February 10, 2020
These days, most businesses need a website to remain competitive. It’s an easy decision to set one up and maintain it. But determining the proper tax treatment for the costs involved in developing a website isn’t so easy.
That’s because the IRS hasn’t released any official guidance on these costs yet. Consequently, you must apply existing guidance on other costs to the issue of website development costs.
Hardware and software
First, let’s look at the hardware you may need to operate a website. The costs involved fall under the standard rules for depreciable equipment. Specifically, once these assets are up and running, you can deduct 100% of the cost in the first year they’re placed in service (before 2023). This favorable treatment is allowed under the 100% first-year bonus depreciation break.
In later years, you can probably deduct 100% of these costs in the year the assets are placed in service under the Section 179 first-year depreciation deduction privilege. However, Sec. 179 deductions are subject to several limitations.
For tax years beginning in 2019, the maximum Sec. 179 deduction is $1.02 million, subject to a phaseout rule. Under the rule, the deduction is phased out if more than a specified amount of qualified property is placed in service during the year. The threshold amount for 2019 is $2.55 million.
There’s also a taxable income limit. Under it, your Sec. 179 deduction can’t exceed your business taxable income. In other words, Sec. 179 deductions can’t create or increase an overall tax loss. However, any Sec. 179 deduction amount that you can’t immediately deduct is carried forward and can be deducted in later years (to the extent permitted by the applicable limits).
Similar rules apply to purchased off-the-shelf software. However, software license fees are treated differently from purchased software costs for tax purposes. Payments for leased or licensed software used for your website are currently deductible as ordinary and necessary business expenses.
Software developed internally
If your website is primarily for advertising, you can also currently deduct internal website software development costs as ordinary and necessary business expenses.
An alternative position is that your software development costs represent currently deductible research and development costs under the tax code. To qualify for this treatment, the costs must be paid or incurred by December 31, 2022.
A more conservative approach would be to capitalize the costs of internally developed software. Then you would depreciate them over 36 months.
Third party payments
Some companies hire third parties to set up and run their websites. In general, payments to third parties are currently deductible as ordinary and necessary business expenses.
Before business begins
Start-up expenses can include website development costs. Up to $5,000 of otherwise deductible expenses that are incurred before your business commences can generally be deducted in the year business commences. However, if your start-up expenses exceed $50,000, the $5,000 current deduction limit starts to be chipped away. Above this amount, you must capitalize some, or all, of your start-up expenses and amortize them over 60 months, starting with the month that business commences.
We can help
We can determine the appropriate treatment for these costs for federal income tax purposes. Contact us if you have questions or want more information.
February 10, 2020
Traditionally, trusts used in estate planning contain “Crummey” withdrawal powers to ensure that contributions qualify for the annual gift tax exclusion. Today, the exclusion allows you to give up to $15,000 per year ($30,000 for married couples) to any number of recipients.
Now that the gift and estate tax exemption has reached an inflation-adjusted $11.4 million, fewer people have to worry about gift and estate taxes. But, for many affluent people, the annual exclusion continues to be an important estate planning strategy. Thus, Crummey powers continue to be relevant.
Reasons to make annual exclusion gifts
Despite the record-high exemption, there are two important reasons to make annual exclusion gifts. First, if your wealth exceeds the exemption amount, an annual gifting program can reduce or even eliminate your liability for gift and estate taxes.
Second, even if your wealth is well within the exemption, annual gifting guarantees that the amounts you give are permanently removed from your taxable estate. If you rely on the exemption, keep in mind that there’s no guarantee that Congress won’t reduce the amount in the future, exposing your estate to tax liability.
Crummey powers explained
The annual exclusion is available only for gifts of “present interests.” But a contribution to a trust is, by definition, a gift of a future interest. To get around this obstacle, trusts typically provide beneficiaries with Crummey withdrawal powers. By giving them the right to withdraw trust contributions for a limited period of time (usually 30 to 60 days), it’s possible to convert a future interest into a present interest, even if the withdrawal rights are never exercised.
For Crummey powers to work, the trust must give beneficiaries real withdrawal rights. Generally, that means you can’t have an agreement with your beneficiaries — expressed or implied — that they won’t exercise their withdrawal rights (although it’s permissible to discuss with them the advantages of keeping assets in the trust).
It also means that the trust should contain sufficient liquid assets so that beneficiaries can exercise their withdrawal rights if they choose to.
Notifying beneficiaries of withdrawal rights is critical
The IRS has long taken the position that a trust contribution isn’t a present-interest gift — and, therefore, is ineligible for the annual exclusion — unless beneficiaries receive actual notice of their withdrawal rights and a “reasonable opportunity” to exercise those rights. To avoid an IRS challenge, it’s prudent to provide beneficiaries with written notice of their withdrawal rights, preferably via certified mail.
There’s no specific requirement regarding the amount of time that constitutes a “reasonable opportunity.” The IRS has indicated in private rulings, however, that 30 days is sufficient, while three days isn’t. Common practice is to give beneficiaries between 30 and 60 days to exercise their withdrawal rights.
If you wish to make annual exclusion gifts to a trust, be sure the trust provides the beneficiaries with Crummey withdrawal powers. Contact us with questions.
February 10, 2020
Do you want to withdraw cash from your closely held corporation at a low tax cost? The easiest way is to distribute cash as a dividend. However, a dividend distribution isn’t tax-efficient, since it’s taxable to you to the extent of your corporation’s “earnings and profits.” But it’s not deductible by the corporation.
Fortunately, there are several alternative methods that may allow you to withdraw cash from a corporation while avoiding dividend treatment. Here are five ideas:
1. Capital repayments. To the extent that you’ve capitalized the corporation with debt, including amounts that you’ve advanced to the business, the corporation can repay the debt without the repayment being treated as a dividend. Additionally, interest paid on the debt can be deducted by the corporation. This assumes that the debt has been properly documented with terms that characterize debt and that the corporation doesn’t have an excessively high debt-to-equity ratio. If not, the “debt” repayment may be taxed as a dividend. If you make cash contributions to the corporation in the future, consider structuring them as debt to facilitate later withdrawals on a tax-advantaged basis.
2. Salary. Reasonable compensation that you, or family members, receive for services rendered to the corporation is deductible by the business. However, it’s also taxable to the recipient. The same rule applies to any compensation (in the form of rent) that you receive from the corporation for the use of property. In either case, the amount of compensation must be reasonable in relation to the services rendered or the value of the property provided. If it’s excessive, the excess will be nondeductible and treated as a corporate distribution.
3. Loans. You may withdraw cash from the corporation tax-free by borrowing money from it. However, to avoid having the loan characterized as a corporate distribution, it should be properly documented in a loan agreement or a note and be made on terms that are comparable to those on which an unrelated third party would lend money to you. This should include a provision for interest and principal. All interest and principal payments should be made when required under the loan terms. Also, consider the effect of the corporation’s receipt of interest income.
4. Fringe benefits. Consider obtaining the equivalent of a cash withdrawal in fringe benefits that are deductible by the corporation and not taxable to you. Examples are life insurance, certain medical benefits, disability insurance and dependent care. Most of these benefits are tax-free only if provided on a nondiscriminatory basis to other employees of the corporation. You can also establish a salary reduction plan that allows you (and other employees) to take a portion of your compensation as nontaxable benefits, rather than as taxable compensation.
5. Property sales. You can withdraw cash from the corporation by selling property to it. However, certain sales should be avoided. For example, you shouldn’t sell property to a more than 50% owned corporation at a loss, since the loss will be disallowed. And you shouldn’t sell depreciable property to a more than 50% owned corporation at a gain, since the gain will be treated as ordinary income, rather than capital gain. A sale should be on terms that are comparable to those on which an unrelated third party would purchase the property. You may need to obtain an independent appraisal to establish the property’s value.
If you’re interested in discussing any of these ideas, contact us. We can help you get the maximum out of your corporation at the minimum tax cost.
February 7, 2020
If you’re in line to inherit property from a parent or other loved one, it’s critical to understand the basis consistency rules. Current tax law, passed in 2015, provides that the income tax basis of property received from a deceased person can’t exceed the property’s fair market value (FMV) as finally determined for estate tax purposes.
Before the 2015 tax law change, estates and their beneficiaries had conflicting incentives when it came to the valuation of a deceased person’s property. Executors had an incentive to value property as low as possible to minimize estate taxes, while beneficiaries had an incentive to value property as high as possible to minimize capital gains, if they decided to sell the property.
The 2015 law requires consistency between a property’s basis reflected on an estate tax return and the basis used to calculate gain when it’s sold by the person who inherits it. It provides that the basis of property in the hands of a beneficiary may not exceed its value as finally determined for estate tax purposes.
Generally, a property’s value is finally determined when:
- Its value is reported on a federal estate tax return and the IRS doesn’t challenge it before the limitations period expires,
- The IRS determines its value and the executor doesn’t challenge it before the limitations period expires, or
- Its value is determined according to a court order or agreement.
But the basis consistency rule isn’t a factor in all situations. The rule doesn’t apply to property unless its inclusion in the deceased’s estate increased the liability for estate taxes. So, for example, the rule doesn’t apply if the value of the deceased’s estate is less than his or her unused exemption amount.
Beware of failure-to-file penalties
Current law also requires estates to furnish information about the value of inherited property to the IRS and the person who inherits it. Estates that fail to comply with these reporting requirements are subject to failure-to-file penalties.
An accurate valuation is key
The basis consistency rules can be complex. The bottom line is that if you inherit property from a person whose estate is liable for estate tax, it’s important that the property’s value be accurately reported on the deceased’s estate tax return. Contact us with any questions.
February 7, 2020
Traditional estate planning strategies generally are based on the assumption that all family members involved are U.S. citizens. However, if you or your spouse is a noncitizen, special rules apply that may require additional planning.
Defining “residency” and “domicile”
If you’re a U.S. resident, but not a citizen, you’re treated similarly to a U.S. citizen by the Internal Revenue Code. You’re subject to federal gift and estate taxes on your worldwide assets, but you also enjoy the benefits of the $11.58 million (for 2020) gift and estate tax exemption and the $15,000 annual gift tax exclusion. And you can double the annual exclusion to $30,000 through gift-splitting with your spouse, so long as your spouse is a U.S. citizen or resident. (Special rules apply to the marital deduction, however, as will be discussed below.)
Residency is a complicated subject. IRS regulations define a U.S. resident for federal estate tax purposes as someone who had his or her domicile in the United States at the time of death. One acquires a domicile in a place by living there, even briefly, with a present intention of making that place a permanent home.
Whether you have your domicile in the United States depends on an analysis of several factors, including the relative time you spend in the United States and abroad, the locations and relative values of your residences and business interests, visa status, community ties, and the location of family members.
What if you’re a “nonresident alien”?
If you’re a nonresident alien — that is, if you’re neither a U.S. citizen nor a U.S. resident — there’s good news and bad news regarding federal estate tax law. The good news is that you’re subject to U.S. gift and estate taxes only on property that’s “situated” in the United States. Also, you can take advantage of the $15,000 annual exclusion (although you can’t split gifts with your spouse).
The bad news is that your estate tax exemption drops from $11.58 million to a miniscule $60,000, so substantial U.S. property holdings can result in a big estate tax bill. Taxable property includes U.S. real estate as well as tangible personal property — such as cars, boats and artwork — located in the United States.
Options for making tax-free transfers
The unlimited marital deduction isn’t available for gifts or bequests to noncitizens. However, there are certain options for making tax-free transfers to a noncitizen spouse. For example, you can use the transferor’s $11.58 million exemption (provided the transferor is a U.S. citizen or resident). You can also make annual exclusion gifts. (For 2020, the limit for gifts to a noncitizen spouse is $157,000.) And last, you can bequeath assets to a qualified domestic trust, which contains provisions designed to ensure that the assets are ultimately taxed as part of the recipient’s estate.
Consider your rights
Understanding federal estate tax laws can be complicated — even more so if you, your spouse or both are noncitizens. We can help you assess your planning options.