuts and Jobs Act on December 22, 2017, the CK team has received many inquiries about its effect on future tax burdens. According to a recent survey from HubSpot, 88.5% of small businesses don’t understand the full impact of the tax bill. It’s apparent that business owners are seeking more clarity. As your trusted business advisors, we hear you loud and clear. To help you get through this transition, we will be posting our latest insights into the effects of the new law. You can subscribe here to receive our weekly email updates.

Last week, we discussed the Qualified Business Income (QBI) deduction and provided an example of how the deduction works if your individual taxable income is under certain thresholds ($315,000 for married filing jointly taxpayers and $157,500 for all others).  The computation was an easy one – 20% of qualified business income yields the QBI deduction. But what happens if your income is above those thresholds?

The QBI deduction computation depends on whether your business is a “specified service”.  A “specified service trade or business” involves the performance of services in the fields of:

• Health
• Law
• Accounting
• Actuarial science
• Performing arts
• Consulting
• Professional athletics
• Financial services
• Brokerage services
• Or any trade or business “where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.”

Note that businesses that involve architecture, engineering, insurance, financing, leasing, or hotel/motels are excluded from the “specified service” definition.

If you are in a “specified service” business and your income is above the thresholds, the standard 20% deduction is gradually reduced over the next $100,000 (married filing jointly) or $50,000 (all others) of taxable income above the threshold. The QBI deduction is reduced to zero if you are a married taxpayer with income at or above $415,000 or a taxpayer with another filing status and income at or above $207,500.

What if I am not in a “specified service”?

The same rules do not apply if you are NOT in a “specified service” trade or business. As such, determining what is or isn’t a “specified service” will be critical. Tax professionals will need to rely on regulations to help us make that determination. Until we have such regulations, we have many of the same questions as you do regarding what is or isn’t a specified service. As the deduction will not be taken until you file your 2018 return, we are grateful for the additional time to understand these complex rules.

For those of you not in a specified service but with taxable income greater than the standard thresholds, click here. If you have any questions in the meantime, please don’t hesitate to call us at 630-953-4900.

Since the recent signing into law of the Tax Cuts and Jobs Act on December 22, 2017, the CK team has received many inquiries about its effect on future tax burdens. According to a recent survey from HubSpot, 88.5% of small businesses don’t understand the full impact of the tax bill. It’s apparent that business owners are seeking more clarity. As your trusted business advisors, we hear you loud and clear. To help you get through this transition, we will be posting our latest insights into the effects of the new law. You can subscribe here to receive our weekly email updates.

The first topic we’d like to address is the elimination of tax benefits for entertainment expenses. We don’t yet have clarifying regulations from the government, but we can’t delay on identifying this significant change that will affect businesses and individuals starting after December 31, 2017.

Under prior law, business entertainment expenses were generally 50% deductible for tax purposes, as were expenses for business meals. Under new rules, the following are NOT deductible:

• The cost of entertaining clients (examples include corporate golf outings or tickets to sporting events)
• Membership dues for any club organized for business, pleasure, recreation, or social purposes
• The cost of entertainment facilities

Even if entertainment expenses are related to your trade or business, these items are no longer deductible. We expect that as a result of this change, businesses will now take a closer look at how sales promotion expenses are budgeted for.

What actions can be taken? As many businesses have grouped meals and entertainment into one account, we recommend that you create separate accounts for these expenses. Also, if you are reimbursing employees’ business meals and entertainment expenses, be sure that your employees are educated on the need to account for these expenses separately. After all, business meals are still 50% deductible.

Recent IRS examinations have shown us that entertainment expenses have been a frequent target of auditors. Given the law change, we expect that these expenses will continue to be an area of emphasis during an audit. Getting your internal recordkeeping and accounting policies updated will help counter proposed adjustments in the future.

If you would like to discuss how to better account for your business entertainment expenses, please don’t hesitate to contact us.

Employee benefit plan (EBP) audits are much more than a simple audit of net assets and income contained in the benefit plan’s financial statements. They also serve as a safeguard to participants, plan management, and plan fiduciaries through compliance testing procedures. In addition to testing the plan’s operational compliance in accordance with DOL/IRS regulations and the plan document, auditors will also note areas for improvement in internal controls and other matters through written communications with management.

It is very important to operate the benefit plan in accordance with the DOL/IRS and plan document for many reasons, such as:

1. It prevents unnecessary fines and penalties, including personal fiduciary responsibility.
2. It protects the participants’ assets.
3. It prevents the plan from losing its tax-exempt status.

Cray Kaiser has extensive experience with EBP audits. Often, when we work with a new client on an EBP audit, it’s their very first benefit plan audit. We also see many cases where the client’s plan was previously audited by a firm without the training and expertise needed in the complex area of EBP audits. During the most recent audit season, we performed an EBP audit for a plan whose previous auditor had stopped performing EBP audits altogether. We discovered numerous operational deficiencies, which if left uncorrected could have jeopardized the plan’s tax-exempt status and potentially exposed the plan sponsor and fiduciaries to fines and penalties. We worked with plan management to identify corrections and processes to prevent the issues from occurring again. Internal control weaknesses were also brought to management’s attention.

Often, plan auditors are selected solely based on fees. While fees are an important consideration, there are other crucial factors to consider when selecting a plan auditor. EBP auditing is a specialized area with complexities not found in traditional audit engagements of company financial statements. For this reason, it is essential to select a firm that:

• has sufficient professional experience in auditing employee benefit plans.
• participates in regular training and updates in the EBP audit area.
• is independent and appropriately licensed.

At Cray Kaiser, we are committed to quality EBP audit engagements. Our highly experienced EBP audit team continually monitors developments and changes in the industry. Cray Kaiser is also a member of the American Institute of Certified Public Accountants’ Employee Benefit Plan Audit Quality Center, a select group that provides EBP audit resources and industry updates to member firms. Our experience and resources ensure that our EBP audit clients receive rigorous, precisely executed audits to support plan operations and help plan fiduciaries fulfill their responsibilities. If you would like more information on EBP audits, please contact us.

So you’ve decided to start a business – congratulations!  While there are many decisions to be made, one of the first tax questions is how best to organize your corporation, if you have decided to use the corporate form.  You may wonder, what is the difference in tax treatment between a C corporation and an S corporation? 

C corporations 

C corporations have not been a popular choice of entity due to “double taxation”. The taxable income of a C corporation is first subject to federal and state income tax (the current federal tax rate is 21%, and the Illinois tax rate is 9.5%). Dividend distributions to owners are then subject to tax again at the owners’ tax rate. Thus, the double layer of tax. The double tax cost is especially detrimental upon the sale of a company’s assets in an exit scenario, unless the gain from the sale qualifies for the Section 1202 exclusion http://craykaiser.com/section-1244/. 

S corporations 

S corporations are considered flow through entities. The taxable income of a corporation is not subject to federal tax (although some states, including Illinois assess a tax – Illinois’ S corporation tax rate is 1.5%). The income flows through to the owners and is subject to tax at the owners’ tax rate. 

For Example: 

Using a basic example, assume XYZ Corporation (an Illinois company owned by actively participating individuals) has $100,000 of 2023 taxable income for federal and state purposes. If XYZ were taxed as a C corporation, the company would be subject to $21,000 of federal tax and $9,500 of Illinois tax. If XYZ wants to distribute dividends to its individual owners, $69,500 would be available for distribution after payment of the corporate tax. Assuming the owners are subject to the 15% federal qualified dividend tax rate and the 4.95% Illinois tax rate, the tax on the dividend income would be $13,865 ($69,500 * 19.95%). The remaining cash of $55,635 would have been subject to an overall effective tax rate of about 44.37%. 

Now, let’s assume that XYZ Corporation elected to be taxed as an S corporation. The $100,000 of taxable income is first subject to the Illinois 1.5% replacement tax. The remaining $98,500 of taxable income flows through to the individual owners’ tax returns. Assuming the individuals are subject to the new highest individual tax rate of 37% (without consideration of the Qualified Business Income Deduction) and the 4.95% Illinois tax rate, the total tax payable would be $41,320, leaving remaining cash of $57,180.   

Although we did not include in our example the benefit of the state tax deduction for federal tax purposes, the math shows that overall an S corporation will provide a lower effective tax rate. 

The Qualified Business Income Deduction 

A further benefit of the S corporation is the effective tax savings from the Qualified Business Income (QBI) deduction. The 20% deduction is available to sole-proprietors, S corporations, and partnerships/LLC’s. Note that the deduction is not available to C corporations. 

QBI is defined as the ordinary (not investment) income less ordinary deductions from qualified trades or businesses. Wages earned as an employee are not considered QBI. 

The QBI deduction phases out for income from “specialized service” trades or businesses. These are trades or businesses involving the performance of services in the fields of health, law, consulting, athletics, financial or brokerage services, or where the principal asset is the reputation or skill of one or more employees or owners. There is also a phaseout based on wages paid in the business. A full discussion of the QBI is beyond the scope of this article; further, we believe regulations will be issued with clarification on this deduction. Click here to read more about the QBI deduction. 

Conclusion 

Although the 2023 tax rates continue to favor S corporations, tax rates are not the only consideration when determining how a corporation should elect to be taxed. As S corporations may not have corporations as shareholders, the types of owners may prohibit the use of S corporations. Additionally, if an S corporation has a loss, the ability to claim the flow through loss by owners may be limited due to insufficient tax basis. Finally, S corporations are not eligible for a Section 1202 gain exclusion. 

If you would like to talk through the corporate choice of entity with us, please contact us at (630) 953-4900. 

Please note that this blog is based on tax laws effective in December 2023, and may not contain later amendments. Please contact Cray Kaiser for most recent information. 

If you’re about to retire, there are many important financial decisions to be made. Most people will depend on their retirement accounts to provide income for their non-working years, but how much and when you withdraw varies by individual. If you’re delaying your distributions past your retirement to maintain the tax-deferment benefits, there will come a time when you must begin withdrawing funds from your retirement savings accounts.

The rules surrounding how and when you must start taking disbursements from your retirement plans are highly complex, and the penalties are severe. Here’s a guide to how you can avoid hefty fines by making withdrawals from your accounts on schedule.

What are RMDs?

According to IRS rules, you’ll have to begin taking required minimum distributions (RMDs) from any retirement plan (except Roth IRAs) starting at age 72, whether you need the funds or not. For those individuals who attain age 70 ½ prior to December 31st, 2019, the age requirement for RMDs is 70 ½. Employer or self-employed sponsored plans, pensions, profit sharing plans, and plans for not-for-profits and government agencies are all subject to the same RMD rules.

When to Take Your RMD

You’ll need to start taking your required RMDs starting on April 1st of the year following when you’ve reached your RMD age. For example, if you were 70 ½ at some point during 2019, you’ll need to take your first RMD on April 1st of 2020. If you turn 70 ½ during 2020 or later, the first RMD is due on April 1st of the year following the year you turn 72. The deadline for RMD withdrawals for subsequent years is December 31st of each year. Therefore, if you took your first RMD distribution in 2019, you’ll need to take at least one more before the end of 2020.

How to Determine Your RMD Amount

To calculate your yearly RMD amount, divide the balances in all of your retirement plans on December 31st of the year before the withdrawal applies, and divide it by your corresponding factor in the IRS expectancy table. Even if you have multiple retirement funds, you can take your RMD from just one or any combination of your accounts. In order to avoid any confusion and mistakes, it’s best to work with your tax professional to ensure you’re using the right figures.

Don’t Procrastinate!

The regulations around RMDs are strict, and IRS takes these distributions very seriously. Once you start, you’re expected to continue to take yearly RMDs without exception, and not doing so has severe penalties. If you miss an RMD withdrawal, the penalty is a whopping 50% of what you should have taken! Since you’re required to pay income taxes on the distributions, a missed RMD means that the amount you receive from a missed withdrawal could be only a sliver of what it should have been.

With all the busyness at year-end, waiting until the very end of the year is risky. Because it can take several days, if not longer, for the transactions to process, we suggest that you finalize your RMD plans for the year by December 1st. Contact Cray Kaiser today to make your RMD arrangements before the end-of-year deadline.

Please note that this blog is based on tax laws effective in January 2020, and may not contain later amendments. Please contact Cray Kaiser for most recent information.