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Should you convert your business from a C to an S corporation?

Choosing the right business entity has many implications, including the amount of your tax bill. The most common business structures are sole proprietorships, partnerships, limited liability companies, C corporations and S corporations.

In some cases, a business may decide to switch from one entity type to another. Although S corporations can provide substantial tax benefits over C corporations in some circumstances, there are potentially costly tax issues that you should assess before making the decision to convert from a C corporation to an S corporation.

Here are four considerations:

1. LIFO inventories. C corporations that use last-in, first-out (LIFO) inventories must pay tax on the benefits they derived by using LIFO if they convert to S corporations. The tax can be spread over four years. This cost must be weighed against the potential tax gains from converting to S status.

2. Built-in gains tax. Although S corporations generally aren’t subject to tax, those that were formerly C corporations are taxed on built-in gains (such as appreciated property) that the C corporation has when the S election becomes effective, if those gains are recognized within five years after the conversion. This is generally unfavorable, although there are situations where the S election still can produce a better tax result despite the built-in gains tax.

3. Passive income. S corporations that were formerly C corporations are subject to a special tax. It kicks in if their passive investment income (including dividends, interest, rents, royalties, and stock sale gains) exceeds 25% of their gross receipts, and the S corporation has accumulated earnings and profits carried over from its C corporation years. If that tax is owed for three consecutive years, the corporation’s election to be an S corporation terminates. You can avoid the tax by distributing the accumulated earnings and profits, which would be taxable to shareholders. Or you might want to avoid the tax by limiting the amount of passive income.

4. Unused losses. If your C corporation has unused net operating losses, they can’t be used to offset its income as an S corporation and can’t be passed through to shareholders. If the losses can’t be carried back to an earlier C corporation year, it will be necessary to weigh the cost of giving up the losses against the tax savings expected to be generated by the switch to S status.

Other issues to explore

These are only some of the factors to consider when switching a business from C to S status. For example, shareholder-employees of S corporations can’t get all the tax-free fringe benefits that are available as a C corporation. And there may be issues for shareholders who have outstanding loans from their qualified plans. These factors must be taken into account in order to understand the implications of converting from C to S status.

If you’re interested in an entity conversion, contact us. We can explain what your options are, how they’ll affect your tax bill and some possible strategies you can use to minimize taxes.

© 2024
TopLine Content Marketing Team

You may be entitled to tax breaks if caring for an elderly relative

There are many rewards for taking care of an elderly relative. They may include feeling needed, making a difference in the person’s life and allowing the person to receive quality care. In addition, you could also be eligible for tax breaks. Here’s a rundown of four of them:

1. Medical expenses. If the individual qualifies as your “medical dependent” and you itemize deductions on your tax return, you can include any medical expenses you incur for the person along with your own when determining your medical deduction. The test for determining whether an individual qualifies as your “medical dependent” is less stringent than that used to determine whether an individual is your “dependent,” which is discussed below. In general, an individual qualifies as a medical dependent if you provide over 50% of his or her support, including medical costs.

However, bear in mind that medical expenses are deductible only to the extent they exceed 7.5% of your adjusted gross income (AGI).

The costs of qualified long-term care services required by a chronically ill individual and eligible long-term care insurance premiums are included in the definition of deductible medical expenses. There’s an annual cap on the amount of premiums that can be deducted. The cap is based on age, and in 2024 goes from $470 for an individual age 40 or less to $5,880 for an individual over 70.

2. Filing status. If you aren’t married, you may qualify for “head-of-household” status by virtue of the individual you’re caring for. You can claim this status if:

  • The person you’re caring for lives in your household,
  • You cover more than half the household costs,
  • The person qualifies as your “dependent,” and
  • The person is a relative.

If the person you’re caring for is your parent, the person doesn’t need to live with you, so long as you provide more than half of the person’s household costs and the person qualifies as your dependent. A head of household has a higher standard deduction and lower tax rates than a single filer.

There are requirements for determining whether your loved one is a “dependent.” Dependency exemptions are suspended (or disallowed) for 2018 through 2025. But even though the dependency exemption is currently suspended, the dependency tests still apply when it comes to determining whether a taxpayer is entitled to various other tax benefits, such as head-of-household filing status.

For an individual to qualify as your “dependent,” the following must be true for the tax year at issue:

  • You must provide more than 50% of the individual’s support costs,
  • The individual must either live with you or be related,
  • The individual must not have gross income in excess of an inflation-adjusted exemption amount,
  • The individual can’t file a joint return for the year, and
  • The individual must be a U.S. citizen or a resident of the U.S., Canada or Mexico.

3. Dependent care credit. If the cared-for individual qualifies as your dependent, lives with you and physically or mentally can’t take care of him- or herself, you may qualify for the dependent care credit for costs you incur for the individual’s care to enable you and your spouse to go to work.

4. Nonchild dependent credit. For 2018 through 2025, the Tax Cuts and Jobs Act (TCJA) established a $500 federal income tax credit for dependents who don’t qualify for the Child Tax Credit. A dependent parent can make you eligible for this $500 credit. However, your parent must pass the aforementioned gross income test to be classified as your dependent for purposes of this credit. You must also pay over half of your parent’s support.

The credit is phased out for taxpayers with adjusted gross income (AGI) above $200,000 ($400,000 for a married couple that files jointly). The credit is reduced by $50 for every $1,000 that your AGI exceeds the applicable threshold.

Contact us if you’d like to further discuss the tax aspects of financially supporting and caring for an elderly relative.

© 2024
TopLine Content Marketing Team

New survey reveals top audit committee concerns

Audit committees act as gatekeepers over the accounting and financial reporting processes, including the effectiveness of the company’s control environment. However, as the regulatory landscape becomes increasingly complex and organizations face evolving risks, the scope of an audit committee’s responsibilities may extend beyond traditional financial reporting.

Top-of-mind list

In March 2024, a survey entitled “Audit Committee Practices Report: Common Threads Across Audit Committees” was published by Deloitte and the Center for Audit Quality, an affiliate of the American Institute of Certified Public Accountants. The survey analyzed 266 responses, including many from people who served on audit committees of public companies.

Respondents identified the following five priorities over the next 12 months:

1. Cybersecurity. This was listed as a top-three concern by a majority (69%) of audit committee members surveyed. The focus on cybersecurity is, in part, caused by a new regulation from the U.S. Securities and Exchange Commission. It requires public companies to 1) report material cybersecurity incidents, 2) disclose cybersecurity risk management and strategy, and 3) explain their board and management oversight processes. Surprisingly, only 24% of respondents said their audit committees had sufficient levels of expertise in this area. So additional resources may be needed to hire external cybersecurity advisors or invest in educational programs to bridge the knowledge gap.

2. Enterprise risk management (ERM). Nearly half (48%) of respondents listed ERM as a top-three concern. This refers to the processes an organization uses to identify, monitor and assess enterprise-wide risks. Audit committees have been tasked with ERM for many years, but extra attention may be warranted as new threats emerge. Examples include pandemics, large natural and climate-related disasters, and global conflicts. It’s important for audit committees to evaluate whether their organizations’ ERM processes can handle new threats efficiently and effectively. 

3. Finance and internal audit talent. More than one-third (37%) of respondents put this concern on their top-three list. Audit committees frequently work closely with in-house finance and internal audit teams. While most respondents (89%) agree or strongly agree that their internal auditors possess high-level understandings of the companies’ operations, there may be opportunities to upskill in-house staff and use artificial intelligence (AI) to streamline routine tasks, eliminate redundancies and identify opportunities to operate more efficiently. Audit committees should oversee succession planning for finance and internal audit teams, particularly if their companies’ CFOs are planning to soon retire.

4. Compliance with laws and regulations. More than one-third (36%) of respondents are focused on the heightened complexity of the regulatory environment. Compliance issues are especially prevalent in heavily regulated industries, such as banking, food services and aviation.

5. Finance transformation. Listed as a top-three concern by 33% of respondents, finance transformation refers to revamping the finance department to better align with the company’s overall strategy. It may entail changes to the department’s operating model, staffing, processes and accounting systems. The goals are to simplify, streamline and optimize the organization’s finance function. Audit committees can help finance teams implement transformation initiatives by understanding the human and technological resources needed. Many are considering possible AI solutions, for example, to expedite closing the books at the end of the reporting period, improve financial planning and detect impending risks.

Collaborative approach

External auditors communicate frequently with audit committees about top concerns, emerging risks, impending regulations and other matters, so they can help each other in performing their respective roles. Contact us. We design audit procedures, draft financial statement disclosures and provide guidance to help address the challenges audit committees face today.

© 2024
TopLine Content Marketing Team

A three-step strategy to save tax when selling appreciated vacant land

Let’s say you own one or more vacant lots. The property has appreciated greatly and you’re ready to sell. Or maybe you have a parcel of appreciated land that you want to subdivide into lots, develop them and sell them off for a big profit. Either way, you’ll incur a tax bill.

For purposes of these examples, let’s assume that you own the vacant land directly as an individual or indirectly through a single-member LLC (SMLLC), a partnership or a multimember LLC that’s treated as a partnership for federal income tax purposes.

Here are a couple of scenarios and a strategy to consider.

Scenario 1: You simply sell vacant land that you’ve held for investment

If you’ve owned the land for more than one year and you’re not classified as a real estate dealer, any gain on sale will be a long-term capital gain (LTCG) eligible for lower federal income tax rates. The current maximum federal rate for LTCGs is 20%. You may also owe the 3.8% net investment income tax (NIIT) on all or part of your gain and maybe state income tax, too.

Scenario 2: You develop a parcel and sell improved lots

In this case, the federal income tax rules generally treat a land developer as a real estate dealer. If you’re classified as a dealer, the profit from developing and selling land is considered profit from selling inventory. That means the entire profit — including the portion from any pre-development appreciation in the value of the land — will be high-taxed ordinary income rather than lower-taxed LTCG. The maximum federal rate on ordinary income recognized by individual taxpayers is currently 37%. The 3.8% NIIT may also be owed and maybe state income tax, too. So, the total tax hit might approach 50% of the gain.

S corporation entity strategy to the rescue

Thankfully, there’s a strategy that allows favorable LTCG tax treatment for all the pre-development appreciation in the value of your land. However, any profit attributable to later subdividing, development and marketing activities will be high-taxed ordinary income because you’ll be treated as a dealer for that part of the process. But if you can manage to pay “only” the 23.8% maximum effective federal rate (20% + 3.8%), or maybe less, on the bulk of a large profit, that’s a win. Here’s a three-step plan to accomplish that tax-saving goal.

1. Establish an S corporation

If you’re the sole owner of the appreciated land, establish a new S corporation owned solely by you to function as the developer entity. If you own the land via a partnership, or via an LLC treated as a partnership for tax purposes, you and the other partners can form the S corporation and be issued stock in proportion to your partnership/LLC ownership percentages.

2. Sell the land to the S corporation

Next, sell the appreciated land to the S corporation for a price equal to the land’s pre-development fair market value. As long as the land has been held for investment and has been owned for more than one year, the sale will trigger a LTCG — equal to the pre-development appreciation — that won’t be taxed at more than the 23.8% maximum federal rate.

3. S corporation develops the land and sells it off

Next, the S corporation will subdivide and develop the property, market it and sell it off. The profit from these activities will be higher-taxed ordinary income passed through to the shareholder(s), including you. If the profit from development is big, you might pay the maximum 40.8% effective federal rate (37% + 3.8%) on that income. However, the part of your total profit that’s attributable to pre-development appreciation in the value of the land will be taxed at no more than the 23.8% maximum federal rate.

Seek professional help

The bottom line is if you’re simply selling appreciated vacant land that you’ve held for investment, the federal income tax results are straightforward. But if you’ll develop the land before selling, the S corporation developer entity strategy could be a big tax-saver in the right circumstances. However, it’s not a DIY project. Consult with us to avoid pitfalls.

© 2024
TopLine Content Marketing Team

Employers: Is it time to upgrade your “well-being” benefits?

Various survey results have been rolling in, and the message for employers is relatively clear: Employees want support in maintaining their wellness — particularly when it comes to mental health.

Employers seem to be responding in kind. Many are ramping up their “well-being” benefits to retain valued staff members and draw strong job candidates. This marks a change in the competitive landscape for talent that every organization, including yours, should consider.

Lots of data

Among the most telling reports is MetLife’s Employee Benefit Trends Study 2024. The insurance giant combined responses from two surveys — one of 2,595 employee benefits decision-makers and influencers and another of 2,809 full-time employees — and found that 92% of employees want more “consistent care” from their employers.

This very high percentage echoes the results of the 2023 Workplace Wellness Survey by the Employee Benefit Research Institute and Greenwald Research. It found that, of 1,505 full- and part-time employees surveyed, 78% agreed that employers are responsible for ensuring staff members are “mentally healthy and emotionally well.”

As mentioned, many employers are actively trying to address these concerns. At the beginning of this year, the Integrated Benefits Institute, a nonprofit benefits research organization, released the results of a survey that found 51% of responding employers said “employee satisfaction” was their top organizational goal — that’s 10% more than the second most important goal of cost mitigation / revenue generation.

In response to this goal or a similar one, many employers are enhancing their employee benefits. The CHRO Confidence Index, which is researched and published by The Conference Board, a global nonprofit think tank and business membership organization, regularly takes the pulse of its member Chief Human Resources Officers (CHROs). In the February 2024 edition, 42% of responding CHROs reported planning to offer new benefits this year. Of those, 20% identified well-being benefits that will involve mental health initiatives.

Benefits to consider

So, what are well-being benefits? They’re generally considered those that augment an employer-sponsored health care plan and help support mental health as well as physical and financial wellness. Here are just a few to consider:

An Employee Assistance Program (EAP). This is a voluntary and confidential work-based intervention program designed to help employees and their dependent family members deal with issues that may be affecting their mental health and job performance. EAPs can help participants deal with issues such as workplace stress, grief, depression, marriage/family problems, psychological disorders, financial troubles, and alcohol and drug dependency.

Revised paid time off (PTO) policies. Many employers are finding that the old “X number of vacation days and X number of sick days” approach lacks the flexibility employees need to care for themselves. Your staff may appreciate a bank of PTO that can be used for any purpose, without question. Some employers are also adding “mental health days” to their lists of organizational holidays.

Trainings related to mental health or financial literacy. Employers are often well-positioned to teach groups of people to lessen behaviors that hurt mental health and emphasize behaviors that improve it.

For example, stress management programs can train workers to recognize strenuous situations and better cope with them. Meanwhile, financial literacy programs may help employees better understand topics such as debt management and investing. In turn, this can lower their stress levels.

A diverse menu 

For many employers, particularly midsize and larger ones, the days of offering up some paid time off, health insurance and a retirement plan are over. Employees increasingly expect a wide and diverse menu of fringe benefits that address multiple facets of their lives. Contact us for help analyzing your benefits costs and choosing cost-effective offerings.

© 2024
TopLine Content Marketing Team

Tax tips when buying the assets of a business

After experiencing a downturn in 2023, merger and acquisition activity in several sectors is rebounding in 2024. If you’re buying a business, you want the best results possible after taxes. You can potentially structure the purchase in two ways:

  1. Buy the assets of the business, or
  2. Buy the seller’s entity ownership interest if the target business is operated as a corporation, partnership or LLC.

In this article, we’re going to focus on buying assets.

Asset purchase tax basics

You must allocate the total purchase price to the specific assets acquired. The amount allocated to each asset becomes the initial tax basis of that asset.

For depreciable and amortizable assets (such as furniture, fixtures, equipment, buildings, software and intangibles such as customer lists and goodwill), the initial tax basis determines the post-acquisition depreciation and amortization deductions.

When you eventually sell a purchased asset, you’ll have a taxable gain if the sale price exceeds the asset’s tax basis (initial purchase price allocation, plus any post-acquisition improvements, minus any post-acquisition depreciation or amortization).

Asset purchase results with a pass-through entity

Let’s say you operate the newly acquired business as a sole proprietorship, a single-member LLC treated as a sole proprietorship for tax purposes, a partnership, a multi-member LLC treated as a partnership for tax purposes or an S corporation. In those cases, post-acquisition gains, losses and income are passed through to you and reported on your personal tax return. Various federal income tax rates can apply to income and gains, depending on the type of asset and how long it’s held before being sold.

Asset purchase results with a C corporation

If you operate the newly acquired business as a C corporation, the corporation pays the tax bills from post-acquisition operations and asset sales. All types of taxable income and gains recognized by a C corporation are taxed at the same federal income tax rate, which is currently 21%.

A tax-smart purchase price allocation

With an asset purchase deal, the most important tax opportunity revolves around how you allocate the purchase price to the assets acquired.

To the extent allowed, you want to allocate more of the price to:

  • Assets that generate higher-taxed ordinary income when converted into cash (such as inventory and receivables),
  • Assets that can be depreciated relatively quickly (such as furniture and equipment), and
  • Intangible assets (such as customer lists and goodwill) that can be amortized over 15 years.

You want to allocate less to assets that must be depreciated over long periods (such as buildings) and to land, which can’t be depreciated.

You’ll probably want to get appraised fair market values for the purchased assets to allocate the total purchase price to specific assets. As stated above, you’ll generally want to allocate more of the price to certain assets and less to others to get the best tax results. Because the appraisal process is more of an art than a science, there can potentially be several legitimate appraisals for the same group of assets. The tax results from one appraisal may be better for you than the tax results from another.

Nothing in the tax rules prevents buyers and sellers from agreeing to use legitimate appraisals that result in acceptable tax outcomes for both parties. Settling on appraised values becomes part of the purchase/sale negotiation process. That said, the appraisal that’s finally agreed to must be reasonable.

Plan ahead

Remember, when buying the assets of a business, the total purchase price must be allocated to the acquired assets. The allocation process can lead to better or worse post-acquisition tax results. We can help you get the former instead of the latter. So get your advisor involved early, preferably during the negotiation phase.

© 2024
TopLine Content Marketing Team