As your business grows, you may find yourself hiring employees out of state. While the growth associated with having an employee in another state is great, keeping up with the payroll compliance in each state can feel like trudging through murky waters. States have varying requirements related to withholding income tax and paying unemployment tax.  Additionally, states have increased their tax compliance efforts over the years making it even more necessary that employers be aware of their responsibilities. So, if you have an out-of-state employee, here’s what you need to consider:

Where does the employee work?

Generally, you are required to withhold income tax and pay unemployment tax in the state in which the employee physically works. Makes sense, right? But it’s not always so straightforward. If your employee travels into several states, you need to be familiar with each state’s requirements. Some states require withholding from the first day an employee works in the state while other states have thresholds (minimum numbers of days or minimum amount earned) that determine when withholding is required.

If your employee works in one state but lives in a neighboring state, he or she may have to file tax returns in both states. However, if the two states have entered into a reciprocal agreement, the employee would only need to file in the resident state.

What is a reciprocal agreement?

Some states have formed reciprocal agreements, which exempt employees from paying income tax on wages earned within the state if the employee lives in a bordering state. That means that wages are only taxed by the employee’s resident state. This simplifies compliance for the employee, who would otherwise be required to file income tax returns both in the resident state and the state in which the wages were earned.

What is a reciprocal exemption?

When an employee has a reciprocal exemption, the employer withholds income tax in the employee’s resident state but generally pays unemployment tax to the state in which the wages were earned. For example, consider an employee working in Illinois but living in Michigan. The employer would report the wages as Michigan wages on the payroll withholding reports, but the wages would be reported as Illinois wages for Illinois unemployment tax reports.

What else should I consider with employees in other states?

Payroll taxes are an obvious consideration when you have employees working in other states. You will also need to consider other workforce requirements of each state, including:

• Minimum wage, overtime, and equal pay requirements
• Employee rights posting requirements
• State disability requirements

Additionally, be sure your workers’ compensation policy includes all employees, even those working remotely. In the case of remote workers, be sure to inform your workers’ compensation company of the employees’ duties, work area and work hours.

Asking yourself these questions is the first step in being compliant with the states and also providing the best possible state withholding for your employees. Cray Kaiser is available to assist you when these issues come into play. Please contact us anytime at 630-953-4900.

Marriage, like every major milestone, brings a multitude of changes. If you’re recently married or engaged, you may not be thinking too much about your taxes yet. But many newly married couples are surprised to discover how marriage impacts their tax situation. After marriage, a couple’s tax liability can go up or down compared to when they were single.

The so-called “marriage penalty” typically occurs when two people with similar incomes marry, which raises their tax liability. To further complicate matters, the Tax Cuts and Jobs Act has brought additional changes to the tax implications of marriage. Whether you’re soon to be married, newly married, or have been married for a long time, we recommend reviewing the new changes to the tax code that may affect how marriage impacts your tax returns.

The Good News and the Tradeoff

Prior to the tax reform, couples in the middle to high income tax brackets faced a tax penalty. Now, that penalty only applies to very high-income earners because the income tax brackets are exactly double those for individual filers.

Unfortunately, that doesn’t mean that the marriage penalty has completely disappeared. Rather, the penalty has been shifted to itemized deductions. If you take the standard deduction you won’t see an impact. But starting this year, taxpayers who itemize their deductions can deduct up to $10,000 in state and local taxes. However, that limit is the same whether you file as an individual or as a married couple, so married couples effectively have that deduction cut in half.

What This Means for You

Each individual’s situation is different, but here are the general implications under the new guidelines:

• Single taxpayers may still want to itemize deductions since the $10,000 state and local tax deduction, in addition to their other tax breaks, may well surpass the value of the standard deduction.
• Married filers will have a harder time finding enough tax breaks to surpass their combined standard deduction, so they may want to take the standard deduction.

Even though the Tax Cuts and Jobs Act has created new tax liability challenges for married couples, there are also new opportunities. You can read our overview of the impact of tax reform here. Please call Cray Kaiser today at 630-953-4900 if you have any questions.

When it is set up and maintained properly, QuickBooks can be an incredibly helpful and powerful tool for business owners and managers. The software can provide up-to-date financial statements and cash flow data and create general efficiencies in your accounting. However, too often we see that QuickBooks is either underutilized or simply a burden to our clients.

With tax season behind us, we thought it would be helpful to share a few challenges that we encountered with our QuickBooks clients this year. These challenges added additional barriers and complications during tax season. By being proactive and taking action now, you can help make next tax season much easier to navigate.

The most common QuickBooks issues included:

1. Unorganized Chart of Accounts: Your financial statements are the framework that gives insight into your organization’s financial health. The financial statements are born from your Chart of Accounts. It’s easy to think more detail is better, but that’s not always the case. Having too many and/or an unorganized Chart of Accounts can hinder the amount of information provided by the financial statements.

For example, when analyzing financial statements, you often want to perform trend analysis (looking for increases, decreases or baseline for certain items). This can be extremely difficult if there are too many accounts. When this occurs, there is an increased chance of the same account appearing multiple times as a subaccount. Thus, creating confusion for those performing the data entry, resulting in errors in the financial statement reporting.

There are a number of different solutions to resolve this problem:

a. Use subaccounts when necessary to the financial reporting.
b. Merge accounts when you find too many accounts which are similar.
c. Mark the account inactive when you no longer need to use the account.

2. Disorderly Items List: QuickBooks defines the product(s) you sell as “items”. Over time, it’s easy to add inventory anywhere into the system and forget to keep amounts updated. This can sometimes create negative inventory amounts on your balance sheet. Here are a few quick steps to clean up your Items List:

a. Mark any items you no longer sell as inactive.
b. Ensure each item is correctly labeled inventory, non-inventory, etc.
c. Double-check the item exists with your physical inventory.
d. Make sure you keep the costs for each item updated.
e. Assign each item correctly with the proper revenue and cost accounts to ensure accuracy in your financial reporting.

3. Unreconciled Bank and/or Credit Card Accounts: Reconciling your bank and credit card accounts every month is very important. Why? Because it serves as a control to ensure that all cash and credit card transactions are accounted for properly. Performing this function monthly helps you identify problems before they get out of hand. Here are a few steps to take when reconciling your accounts:

a. Review uncleared transactions.
b. Make sure the transaction hit the right account.
c. Check to see if there are any duplicate entries.

4. Incorrectly Applying Deposits to Invoices: When customer balances appear on your accounts receivable aging as a ‘negative balance’, unless the customer has an overpaid balance, this is usually a pretty good indicator that something is wrong. In most cases, this is the result of invoices being applied incorrectly. Every time you get paid by a customer, you should be able to receive that payment against an open invoice. Take a second look to make sure this is happening in your QuickBooks account.

5. Not Applying Payments to a Vendor Bill: Sometimes vendors who have been paid still show amounts due on the AP Aging reports. This creates a situation where a company’s liabilities are being overstated. To correct this, you may need to void or delete the bill that has already been paid. We recommend contacting your accountant before deleting any entries as they may be linked to other transactions.

6. Misusing the Undeposited Funds Account: Are you receiving payments from customers but your cash account isn’t increasing on your financial reports? It’s likely that you’re using Undeposited Funds incorrectly. Undeposited Funds is an internal current asset account created by QuickBooks to hold funds until you are ready to deposit them in the system. When you receive a customer payment, open the deposit module, batch checks together that you’re taking to the bank, and record them as one single deposit in the software.

7. Forgetting to Lock a Closed Period: When you close out a month (or any period), make sure to lock it so that no one can go back and change the amounts that were used to file tax returns and financial statements. Please note that all entries should be made in the current period.

Following these few steps will allow management to make decisions using timely and reliable financial information. By taking the opportunity to implement these strategies now, next tax season will be less stressful and provide management greater opportunities throughout the rest of 2018. Our QuickBooks Pro Advisors team can provide you support in any of the above areas. Please contact Cray Kaiser today for more information on how you can maximize QuickBooks.

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.

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.