Davidson / Pargman and Company

Certified Public Accountants and Advisors

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Six tax issues to consider if you’re getting divorced

Divorce entails difficult personal issues, and taxes are probably the farthest thing from your mind. However, several tax concerns may need to be addressed to ensure that taxes are kept to a minimum and that important tax-related decisions are properly made. Here are six issues to be aware of if you’re in the process of getting a divorce.

1. Personal residence sale 

In general, if a couple sells their home in connection with a divorce or legal separation, they should be able to avoid tax on up to $500,000 of gain (as long as they’ve owned and used the home as their principal residence for two of the previous five years). If one former spouse continues to live in the home and the other moves out (but they both remain owners of the home), they may still be able to avoid gain on the future sale of the home (up to $250,000 each), but special language may have to be included in the divorce decree or separation agreement to protect this tax exclusion for the spouse who moves out.

If the couple doesn’t meet the two-year ownership and use tests, any gain from the sale may qualify for a reduced exclusion due to unforeseen circumstances.

2. Pension benefits

A spouse’s pension benefits are often part of a divorce property settlement. In these cases, the commonly preferred method to handle the benefits is to get a “qualified domestic relations order” (QDRO). This gives one former spouse the right to share in the pension benefits of the other and taxes the former spouse who receives the benefits. Without a QDRO, the former spouse who earned the benefits will still be taxed on them even though they’re paid out to the other former spouse.

3. Filing status

If you’re still married at the end of the year, but in the process of getting divorced, you’re still treated as married for tax purposes. We’ll help you determine how to file your 2024 tax return — as married filing jointly or married filing separately. Some separated individuals may qualify for “head of household” status if they meet the requirements.

4. Alimony or support payments

For alimony under divorce or separation agreements that are executed after 2018, there’s no deduction for alimony and separation support payments for the former spouse making them. And the alimony payments aren’t included in the gross income of the former spouse receiving them. (The rules are different for divorce or separation agreements executed before 2019.) This was a change made in the Tax Cuts and Jobs Act. However, unlike some provisions of the law that are temporary, the repeal of alimony and support payment deduction is permanent.

5. Child support and child-related tax return filing

No matter when the divorce or separation instrument is executed, child support payments aren’t deductible by the paying former spouse (or taxable to the recipient). You and your ex-spouse will also need to determine who will claim your child or children on your tax returns in order to claim related tax breaks.

6. Business interests 

If certain types of business interests are transferred in connection with divorce, care should be taken to make sure “tax attributes” aren’t forfeited. For example, interests in S corporations may result in “suspended” losses (losses that are carried into future years instead of being deducted in the year they’re incurred). When these interests change hands in a divorce, the suspended losses may be forfeited. If a partnership interest is transferred, a variety of more complex issues may arise involving partners’ shares of partnership debt, capital accounts, built-in gains on contributed property and other complex issues.

A range of tax challenges

These are just some of the issues you may have to cope with if you’re getting a divorce. In addition, you may need to adjust your income tax withholding, and you should notify the IRS of any new address or name change. There are also estate planning considerations. We can help you tackle the financial issues involved in divorce.

© 2024
TopLine Content Marketing Team

Employers: Don’t overlook internal hires when addressing staffing needs

If your organization is having a tough time finding the right person to fill a key role, it might be time to set aside the resumés and pick up your organizational chart. Many employers become so consumed with posting job ads and conducting interviews that they overlook the potential of their own in-house talent. Let’s review some of the upsides of internal hires, as well as some of the inevitable risks.

Cost-effective approach

Two of the biggest upsides to promoting employees to open positions are efficiency and cost-effectiveness. (For the purposes of this article, we’re assuming internal hires are promotions. In some cases, they may be lateral moves.)

It’s usually faster and easier to identify and meet with employees than to find and schedule interviews with outside candidates. And promoting internally is generally less expensive because you save on the costs of finding, recruiting and hiring. These costs include advertising on job boards and engaging with recruiters. Plus, internal hires won’t need onboarding and may require less training, depending on the position.

In addition, promoting employees can help boost morale and improve retention. One reason some employees leave their jobs is because they don’t see opportunities for advancement. Staff members might be less likely to feel this way if they see colleagues promoted to higher positions.

Another benefit is the level of familiarity you have with your employees. An external applicant’s resumé might look impressive, and the interviews could go great, but the individual’s personality might clash with your organizational culture once work begins. Or the person’s actual skill level might not match up to what was presented. You should already have documented records of internal candidates’ skill sets and performance histories.

Risks to consider

Naturally, for many positions, promoting employees isn’t risk-free. Some employees simply aren’t cut out to be managers, supervisors or to fill other “high stakes” roles. For example, a star salesperson might thrive out in the world selling but flounder when asked to sit in an office and manage a sales team.

Indeed, shifting more emphasis to internal promotions shouldn’t mean giving up on outside hires. The greater job market still offers a much larger pool of candidates. And new employees could provide fresh perspectives, innovative ideas, new skills and insightful experiences that might lead to more efficient processes and improved organizational performance.

Furthermore, recruiting outside candidates avoids the unhealthy competition that may arise when employees vie against each other for higher positions. Resentment often occurs among those ultimately passed over for promotion who now must report to someone who used to be their peer. For these reasons, it’s critical to carefully choose which positions to open to internal hires.

The right balance

Hiring internally is no silver bullet. For starters, if you promote an employee to a new position, you’ll need to fill that person’s former job! Then again, it does tend to be easier to fill lower-level positions than upper-level ones.

The bottom line is to ensure your approach to hiring is flexible and isn’t turning a blind eye to the cost- and time-efficiencies of internal hires. We can help you assess your hiring costs, compensation structure and other factors that play into staffing decisions.

© 2024
TopLine Content Marketing Team

Why auditors monitor journal entries

With a median loss of $766,000, financial misstatement schemes are the costliest type of fraud, according to “Occupational Fraud 2024: A Report to the Nations,” a study published by the Association of Certified Fraud Examiners. Fortunately, auditors and forensic accountants may be able to detect financial statement fraud by testing journal entries for errors and irregularities. Here’s what they look for and how these tests work.

Suspicious entries 

Statement on Auditing Standards (SAS) No. 99, Consideration of Fraud in a Financial Statement Audit, provides valuable audit guidance that can be applied when investigating fraudulent financial statements. It notes that “material misstatements of financial statements due to fraud often involve the manipulation of the financial reporting by … recording inappropriate or unauthorized journal entries throughout the year or at period end.”

Financial misstatement comes in many forms. For example, out-of-period revenue can be recorded to inflate revenue — or checks can be held to hide current period expenses and boost earnings. Accounts payable can be understated by recording post-closing journal entries to income. Or expenses can be reclassified to reserves and intercompany accounts, thereby increasing earnings.

To detect these types of scams, SAS 99 requires financial statement auditors to:

  • Learn about the entity’s financial reporting process and controls over journal entries and other entries,
  • Identify and select journal entries and other adjustments for testing,
  • Determine the timing of the testing,
  • Compare journal entries to original source documents, such as invoices and purchase orders, and
  • Interview individuals involved in the financial reporting process about inappropriate or unusual activity relating to the processing of journal entries or other adjustments.

Forensic accountants also follow audit guidelines when investigating allegations of financial misstatement. And financial statement auditors may call on these experts when they notice significant irregularities in a company’s financial records.

Testing procedures 

AICPA Practice Alert 2003-02, Journal Entries and Other Adjustments, identifies several common denominators among fraudulent journal entries. Auditors will ask for access to the company’s accounting system to test journal entries made during the period for signs of fraud.

Specifically, they tend to scrutinize entries made:

  • To unrelated, unusual or seldom-used accounts,
  • By individuals who typically don’t normally make journal entries,
  • At the end of the period or as post-closing entries that have little or no explanation or description,
  • Before or during the preparation of the financial statements without account numbers, and
  • To accounts that contain transactions that are complex or unusual in nature and that have significant estimates and period-end adjustments.

Other red flags include adjustments for intercompany transfers and entries for amounts made just below the individual’s approval threshold or containing large, round dollar amounts.

Getting professional help

Financial misstatement can be costly. But your organization can take steps to minimize its risk. External financial statement audits, surprise audits and forensic accounting investigations can help identify vulnerabilities and unearth anomalies. Contact us for more information, including how we use computer-assisted audit techniques to review accounting transactions.

© 2024
TopLine Content Marketing Team

Planning your estate? Don’t overlook income taxes

The current estate tax exemption amount ($13.61 million in 2024) has led many people to feel they no longer need to be concerned about federal estate tax. Before 2011, a much smaller exemption resulted in many people with more modest estates attempting to avoid it. But since many estates won’t currently be subject to estate tax, it’s a good time to devote more planning to income tax saving for your heirs.

Important: Keep in mind that the federal estate tax exclusion amount is scheduled to sunset at the end of 2025. Beginning on January 1, 2026, the amount is due to be reduced to $5 million, adjusted for inflation. Of course, Congress could act to extend the higher amount or institute a new amount.

Here are some strategies to consider in light of the current large exemption amount.

Using the annual exclusion 

One of the benefits of using the gift tax annual exclusion to make transfers during your lifetime is to save estate tax. This is because both the transferred assets and any post-transfer appreciation generated by those assets are removed from your (the donor’s) estate.

As mentioned, estate tax savings may not be an issue because of the large exemption amount. Further, making an annual exclusion transfer of appreciated property carries a potential income tax cost because the recipient receives your basis upon transfer. Thus, the recipient could face income tax, in the form of capital gains tax, on the sale of the gifted property in the future. If there’s no concern that an estate will be subject to estate tax, even if the gifted property grows in value, then you might want to base the decision to make a gift on other factors.

For example, gifts may be made to help a relative buy a home or start a business. But a donor shouldn’t gift appreciated property because of the capital gains that could be realized on a future sale by the recipient. If the appreciated property is held until the donor’s death, under current law, the heir will get a step-up in basis that will wipe out the capital gains tax on any pre-death appreciation in the property’s value.

Spouses now have more flexibility 

Years ago, spouses often undertook complicated strategies to equalize their estates so that each could take advantage of the estate tax exemption amount. In many cases, a two-trust plan was established to minimize estate tax. “Portability,” or the ability to apply the decedent’s unused exclusion amount to the surviving spouse’s transfers during life and at death, became effective for estates of decedents dying after 2010. As long as the election is made, portability allows the surviving spouse to apply the unused portion of a decedent’s applicable exclusion amount (the deceased spousal unused exclusion amount) as calculated in the year of the decedent’s death. The portability election gives married couples more flexibility in deciding how to use their exclusion amounts.

Valuation discounts

Be aware that it may no longer be worth pursuing some estate exclusion or valuation discount strategies to avoid inclusion of property in an estate. It may be better to have the property included in the estate or not qualify for valuation discounts so that the property receives a step-up in basis. For example, the special use valuation — the valuation of qualified real property used for farming or in a business, based on the property’s actual use rather than on its highest and best use — may not save enough, or any, estate tax to justify giving up the step-up in basis that would otherwise occur for the property.

If you want to discuss estate planning or income tax saving strategies, contact us.

© 2024
TopLine Content Marketing Team

Could a cash balance retirement plan suit your organization?

When an employer is ready to sponsor a new qualified retirement plan for its employees, it will have many options to choose from. Although “401(k)” may be the first thing that comes to mind, some lesser-known plan types could suit the needs of some organizations under certain circumstances. One example is a cash balance plan.

Allocating credits

Most qualified retirement plans in action today, including 401(k)s, are defined contribution plans. These plans specify the amount that goes into each participant’s account, typically a percentage of compensation or a specific dollar amount. Of course, they don’t guarantee a set return because the plans use investments to accrue balances.

In contrast, a cash balance plan is a defined benefit plan; it specifies the amount a participant will receive in retirement. But unlike traditional defined benefit plans, otherwise known as pensions, cash balance plans express those benefits as a 401(k)-style account balance rather than a formula tied to years of service and salary history.

More specifically, these fully employer-funded plans allocate to participants’ accounts:

  • “Pay credits” (generally, a set percentage of annual compensation), and
  • “Interest credits” (typically at a fixed rate or a rate linked to an index such as the one-year treasury bill rate).

Doing so allows participants to accrue retirement funds more uniformly over their careers, with a clearer picture of the ultimate benefits than a traditional pension plan provides. Benefits are usually paid out as a lump sum or monthly annuity.

Making larger contributions

Cash balance plans tend to best suit small business owners, but they may also appeal to organizations with high-income professionals (such as health care providers) and those with key employees nearing retirement. The reason why is these plans offer a relatively quick way to build retirement funds for those who, up until now, may have been more focused on their careers than on saving for their golden years.

For example, in 2024, the total limit for employer contributions, employee deferrals and after-tax contributions to defined contribution plans is $69,000 ($76,500 for participants age 50 or older). Contrast that with 401(k) employee contributions, which are limited to $23,000 ($30,500 for participants age 50 or older) in 2024.

What’s more, under the legal mandates for many qualified plan types — including 401(k)s — nondiscrimination rules can reduce contributions even further for business owners and other key employees. The rules are intended to prevent a plan from unfairly favoring highly compensated employees (HCEs).

But the good news is cash balance plans aren’t bound by these limits. For them, the nondiscrimination rules require that only benefits for HCEs and non-HCEs be comparable. Contributions may be as high as necessary to fund those benefits.

Therefore, with cash balance plans, employers may make sizable contributions on behalf of executives and key employees approaching retirement and relatively smaller contributions on behalf of younger, lower-paid employees. The plans are, however, subject to a cap on annual benefit payouts in retirement: $275,000 in 2024.

Of course, there are potential risks to cash balance plans as well. A notable one is that plan sponsors can’t reduce or suspend contributions during financially difficult years. So, organizations considering one generally need to have reliably steady cash flow to ensure funding obligations will be met.

Making the right choice

When evaluating retirement plans for your organization, or reevaluating your current one, be sure to consider all your choices. A cash balance plan may be viable option. For help choosing the best plan type, contact us.

© 2024
TopLine Content Marketing Team

Bookkeeping provides a solid foundation for financial reporting

There are currently more than 33 million small businesses in the United States, according to the U.S. Chamber of Commerce. To succeed in today’s competitive markets, it’s essential for your business organization to have accurate books and records. 

Bookkeeping vs. accounting 

For starters, you should understand the distinction between bookkeeping and accounting. Bookkeeping refers to the systematic storing of financial documentation, such as receipts, purchase orders and invoices, as well as recording of daily financial transactions, such as purchases and sales of goods and services. In general, bookkeeping is the basis for accounting. Bookkeepers record journal entries — that is, debits and credits — for each transaction using accounting software, such as QuickBooks®, NetSuite® or Xero™. However, bookkeepers do more than data entry; they also may be responsible for sending invoices, processing payments and payroll, conducting banking activities, and reconciling accounts.

Accounting involves classifying, interpreting and communicating financial transactions. Accounting uses the records maintained by the bookkeeper throughout the period to generate historic and prospective financial statements. These reports — balance sheets, income statements and statements of cash flow — provide financial insights that help management and external stakeholders evaluate financial performance.

2 methods

Business owners must choose a method for recording and classifying financial transactions. There are two main options for small and midsize businesses:

1. Cash accounting. Under this simplified method, a business records revenue when cash is received and expenditures (such as expenses and asset purchases) when they’re paid.

2. Accrual accounting. This method is prescribed under U.S. Generally Accepted Accounting Principles. Here, revenue is recorded when earned and expenses are recorded when incurred, without regard to when cash changes hands. It’s based on the principle that revenue should be “matched” to the related expenses incurred in the reporting period. The chart of accounts for an accrual-basis business includes such items as accounts receivable (invoices that have been sent but haven’t yet been paid by customers) and accounts payable (bills that have been received but haven’t yet been paid).

It’s important to choose one accounting method and stick with it as you record transactions (a bookkeeping function) and prepare your financial statements (an accounting function). Some organizations start with cash accounting and switch to accrual accounting as they grow.

Getting professional help

Complying with accounting rules, tax laws and payroll regulations can be overwhelming for many closely held businesses. Fortunately, you don’t have to go it alone. We can help you set up and maintain a reliable system of reporting financial transactions in an accurate, timely manner. Contact us for more information.

© 2024
TopLine Content Marketing Team