Small Business

Do you have an excess business loss?

February 19, 2025

If an individual taxpayer has substantial business losses, unfavorable federal income tax rules can potentially come into play. Here’s what you need to know as you assess your 2024 tax situation.

Disallowance rule

The tax rules can get complicated if your business or rental activity throws off a tax loss — and many do during the early years. First, the passive activity loss (PAL) rules may apply if you aren’t very involved in the business or if it’s a rental activity. The PAL rules generally only allow you to deduct passive losses to the extent you have passive income from other sources. However, you can deduct passive losses that have been disallowed in previous years (called suspended PALs) when you sell the activity or property that produced the suspended losses.

If you successfully clear the hurdles imposed by the PAL rules, you face another hurdle: You can’t deduct an excess business loss in the current year. For 2024, an excess business loss is the excess of your aggregate business losses over $305,000 ($610,000 for married joint filers). For 2025, the thresholds are $313,000 and $626,000, respectively. An excess business loss is carried over to the following tax year and can be deducted under the rules for net operating loss (NOL) carryforwards explained below.

Deducting NOLs

You generally can’t use an NOL carryover, including one from an excess business loss, to shelter more than 80% of your taxable income in the carryover year. Also, NOLs generally can’t be carried back to an earlier tax year. They can only be carried forward and can be carried forward indefinitely. The requirement that an excess business loss must be carried forward as an NOL forces you to wait at least one year to get any tax-saving benefit from it.

Example 1: Taxpayer has a partial deductible business loss

David is unmarried. In 2024, he has an allowable loss of $400,000 from his start-up AI venture that he operates as a sole proprietorship.

Although David has no other income or losses from business activities, he has $500,000 of income from other sources (salary, interest, dividends, capital gains and so forth).

David has an excess business loss for the year of $95,000 (the excess of his $400,000 AI venture loss over the $305,000 excess business loss disallowance threshold for 2024 for an unmarried taxpayer). David can deduct the first $305,000 of his loss against his income from other sources. The $95,000 excess business loss is carried forward to his 2025 tax year and treated as part of an NOL carryover to that year.

Variation: If David’s 2024 business loss is $305,000 or less, he can deduct the entire loss against his income from other sources because he doesn’t have an excess business loss.

Example 2: Taxpayers aren’t affected by the disallowance rule

Nora and Ned are married and file tax returns jointly. In 2024, Nora has an allowable loss of $350,000 from rental real estate properties (after considering the PAL rules).

Ned runs a small business that’s still in the early phase of operations. He runs the business as a single-member LLC that’s treated as a sole proprietorship for tax purposes. For 2024, the business incurs a $150,000 tax loss.

Nora and Ned have no income or losses from other business or rental activities, but they have $600,000 of income from other sources.

They don’t have an excess business loss because their combined losses are $500,000. That amount is below the $610,000 excess business loss disallowance threshold for 2024 for married joint filers. So, they’re unaffected by the disallowance rule. They can use their $500,000 business loss to shelter income from other sources.

Partnerships, LLCs and S corporations

The excess business loss disallowance rule is applied at the owner level for business losses from partnerships, S corporations and LLCs treated as partnerships for tax purposes. Each owner’s allocable share of business income, gain, deduction, or loss from these pass-through entities is taken into account on the owner’s Form 1040 for the tax year that includes the end of the entity’s tax year.

The best way forward

As you can see, business losses can be complex. Contact us if you have questions or want more information about the best strategies for your situation.

7 common M&A due diligence pitfalls

February 17, 2025

In 2025, global merger and acquisition (M&A) volume is expected to surge to the highest level in four years, according to Reuters. M&As require thorough due diligence to minimize risks and maximize long-term value. Some business combinations fail to achieve expected results due to financial missteps, overlooked liabilities and integration challenges.

Here’s an overview of seven common mistakes that inexperienced buyers might make when vetting deals — and how to avoid them:

1. Overlooking financial red flags. Buyers may fail to critically assess financial statements, which can lead to unexpected financial burdens. Pay special attention to potential tax liabilities, including unpaid payroll or sales tax, pending audits and evasive tax practices. Also, consider obtaining a quality of earnings report to help identify nonrecurring revenue, accounting inconsistencies and working capital needs. Site visits may help shed light on details you might not notice from reviewing the seller’s financials, such as old, obsolete or damaged equipment and inventory.

2. Missing hidden liabilities. Unreported liabilities may result in costly post-acquisition surprises. Forensic accounting techniques can help buyers identify and quantify off-balance-sheet items, such as undisclosed property liens, environmental violations, pending litigation and golden parachute clauses.

3. Overestimating projected financial results. Overly optimistic seller representations and financial projections can cause an unwary buyer to overpay. Carefully assess revenue and cash flow projections, including their underlying assumptions, to ensure they’re realistic and supported by historical trends. Stress-testing projections and evaluating customer concentration risks can help ensure revenue sustainability.

4. Failing to assess internal controls. Weak controls expose businesses to fraud and financial mismanagement. Issues such as lack of segregation of duties or poor inventory tracking can result in operational inefficiencies. Due diligence should include an internal control assessment to identify deficiencies and develop a proactive plan to correct them.

5. Misjudging tax implications. The structure of an M&A deal — whether an asset or stock purchase — can significantly affect tax outcomes. If properly structured, creative deal terms, such as earnouts and installment sales, may provide tax advantages. It’s critical to structure a deal that optimizes tax benefits while complying with state and federal tax regulations.

6. Rushing due diligence. Hasty due diligence can result in costly oversights. Buyers should conduct comprehensive, methodical reviews of financial statements, legal agreements and operational structures before finalizing deals. Reading the fine print of key contracts may help buyers anticipate restrictions related to franchise agreements, insurance policies, and equipment and property leases. Some agreements require renegotiation before closing.

7. Flying solo. Do-it-yourself due diligence can be risky. M&As are complex undertakings, and the financial nuances may be unfamiliar to business owners and managers.

If you’re contemplating buying or merging with another company, contact us early in the M&A process. Our experienced accounting professionals can help you avoid financial surprises, negotiate favorable terms, address post-deal accounting and tax issues, and build long-term value.

2025 adjusted penalty amounts for health and welfare plans

February 14, 2025

Last month, the U.S. Department of Labor (DOL) announced its annual inflation adjustments to the civil monetary penalties for a wide range of violations related to health and welfare plans. Legislation enacted in 2015 requires annual adjustments to certain penalty amounts by January 15 of each year. This year, the DOL beat that deadline by five days.

The adjustments are effective for penalties assessed after January 15, 2025. Here are some potential foibles to watch out for:

Failure to file Form 5500, “Annual Return/Report of Employee Benefit Plan.” Employers must file this form annually for most plans subject to the requirements of the Employee Retirement Income Security Act. It provides the IRS and DOL with information about a plan’s operation and compliance with government regulations. The maximum penalty for failing to file Form 5500 has increased to $2,739 per day that the filing is late (up from $2,670 per day in 2024).

Failure to provide a summary of benefits and coverage (SBC). Under the Affordable Care Act, employers must provide this disclosure to each eligible employee. Its purpose is to provide a clear and concise overview of a health or welfare plan’s coverage and costs. The maximum penalty for failing to provide an SBC has increased to $1,443 per failure (up from $1,406 per failure in 2024).

Failure to comply with the Genetic Information Nondiscrimination Act (GINA) and/or the Children’s Health Insurance Program (CHIP). Violations of GINA may include establishing eligibility rules based on genetic information or requesting genetic data for underwriting purposes. CHIP violations may include failure to disclose Medicaid or CHIP assistance availability. Any such violations may result in penalties of $145 per participant per day (up from $141 per participant per day in 2024).

Violations of reporting requirements for Multiple Employer Welfare Arrangements (MEWAs). A MEWA is generally defined as a single plan that covers the employees of two or more unrelated employers. MEWAs must, among other things, file Form M-1, “Report for Multiple Employer Welfare Arrangements (MEWAs) and Certain Entities Claiming Exception (ECEs).” Penalties for failure to meet applicable filing requirements for such arrangements, which include annually filing Form M-1 and filings upon origination, have increased to $1,992 per day (up from $1,942 per day in 2024).

Other penalties related to health and welfare plans, including those for failing to provide certain information requested by the DOL, as well as for certain defined benefit plan compliance failures, have also been adjusted. For example, the penalty for failing to provide DOL-requested documents has increased to $195 per day (up from $190 per day in 2024). This penalty amount, however, can’t exceed $1,956 per request.

As you might have noticed, every penalty amount we’ve mentioned has increased when adjusted for inflation — making each one more onerous for employers. The good news is that violations don’t always trigger the highest permitted penalty. In some instances, such as under programs designed to encourage Form 5500 filing, the DOL has the discretion to impose lower penalties.

Contact us for further information about all of this year’s penalties related to health and welfare plans, as well as for assistance in managing the costs of your benefits.

Questions about taxes and tips? Here are some answers for employers

February 11, 2025

Businesses in certain industries employ service workers who receive tips as a large part of their compensation. These businesses include restaurants, hotels and salons. Compliance with federal and state tax regulations is vital if your business has employees who receive tips.

Are tips becoming tax-free?

During the campaign, President Trump promised to end taxes on tips. While the proposal created buzz among employees and some business owners, no legislation eliminating taxes on tips has been passed. For now, employers should continue to follow the existing IRS rules until the law changes — if it does. Unless legal changes are enacted, the status quo remains in effect.

With that in mind, here are answers to questions about the current rules.

How are tips defined?

Tips are optional and can be cash or noncash. Cash tips are received directly from customers. They can also be electronically paid tips distributed to employees by employers and tips received from other employees in tip-sharing arrangements. Workers must generally report cash tips to their employers. Noncash tips are items of value other than cash. They can include tickets, passes or other items that employees receive from customers. Workers don’t have to report noncash tips to employers.

Four factors determine whether a payment qualifies as a tip for tax purposes:

The customer voluntarily makes a payment,
The customer has an unrestricted right to determine the amount,
The payment isn’t negotiated with, or dictated by, employer policy, and
The customer generally has a right to determine who receives the payment.

There are more relevant definitions. A direct tip occurs when an employee receives it directly from a customer (even as part of a tip pool). Directly tipped employees include wait staff, bartenders and hairstylists. An indirect tip occurs when an employee who normally doesn’t receive tips receives one. Indirectly tipped employees can include bussers, service bartenders, cooks and salon shampooers.

What records need to be kept?

Tipped workers must keep daily records of the cash tips they receive. To do so, they can use Form 4070A, Employee’s Daily Record of Tips. It’s found in IRS Publication 1244.

Workers should also keep records of the dates and values of noncash tips. The IRS doesn’t require workers to report noncash tips to employers, but they must report them on their tax returns.

How must employees report tips to employers?

Employees must report tips to employers by the 10th of the month after the month they were received. The IRS doesn’t require workers to use a particular form to report tips. However, a worker’s tip report generally should include the:

Employee’s name, address, Social Security number and signature,
Employer’s name and address,
Month or period covered, and
Total tips received during the period.

Note: If an employee’s monthly tips are less than $20, there’s no requirement to report them to his or her employer. However, they must be included as income on his or her tax return.

Are there other employer requirements?

Yes. Send each employee a Form W-2 that includes reported tips. In addition, employers must:

Keep employees’ tip reports.
Withhold taxes, including income taxes and the employee’s share of Social Security and Medicare taxes, based on employees’ wages and reported tip income.
Pay the employer share of Social Security and Medicare taxes based on the total wages paid to tipped employees as well as reported tip income.
Report this information to the IRS on Form 941, Employer’s Quarterly Federal Tax Return.
Deposit withheld taxes in accordance with federal tax deposit requirements.

In addition, “large” food or beverage establishments must file another annual report. Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips, discloses receipts and tips.

What’s the tip tax credit?

Suppose you’re an employer with tipped workers providing food and beverages. In that case, you may qualify for a valuable federal tax credit involving the Social Security and Medicare taxes you pay on employees’ tip income.

How should employers proceed?

Running a business with tipped employees involves more than just providing good service. It requires careful adherence to wage and hour laws, thorough recordkeeping, accurate reporting and an awareness of changing requirements. While President Trump’s pledge to end taxes on tips hasn’t yet materialized into law, stay alert for potential changes. In the meantime, continue meeting all current requirements to ensure compliance. Contact us for guidance about your situation.

6 ways employers can address payroll costs during economic uncertainty

February 10, 2025

Payroll is one of the biggest costs for most small to midsize employers. If this holds true for your organization, you may be looking at the year ahead with some measure of uncertainty.

The Trump administration has stated that its priorities include using tariffs and strict immigration policies to accomplish its objectives. We don’t yet know how this approach will affect big-picture issues such as inflation and the labor market in the short term — particularly in some industries. However, there are likely to be implications. Here are six ways to address payroll costs as we all await further developments:

1. Conduct a payroll audit. If your organization has been operational for a while, you may have a relatively complex compensation structure and payroll system. By meticulously evaluating the related expenditures under a formal audit, you may be able to identify flexible or nonessential costs. These costs represent potential money-saving opportunities to be seized upon without drastically altering your existing structure and system.

2. Optimize how you use and classify workers. A long-standing risk for many employers is misclassifying employees as independent contractors. If anything, this risk has only grown as “gig workers” remain popular in various industries. So, first and foremost, review employee classification throughout your organization to verify that you’re not at risk for compliance penalties. From there, look at every position and consider whether it could or should be converted to a part-time role or contractual arrangement without adversely affecting productivity and efficiency.

3. Ensure you’re not overlooking payroll-related tax breaks. Your organization may be eligible for tax credits or incentives now, or you could shift your employment strategy to qualify for them. For example, if you need to expand your workforce later this year, the Work Opportunity Tax Credit potentially offers a dollar-for-dollar reduction in your tax liability for hiring individuals from certain target groups. There may also be state and local tax relief programs available. Identifying and claiming every tax break you’re eligible for can reduce payroll costs and improve cash flow.

4. Explore strategic compensation adjustments. When payroll costs become problematic, many employers want to immediately jump to drastic steps such as layoffs or cuts to salaries or wages. However, these may devastate employee morale and hamper hiring in the future. Explore the feasibility of more measured adjustments, such as:

Reducing work hours for some employees,
Suspending employer matches for your qualified retirement plan,
Transitioning from fixed bonuses to performance-based incentives, and
Entering into deferred compensation agreements with highly compensated employees or other key staff.

These or other actions can reduce immediate payroll costs without radically changing your compensation philosophy and program.

5. Consider technological improvements. Another good reason to undertake the aforementioned payroll audit is it might reveal financial losses attributable to compliance penalties, overpayments, or unnecessary or redundant administrative costs. Although there’s no guarantee better technology will solve such problems, enhanced automation and functionality tend to reduce human errors, eliminate redundancies and facilitate real-time monitoring that can catch minor inaccuracies before they turn into major crises.

6. Work with your professional advisors. Employers generally need to take a nimbler approach to payroll management, hiring and other operational functions during times of economic uncertainty. Obviously, you and your leadership team should keep an eye on the news, but your professional advisors can provide invaluable insights into their various areas of expertise. Please contact us for tailored guidance on cost management, tax optimization and regulatory compliance to ensure your payroll decisions support long-term sustainability.

How to forecast smarter

February 7, 2025

Financial forecasting provides a roadmap to guide your organization on the path to success. Forecasts support strategic planning by helping you allocate resources efficiently, manage risks effectively and optimize capital investments. However, today’s dynamic marketplace is uncharted territory, so you can’t rely solely on historical data. Reliable forecasts also consider external market trends and professional insights. Here are some tips to strengthen your forecasting models and help you avoid common pitfalls.

Determine the optimal approach

What’s the right forecasting method for your situation? The answer depends on several critical factors, including:

Forecast length. Short-term forecasts (that cover a year or less) often rely more heavily on historical data. These plans focus primarily on the organization’s immediate needs. Long-term forecasts require more qualitative inputs to account for uncertainties, such as market disruptions, economic shifts, and changing regulations and consumer behaviors. These plans are essential to support strategic decisions and attract funding from investors and lenders. The longer your forecast period is, the more likely internal and external conditions will change. So short-term forecasts tend to be more accurate than long-term plans. Long-term forecasts may need to be updated as market conditions evolve.

Stability of demand. Industries with consistent sales patterns may be able to use straightforward historical data analysis. However, those with seasonal and cyclical fluctuations might need to incorporate techniques like time-series decomposition to adjust for peaks and downturns. Companies experiencing unpredictable demand might consider using advanced forecasting software that integrates real-time sales data and external variables to enhance accuracy.

Availability of historical data. Techniques such as exponential smoothing require at least three years of data to generate reliable projections. For businesses launching new products or entering new markets, qualitative forecasting methods that incorporate expert opinions and market research may be more effective.

Business offerings. Companies with a wide range of products and services may prefer simplified forecasting models. Conversely, those with a focused product line can achieve greater accuracy with more complex statistical models.

Relying on just one forecasting model can be problematic. What happens if the forecast model gets things wrong? It may be more prudent to use a combination of approaches tailored to individual products and locations. Considering the results from multiple forecasting approaches can lead to better outcomes, especially when managing inventory levels.

Implement advanced forecasting techniques

Businesses seeking greater forecasting accuracy can implement advanced techniques, such as:

Time-series analysis, which breaks historical data into trend, seasonal and cyclical components to better understand patterns,
Regression models that identify relationships between financial variables to improve prediction accuracy,
Scenario planning that prepares best-case, worst-case and expected forecasts,
Sensitivity analysis that determines which forecasting assumptions have the greatest impact on expected financial outcomes, and
Rolling forecasts that are continuously updated based on current data to provide greater flexibility and adaptability.

Increasingly, businesses are leveraging artificial intelligence and machine learning to enhance forecasting precision. These technologies analyze large datasets quickly, identify trends and adjust predictions dynamically based on real-time changes. By integrating AI-driven forecasting tools, businesses can optimize their decision-making and gain a competitive edge.

Seek outside guidance

Financial statements are often the starting point for forecasts. Our accounting and auditing team can help ensure your historical data is accurate and then guide you through the process of developing reliable, market-driven forecasts based on your current needs. From developing realistic assumptions and reliable models to tracking forecast accuracy and updating for market shifts, we’ve got you covered. Contact us for more information.