We don’t mean to paint a bleak picture – but what would happen to your company in the event of your own disability or death? No one likes to think about these things, but it’s extremely important to have a succession plan of who, what, why, when, how just in case. If you want your business to survive in your absence, don’t let it suffer from a lack of planning like 30% of small businesses do.

Unless you’re a manager in an accounting or finance firm, working capital may be a foreign term to you. With today’s ever-shifting economy, it’s important to understand the benefits and complications that arise from managing working capital.

Although the tax code contains some exceptions, income is generally taxable in the tax year received and expenses are claimed as deductions in the year paid. But “carryforwards” and “carrybacks” have special rules. In this case, certain losses and deductions can be carried forward to offset income in future years or carried back to offset income in prior years, providing tax benefits. 

Here are four examples:

Capital losses. After you net annual capital gains and capital losses, you can use any excess loss to offset up to $3,000 of ordinary income. Remaining losses can be carried over to offset gains in future years. The carryforward continues until the excess loss is exhausted. For example, suppose you have a net capital loss of $10,000 for 2023. After using $3,000 to offset ordinary income on your 2023 return, you carry the remaining $7,000 to 2024. The excess loss is first applied to your 2024 capital gains, and then to as much as $3,000 of your ordinary income. Any remaining loss is carried forward to 2025 and future years. 

Charitable deductions. Your annual charitable deductions are limited by a “ceiling” or maximum amount, as measured by a percentage. For example, the general rule is that your itemized deduction for most charitable donations for a year can’t exceed 50% of your adjusted gross income (AGI) (60% for years through 2025). Gifts of appreciated property are limited to 30% of your AGI (20% in some cases) in the tax year in which the donations are made. When you contribute more than these limits in a year, you can deduct the excess on future tax returns. The carryover period for charitable deductions is five years. 

Home office deduction. If you qualify for a home office deduction and you calculate your deduction using the regular method, your benefit for the current year can’t exceed the gross income from your business minus business expenses (other than home office expenses). Any excess is carried forward to the next year. Caution: No carryforward is available when you choose the “simplified” method to compute your home office deduction. 

Net operating losses (NOLs). Historically, NOLs could be carried back two years and forward 20 years. Under current law, NOL’s can only be carried forward in most cases. Give us a call for help in maximizing the tax benefits of carryforwards or carrybacks. 

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. 

By implementing sound principles of saving and investing, average people – with average salaries and expenses – can build wealth. For most people wondering how to build wealth, it may be a lot like cooking stew in a crock pot. Two ingredients are required: discipline and time.

 

• Time harnesses the power of compound interest. Simply put, compound interest is the money gained by leaving your dollars invested. It’s interest earned on the interest. Say, for example, you put $1,000 in an investment earning 5% annually. After the first year, your account balance will have grown to $1,050. Leave your money invested, and by the end of the following year you’ll have $1,102.50. You make more money the second year because you also earn interest ($2.50) on the first year’s interest ($50).
• The sooner you start investing, the less you’ll need to save. Take, for example, two fellows named Tom and Jerry. Both are 18 years old. Tom paid attention in accounting class and started saving $100 a month. For ten years he contributed to a relatively conservative mutual fund that earned 7% annually. At age 28, Tom lost motivation and stopped saving.

 

Jerry, on the other hand, was a party animal. For the first ten years after high school, he spent every penny he earned. But at age 28, he got discipline. He started saving $100 each month, the same amount Tom had been saving for ten years.

 

By age 65, who comes out ahead? Tom is the clear winner with about $230,000; Jerry places second with $210,000. Consider that Tom saved $100 a month for ten years ($12,000) and Jerry saved the same monthly amount for 37 years ($44,400). Why did Tom end up with more money? Because his funds were invested longer. The power of compounding amplified his investment. (By the way, had Tom invested $250 a month from age 18 to 65, he’d have over a million dollars by age 65.)

 

Are you wondering how to build wealth? Cray Kaiser can help you with tax and financial planning strategies. Contact us today!

Estate tax planning looks much different than it did in the past. In prior years, estate planning often focused on minimizing taxpayer’s estates as exemptions were low and federal estate tax rates were as high as 77%. Today, the top marginal federal estate rate is 40%. The American Taxpayer Relief Act of 2012 (ATRA) made permanent the generous $5,000,000 federal transfer tax exemption, which is indexed yearly for inflation. This means an individual can die with $5,430,000 in assets and owe no federal estate tax. ATRA also made “portability” permanent. Portability permits a married couple to fully utilize both a taxpayer and a spouse’s combined exemption ($10,860,000 in 2015) by letting the surviving spouse claim any unused portion of the deceased spouse’s exemption as long as an estate tax return is filed. With these permanent changes, the Tax Policy Center projects that only .14% of adult deaths will result in federal estate tax.

At the same time, federal income tax rates are at higher levels – top rates are 39.6% for ordinary income items, 20% for capital gain items, plus the potential of an additional net investment income tax of 3.8%. Given the changing tax environment, one must now carefully consider the estate and income tax rate differentials when putting together an estate plan.

An important concept to understand when discussing estate and income tax planning is the “step-up” in basis. When a person dies their heirs receive a step-up in the tax basis of most inherited assets. The new tax basis is equal to the fair market value of the assets held by the decedent at the date of death. For example, if the decedent owned 1,000 shares of stock that they purchased for $10,000 in 1983 but was worth $100,000 when they died in 2015, the basis to the heirs is stepped up to $100,000. (Note that the decedent would also be subject to estate tax on the $100,000, if applicable). When the heirs sell the stock a few months later they will likely recognize little gain or loss, as compared to the $90,000 gain the decedent would have realized if they sold the stock right before they died. If the decedent were to have given the stock to the heir before he died, the heir would have to take on the basis of the donor, resulting in a $90,000 gain to the heir.

Planning for achieving the maximum step-up in basis of family assets at death has become more important than ever especially considering that most estates will not be subject to estate tax. It would make sense to hold onto highly appreciated assets, such as stock and fully depreciated real estate investments in order to obtain the basis step-up. An important item to note – step-up does NOT apply to many retirement accounts, such as IRA’s and 401(k)’s.

State estate tax considerations are just as important. For example, Illinois has an income tax rate of 3.75%. The estate tax rate is 8-16%; however, there is a lower estate tax exemption than the federal exemption – $4,000,000. Therefore, individuals with assets more than $4,000,000 and less than $5,430,000 will be subject to Illinois estate tax yet not to federal estate tax. As the estate tax rate will be less than the combined federal and state income tax rate in such a case, it would make sense for Illinois decedents in this asset range to maximize the value of their estates and minimize their income tax.

For married couples who will be comfortably below the $10,860,000 combined estate exemption amount, it would be wise to revisit existing trust agreements. Assets in a typical bypass trust (a staple in estate planning pre-ATRA) will not get a step-up in basis at the death of the second spouse. However, if you live in Illinois a bypass trust may make sense since Illinois does not honor portability. In addition, unless trust income is always distributed, the tax on the trust can be dramatic, as trusts reach the highest tax rate at $12,300 of income. While trusts may offer creditor protection and can offer protection in the event of a divorce of an heir, these benefits should be weighed with the potential tax consequences.

With the large federal estate tax exemption, the permanence of portability and the increase in income tax rates all brought about by ATRA, it is important to revisit your estate plan in light of income tax considerations. If you would like to discuss your estate plan, or have any questions on the information presented, please contact our office.

Changes to the federal income tax code can prompt you to review the legal structure of your business. The 2018 TCJA lowered the corporate tax rate to 21% while barely adjusting the highest individual rate to 37%. At the most basic level, businesses are taxed as either stand-alone or pass-through entities, and a significant difference between corporate and individual tax rates is reason for a new assessment.

If you’re debating between operating as a C corporation or an S corporation, here are three tax aspects to consider.

1.) Income taxes. A difference you’re probably aware of between the two types of corporations is the way earnings are taxed. C corporations are stand-alone entities and pay federal income tax at the corporate level, based on business earnings. If the corporation has a loss, the loss offsets business income in past or future years.

S corporation earnings and losses are passed through to you, as a shareholder. Earnings are taxed on your individual income tax return at your personal tax rate. This is true even if you receive no cash from the business. Losses can offset other types of income such as wages, portfolio, or retirement income.

2.) Ownership. Tax rules limit the number and type of shareholders who can own an interest in your S corporation. For example, an S corporation can have no more than 100 shareholders, and they must all be U.S. citizens or residents. In addition, your S corporation can issue only one class of stock, meaning all shareholders have the same liquidation and distribution rights. When you form a C corporation, foreign owners can hold stock in your business. You can also issue stock with different ownership privileges, such as preferred stock, which grants priority in receiving corporate dividends.

3.) Dividends and distributions. In general, when corporate income is distributed to you as a shareholder, the distribution is a dividend. Whether your corporation is formed as a C corporation or an S corporation, the business gets no deduction.

However, as a C corporation shareholder, you’re required to include income distributions on your personal tax return. In effect, distributions are taxed twice, once on the corporate return and once on your return.

When you own stock in an S corporation, distributions can be considered a return of the money you invested in the business (and has already been taxed at your personal level). The distinction means you may not owe income tax, assuming you have basis in the corporation.

Many tax and nontax reasons will affect your choice of the best type of structure for your business. Please call our office for a complete evaluation.

Mutual funds offer an efficient means of combining investment diversification with professional management. Their income tax effects can be complex, however, and poorly timed purchases or sales can create unpleasant year-end surprises.

Mutual fund investors (excluding qualifying retirement plans) are taxed based on activities within each fund. If a fund investment generates taxable income or the fund sells one of its investments, the income or gain must be passed through to the shareholders. The taxable event occurs on the date the proceeds are distributed to the shareholders, who then owe tax on their individual allocations.

If you buy mutual fund shares toward the end of the year, your cost may include the value of undistributed earnings that have previously accrued within the fund. If the fund then distributes those earnings at year-end, you’ll pay tax on your share even though you paid for the built-up earnings when you bought the shares and thus realized no profit. Additionally, if the fund sold investments during the year at a profit, you’ll be taxed on your share of its year-end distribution of the gain, even if you didn’t own the fund at the time the investments were sold.

Therefore, if you’re considering buying a mutual fund late in the year, ask if it’s going to make a large year-end distribution, and if so, buy after the distribution is completed. Conversely, if you’re selling appreciated shares that you’ve held for over a year, do so before a scheduled distribution, to ensure that your entire profit will be treated as long-term capital gain.

Most mutual fund earnings are taxable (unless earned within a retirement account) even if you automatically reinvest them. Funds must report their annual distributions on Forms 1099, which also indicate the nature of the distributions (interest, capital gains, etc.) so you can determine the proper tax treatment.

Outside the funds, shareholders generate capital gains or losses whenever they sell their shares. The gains or losses are computed by subtracting selling expenses and the “basis” of the shares (generally purchase costs) from the selling price. Determining the basis requires keeping records of each purchase of fund shares, including purchases made by reinvestments of fund earnings. Although mutual funds are now required to track and report shareholders’ cost basis, that requirement only applies to funds acquired after 2011.

When mutual funds are held within IRAs, 401(k) plans, and other qualified retirement plans, their earnings are tax-deferred. However, distributions from such plans are taxed as ordinary income, regardless of how the original earnings would have been taxed if the mutual funds had been held outside the plan. (Roth IRAs are an exception to this treatment.)

If you’re considering buying or selling mutual funds and would like to learn more about them, give us a call.

*This newsletter is issued quarterly to provide you with an informative summary of current business, financial, and tax planning news and opportunities. Do not apply this general information to your specific situation without additional details and/or professional assistance.

To expense or to capitalize? If you buy, build or repair business assets, you might ask that question when deciding whether your costs are currently deductible on your federal income tax return or whether they’re considered capital improvements. Since deductions for capital improvements are typically spread over the life of an asset, the answer can be important even when accelerated depreciation methods are available.

 

New tax rules can make the expense-or-capitalize decision easier. These “repair regulations” provide guidelines and safe harbors to help you determine when certain purchases and expenditures are considered repairs, maintenance, improvements, materials or supplies that can be deducted in the year of purchase. Here’s an overview of safe harbor rules that may affect the way you classify expenses.

 

De minimis purchases. In general, you can deduct the cost of tangible property purchased during a taxable year if the amount you pay for the property is less than $500 per invoice, or per item. This is an all-or-nothing rule, meaning if an asset costs more than $500, you cannot take a partial deduction.

 

To take the deduction, you’ll need a written accounting policy in place by the beginning of your tax year, and you’re required to file an annual statement with your federal tax return.

 

Note: This safe harbor does not apply to intangible assets such as computer software.

 

Repairs and maintenance. You can expense costs for routine maintenance of buildings and other property. For buildings, “routine” means maintenance you expect to perform more than once in a ten-year period. The costs for material additions or defects or for adapting your property to a new or different use are not considered routine maintenance, and they should be capitalized.

 

For other assets, “routine” is defined as maintenance you expect to undertake more than once during the asset’s depreciable class life.

 

Improvements. Generally, improvements you make to your business building are capitalized and depreciated over the life of the building. Under the new rules, if your business’s gross receipts are $10 million or less and the unadjusted basis of your building is $1 million or less, you may choose to write off the cost of improvements.

 

You can make the election annually on a building-by-building basis for property you own or lease by filing a statement with your tax return. To qualify, the total amount you pay during the year for repairs, maintenance, and improvements cannot be greater than $10,000 or 2% of the unadjusted basis of the building, whichever is less.

 

Note: The total includes amounts you deduct under the “repairs and maintenance” and “de minimis” safe harbors.

 

Materials and supplies. Incidental materials and supplies – supplies for which you do not maintain an inventory – costing less than $200 can be expensed in the year of purchase.

 

Note: This safe harbor does not affect prior rules for deducting materials and supplies, such as restaurant smallwares.

 

The repair regulations will affect your federal income tax return. In some cases, you can apply the new rules to prior years. Please contact Cray Kaiser today for additional information.

One of the greatest perks of owning a small business is flexibility. You can set your own hours and salary. You can plot the firm’s trajectory without consulting your boss, upper management, or even corporate policy. But that same flexibility may become a curse if handled unwisely. A small business owner without discipline and a well-thought-out strategy may fall into serious financial trouble. Employees in larger firms often rely on the human resources department to establish pay scales, retirement plans, and health insurance policies. In a small company, all those choices – and many more – fall to the owner, including decisions about personal compensation.

 

How to Set Your Salary

While there’s not a one-size-fits-all formula for determining how much to pay yourself as a business owner, here are three factors to consider:

 

Personal expenses. Tracking your business and personal expenses separately makes it easier to track the firm’s cash flow, and lets you know how much salary you can realistically draw without hurting profitability.

 

Start with your household budget, then determine how much you’re willing to draw from personal savings to keep your household afloat as the company grows. For a start-up company, owner compensation may be minimal. Beware, however, of going too long without paying yourself a reasonable salary. Be sure to document that you’re in business to make a profit; otherwise the IRS may view your perpetually unprofitable business as a hobby – a sham enterprise aimed at avoiding taxes.

 

The market. If you were working for someone else, what would they pay for your skills and knowledge? Start by answering that question; then discuss salary levels with small business groups and colleagues in your geographic area and industry. Check out the Department of Labor and Small Business Administration websites. In the early stages of your business, you probably won’t draw a salary that’s commensurate with the higher range of salaries, but at least you’ll learn what’s reasonable.

 

Affordability. Review and continually update your firm’s cash flow projections to determine the salary level you can reasonably sustain while keeping the business profitable. As the company grows, that level can be adjusted upward.

 

If you’re not sure how to set your salary, please contact Cray Kaiser today. We’re here to help!

The tax law provides a valuable tax-saving opportunity to business owners and real estate investors who want to sell property and acquire similar property at about the same time. This tax break is known as a like-kind or tax-deferred exchange. By following certain rules, you can postpone some or all of the tax that would otherwise be due when you sell property at a gain.

A like-kind exchange simply involves swapping assets that are similar in nature. For example, you can trade an old business vehicle for a new one, or you can swap land for a strip mall. However, you can’t swap your vehicle for an apartment building because the properties are not similar. Certain types of assets don’t qualify for a tax-deferred exchange, including inventory, accounts receivable, stocks and bonds, and your personal residence.

Typically, an equal swap is rare; some amount of cash or debt must change hands between two parties to complete an exchange. Cash or other dissimilar property received in an exchange may be taxable.

It is not necessary for the exchange of properties to be simultaneous. However, in the case of such a “deferred” exchange, the replacement property must be specifically identified in writing within 45 days and must be received within 180 days (or by your tax return due date, if earlier), after transfer of the exchange property.

With a real estate exchange, it is unusual to find two parties whose properties are suitable to each other. This isn’t a problem because the rules allow for three-party exchanges. Three-party exchanges require the use of an intermediary. The intermediary coordinates the paperwork and holds your sale proceeds until you find a replacement property. Then he forwards the money to your closing agent to complete the exchange.

When done properly, exchanges let you trade up in value without owing tax on a sale. There’s no limit on the number of times you can exchange property. If you would like to learn more about tax-deferred exchanges, contact us.

 

*This newsletter is issued quarterly to provide you with an informative summary of current business, financial, and tax planning news and opportunities. Do not apply this general information to your specific situation without additional details and/or professional assistance.