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Choosing the right accounting method for tax purposes

The Tax Cuts and Jobs Act (TCJA) liberalized the eligibility rules for using the cash method of accounting, making this method — which is simpler than the accrual method — available to more businesses. Now the IRS has provided procedures a small business taxpayer can use to obtain automatic consent to change its method of accounting under the TCJA. If you have the option to use either accounting method, it pays to consider whether switching methods would be beneficial.

Cash vs. accrual

Generally, cash-basis businesses recognize income when it’s received and deduct expenses when they’re paid. Accrual-basis businesses, on the other hand, recognize income when it’s earned and deduct expenses when they’re incurred, without regard to the timing of cash receipts or payments.

In most cases, a business is permitted to use the cash method of accounting for tax purposes unless it’s:

  1. Expressly prohibited from using the cash method, or
  2. Expressly required to use the accrual method.

Cash method advantages

The cash method offers several advantages, including:

Simplicity. It’s easier and cheaper to implement and maintain.

Tax-planning flexibility. It offers greater flexibility to control the timing of income and deductible expenses. For example, it allows you to defer income to next year by delaying invoices or to shift deductions into this year by accelerating the payment of expenses. An accrual-basis business doesn’t enjoy this flexibility. For example, to defer income, delaying invoices wouldn’t be enough; the business would have to put off shipping products or performing services.

Cash flow benefits. Because income is taxed in the year it’s received, the cash method does a better job of ensuring that a business has the funds it needs to pay its tax bill.

Accrual method advantages

In some cases, the accrual method may offer tax advantages. For example, accrual-basis businesses may be able to use certain tax-planning strategies that aren’t available to cash-basis businesses, such as deducting year-end bonuses that are paid within the first 2½ months of the following year and deferring income on certain advance payments.

The accrual method also does a better job of matching income and expenses, so it provides a more accurate picture of a business’s financial performance. That’s why it’s required under Generally Accepted Accounting Principles (GAAP).

If your business prepares GAAP-compliant financial statements, you can still use the cash method for tax purposes. But weigh the cost of maintaining two sets of books against the potential tax benefits.

Making a change

Keep in mind that cash and accrual are the two primary tax accounting methods, but they’re not the only ones. Some businesses may qualify for a different method, such as a hybrid of the cash and accrual methods.

If your business is eligible for more than one method, we can help you determine whether switching methods would make sense and can execute the change for you if appropriate.

 

 

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Do you need to make an estimated tax payment by September 17?

To avoid interest and penalties, you must make sufficient federal income tax payments long before your April filing deadline through withholding, estimated tax payments, or a combination of the two. The third 2018 estimated tax payment deadline for individuals is September 17.

If you don’t have an employer withholding tax from your pay, you likely need to make estimated tax payments. But even if you do have withholding, you might need to pay estimated tax. It can be necessary if you have more than a nominal amount of income from sources such as self-employment, interest, dividends, alimony, rent, prizes, awards or the sales of assets.

A two-prong test

Generally, you must pay estimated tax for 2018 if both of these statements apply:

  1. You expect to owe at least $1,000 in tax after subtracting tax withholding and credits, and
  2. You expect withholding and credits to be less than the smaller of 90% of your tax for 2018 or 100% of the tax on your 2017 return — 110% if your 2017 adjusted gross income was more than $150,000 ($75,000 for married couples filing separately).

If you’re a sole proprietor, partner or S corporation shareholder, you generally have to make estimated tax payments if you expect to owe $1,000 or more in tax when you file your return.

Quarterly payments

Estimated tax payments are spaced through the year into four periods or due dates. Generally, the due dates are April 15, June 15 and September 15 of the tax year and January 15 of the next year, unless the date falls on a weekend or holiday (hence the September 17 deadline this year).

Estimated tax is calculated by factoring in expected gross income, taxable income, deductions and credits for the year. The easiest way to pay estimated tax is electronically through the Electronic Federal Tax Payment System. You can also pay estimated tax by check or money order using the Estimated Tax Payment Voucher or by credit or debit card.

Confirming withholding

If you determine you don’t need to make estimated tax payments for 2018, it’s a good idea to confirm that the appropriate amount is being withheld from your paycheck. To reflect changes under the Tax Cuts and Jobs Act (TCJA), the IRS updated the tables that indicate how much employers should withhold from their employees’ pay, generally reducing the amount withheld.

The new tables might cause some taxpayers to not have enough withheld to pay their ultimate tax liabilities under the TCJA. The IRS has updated its withholding calculator (available at irs.gov) to assist taxpayers in reviewing their situations.

Avoiding penalties

Keep in mind that, if you underpaid estimated taxes in earlier quarters, you generally can’t avoid penalties by making larger estimated payments in later quarters. But if you also have withholding, you may be able to avoid penalties by having the estimated tax shortfall withheld.

To learn more about estimated tax and withholding — and for help determining how much tax you should be paying during the year — contact us.

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Do you still need to worry about the AMT?

There was talk of repealing the individual alternative minimum tax (AMT) as part of last year’s tax reform legislation. A repeal wasn’t included in the final version of the Tax Cuts and Jobs Act (TCJA), but the TCJA will reduce the number of taxpayers subject to the AMT.

Now is a good time to familiarize yourself with the changes, assess your AMT risk and see if there are any steps you can take during the last several months of the year to avoid the AMT, or at least minimize any negative impact.

AMT vs. regular tax

The top AMT rate is 28%, compared to the top regular ordinary-income tax rate of 37%. But the AMT rate typically applies to a higher taxable income base and will result in a larger tax bill if you’re subject to it.

The TCJA reduced the number of taxpayers who’ll likely be subject to the AMT in part by increasing the AMT exemption and the income phaseout ranges for the exemption:

  • For 2018, the exemption is $70,300 for singles and heads of households (up from $54,300 for 2017), and $109,400 for married couples filing jointly (up from $84,500 for 2017).
  • The 2018 phaseout ranges are $500,000–$781,200 for singles and heads of households (up from $120,700–$337,900 for 2017) and $1,000,000–$1,437,600 for joint filers (up from $160,900–$498,900 for 2017).

You’ll be subject to the AMT if your AMT liability is greater than your regular tax liability.

AMT triggers

In the past, common triggers of the AMT were differences between deductions allowed for regular tax purposes and AMT purposes. Some popular deductions aren’t allowed under the AMT.

New limits on some of these deductions for regular tax purposes, such as on state and local income and property tax deductions, mean they’re less likely to trigger the AMT. And certain deductions not allowed for AMT purposes are now not allowed for regular tax purposes either, such as miscellaneous itemized deductions subject to the 2% of adjusted gross income floor.

But deductions aren’t the only things that can trigger the AMT. Some income items might do so, too, such as:

  • Long-term capital gains and dividend income, even though they’re taxed at the same rate for both regular tax and AMT purposes,
  • Accelerated depreciation adjustments and related gain or loss differences when assets are sold,
  • Tax-exempt interest on certain private-activity municipal bonds, and
  • The exercise of incentive stock options.

AMT planning tips

If it looks like you could be subject to the AMT in 2018, consider accelerating income into this year. Doing so may allow you to benefit from the lower maximum AMT rate. And deferring expenses you can’t deduct for AMT purposes may allow you to preserve those deductions. If you also defer expenses you can deduct for AMT purposes, the deductions may become more valuable because of the higher maximum regular tax rate.

Please contact us if you have questions about whether you could be subject to the AMT this year or about minimizing negative consequences from the AMT.

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Close-up on the new QBI deduction’s wage limit

The Tax Cuts and Jobs Act (TCJA) provides a valuable new tax break to noncorporate owners of pass-through entities: a deduction for a portion of qualified business income (QBI). The deduction generally applies to income from sole proprietorships, partnerships, S corporations and, typically, limited liability companies (LLCs). It can equal as much as 20% of QBI. But once taxable income exceeds $315,000 for married couples filing jointly or $157,500 for other filers, a wage limit begins to phase in.

Full vs. partial phase-in

When the wage limit is fully phased in, at $415,000 for joint filers and $207,500 for other filers, the QBI deduction generally can’t exceed the greater of the owner’s share of:

  • 50% of the amount of W-2 wages paid to employees during the tax year, or
  • The sum of 25% of W-2 wages plus 2.5% of the cost of qualified business property (QBP).

When the wage limit applies but isn’t yet fully phased in, the amount of the limit is reduced and the final deduction is calculated as follows:

  1. The difference between taxable income and the applicable threshold is divided by $100,000 for joint filers or $50,000 for other filers.
  2. The resulting percentage is multiplied by the difference between the gross deduction and the fully wage-limited deduction.
  3. The result is subtracted from the gross deduction to determine the final deduction.

Some examples

Let’s say Chris and Leslie have taxable income of $600,000. This includes $300,000 of QBI from Chris’s pass-through business, which pays $100,000 in wages and has $200,000 of QBP. The gross deduction would be $60,000 (20% of $300,000), but the wage limit applies in full because the married couple’s taxable income exceeds the $415,000 top of the phase-in range for joint filers. Computing the deduction is fairly straightforward in this situation.

The first option for the wage limit calculation is $50,000 (50% of $100,000). The second option is $30,000 (25% of $100,000 + 2.5% of $200,000). So the wage limit — and the deduction — is $50,000.

What if Chris and Leslie’s taxable income falls within the phase-in range? The calculation is a bit more complicated. Let’s say their taxable income is $400,000. The full wage limit is still $50,000, but only 85% of the full limit applies:

($400,000 taxable income – $315,000 threshold)/$100,000 = 85%

To calculate the amount of their deduction, the couple must first calculate 85% of the difference between the gross deduction of $60,000 and the fully wage-limited deduction of $50,000:

($60,000 – $50,000) × 85% = $8,500

That amount is subtracted from the $60,000 gross deduction for a final deduction of $51,500.

That’s not all

Be aware that another restriction may apply: For income from “specified service businesses,” the QBI deduction is reduced if an owner’s taxable income falls within the applicable income range and eliminated if income exceeds it. Please contact us to learn whether your business is a specified service business or if you have other questions about the QBI deduction.

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Why the “kiddie tax” is more dangerous than ever

Once upon a time, some parents and grandparents would attempt to save tax by putting investments in the names of their young children or grandchildren in lower income tax brackets. To discourage such strategies, Congress created the “kiddie” tax back in 1986. Since then, this tax has gradually become more far-reaching. Now, under the Tax Cuts and Jobs Act (TCJA), the kiddie tax has become more dangerous than ever.

A short history

Years ago, the kiddie tax applied only to children under age 14 — which still provided families with ample opportunity to enjoy significant tax savings from income shifting. In 2006, the tax was expanded to children under age 18. And since 2008, the kiddie tax has generally applied to children under age 19 and to full-time students under age 24 (unless the students provide more than half of their own support from earned income).

What about the kiddie tax rate? Before the TCJA, for children subject to the kiddie tax, any unearned income beyond a certain amount ($2,100 for 2017) was taxed at their parents’ marginal rate (assuming it was higher), rather than their own likely low rate.

A fiercer kiddie tax

The TCJA doesn’t further expand who’s subject to the kiddie tax. But it will effectively increase the kiddie tax rate in many cases.

For 2018–2025, a child’s unearned income beyond the threshold ($2,100 again for 2018) will be taxed according to the tax brackets used for trusts and estates. For ordinary income (such as interest and short-term capital gains), trusts and estates are taxed at the highest marginal rate of 37% once 2018 taxable income exceeds $12,500. In contrast, for a married couple filing jointly, the highest rate doesn’t kick in until their 2018 taxable income tops $600,000.

Similarly, the 15% long-term capital gains rate takes effect at $77,201 for joint filers but at only $2,601 for trusts and estates. And the 20% rate kicks in at $479,001 and $12,701, respectively.

In other words, in many cases, children’s unearned income will be taxed at higher rates than their parents’ income. As a result, income shifting to children subject to the kiddie tax will not only not save tax, but it could actually increase a family’s overall tax liability.

The moral of the story

To avoid inadvertently increasing your family’s taxes, be sure to consider the big, bad kiddie tax before transferring income-producing or highly appreciated assets to a child or grandchild who’s a minor or college student. If you’d like to shift income and you have adult children or grandchildren who’re no longer subject to the kiddie tax but in a lower tax bracket, consider transferring such assets to them.

Please contact us for more information about the kiddie tax — or other TCJA changes that may affect your family.

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What you can deduct when volunteering

Because donations to charity of cash or property generally are tax deductible (if you itemize), it only seems logical that the donation of something even more valuable to you — your time — would also be deductible. Unfortunately, that’s not the case.

Donations of time or services aren’t deductible. It doesn’t matter if it’s simple administrative work, such as checking in attendees at a fundraising event, or if it’s work requiring significant experience and expertise that would be much more costly to the charity if it had to pay for it, such as skilled carpentry or legal counsel.

However, you potentially can deduct out-of-pocket costs associated with your volunteer work.

The basic rules

As with any charitable donation, for you to be able to deduct your volunteer expenses, the first requirement is that the organization be a qualified charity. You can use the IRS’s “Tax Exempt Organization Search” tool (formerly “Select Check”) at https://www.irs.gov/charities-non-profits/tax-exempt-organization-search to find out.

Assuming the charity is qualified, you may be able to deduct out-of-pocket costs that are:

  • Unreimbursed,
  • Directly connected with the services you’re providing,
  • Incurred only because of your charitable work, and
  • Not “personal, living or family” expenses.

Supplies, uniforms and transportation

A wide variety of expenses can qualify for the deduction. For example, supplies you use in the activity may be deductible. And the cost of a uniform you must wear during the activity may also be deductible (if it’s required and not something you’d wear when not volunteering).

Transportation costs to and from the volunteer activity generally are deductible, either the actual cost or 14 cents per charitable mile driven. But you have to be the volunteer. If, say, you drive your elderly mother to the nature center where she’s volunteering, you can’t deduct the cost.

You also can’t deduct transportation costs you’d be incurring even if you weren’t volunteering. For example, if you take a commuter train downtown to work, then walk to a nearby volunteer event after work and take the train back home afterwards, you won’t be able to deduct your train fares. But if you take a cab from work to the volunteer event, then you potentially can deduct the cab fare for that leg of your transportation.

Volunteer travel

Transportation costs may also be deductible for out-of-town travel associated with volunteering. This can include air, rail and bus transportation; driving expenses; and taxi or other transportation costs between an airport or train station and wherever you’re staying. Lodging and meal costs also might be deductible.

The key to deductibility is that there is no significant element of personal pleasure, recreation or vacation in the travel. That said, according to the IRS, the deduction for travel expenses won’t be denied simply because you enjoy providing services to the charitable organization. But you must be volunteering in a genuine and substantial sense throughout the trip. If only a small portion of your trip involves volunteer work, your travel expenses generally won’t be deductible.

Keep careful records

The IRS may challenge charitable deductions for out-of-pocket costs, so it’s important to keep careful records. If you have questions about what volunteer expenses are and aren’t deductible, please contact us.

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Do you know the ABCs of HSAs, FSAs and HRAs?

There continues to be much uncertainty about the Affordable Care Act and how such uncertainty will impact health care costs. So it’s critical to leverage all tax-advantaged ways to fund these expenses, including HSAs, FSAs and HRAs. Here’s how to make sense of this alphabet soup of health care accounts.

HSAs

If you’re covered by a qualified high-deductible health plan (HDHP), you can contribute pretax income to an employer-sponsored Health Savings Account — or make deductible contributions to an HSA you set up yourself — up to $3,450 for self-only coverage and $6,900 for family coverage for 2018. Plus, if you’re age 55 or older, you may contribute an additional $1,000.

You own the account, which can bear interest or be invested, growing tax-deferred similar to an IRA. Withdrawals for qualified medical expenses are tax-free, and you can carry over a balance from year to year.

FSAs

Regardless of whether you have an HDHP, you can redirect pretax income to an employer-sponsored Flexible Spending Account up to an employer-determined limit — not to exceed $2,650 in 2018. The plan pays or reimburses you for qualified medical expenses.

What you don’t use by the plan year’s end, you generally lose — though your plan might allow you to roll over up to $500 to the next year. Or it might give you a grace period of two and a half months to incur expenses to use up the previous year’s contribution. If you have an HSA, your FSA is limited to funding certain “permitted” expenses.

HRAs

A Health Reimbursement Account is an employer-sponsored account that reimburses you for medical expenses. Unlike an HSA, no HDHP is required. Unlike an FSA, any unused portion typically can be carried forward to the next year.

There’s no government-set limit on HRA contributions. But only your employer can contribute to an HRA; employees aren’t allowed to contribute.

Maximize the benefit

If you have one of these health care accounts, it’s important to understand the applicable rules so you can get the maximum benefit from it. But tax-advantaged accounts aren’t the only way to save taxes in relation to health care. If you have questions about tax planning and health care expenses, please contact us.

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2018 Q3 tax calendar: Key deadlines for businesses and other employers

Here are some of the key tax-related deadlines affecting businesses and other employers during the third quarter of 2018. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

July 31

  • Report income tax withholding and FICA taxes for second quarter 2018 (Form 941), and pay any tax due. (See the exception below, under “August 10.”)
  • File a 2017 calendar-year retirement plan report (Form 5500 or Form 5500-EZ) or request an extension.

August 10

  • Report income tax withholding and FICA taxes for second quarter 2018 (Form 941), if you deposited on time and in full all of the associated taxes due.

September 17

  • If a calendar-year C corporation, pay the third installment of 2018 estimated income taxes.
  • If a calendar-year S corporation or partnership that filed an automatic six-month extension:
    • File a 2017 income tax return (Form 1120S, Form 1065 or Form 1065-B) and pay any tax, interest and penalties due.
    • Make contributions for 2017 to certain employer-sponsored retirement plans

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The tax impact of the TCJA on estate planning

The massive changes the Tax Cuts and Jobs Act (TCJA) made to income taxes have garnered the most attention. But the new law also made major changes to gift and estate taxes. While the TCJA didn’t repeal these taxes, it did significantly reduce the number of taxpayers who’ll be subject to them, at least for the next several years. Nevertheless, factoring taxes into your estate planning is still important.

Exemption increases

The TCJA more than doubles the combined gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption, from $5.49 million for 2017 to $11.18 million for 2018.

This amount will continue to be annually adjusted for inflation through 2025. Absent further congressional action, however, the exemptions will revert to their 2017 levels (adjusted for inflation) for 2026 and beyond.

The rate for all three taxes remains at 40% — only three percentage points higher than the top income tax rate.

The impact

Even before the TCJA, the vast majority of taxpayers didn’t have to worry about federal gift and estate taxes. While the TCJA protects even more taxpayers from these taxes, those with estates in the roughly $6 million to $11 million range (twice that for married couples) still need to keep potential post-2025 estate tax liability in mind in their estate planning. Although their estates would escape estate taxes if they were to die while the doubled exemption is in effect, they could face such taxes if they live beyond 2025.

Any taxpayer who could be subject to gift and estate taxes after 2025 may want to consider making gifts now to take advantage of the higher exemptions while they’re available.

Factoring taxes into your estate planning is also still important if you live in a state with an estate tax. Even before the TCJA, many states imposed estate tax at a lower threshold than the federal government did. Now the differences in some states will be even greater.

Finally, income tax planning, which became more important in estate planning back when exemptions rose to $5 million more than 15 years ago, is now an even more important part of estate planning.

For example, holding assets until death may be advantageous if estate taxes aren’t a concern. When you give away an appreciated asset, the recipient takes over your tax basis in the asset, triggering capital gains tax should he or she turn around and sell it. When an appreciated asset is inherited, on the other hand, the recipient’s basis is “stepped up” to the asset’s fair market value on the date of death, erasing the built-in capital gain. So retaining appreciating assets until death can save significant income tax.

Review your estate plan

Whether or not you need to be concerned about federal gift and estate taxes, having an estate plan in place and reviewing it regularly is important. Contact us to discuss the potential tax impact of the TCJA on your estate plan.

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Factor in state and local taxes when deciding where to retire

Many Americans relocate to another state when they retire. If you’re thinking about such a move, state and local taxes should factor into your decision.

Income, property and sales tax

Choosing a state that has no personal income tax may appear to be the best option. But that might not be the case once you consider property taxes and sales taxes.

For example, suppose you’ve narrowed your decision down to two states: State 1 has no individual income tax, and State 2 has a flat 5% individual income tax rate. At first glance, State 1 might appear to be much less expensive from a tax perspective. What happens when you factor in other state and local taxes?

Let’s say the property tax rate in your preferred locality in State 1 is 5%, while it’s only 1% in your preferred locality in State 2. That difference could potentially cancel out any savings in state income taxes in State 1, depending on your annual income and the assessed value of the home.

Also keep in mind that home values can vary dramatically from location to location. So if home values are higher in State 1, there’s an even greater chance that State 1’s overall tax cost could be higher than State 2’s, despite State 1’s lack of income tax.

The potential impact of sales tax can be harder to estimate, but it’s a good idea at minimum to look at the applicable rates in the various retirement locations you’re considering.

More to think about

If states you’re considering have an income tax, also look at what types of income they tax. Some states, for example, don’t tax wages but do tax interest and dividends. Others offer tax breaks for retirement plan and Social Security income.

In the past, the federal income tax deduction for state and local property and income or sales tax could help make up some of the difference between higher- and lower-tax states. But with the Tax Cuts and Jobs Act (TCJA) limiting that deduction to $10,000 ($5,000 for married couples filing separately), this will be less help — at least through 2025, after which the limit is scheduled to expire.

There’s also estate tax to consider. Not all states have estate tax, but it can be expensive in states that do. While under the TJCA the federal estate tax exemption has more than doubled from the 2017 level to $11.18 million for 2018, states aren’t necessarily keeping pace with the federal exemption. So state estate tax could be levied after a much lower exemption.

Choose wisely

As you can see, it’s important to factor in state and local taxes as you decide where to live in retirement. You might ultimately decide on a state with higher taxes if other factors are more important to you. But at least you will have made an informed decision and avoid unpleasant tax surprises. Contact us to learn more.

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