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Tax Advantages

When do valuable gifts to charity require an appraisal?

If you donate valuable items to charity and you want to deduct them on your tax return, you may be required to get an appraisal. The IRS requires donors and charitable organizations to supply certain information to prove their right to deduct charitable contributions.

How can you protect your deduction?

First, be aware that in order to deduct charitable donations, you must itemize deductions. Due to today’s relatively high standard deduction amounts, fewer taxpayers are itemizing deductions on their federal returns than before the Tax Cuts and Jobs Act became effective in 2018.

If you clear the itemizing hurdle and donate an item of property (or a group of similar items) worth more than $5,000, certain appraisal requirements apply. You must:

  • Get a “qualified appraisal,”
  • Receive the qualified appraisal before your tax return is due,
  • Attach an “appraisal summary” to the first tax return on which the deduction is claimed,
  • Include other information with the return, and
  • Maintain certain records.

Keep these definitions in mind. A “qualified appraisal” is a complex and detailed document. It must be prepared and signed by a qualified appraiser. An “appraisal summary” is a summary of a qualified appraisal made on Form 8283 and attached to the donor’s return.

While courts have allowed taxpayers some latitude in following these rules, you should aim for exact compliance.

The qualified appraisal isn’t submitted to the IRS in most cases. Instead, the appraisal summary, which is a separate statement prepared on an IRS form, is attached to the donor’s tax return. However, a copy of the appraisal must be attached for gifts of art valued at $20,000 or more and for all gifts of property valued at more than $500,000, other than inventory, publicly traded stock and intellectual property. If an item of art has been appraised at $50,000 or more, you can ask the IRS to issue a “Statement of Value” that can be used to substantiate the value.

What if you don’t comply with the requirements?

The penalty for failing to get a qualified appraisal and attach an appraisal summary to the return is denial of the charitable deduction. The deduction may be lost even if the property was valued correctly. There may be relief if the failure was due to reasonable cause.

Are there exceptions to the requirements?

A qualified appraisal isn’t required for contributions of:

  • A car, boat or airplane for which the deduction is limited to the charity’s gross sales proceeds,
  • Stock in trade, inventory or property held primarily for sale to customers in the ordinary course of business,
  • Publicly traded securities for which market quotations are “readily available,” and
  • Qualified intellectual property, such as a patent.

Also, only a partially completed appraisal summary must be attached to the tax return for contributions of:

  • Nonpublicly traded stock for which the claimed deduction is greater than $5,000 and doesn’t exceed $10,000, and
  • Publicly traded securities for which market quotations aren’t “readily available.”

What if you have more than one gift? 

If you make gifts of two or more items during a tax year, even to multiple charitable organizations, the claimed values of all property of the same category or type (such as stamps, paintings, books, stock that isn’t publicly traded, land, jewelry, furniture or toys) are added together in determining whether the $5,000 or $10,000 limits are exceeded.

The bottom line is you must be careful to comply with the appraisal requirements or risk disallowance of your charitable deduction. Contact us if you have any further questions or want to discuss your charitable giving plans.

© 2024
TopLine Content Marketing Team

The tax advantages of including debt in a C corporation capital structure

Let’s say you plan to use a C corporation to operate a newly acquired business or you have an existing C corporation that needs more capital. You should know that the federal tax code treats corporate debt more favorably than corporate equity. So for shareholders of closely held C corporations, it can be a tax-smart move to include in the corporation’s capital structure:

  • Some third-party debt (owed to outside lenders), and/or
  • Some owner debt.

Tax rate considerations

Let’s review some basics. The top individual federal income tax rate is currently 37%. The top individual federal rate on net long-term capital gains and qualified dividends is currently 20%. On top of this, higher-income individuals may also owe the 3.8% net investment income tax on all or part of their investment income, which includes capital gains, dividends and interest.

On the corporate side, the Tax Cuts and Jobs Act (TCJA) established a flat 21% federal income tax rate on taxable income recognized by C corporations.

Third-party debt

The non-tax advantage of using third-party debt financing for a C corporation acquisition or to supply additional capital is that shareholders don’t need to commit as much of their own money.

Even when shareholders can afford to cover the entire cost with their own money, tax considerations may make doing so inadvisable. That’s because a shareholder generally can’t withdraw all or part of a corporate equity investment without worrying about the threat of double taxation. This occurs when the corporation pays tax on its profits and the shareholders pay tax again when the profits are distributed as dividends.

When third-party debt is used in a corporation’s capital structure, it becomes less likely that shareholders will need to be paid taxable dividends because they’ll have less money tied up in the business. The corporate cash flow can be used to pay off the corporate debt, at which point the shareholders will own 100% of the corporation with a smaller investment on their part.

Owner debt

If your entire interest in a successful C corporation is in the form of equity, double taxation can arise if you want to withdraw some of your investment. But if you include owner debt (money you loan to the corporation) in the capital structure, you have a built-in mechanism for withdrawing that part of your investment tax-free. That’s because the loan principal repayments made to you are tax-free. Of course, you must include the interest payments in your taxable income. But the corporation will get an offsetting interest expense deduction — unless an interest expense limitation rule applies, which is unlikely for a small to medium-sized company.

An unfavorable TCJA change imposed a limit on interest deductions for affected businesses. However, for 2024, a corporation with average annual gross receipts of $30 million or less for the three previous tax years is exempt from the limit.

An example to illustrate

Let’s say you plan to use your solely owned C corporation to buy the assets of an existing business. You plan to fund the entire $5 million cost with your own money — in a $2 million contribution to the corporation’s capital (a stock investment), plus a $3 million loan to the corporation.

This capital structure allows you to recover $3 million of your investment as tax-free repayments of corporate debt principal. The interest payments allow you to receive additional cash from the corporation. The interest is taxable to you but can be deducted by the corporation, as long as the limitation explained earlier doesn’t apply.

This illustrates the potential federal income tax advantages of including debt in the capital structure of a C corporation. Contact us to explain the relevant details and project the tax savings.

© 2024
TopLine Content Marketing Team

Taxes when you sell an appreciated vacation home

Vacation homes in upscale areas may be worth way more than owners paid for them. That’s great, but what about taxes? Here are three scenarios to illustrate the federal income tax issues you face when selling an appreciated vacation home.

Scenario 1: You’ve never used the home as your primary residence

In this case, the home sale gain exclusion tax break (up to $250,000 or $500,000 for a married couple) is unavailable. Your vacation home sale profit will be treated as a capital gain.

If you’ve owned the property for more than one year, the gain will be taxed at no more than the 20% maximum federal rate on long-term capital gains (LTCGs), plus the net investment income tax (NIIT), if applicable. However, the 20% rate only applies to the lesser of:

  • Your net LTCG for the year, or
  • The excess of your taxable income, including any net LTCG, over the applicable threshold.

For 2024, the thresholds are $518,900 for single filers, $583,750 for married joint filers and $551,350 for heads of households. If your taxable income is below the applicable threshold, the maximum federal rate on net LTCGs is 15%.

If you also owe the 3.8% NIIT, the effective federal rate on some or all of your net LTCG will be 18.8% (15% + 3.8%) or 23.8% (20% + 3.8%).

You may owe state income tax, too.

Scenario 2: You’ve rented out the vacation home

In this situation, you probably deducted depreciation for rental periods. If so, the federal rate on gain attributable to depreciation (so-called unrecaptured Section 1250 gain) can be up to 25%, assuming you’ve held the property for over one year. You may also owe the 3.8% NIIT on the unrecaptured Section 1250 gain. Any remaining gain will be taxed at the federal rates explained earlier.

Plus, if you rented out the vacation home but used it only a little for personal purposes, it has probably been classified as a rental property for federal tax purposes. If so, you may have had rental losses that couldn’t be deducted currently due to the passive activity loss (PAL) rules. You can deduct these suspended PALs when the property is sold.

Scenario 3: You used the vacation home as a principal residence for a time

In this case, you might be able to claim the tax-saving principal residence gain exclusion break. Specifically, if you owned and used the property as your principal residence for at least two years during the five-year period ending on the sale date, you probably qualify for the exclusion.

There’s another major qualification rule for the home sale gain exclusion tax break. The exclusion is generally available only when you’ve not excluded an earlier gain within the two-year period ending on the date of the later sale. In other words, you generally cannot claim the gain exclusion until two years have passed since you last used it.

Of course, if you have a really big gain from selling your vacation home, it may be too big to fully shelter with the gain exclusion — even if you qualify for the maximum $250,000/$500,000 break. Assuming you’ve owned the property for more than one year, the part of the gain that can’t be excluded will be an LTCG taxed under the rules explained earlier.

Conclusion

Taxes on vacation home sales can get complicated, and we haven’t covered all the potential issues here. However, the tax results are simple if you’ve never rented out the property and never used it as a principal residence. We can fill in the blanks in your situation and answer any questions that you may have.

© 2024
TopLine Content Marketing Team

IRS to employers: Only medical expenses qualify for tax-advantaged accounts

Tax-advantaged accounts or reimbursement arrangements for health care have become popular employer-sponsored benefits. And for good reason — these accounts or arrangements ease the burden of high costs on organizations while giving employees a tax-friendly way to manage medical expenses.

The IRS, however, has concerns. The tax agency recently issued a news release (IR-2024-65) warning plan administrators that only qualified medical expenses are eligible for deductions or reimbursements under these accounts or arrangements. Personal expenses for “general health and wellness” aren’t.

4 common vehicles

The IRS news release specifically addresses four commonly used vehicles for helping employees manage medical expenses:

1. Health Flexible Spending Accounts (FSAs). Participants can channel up to $3,200 in 2024 (up from $3,050 in 2023) of pretax income into these standalone, employer-owned accounts. The account then reimburses the participant for qualified medical expenses.

2. Health Savings Accounts (HSAs). These participant-owned accounts must be offered in conjunction with a high-deductible health plan. In 2024, participants can contribute pretax income of up to $4,150 for self-only coverage (up from $3,850 in 2023) and $8,300 for family coverage (up from $7,750 in 2023).

3. Health Reimbursement Arrangements (HRAs). Rather than being individual participant accounts, HRAs are employer-sponsored plans that reimburse participants for eligible medical expenses. There are several different versions. Generally, employers may claim a tax deduction for reimbursements, which are typically tax-free for participants.

4. Medical Savings Accounts (MSAs). These participant-owned accounts, sometimes referred to as “Archer MSAs,” are a precursor to HSAs intended for self-employed people and very small businesses. Congress discontinued the creation of new MSAs in 2007, but some employers still sponsor accounts created before then.

Aggressive marketing 

The IRS’s concerns spring largely from what it calls “aggressive marketing.” That is, according to the news release, “… some companies are misrepresenting circumstances under which food and wellness expenses can be paid or reimbursed under FSAs and other health spending plans.”

The tax agency says certain businesses are telling customers that, if they can get a doctor’s note supporting purchases of nonmedical food, wellness or exercise products or services, the associated costs can be converted to tax-qualified medical expenses. But this generally isn’t true. The news release even includes an example in which a company offers to provide a doctor’s note to a customer, for a fee, that would allow the individual to claim an FSA reimbursement for low-carb food products targeted at people with diabetes.

Under Internal Revenue Code Section 213, qualifying medical expenses are defined as amounts paid for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting a structure or function of the body. They don’t include expenses related to products or services that are merely beneficial to health and wellness.

Friendly reminder

If your organization sponsors one of the accounts or arrangements mentioned above, you may want to pass along the IRS’s friendly reminder to participants. The tax agency warns in the news release that if a health FSA, HSA, HRA or MSA is used to pay or reimburse nonmedical expenses, all payments from the account or arrangement — including valid reimbursements — may be includible in the participant’s income. Contact us for more information.

© 2024
TopLine Content Marketing Team

When businesses may want to take a contrary approach with income and deductions

Businesses usually want to delay recognition of taxable income into future years and accelerate deductions into the current year. But when is it wise to do the opposite? And why would you want to?

One reason might be tax law changes that raise tax rates. The Biden administration has proposed raising the corporate federal income tax rate from its current flat 21% to 28%. Another reason may be because you expect your noncorporate pass-through entity business to pay taxes at higher rates in the future and the pass-through income will be taxed on your personal return. There have also been discussions in Washington about raising individual federal income tax rates.

If you believe your business income could be subject to tax rate increases, you might want to accelerate income recognition into the current tax year to benefit from the current lower tax rates. At the same time, you may want to postpone deductions into a later tax year, when rates are higher and the deductions will be more beneficial.

To fast-track income

Consider these options if you want to accelerate revenue recognition into the current tax year:

  • Sell appreciated assets that have capital gains in the current year, rather than waiting until a later year.
  • Review the company’s list of depreciable assets to determine if any fully depreciated assets are in need of replacement. If fully depreciated assets are sold, taxable gains will be triggered in the year of sale.
  • For installment sales of appreciated assets, elect out of installment sale treatment to recognize gain in the year of sale.
  • Instead of using a tax-deferred like-kind Section 1031 exchange, sell real property in a taxable transaction.
  • Consider converting your S corporation into a partnership or LLC treated as a partnership for tax purposes. That will trigger gains from the company’s appreciated assets because the conversion is treated as a taxable liquidation of the S corp. The partnership will have an increased tax basis in the assets.
  • For construction companies with long-term construction contracts previously exempt from the percentage-of-completion method of accounting for long-term contracts: Consider using the percentage-of-completion method to recognize income sooner as compared to the completed contract method, which defers recognition of income until the long-term construction is completed.

To postpone deductions

Consider the following actions to postpone deductions into a higher-rate tax year, which will maximize their value:

  • Delay purchasing capital equipment and fixed assets, which would give rise to depreciation deductions.
  • Forego claiming big first-year Section 179 deductions or bonus depreciation deductions on new depreciable assets and instead depreciate the assets over a number of years.
  • Determine whether professional fees and employee salaries associated with a long-term project could be capitalized, which would spread out the costs over time.
  • Buy bonds at a discount this year to increase interest income in future years.
  • If allowed, put off inventory shrinkage or other write-downs until a year with a higher tax rate.
  • Delay charitable contributions into a year with a higher tax rate.
  • If allowed, delay accounts receivable charge-offs to a year with a higher tax rate.
  • Delay payment of liabilities where the related deduction is based on when the amount is paid.

Contact us to discuss the best tax planning actions in the light of your business’s unique tax situation.

© 2024
TopLine Content Marketing Team

6 major payroll taxes every employer should keep an eye on

As you’re no doubt aware, employers are responsible for withholding and paying payroll taxes. If you don’t use a third-party provider, it’s critical to stay focused on payroll tax compliance. Given the potential penalties involved, you can’t get complacent about proper administration. Let’s review the six major payroll taxes to keep an eye on:

1. Federal. Employers must withhold federal income tax from employees’ paychecks. The amount of income tax withheld from each employee’s pay depends on two factors: 1) the amount of the wages, and 2) information provided on the employee’s Form W-4, “Employee’s Withholding Certificate.” Additional withholding rules may apply to commissions and other forms of compensation.

2. State and local. Be sure to stay apprised of your non-federal payroll tax obligations. State income tax withholding rules, for example, apply to many employers. However, eight states (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming) don’t impose an income tax. New Hampshire and Tennessee don’t tax wages. Certain localities also impose income taxes. And in some places, withholding is required to cover short-term disability, paid family leave or unemployment benefits.

3. FICA. Payroll taxes authorized under the Federal Insurance Contributions Act (FICA) comprise two components. The first is a Social Security tax of 6.2% on an amount up to an annual “wage base.” In 2024, that wage base is $168,600. The second FICA component is a Medicare tax of 1.45% on all wages. Both employers and employees must pay FICA tax; employers must withhold the employees’ share.

4. FUTA. The Federal Unemployment Tax Act (FUTA) created a special tax that applies to the first $7,000 of wages of every employee. The purpose of this tax is to help states pay employees who have been involuntarily terminated from their jobs. The basic FUTA rate is 6%, but employers can benefit from a credit for state unemployment tax of up to 5.4%, resulting in an effective tax of 0.6%. However, the credit is reduced if a state borrows from the federal government to cover its unemployment benefits liability and doesn’t repay the funds.

5. State unemployment. Every state also runs its own unemployment insurance program to provide benefits to eligible workers who are involuntarily terminated. Generally, the rate employers must pay is based on their claims experience. The more claims made by former employees, the higher the tax rate. States update these rates annually.

6. Additional Medicare tax. This payroll tax often flies under the radar. Under a provision of the Affordable Care Act, the additional Medicare tax of 0.9% applies to employee wages above $200,000 for single filers, $250,000 for joint married filers and $125,000 for separate married filers. Note that this tax is paid by employees only. However, employers are responsible for withholding it, when applicable.

If your organization has been operational for a while, you’re likely well aware of the additional Medicare tax, as well as the other five common payroll taxes discussed above. Nevertheless, most employers can benefit from taking a continuous-improvement approach to payroll taxes, always looking for ways to improve efficiency and better ensure compliance. We can help you assess the costs and efficacy of your payroll processes.

© 2024
TopLine Content Marketing Team