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. 

If you own a business that operates out of your home, you may be able to deduct a wide variety of expenses. These deductions could include part of your rent or mortgage costs, insurance, utilities, repairs, maintenance and even cleaning costs. This can be a tricky area of the tax code, so make sure you have professional guidance.

Here are some of the top mistakes people make when taking home office deductions:

1. Not Taking the Deduction

The most common mistake for home office users is simply not taking the deduction! Taking the deduction seems too complicated for some, while others believe taking it increases your chances of being audited. The rules can be complex, but a home office structured correctly would allow for the home office deduction. There is even a simplified method that can be used to compute the deduction. Contact Cray Kaiser for any questions you may have.

2. The Space Isn’t Exclusive or Regular

The IRS mandates that the space you use must be exclusive and regular for your business. In a nutshell, here’s what that means:

Exclusively: If you use a spare bedroom as a business office, it can’t double as a guest room, a playroom for the kids or a place to store your hockey gear. Any kind of non-business use can invalidate the deduction.

Regularly: Your home office needs to be the primary place you conduct your regular business activities. That doesn’t mean that you must use it every day or that you can’t ever work outside the office. However, it should be the primary place for activities such as recordkeeping, billing, making appointments, ordering equipment or storing supplies.

3. Mixing Up Your Other Work

If you work for someone else in addition to running your own business, you need to be extra careful. IRS rules state that you can use a home office deduction as an employee only if you work remotely for your employer.

Unfortunately, this means if you run a side business out of your home, you can’t bring work home from your employer’s office and do it in your home office. Doing so would invalidate your use of the home office deduction.

4. The Recapture Problem

If you own your home and have been using your home office deduction, you could be in for a future tax surprise. If you sell your house, you will need to account for the depreciation of your home office. This rule, called the Depreciation Recapture Rule, often creates a tax liability for many unsuspecting home office users.

5. Not Getting Help

There are special rules that apply to your use of the home office deduction. If any of the below statements are true for you, contact us for support with navigating the deduction.

• You are an employee of someone else.
• You are running a daycare or assisted living facility out of your home.
• You have a business renting out your primary residence or a vacation home.

While there are benefits of utilizing the home office deduction, there are many details that are important not to overlook. If you have questions about your home office and the deductions available to you, please contact us today.

Your tax return is filed and you’ve even received your refund check. Naturally, you had hoped to be done with taxes for another year. But what do you do if you discover a mistake on your return? Should you file an amended return? Depending on a few circumstances, filing a 1040X may not end up working in your favor. Before you decide to amend your tax return, here are some things to consider.

If You Are Due a Tax Refund

If a correction will result in a substantial additional refund, usually your best option is to file the amended return. However, there some caveats:

• Extra Paperwork: Amending your current tax return may require you to amend previous returns. Even a minor change may require you to report changes in other tax years, which may not be worth the hassle.
• Even More Paperwork: A change to your federal tax return could require you to file an amended state or local tax return, which may not necessarily work out to your benefit.
• Delayed Results: The review process can take can take a very long time. In extreme cases, the IRS can take up to a year and a half to process amended returns.
• Potential for an Audit: Amending a tax return could put a spotlight on your return. Amended returns based on things like the Earned Income Tax Credit (EITC), small business income, and the Research Tax Credit could result in extra IRS scrutiny. You will need to make sure you have the necessary records to substantiate your amended return.
• Extended Audit Review Period: Federal tax returns are subject to audit for three years after the original tax return due date or the date the return was filed, whichever is later. If you file an amended return, the IRS could extend the audit review period. The refund also resets the IRS erroneous refund recovery statute, adding two to five years of possible review based on the date of your latest tax return refund.

If You Owe Additional Taxes

If you discover errors on your tax return that will result in an additional tax obligation, you are required to correct the errors and file an amended tax return, along with the amount due.

If the IRS discovers your tax error before you do, they could add interest and penalty fees. The sooner you file the amended return and pay the tax that is the due, the better.

Finding an error on your tax return can be unsettling, but rest assured there are ways to fix the problem. Contact Cray Kaiser today to determine the best solution for you.

State taxes used to be simple. You have a store in Chicago; you pay Illinois tax. You have a warehouse in Indianapolis; you pay Indiana tax. But what if you have sales people visiting Denver? Or you work with an online reseller with a location in Denver? Do you need to pay Colorado tax? The tax term used when determining in which localities a business must pay tax is called nexus. How nexus works often stumps even the most tax-savvy business owners, especially with the impact of online sales and constantly changing rules. By understanding and correctly determining nexus, you can avoid unnecessary penalties and stop asking yourself, “do I have nexus?”

 

What is Nexus?

Simply put, nexus is the factor that dictates a states’ ability to assess tax. Nexus, or sufficient presence, is determined by a number of factors, including a business’ temporary or permanent presence of people or property in a state.

 

• People can include employees, service people, independent sales agents and independent service agents.
• Property can include inventory, offices, warehouses and temporarily consigned physical space.
• Temporary presence can include making sales calls, visiting customers or attending trade shows.

Do I Have Nexus? How is it Determined?

Some aspects of nexus are clear. For example, if a business has a permanent location in a particular state, there is no federal limitation on a states’ ability to subject the business to income tax. Beyond the obvious, however, each state defines nexus in its own way, and differently for different tax types.

 

For example, states may consider the following when determining nexus:

• If products are sold in a particular state but there is no physical presence or employees in that state, the business is exempt from that state’s income tax, but may owe sales tax.
• If a business physically sends salespeople to a different state, they would generally owe sales tax in that state. However, if the salesperson conducts the entire sale from one state, and there is no other connection to the other state, the business would only owe sales tax in the state in which they conducted the sale.
• Some states may charge sales tax to online resellers. Because online sales are still relatively new to the business world, click-through nexus rules are one of the most complicated and debated areas of state tax.
• Most states consider nexus present if delivery is made in a state using the business’ own vehicles. Using a common carrier can help to limit nexus.

Why are Definitions Changing?

States’ definitions of nexus are adapting to evolution in technology. Constantly changing technology changes the way we do business. As online sales grow, businesses conduct more and more business out of state. In addition, advances in technology make it easier for states to collect information about sales occurring within their state.

 

Additionally, given budget constraints, states are becoming more aggressive in seeking out additional tax revenue.

How Do Changes in Nexus Impact the Small Business Owner? 

The lack of a consistent definition of nexus state-to-state creates confusion and exposure to tax liability. Small businesses with little to no internal accounting departments may not have the time or the expertise to properly assess nexus. For businesses with interstate activity that only file a home state tax return, the potential tax exposure and tax complexity can be a significant cause for concern.

How Does What’s Next Impact You?

A federal nexus definition has been spoken of for years, but thus far has not become a reality. In the meantime, it’s important for business owners to understand their risk. Consult with an accountant to determine how nexus is defined in the states in which you do business. Find out if you need to register to do business in other states or file additional state tax forms. Explore voluntary disclosure programs and statutes of limitations. Most importantly, any time you have a question about whether or not you have nexus in a particular state, check in with your accountant.

 

Don’t be stumped by your nexus questions. Contact Cray Kaiser today.

John’s skills and talent have resulted in a great deal of success for the company. His sales job involves quite a bit of driving throughout the Midwest. You’ve decided you want to reward his efforts and success with a company car. Before you tell John, you have a decision to make. Will his car be leased? Or will the company buy it outright? What kind of impact does leasing versus owning have on the company’s tax situation? Several factors impact this decision, including how long the car will be kept and how consistently the car will be driven.

How long will the company keep the car?

If the company plans for John to keep the car longer than a leasing period, it likely makes sense to buy the car outright. If the company plans to reward John with new cars fairly frequently, a lease may make more sense. Weigh the annual lease payments against the annual deductions.

Will the use of the car be consistent year-to-year?

Regardless of whether you lease or buy John’s car, the company has a choice to make.  They can either deduct all expenses, including gas, service, repairs, depreciation/lease expenses and insurance, or use the standard mileage rate (54¢ per mile in 2016). Tolls and parking can be expensed in addition to the standard mileage rate.

Only mileage associated with business use can be deducted, and a log must be kept to separate business mileage from personal use. In order for the expenses/mileage to be fully deductible to the company, the employee using the car must have the personal portion of the auto use recorded on their W2 as a fringe benefit. The pretax benefit to the employee far outweighs the small amount of additional income associated with the fringe benefit.

Different rules apply to switching between deduction methods for leasing versus buying.

If John’s use of the company car will vary from year to year, buying the car will offer more flexibility. In addition, inconsistent use can also create costly leasing expenses. Leases include an annual mileage allowance with per mile surcharges for overages.

Choosing the best option between leasing and buying John’s new car means considering tax implications and predicting the use of the car. Careful planning including consideration of when John’s car will be replaced and how consistent his travel will be will help you reach the best decision for your company.

If you are facing a similar decision and want to talk through the tax implications, we would be happy to help. Contact us today.

2016 W2 Forms must be filed with the Social Security Administration (SSA) by January 31, a month earlier than in past years. The deadline to mail W2s to employees remains January 31. The date was accelerated as an attempt to reduce fraud.

Follow these tips to avoid errors:

• Allow time to review W2s. Even if you use a third-party payroll service, you are responsible for confirming that W2s are accurate and complete. The new timing eliminates the opportunity for employers to easily correct any errors noticed by employees before filing with the SSA. Employers can regain this benefit by sending W2s to employees as soon after January 1 as possible.

• Calculate value of taxable benefits in advance. Third-party payroll services will typically require employers to provide this data. Taxable benefits include:
  • Value of personal use of company cars. Your accountant can help you determine this taxable amount based on information including make and year of the car, mileage and amount of personal use.
  • Value of life insurance benefits. The value is determined by consulting IRS charts. Age and exemptions impact the amount taxable to the employee.
  • Medical insurance benefits for S-Corp owners who own more than 2% of the company.

• Be aware of ownership tax filing requirements. Owners of S-Corps should receive W2s while owners of partnerships and limited liability companies should receive K1 forms, not W2s.

Meeting the new deadline can be stress-free if you take the time to prepare in advance. Throughout the next year, create a set process for collecting taxable benefit data. For example, require any employees who use a company car to maintain and submit an auto log and collect the log on a monthly or annual basis.

We are happy to help calculate the value of your employees’ taxable benefits for your W2s. For help or to learn more about W2 preparation and filing, contact us today.