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Beware the Ides of March – If You Own a Pass-Through Entity

Shakespeare’s words don’t apply just to Julius Caesar; they also apply to calendar-year partnerships, S corporations and limited liability companies (LLCs) treated as partnerships or S corporations for tax purposes. Why? The Ides of March, more commonly known as March 15, is the federal income tax filing deadline for these “pass-through” entities.

Not-so-ancient history

Until the 2016 tax year, the filing deadline for partnerships was the same as that for individual taxpayers: April 15 (or shortly thereafter if April 15 fell on a weekend or holiday). One of the primary reasons for moving up the partnership filing deadline was to make it easier for owners to file their personal returns by the April filing deadline. After all, partnership (and S corporation) income passes through to the owners. The earlier date allows owners to use the information contained in the pass-through entity forms to file their personal returns.

For partnerships with fiscal year ends, tax returns are now due the 15th day of the third month after the close of the tax year. The same deadline applies to fiscal-year S corporations. Under prior law, returns for fiscal-year partnerships were due the 15th day of the fourth month after the close of the fiscal tax year.

Avoiding a tragedy

If you haven’t filed your calendar-year partnership or S corporation return yet and are worried about having sufficient time to complete it, you can avoid the tragedy of a late return by filing for an extension. Under the current law, the maximum extension for calendar-year partnerships is six months (until September 16, 2019, for 2018 returns). This is up from five months under the old law. So the extension deadline is the same — only the length of the extension has changed. The extension deadline for calendar-year S corporations also is September 16, 2019, for 2018 returns.

Whether you’ll be filing a partnership or an S corporation return, you must file for the extension by March 15 if it’s a calendar-year entity.

Extending the drama

Filing for an extension can be tax-smart if you’re missing critical documents or you face unexpected life events that prevent you from devoting sufficient time to your return right now.

But to avoid potential interest and penalties, you still must (with a few exceptions) pay any tax due by the unextended deadline. There probably won’t be any tax liability from the partnership or S corporation return. But, if filing for an extension for the entity return causes you to also have to file an extension for your personal return, it could cause you to owe interest and penalties in relation to your personal return.

We can help you file your tax returns on a timely basis or determine whether filing for an extension is appropriate. Contact us today.

© 2019

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How to Report Stock Compensation Paid to Non-employees

The accounting rules for reporting stock compensation have been expanded. They now include share-based payments to non-employees for providing goods and services, under recent guidance issued by the Financial Accounting Standards Board (FASB).

Old Rules

Under existing U.S. Generally Accepted Accounting Principles (GAAP), the FASB requires businesses that give stock awards to independent contractors or consultants to follow a separate standard from the one used for employee stock compensation.

Under Accounting Standards Codification (ASC) Subtopic 505-50, Equity — Equity-Based Payments to Non-Employees, the measurement date for nonemployees is determined at the earlier of the date at which:

  • The commitment for performance is complete, or
  • The counterparty’s performance is complete.

This requires judgment and tracking issues that have led to inconsistencies in financial reporting, especially if nonemployees are awarded stock options on a one-by-one basis, rather than a single large grant.

The FASB originally chose to apply different stock compensation guidance to nonemployees because independent contractors and consultants were perceived as having significant freedom to move from company to company. In theory, independent contractors could watch stock price movements to determine where to work.

However, the FASB now believes the assumptions behind the dual standards were overstated, because full-time employees also have the freedom to move from job to job.

New Rules

In June 2018, the FASB issued Accounting Standards Update (ASU) No. 2018-07, Compensation — Stock Compensation: Improvements to Non-employee Share-Based Payment Accounting. It eliminates the separate guidance for stock compensation paid to non-employees and aligns it with the guidance for stock compensation paid to employees.

Under the aligned guidance, all share-based compensation payments will be measured with an estimate of the fair value of the equity the business is obligated to issue at the grant date. The grant date is the date the business and the stock award recipient agree to the terms of the award. Essentially, compensation will be recognized in the same period and in the same manner as if the company had paid cash for goods or services instead of stock.

The guidance doesn’t cover stock compensation that’s used to provide financing to the company that issued the shares. It also doesn’t include stock awards tied to a sale of goods or services as part of a contract accounted for under the new-and-improved revenue recognition standard.

Effective Dates

The updated standard is effective for public companies for fiscal years that begin after December 15, 2018. Private companies have an extra year to implement the changes for annual reports.

Early adoption is generally permitted, but businesses aren’t allowed to follow the changes in ASU No. 2018-07 until they’ve implemented the new revenue recognition standard. Contact us for more information.

© 2019

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The Home Office Deduction: Actual Expenses vs. the Simplified Method

If you run your business from your home or perform certain functions at home that are related to your business, you might be able to claim a home office deduction against your business income on your 2018 income tax return. Thanks to a tax law change back in 2013, there are now two methods for claiming this deduction: the actual expenses method and the simplified method.

Basics of the deduction

In general, you’ll qualify for a home office deduction if part of your home is used “regularly and exclusively” as your principal place of business.

If your home isn’t your principal place of business, you may still be able to deduct home office expenses if 1) you physically meet with patients, clients or customers on your premises, or 2) you use a storage area in your home (or a separate free-standing structure, such as a garage) exclusively and regularly for your business.

Actual expenses

Traditionally, taxpayers have deducted actual expenses when they claim a home office deduction. Deductible home office expenses may include:

  • Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,
  • A proportionate share of indirect expenses, such as mortgage interest, property taxes, utilities, repairs and insurance, and
  • A depreciation allowance.

But keeping track of actual expenses can be time consuming.

The simplified method

Fortunately, there’s a simplified method that’s been available since 2013: You can deduct $5 for each square foot of home office space, up to a maximum total of $1,500.

For example, if you’ve converted a 300-square-foot bedroom to an office you use exclusively and regularly for business, you can write off $1,500 under the simplified method (300 square feet x $5). However, if your business is located in a 600-square-foot finished basement, the deduction will still be only $1,500 because of the cap on the deduction under this method.

As you can see, the cap can make the simplified method less beneficial for larger home office spaces. But even for spaces of 300 square feet or less, taxpayers may qualify for a bigger deduction using the actual expense method. So, tracking your actual expenses can be worth the extra hassle.

Flexibility in filing

When claiming the home office deduction, you’re not locked into a particular method. For instance, you might choose the actual expense method on your 2018 return, use the simplified method when you file your 2019 return next year and then switch back to the actual expense method thereafter. The choice is yours.

Unsure whether you qualify for the home office deduction? Or wondering whether you should deduct actual expenses or use the simplified method? Contact us. We can help you determine what’s right for your specific situation.

© 2019

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When Are LLC Members Subject to Self-Employment Tax?

Limited liability company (LLC) members commonly claim that their distributive shares of LLC income — after deducting compensation for services in the form of guaranteed payments — aren’t subject to self-employment (SE) tax. But the IRS has been cracking down on LLC members it claims have underreported SE income, with some success in court.

SE tax background

Self-employment income is subject to a 12.4% Social Security tax (up to the wage base) and a 2.9% Medicare tax. Generally, if you’re a member of a partnership — including an LLC taxed as a partnership — that conducts a trade or business, you’re considered self-employed.

General partners pay SE tax on all their business income from the partnership, whether it’s distributed or not. Limited partners, however, are subject to SE tax only on any guaranteed payments for services they provide to the partnership. The rationale is that limited partners, who have no management authority, are more akin to passive investors.

(Note, however, that “service partners” in service partnerships, such as law firms, medical practices, and architecture and engineering firms, generally may not claim limited partner status regardless of their level of participation.)

LLC uncertainty

Over the years, many LLC members have taken the position that they’re equivalent to limited partners and, therefore, exempt from SE tax (except on guaranteed payments for services). But there’s a big difference between limited partners and LLC members. Both enjoy limited personal liability, but, unlike limited partners, LLC members can actively participate in management without jeopardizing their liability protection.

Arguably, LLC members who are active in management or perform substantial services related to the LLC’s business are subject to SE tax, while those who more closely resemble passive investors should be treated like limited partners. The IRS issued proposed regulations to that effect in 1997, but hasn’t finalized them — although it follows them as a matter of internal policy.

Some LLC members have argued that the IRS’s failure to finalize the regulations supports the claim that their distributive shares aren’t subject to SE tax. But the IRS routinely rejects this argument and has successfully litigated its position. The courts generally have imposed SE tax on LLC members unless, like traditional limited partners, they lack management authority and don’t provide significant services to the business.

Review your situation

The law in this area remains uncertain, particularly with regard to capital-intensive businesses. But given the IRS’s aggressiveness in collecting SE taxes from LLCs, LLC members should assess whether the IRS might claim that they’ve underpaid SE taxes.

Those who wish to avoid or reduce these taxes in the future may have some options, including converting to an S corporation or limited partnership, or restructuring their ownership interests. When evaluating these strategies, there are issues to consider beyond taxes. Contact us to discuss your specific situation.

© 2019

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Fundamental Tax Truths for C-Corporations

The flat 21% federal income tax rate for C corporations under the Tax Cuts and Jobs Act (TCJA) has been great news for these entities and their owners. But some fundamental tax truths for C corporations largely remain the same:

C corporations are subject to double taxation.

Double taxation occurs when corporate income is taxed once at the corporate level and again at the shareholder level as dividends are paid out. The cost of double taxation, however, is now generally less because of the 21% corporate rate.

And double taxation isn’t a problem when a C corporation needs to retain all its earnings to finance growth and capital investments. Because all the earnings stay “inside” the corporation, no dividends are paid to shareholders, and, therefore, there’s no double taxation.

Double taxation also isn’t an issue when a C corporation’s taxable income levels are low. This can often be achieved by paying reasonable salaries and bonuses to shareholder-employees and providing them with tax-favored fringe benefits (deductible by the corporation and tax-free to the recipient shareholder-employees).

C corporation status isn’t generally advisable for ventures with appreciating assets or certain depreciable assets.

If assets such as real estate are eventually sold for substantial gains, it may be impossible to extract the profits from the corporation without being subject to double taxation. In contrast, if appreciating assets are held by a pass-through entity (such as an S corporation, partnership or limited liability company treated as a partnership for tax purposes), gains on such sales will be taxed only once, at the owner level.

But assets held by a C corporation don’t necessarily have to appreciate in value for double taxation to occur. Depreciation lowers the tax basis of the property, so a taxable gain results whenever the sale price exceeds the depreciated basis. In effect, appreciation can be caused by depreciation when depreciable assets hold their value.

To avoid this double-taxation issue, you might consider using a pass-through entity to lease to your C corporation appreciating assets or depreciable assets that will hold their value.

C corporation status isn’t generally advisable for ventures that will incur ongoing tax losses.

When a venture is set up as a C corporation, losses aren’t passed through to the owners (the shareholders) like they would be in a pass-through entity. Instead, they create corporate net operating losses (NOLs) that can be carried over to future tax years and then used to offset any corporate taxable income.

This was already a potential downside of C corporations, because it can take many years for a start-up to be profitable. Now, under the TCJA, NOLs that arise in tax years beginning after 2017 can’t offset more than 80% of taxable income in the NOL carryover year. So it may take even longer to fully absorb tax losses.

Do you have questions about C corporation tax issues post-TCJA? Contact us.

© 2019

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Depreciation-Related Breaks on Business Real Estate: What You Need to Know When You File Your 2018 Return

Commercial buildings and improvements generally are depreciated over 39 years, which essentially means you can deduct a portion of the cost every year over the depreciation period. (Land isn’t depreciable.) But special tax breaks that allow deductions to be taken more quickly are available for certain real estate investments.

Some of these were enhanced by the Tax Cuts and Jobs Act (TCJA) and may provide a bigger benefit when you file your 2018 tax return. But there’s one break you might not be able to enjoy due to a drafting error in the TCJA.

Section 179 expensing

This allows you to deduct (rather than depreciate over a number of years) qualified improvement property — a definition expanded by the TCJA from qualified leasehold-improvement, restaurant and retail-improvement property. The TCJA also allows Sec. 179 expensing for certain depreciable tangible personal property used predominantly to furnish lodging and for the following improvements to nonresidential real property: roofs, HVAC equipment, fire protection and alarm systems, and security systems.

Under the TCJA, for qualifying property placed in service in tax years starting in 2018, the expensing limit increases to $1 million (from $510,000 for 2017), subject to a phaseout if your qualified asset purchases for the year exceed $2.5 million (compared to $2.03 million for 2017). These amounts will be adjusted annually for inflation, and for 2019 they’re $1.02 million and $2.55 million, respectively.

Accelerated depreciation

This break allows a shortened recovery period of 15 years for qualified improvement property. Before the TCJA, the break was available only for qualified leasehold-improvement, restaurant and retail-improvement property.

Bonus depreciation

This additional first-year depreciation allowance is available for qualified assets, which before the TCJA included qualified improvement property. But due to a drafting error in the new law, qualified improvement property will be eligible for bonus depreciation only if a technical correction is issued.

When available, bonus depreciation is increased to 100% (up from 50%) for qualified property placed in service after Sept. 27, 2017, but before Jan. 1, 2023. For 2023 through 2026, bonus depreciation is scheduled to be gradually reduced. Warning: Under the TCJA, real estate businesses that elect to deduct 100% of their business interest will be ineligible for bonus depreciation starting in 2018.

Can you benefit?

Although the enhanced depreciation-related breaks may offer substantial savings on your 2018 tax bill, it’s possible they won’t prove beneficial over the long term. Taking these deductions now means forgoing deductions that could otherwise be taken later, over a period of years under normal depreciation schedules. In some situations — such as if in the future your business could be in a higher tax bracket or tax rates go up — the normal depreciation deductions could be more valuable long-term.

For more information on these breaks or advice on whether you should take advantage of them, please contact us.

© 2019

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Many Tax-Related Limits Affecting Businesses Increase for 2019

A variety of tax-related limits affecting businesses are annually indexed for inflation, and many have gone up for 2019. Here’s a look at some that may affect you and your business.

Deductions

  • Section 179 expensing:
    • Limit: $1.02 million (up from $1 million)
    • Phaseout: $2.55 million (up from $2.5 million)
  • Income-based phase-ins for certain limits on the Sec. 199A qualified business income deduction:
    • Married filing jointly: $321,400-$421,400 (up from $315,000-$415,000)
    • Married filing separately: $160,725-$210,725 (up from $157,500-$207,500)
    • Other filers: $160,700-$210,700 (up from $157,500-$207,500)

Retirement plans

  • Employee contributions to 401(k) plans: $19,000 (up from $18,500)
  • Catch-up contributions to 401(k) plans: $6,000 (no change)
  • Employee contributions to SIMPLEs: $13,000 (up from $12,500)
  • Catch-up contributions to SIMPLEs: $3,000 (no change)
  • Combined employer/employee contributions to defined contribution plans (not including catch-ups): $56,000 (up from $55,000)
  • Maximum compensation used to determine contributions: $280,000 (up from $275,000)
  • Annual benefit for defined benefit plans: $225,000 (up from $220,000)
  • Compensation defining “highly compensated employee”: $125,000 (up from $120,000)
  • Compensation defining “key employee”: $180,000 (up from $175,000)

Other employee benefits

  • Qualified transportation fringe-benefits employee income exclusion: $265 per month (up from $260)
  • Health Savings Account contributions:
    • Individual coverage: $3,500 (up from $3,450)
    • Family coverage: $7,000 (up from $6,900)
    • Catch-up contribution: $1,000 (no change)
  • Flexible Spending Account contributions:
    • Health care: $2,700 (up from $2,650)
    • Dependent care: $5,000 (no change) 

Additional rules apply to these limits, and they are only some of the limits that may affect your business. Please contact us for more information.

© 2019

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M&A Due Diligence: Don’t Accept Financial Statements at Face Value

The M&A market was hot last year, and that momentum is expected to continue in 2019. Before acquiring another business, however, it’s important to do your homework. Conducting comprehensive due diligence can be a daunting task, especially if you’ve never negotiated a deal before. So, consider seeking input from an experienced accounting professional.

Reviewing historical performance

For starters, the target company’s historical financial statements must be reviewed. This will help you understand the nature of the company’s operations and the types of assets it owns — and the liabilities it owes.

When reviewing historical results, it’s important to evaluate a full business cycle, including any cyclical peaks and troughs. If a seller provides statements during only peak years, there’s a risk that you could overpay.

Historical financial statements also may be used to determine how much to offer the seller. An offer should be based on how much return the business interest is expected to generate. An accounting expert can project expected returns, as well as provide pricing multiples based on real-world comparable transactions.

Evaluating the target’s historical balance sheet also may help you decide whether to structure the deal as a stock purchase (where all assets and liabilities transfer from the seller to the buyer) or as an asset purchase (where the buyer cherry-picks specific assets and liabilities).

Looking to the Future

Prospective financial statements are typically based on management’s expectations for the future. When reviewing these reports, the underlying assumptions must be critically evaluated, especially for start-ups and other businesses where prospective financials serve as the primary basis for your offer price.

It’s also important to consider who prepared the prospective financials. If forecasts or projections are prepared by an outside accountant, do the reports follow the AICPA standards? You may have more confidence when reports provided by the seller conform to these standards. However, it’s a good idea to hire your own expert to perform an independent analysis, because management may have an incentive to paint a rosy picture of financial performance.

Digging deeper

A target company’s historical balance sheet tells you about the company’s tangible assets, acquired intangibles and debts. But some liabilities may not appear on the financial statements. An accounting expert can help you identify unrecorded liabilities, such as:

•Pending lawsuits and regulatory audits, •Warranty and insurance claims, •Uncollectible accounts receivable, and •Underfunded pensions.
You also need to be skeptical of representations the seller makes to seal a deal. Misrepresentations that are found after closing can lead to expensive legal battles. An earnout provision or escrow account can be used to reduce the risk that the deal won’t pan out as the seller claimed it would.

Avoiding M&A mishaps

Do-it-yourself acquisitions can lead to costly mistakes. In addition to evaluating historical and prospective financial statements, we can help identify potential hidden liabilities and misrepresentations, as well as prepare independent forecasts and projections. We also can help you determine the optimal offer price and deal terms based on an objective review of the target’s historical, prospective and unreported financial information.

© 2019

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Higher Mileage Rate May Mean Larger Tax Deductions for Business Miles in 2019

This year, the optional standard mileage rate used to calculate the deductible costs of operating an automobile for business increased by 3.5 cents, to the highest level since 2008. As a result, you might be able to claim a larger deduction for vehicle-related expense for 2019 than you can for 2018.

Actual costs vs. mileage rate

Businesses can generally deduct the actual expenses attributable to business use of vehicles. This includes gas, oil, tires, insurance, repairs, licenses and vehicle registration fees. In addition, you can claim a depreciation allowance for the vehicle. However, in many cases depreciation write-offs on vehicles are subject to certain limits that don’t apply to other types of business assets.

The mileage rate comes into play when taxpayers don’t want to keep track of actual vehicle-related expenses. With this approach, you don’t have to account for all your actual expenses, although you still must record certain information, such as the mileage for each business trip, the date and the destination.

The mileage rate approach also is popular with businesses that reimburse employees for business use of their personal automobiles. Such reimbursements can help attract and retain employees who’re expected to drive their personal vehicle extensively for business purposes. Why? Under the Tax Cuts and Jobs Act, employees can no longer deduct unreimbursed employee business expenses, such as business mileage, on their individual income tax returns.

But be aware that you must comply with various rules. If you don’t, you risk having the reimbursements considered taxable wages to the employees.

The 2019 rate

Beginning on January 1, 2019, the standard mileage rate for the business use of a car (van, pickup or panel truck) is 58 cents per mile. For 2018, the rate was 54.5 cents per mile.

The business cents-per-mile rate is adjusted annually. It is based on an annual study commissioned by the IRS about the fixed and variable costs of operating a vehicle, such as gas, maintenance, repair and depreciation. Occasionally, if there is a substantial change in average gas prices, the IRS will change the mileage rate midyear.

More considerations

There are certain situations where you can’t use the cents-per-mile rate. It depends in part on how you’ve claimed deductions for the same vehicle in the past or, if the vehicle is new to your business this year, whether you want to take advantage of certain first-year depreciation breaks on it.

As you can see, there are many variables to consider in determining whether to use the mileage rate to deduct vehicle expenses. Contact us if you have questions about tracking and claiming such expenses in 2019 — or claiming them on your 2018 income tax return.

© 2019

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Is There Still Time to Pay 2018 Bonuses and Deduct Them on Your 2018 Return?

There aren’t too many things businesses can do after a year ends to reduce tax liability for that year. However, you might be able to pay employee bonuses for 2018 in 2019 and still deduct them on your 2018 tax return. In certain circumstances, businesses can deduct bonuses employees have earned during a tax year if the bonuses are paid within 2½ months after the end of that year (by March 15 for a calendar-year company).

Basic requirements

First, only accrual-basis taxpayers can take advantage of the 2½ month rule. Cash-basis taxpayers must deduct bonuses in the year they’re paid, regardless of when they’re earned.

Second, even for accrual-basis taxpayers, the 2½ month rule isn’t automatic. The bonuses can be deducted on the tax return for the year they’re earned only if the business’s bonus liability was fixed by the end of the year.


Passing the test

For accrual-basis taxpayers, a liability (such as a bonus) is deductible when it is incurred. To determine this, the IRS applies the “all-events test.” Under this test, a liability is incurred when:

  • All events have occurred that establish the taxpayer’s liability,
  • The amount of the liability can be determined with reasonable accuracy, and
  • Economic performance has occurred.

Generally, the last requirement isn’t an issue; it’s satisfied when an employee performs the services required to earn a bonus. But the first two requirements can delay your tax deduction until the year of payment, depending on how your bonus plan is designed.

For example, many bonus plans require an employee to still be an employee on the payment date to receive the bonus. Even when the amount of each employee’s bonus is fixed at the end of the tax year, if employees who leave the company before the payment date forfeit their bonuses, the all-events test isn’t satisfied until the payment date. Why? The business’s liability for bonuses isn’t fixed until then.


Diving into a bonus pool

Fortunately, it’s possible to accelerate deductions with a carefully designed bonus pool arrangement. According to the IRS, employers may deduct bonuses in the year they’re earned — even if there’s a risk of forfeiture — as long as any forfeited bonuses are reallocated among the remaining employees in the bonus pool rather than retained by the employer.

Under such a plan, an employer satisfies the all-events test because the aggregate bonus amount is fixed at the end of the year. It doesn’t matter that amounts allocated to specific employees aren’t determined until the payment date.


When you can deduct bonuses

So does your current bonus plan allow you to take 2018 deductions for bonuses paid in early 2019? If you’re not sure, contact us. We can review your situation and determine when you can deduct your bonus payments.

If you’re an accrual taxpayer but don’t qualify to accelerate your bonus deductions this time, we can help you design a bonus plan for 2019 that will allow you to accelerate deductions when you file your 2019 return next year.

© 2019