June 22, 2022
Here’s an interesting option if your small company or start-up business is planning to claim the research tax credit. Subject to limits, you can elect to apply all or some of any research tax credits that you earn against your payroll taxes instead of your income tax. This payroll tax election may influence some businesses to undertake or increase their research activities. On the other hand, if you’re engaged in or are planning to engage in research activities without regard to tax consequences, be aware that some tax relief could be in your future.
Here are some answers to questions about the option.
Why is the election important?
Many new businesses, even if they have some cash flow, or even net positive cash flow and/or a book profit, pay no income taxes and won’t for some time. Therefore, there’s no amount against which business credits, including the research credit, can be applied. On the other hand, a wage-paying business, even a new one, has payroll tax liabilities. The payroll tax election is thus an opportunity to get immediate use out of the research credits that a business earns. Because every dollar of credit-eligible expenditure can result in as much as a 10-cent tax credit, that’s a big help in the start-up phase of a business — the time when help is most needed.
Which businesses are eligible?
To qualify for the election a taxpayer:
- Must have gross receipts for the election year of less than $5 million and
- Be no more than five years past the period for which it had no receipts (the start-up period).
In making these determinations, the only gross receipts that an individual taxpayer takes into account are from his or her businesses. An individual’s salary, investment income or other income aren’t taken into account. Also, note that neither an entity nor an individual can make the election for more than six years in a row.
Are there limits on the election?
Research credits for which a taxpayer makes the payroll tax election can be applied only against the employer’s old-age, survivors and disability liability — the OASDI or Social Security portion of FICA taxes. So the election can’t be used to lower 1) the employer’s liability for the Medicare portion of FICA taxes or 2) any FICA taxes that the employer withholds and remits to the government on behalf of employees.
The amount of research credit for which the election can be made can’t annually exceed $250,000. Note too that an individual or C corporation can make the election only for those research credits which, in the absence of an election, would have to be carried forward. In other words, a C corporation can’t make the election for research credits that the taxpayer can use to reduce current or past income tax liabilities.
The above Q&As just cover the basics about the payroll tax election. And, as you may have already experienced, identifying and substantiating expenses eligible for the research credit itself is a complex area. Contact us for more information about the payroll tax election and the research credit.
June 22, 2022
For many business owners, estate planning and succession planning go hand in hand. As the owner of a closely held business, you likely have a significant portion of your wealth tied up in the business. If you don’t take the proper estate planning steps to ensure that the business lives on after you’re gone, you may be placing your family at risk.
Separate ownership and management succession
One reason transferring a family business can be a challenge is the distinction between ownership and management succession. When a business is sold to a third party, ownership and management succession typically happen simultaneously. But in the context of a family business, there may be reasons to separate the two.
From an estate planning perspective, transferring assets to the younger generation as early as possible allows you to remove future appreciation from your estate, minimizing any estate taxes due after your death. On the other hand, you may not be ready to hand over the reins or you may feel that your children aren’t ready to take over.
There are strategies family business owners can use to transfer ownership without immediately giving up control, including:
- Transferring ownership to the next generation in the form of nonvoting stock,
- Placing business interests in a trust, family limited partnership or other vehicle that allows the owner to transfer substantial ownership interests to the younger generation while retaining management control, or
- Establishing an employee stock ownership plan.
Another reason to separate ownership and management succession is to deal with family members who aren’t involved in the business. Providing heirs outside the business with nonvoting stock or other equity interests that don’t confer control can be an effective way to share the wealth while allowing those who work in the business to take over management.
Work around conflicts
Another unique challenge presented by a family business is that the older and younger generations may have conflicting financial needs. Fortunately, there are strategies available to generate cash flow for the owner while minimizing the burden on the next generation.
For example, you may want to structure an installment sale of the business to your heirs. This option can provide you liquidity while easing the burden on your adult children or other heirs. It may also improve the chances that the purchase can be funded by cash flows from the business. Plus, as long as the price and terms are comparable to arm’s-length transactions between unrelated parties, the sale shouldn’t trigger gift or estate tax.
Get an early start
Regardless of your strategy, the earlier you start planning the better. Transitioning the business gradually over several years or even a decade or more gives you time to educate family members about your succession planning philosophy. It also allows you to relinquish control over time, and to implement tax-efficient business structures and transfer strategies. Because each family business is different, work with us to identify appropriate strategies in line with your objectives and resources.
May 25, 2022
Are you a partner in a business? You may have come across a situation that’s puzzling. In a given year, you may be taxed on more partnership income than was distributed to you from the partnership in which you’re a partner.
Why does this happen? It’s due to the way partnerships and partners are taxed. Unlike C corporations, partnerships aren’t subject to income tax. Instead, each partner is taxed on the partnership’s earnings — whether or not they’re distributed. Similarly, if a partnership has a loss, the loss is passed through to the partners. (However, various rules may prevent a partner from currently using his or her share of a partnership’s loss to offset other income.)
Pass through your share
While a partnership isn’t subject to income tax, it’s treated as a separate entity for purposes of determining its income, gains, losses, deductions and credits. This makes it possible to pass through to partners their share of these items.
An information return must be filed by a partnership. On Schedule K of Form 1065, the partnership separately identifies income, deductions, credits and other items. This is so that each partner can properly treat items that are subject to limits or other rules that could affect their correct treatment at the partner’s level. Examples of such items include capital gains and losses, interest expense on investment debts and charitable contributions. Each partner gets a Schedule K-1 showing his or her share of partnership items.
Basis and distribution rules ensure that partners aren’t taxed twice. A partner’s initial basis in his or her partnership interest (the determination of which varies depending on how the interest was acquired) is increased by his or her share of partnership taxable income. When that income is paid out to partners in cash, they aren’t taxed on the cash if they have sufficient basis. Instead, partners just reduce their basis by the amount of the distribution. If a cash distribution exceeds a partner’s basis, then the excess is taxed to the partner as a gain, which often is a capital gain.
Two people each contribute $10,000 to form a partnership. The partnership has $80,000 of taxable income in the first year, during which it makes no cash distributions to the two partners. Each of them reports $40,000 of taxable income from the partnership as shown on their K-1s. Each has a starting basis of $10,000, which is increased by $40,000 to $50,000. In the second year, the partnership breaks even (has zero taxable income) and distributes $40,000 to each of the two partners. The cash distributed to them is received tax-free. Each of them, however, must reduce the basis in his or her partnership interest from $50,000 to $10,000.
More rules and limits
The example and details above are an overview and, therefore, don’t cover all the rules. For example, many other events require basis adjustments and there are a host of special rules covering noncash distributions, distributions of securities, liquidating distributions and other matters. Contact us if you’d like to discuss how a partner is taxed.
May 23, 2022
According to a University of Pennsylvania report, approximately 37% of Americans have “advance directives,” which include living wills and power-of-attorney designations. These documents specify what should occur and who should make medical decisions should someone become seriously ill and unable to make these decisions for him- or herself.
If you belong to the other 63% or so of Americans who haven’t made such arrangements, put it at the top of your to-do list. Your peace of mind — and that of your family — depend on it.
Differentiate between documents
Many people confuse a living will with a last will and testament, but they aren’t the same. These separate documents serve different, but vital, purposes.
A last will and testament is what you probably think of when you hear the term “will.” This document details how your assets will be distributed when you die. A living will (or health care directive) details how life-sustaining medical treatment decisions would be made if you become incapacitated and unable to communicate them yourself.
The thought of becoming terminally ill or entering a coma isn’t pleasant, which is one reason many people put off creating a living will. However, it’s important to think through what you’d like to happen should this ever occur. A living will can provide guidance and reassurance to family members at a time they’re likely to be emotionally distressed.
Provide power of attorney
Often, a living will is drafted in conjunction with two other documents: a durable power of attorney for property and a health care power of attorney.
A durable power of attorney for property identifies someone who can handle your financial affairs, such as paying bills and undertaking other routine tasks, should you become incapacitated. The health care power of attorney becomes effective if you’re incapacitated, but not terminal or in a vegetative state. Your designee can make medical decisions on your behalf if you’re unable to do so. But this person can’t officially make life-sustaining choices. That requires a living will.
Enlist expert help
As tempting as do-it-yourself legal document kits may seem, it’s much better to work with an attorney when drafting a living will, durable power of attorney and power of attorney for health care. These documents are too important to get wrong. Another tip: Discuss the details of your living will and other directives with your loved ones so they’ll know what to expect should they ever be required to act.
May 17, 2022
Families that have children who are adopted, or stepchildren who haven’t been legally adopted, may face unique estate planning challenges. Additional consideration must be taken when a family includes an unmarried couple in a long-term relationship and one person has biological or adopted children. If your family’s makeup is as such, it’s important to understand your estate planning options.
Treated as equals
Adopted children are placed on an equal footing with biological children in most situations for estate planning purposes. Thus, adopted and biological children are treated the same way under a state’s intestate succession laws, which control who inherits property in the absence of a will.
In addition, adopted children generally are treated identically to biological children for purposes of wills or trusts that provide for gifts or distributions to a class of persons, such as “children,” “grandchildren” or “lineal descendants” — even if the child was adopted after the will or trust was executed.
No inheritance rights unless adopted
Stepchildren generally don’t have any inheritance rights with respect to their parents’ new spouses unless the spouse legally adopts them. If you have stepchildren and want them to share in your estate, either adopt them or amend your estate plan to provide for them expressly.
Of course, estate planning isn’t the only reason to adopt stepchildren. Adoption also gives you the legal rights of a parent during your life.
Before you adopt stepchildren, however, you and your spouse should consider the potential effect on their ability to inherit from (or through) their other biological parent and his or her relatives. In most states, when a child is adopted by a stepparent, the adoption decree severs the parent-child relationship with the other biological parent and his or her family. That means the child can’t inherit from that biological parent’s branch of the family — and vice versa — through intestate succession.
Second-parent adoption considerations
A growing minority of states now permit second-parent adoptions, in which an unmarried person adopts his or her partner’s biological or adopted children without terminating the partner’s parental rights. However, in states that recognize second-parent adoptions, their intestate succession laws may not provide for a child to inherit from the “second parent.”
Spell out your wishes
If you have children who are adopted or stepchildren whom you haven’t legally adopted, or you’re unmarried but in a long-term relationship and your partner has biological or adopted children, clearly address your intentions in your will or living trust. Your estate planning advisor can help you understand your options.
May 11, 2022
The IRS recently released guidance providing the 2023 inflation-adjusted amounts for Health Savings Accounts (HSAs). High inflation rates will result in next year’s amounts being increased more than they have been in recent years.
An HSA is a trust created or organized exclusively for the purpose of paying the “qualified medical expenses” of an “account beneficiary.” An HSA can only be established for the benefit of an “eligible individual” who is covered under a “high deductible health plan.” In addition, a participant can’t be enrolled in Medicare or have other health coverage (exceptions include dental, vision, long-term care, accident and specific disease insurance).
A high deductible health plan (HDHP) is generally a plan with an annual deductible that isn’t less than $1,000 for self-only coverage and $2,000 for family coverage. In addition, the sum of the annual deductible and other annual out-of-pocket expenses required to be paid under the plan for covered benefits (but not for premiums) can’t exceed $5,000 for self-only coverage, and $10,000 for family coverage.
Within specified dollar limits, an above-the-line tax deduction is allowed for an individual’s contribution to an HSA. This annual contribution limitation and the annual deductible and out-of-pocket expenses under the tax code are adjusted annually for inflation.
Inflation adjustments for next year
In Revenue Procedure 2022-24, the IRS released the 2023 inflation-adjusted figures for contributions to HSAs, which are as follows:
Annual contribution limitation. For calendar year 2023, the annual contribution limitation for an individual with self-only coverage under an HDHP will be $3,850. For an individual with family coverage, the amount will be $7,750. This is up from $3,650 and $7,300, respectively, for 2022.
In addition, for both 2022 and 2023, there’s a $1,000 catch-up contribution amount for those who are age 55 and older at the end of the tax year.
High deductible health plan defined. For calendar year 2023, an HDHP will be a health plan with an annual deductible that isn’t less than $1,500 for self-only coverage or $3,000 for family coverage (these amounts are $1,400 and $2,800 for 2022). In addition, annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) won’t be able to exceed $7,500 for self-only coverage or $15,000 for family coverage (up from $7,050 and $14,100, respectively, for 2022).
Reap the rewards
There are a variety of benefits to HSAs. Contributions to the accounts are made on a pre-tax basis. The money can accumulate tax free year after year and can be withdrawn tax free to pay for a variety of medical expenses such as doctor visits, prescriptions, chiropractic care and premiums for long-term care insurance. In addition, an HSA is “portable.” It stays with an account holder if he or she changes employers or leaves the workforce. If you have questions about HSAs at your business, contact your employee benefits and tax advisors.
May 10, 2022
A Health Savings Account (HSA) can be a powerful tool for financing health care expenses while supplementing your other retirement savings vehicles. And it offers estate planning benefits to boot.
ABCs of an HSA
Similar to a traditional IRA or 401(k) plan, an HSA is a tax-advantaged savings account funded with pretax dollars. Funds can be withdrawn tax-free to pay for a wide range of qualified medical expenses. (Withdrawals for nonqualified expenses are taxable and, if you’re under 65, subject to penalties.)
An HSA must be coupled with a high-deductible health plan (HDHP). For 2022, an HDHP is a plan with a minimum deductible of $1,400 for individuals and $2,800 for family coverage, and maximum out-of-pocket expenses of $7,050 for individuals and $14,100 for family coverage.
The IRS recently issued inflation-adjusted amounts for 2023: the minimum HDHP deductible for individuals will be $1,500 and $3,000 for family coverage. The maximum HDHP out-of-pocket cost will be $7,500 for self-only coverage and $15,000 for family coverage.
Be aware that, to contribute, you must not be enrolled in Medicare or covered by any non-HDHP insurance (a spouse’s plan, for example).
For 2022, the annual contribution limit for HSAs is $3,650 for individuals and $7,300 for those with family coverage. For 2023, the HSA contribution limit for individuals will be $3,850 and $7,750 for those with family coverage.
If you’re 55 or older, you can add another $1,000 annually. Typically, contributions are made by individuals, but some employers contribute to employees’ accounts.
HSAs can lower health care costs in two ways: 1) by reducing your insurance expense (HDHP premiums are substantially lower than those of other plans) and 2) by allowing you to pay qualified expenses with pretax dollars.
In addition, any funds remaining in an HSA may be carried over from year to year and invested, growing on a tax-deferred basis indefinitely. To the extent that HSA funds aren’t used to pay for qualified medical expenses, they behave much like in an IRA or a 401(k) plan.
Estate planning and your HSA
Unlike traditional IRA and 401(k) plan accounts, HSAs need not make required minimum distributions once you reach a certain age. Except for funds used to pay qualified medical expenses, the account balance continues to grow on a tax-deferred basis indefinitely, providing additional assets for your heirs. The tax implications of inheriting an HSA differ substantially depending on who receives it, so it’s important to consider your beneficiary designation.
If you name your spouse as beneficiary, the inherited HSA will be treated as his or her own HSA. That means your spouse can allow the account to continue growing and withdraw funds tax-free for his or her own qualified medical expenses.
If you name your child or someone else other than your spouse as beneficiary, the HSA terminates and your beneficiary is taxed on the account’s fair market value. It’s possible to designate your estate as beneficiary, but in most cases that’s not the best choice, because a beneficiary other than your estate can avoid taxes on qualified medical expenses paid with HSA funds within one year after death.
Contact us for more information regarding HSAs.