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Income Tax Planning

Compensation- or Dividend in Disguise?

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When your corporation has a profitable year, do you take more salary or pay yourself a year-end bonus? Since you are pivotal to your company’s success, paying yourself more in the good years only makes sense. Increasing or decreasing your compensation from year to year based on company performance can also help manage your company’s cash flow — and the amount of income taxes it has to pay.

Tax Impact

A corporation may deduct compensation as a business expense if it is reasonable in amount. Distributing profits as salaries and bonuses can help minimize taxable corporate income, although you and other recipients will be taxed individually on the compensation you receive.

You may decide that paying additional compensation is preferable to paying out profits as dividends. Unlike compensation, dividends are not deductible. Result: C-Corporate profits are taxed twice — once at the corporate level and again to the shareholders who receive the dividends.

A Word of Caution

If the amount of compensation paid to you and other shareholder-employees is deemed to be unreasonable, the IRS could challenge your company’s deduction for the expense, reclassifying the “excessive” amounts as nondeductible dividends. This applies to C-Corporations.

To potentially reduce the chances of problems with the IRS, consider these strategies:

  • Divide the profits and pay out a portion as bonuses. Leave enough money in the company to generate a small amount of taxable income.
  • When setting bonuses, avoid using ownership percentages to determine the amounts shareholders will receive, since that method suggests the payment of dividends.
  • Adopt and follow a formal compensation plan for executives that includes bonus payments based on meeting specified financial goals.
  • Earmark a portion of company profits for dividends. Individual shareholders will generally pay federal income tax on qualified dividends at a maximum rate of 20%, which is significantly lower than the maximum rate on compensation and other ordinary income.

What is reasonable compensation? The following factors must be considered :

  • The profession
  • Your specialty within the profession
  • Years of experience
  • Geographic area of business
  • Job responsibilities

Your tax situation, profession and circumstances are unique. Jeff Urbach, CPA and partner at Urbach & Avraham, CPAs is an expert is determining reasonable compensation. Jeff is also a CVA (Certified Valuation Analyst) and an ABV (Accredited in Business Valuations). Contact us for a consultation regarding your situation.

Retirement Savings Credit- Who Can Benefit?

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It’s not always easy to keep contributing to your employer-provided retirement plan. Bills and unexpected expenses can eat up most of your salary, leaving little for retirement savings. You might be tempted to forget about it until you start earning more money.
But before you stop or cut back (or never start) contributing to your plan, understand that you could be entitled to a federal tax credit called the Retirement Savings Contributions Credit, or Saver’s Credit, if you meet certain income requirements. In effect, the credit repays a percentage of the contributions you make to your 401(k) or other retirement savings plan by reducing your income tax liability for the year. It may be just the thing that enables you to keep participating in your retirement plan or increase your contributions.
What It Is?
The credit is a percentage — 50%, 20%, or 10% — of up to $2,000 in qualified retirement savings contributions for a maximum credit of $1,000 (or twice that amount for a married couple filing jointly who each contribute $2,000). The percentage depends on adjusted gross income (AGI) and filing status. The credit is available for contributions to a 401(k), 403(b), governmental 457(b), SIMPLE IRA, or salary reduction SEP as well as for traditional and Roth IRA contributions.

Who Qualifies? To claim the credit, you must be at least age 18, not claimed as a dependent on another person’s return, and not a full-time student. You will not be able to claim the credit if your AGI exceeds the top of the range for the 10% credit.

                                                                                        2019 Tax Credit
Percentage of Contribution:   50%                     20%                        10%                       0% 
 Tax Filing Status                                          Adjusted Gross Income
Married Filing Jointly    $38,500 or less     $38,501-$41,500      $41,501-$64,000      > $64K
Head of Household         $28,875 or less     $28,876-$31,125       $31,126-$48,000      > $48K
All other filers*                 $19,250 or less     $19,251-$20,750       $20,751-$32,000      > $32K
*Single, married filing separately, or qualifying widow(er)

This is an excellent saving tool for those who just entered the workforce or those with a lower than usual income year. Everyone’s tax situation is different. Contact one of our tax professionals at Urbach & Avraham, CPAs to discuss your circumstances.

 

 

 

Year End Tax Planning

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Tax planning in the weeks before year-end allows you to take advantage of strategies that might reduce your income tax obligation.

Tax Savings

Capitalize on Winners
Your investments are a good starting point for implementing tax-saving strategies. You can benefit from favorable tax rates on long-term capital gains by selling and taking profits on appreciated securities you’ve held longer than one year. Long-term gains are currently taxed at a maximum rate of 15% for most taxpayers and 20% for taxpayers with taxable income of over $434,550 ($488,850 for joint filers) in 2019.
Cut Your Tax Bite With Losers
Investments that have lost value and have consistently underperformed a benchmark over time may be perfect sell candidates, particularly if you’re not confident of a turnaround. By selling your losers, you can use your losses to offset gains on appreciated securities you’ve sold. Capital losses are fully deductible to offset capital gains and up to $3,000 of ordinary income each year ($1,500 if married filing separately). Any losses that you can’t deduct for 2019 can be carried over for deduction in future years, subject to the same limits.
Don’t make taxes your only reason for selling an investment. Many different factors should be considered when selling securities, including how the sale of a specific investment would affect your overall portfolio.
Curb Surtax Exposure
The 3.8% surtax on net investment income (NIIT) is a relatively new wrinkle for higher income taxpayers. The surtax comes into play when an individual filer’s modified adjusted gross income (AGI) is more than $200,000 ($250,000 on a joint return or $125,000 if married filing separately). The NIIT applies to the lesser of net investment income or the amount by which modified AGI exceeds the threshold. For purposes of the surtax, net investment income includes taxable interest, dividends, annuities, royalties, rents, net capital gain, and income from passive trade or business activities. The surtax doesn’t apply to municipal bond interest or distributions from tax-deferred retirement plans.
Several planning moves are available that may help reduce your exposure to the surtax. These include:
• Maximizing contributions to your employer’s qualified retirement plan. For 2019, you can contribute up to $19,000, plus an additional catch-up amount of $6,000 if you’re age 50 or older and your plan allows. Pretax contributions to a tax-qualified plan reduce your taxable income.
• Contributing to a traditional individual retirement account (IRA). Contributions are tax deductible if neither you nor your spouse actively participates in an employer-sponsored retirement plan. For 2019, the contribution limit is $6,000 ($7,000 with catch-up contribution- for individuals over age 50).
• Investing in tax-free municipal bonds. Be cautious, however, about investing in private activity municipal bonds, which can increase your exposure to the alternative minimum tax (AMT).
• Deferring capital gains through the use of installment sales. The installment method lets you defer taxes on the sale of certain property by recognizing profit over more than one tax year.

As everyone’s situation is different, please contact one of our tax professionals at Urbach & Avraham, CPAs, to discuss your personal circumstances

Did Grandma Move in with Your Family?

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Grandma is struggling and someone must take her to her many doctor visits, do her shopping and handle all her finances. Grandpa now needs assistance with daily living activities. It is much easier to take care of grandparents if they live closer…so, they move into your home.
As nursing home costs increase, adult children are finding that living together is an excellent arrangement, both financially and emotionally. However, having a parent move in is a huge adjustment and many logistics are involved.
Siblings tend to resent that one child may be enriching himself under the guise of taking care of Mom. They will be very concerned about many issues which can be subject to great controversy including:
• Compensation: Should Grandpa pay rent? How much can or should the parent contribute to the household? Should Grandma compensate the care-giver child? Will the adult child reduce his work hours or take early retirement as a result of the care-giving duties?
• Renovation of Home: Will the house need to be remodeled to accommodate an aging parent? Usually a room must be converted to a bedroom. Bathrooms need to be fitted with equipment for the elderly. Ramps are needed for easy access to the home.

  • Will the parents gift the funds to renovate?
  • Will the parents retain an ownership interest in the house?
  • Will this affect the parent’s eligibility for Medicaid?

• Tax ramifications: Can the adult child take Grandpa as a dependent and qualify as head of household?

  •  Can someone deduct as a medical expense the renovations to the home done to accommodate a disabled person?

• Healthcare: Should Grandma attend an adult day care? Will home-health aides be needed? What level care is needed? How do we properly pay the aides?
• Finances: Should Grandpa execute a Power of Attorney or is a Guardian needed? Will Mom qualify for Medicaid? Should an accounting be provided periodically to address financial concerns on an on-going basis? This may eliminate suspicions and avoid brewing family disputes.
There are many legal, financial and tax issues involved. Even if there are no siblings, all these items should be reviewed with an elder law attorney and a CPA. We work with many competent elder-law attorneys who can establish and document the plan most suitable for your family. We can advise as to the many tax ramifications. A plan well-structured and documented can reduce income taxes, maximize funds for grandparent’s care, enable your parent to qualify for Medicaid and avoid explosive family battles. Call our CPA firm to see how we can assist.

Choice of Business Entity

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When you start a business, there are endless decisions to make. Among the most important is how to structure your business. Why is it so significant? Because the structure you choose will affect how your business is taxed and the degree to which you (and other owners) can be held personally liable. Here’s an overview of the various structures.

Sole Proprietorship

This is a popular structure for single-owner businesses. No separate business entity is formed, although the business may have a name (often referred to as a DBA, short for “doing business as”). A sole proprietorship does not limit liability, but insurance may be purchased. You report your business income and expenses on Schedule C, an attachment to your personal income tax return (Form 1040). Net earnings the business generates are subject to both self-employment taxes and income taxes. Sole proprietors may have employees but don’t take paychecks themselves.

Limited Liability Company

If you want protection for your personal assets in the event your business is sued, you might prefer a limited liability company (LLC). An LLC is a separate legal entity that can have one or more owners (called “members”). A one-member LLC is considered to be a “disregarded entity” by the IRS. Usually, income is taxed to the owners individually on Form Schedule C- Business Income (part of Form 1040), and earnings are subject to self-employment taxes. Note: It’s not unusual for lenders to require a small LLC’s owners to personally guarantee any business loans.

An LLC can make an election to be taxed as a corporation or a partnership by filing IRS Form 8832- Entity Classification Election.

Corporation

A corporation is a separate legal entity that can transact business in its own name and files corporate income tax returns. Like an LLC, a corporation can have one or more owners (shareholders). Shareholders generally are protected from personal liability but can be held responsible for repaying any business debts they’ve personally guaranteed. If you make a “Subchapter S” election, shareholders will be taxed individually on their share of corporate income. This structure generally avoids federal income taxes at the corporate level.

Partnership

In certain respects, a partnership is similar to an LLC or an S corporation. However, partnerships must have at least one general partner who is personally liable for the partnership’s debts and obligations. Profits and losses are divided among the partners and taxed to them individually.

Summary

There is no right or wrong entity. The question is which one is correct for your company, needs and circumstances. Call us for a consultation to help you select the appropriate entity form for your business and family.

Tax Planning for College Expenses

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It’s no secret that a college education is expensive. Average annual charges for tuition, fees, and room and board at four-year public colleges and universities stood at $20,770 for in-state

Jr in First Grade

students and $36,420 for out-of-state students for the 2017-2018 school year. Average charges were $46,950 at four-year private colleges and universities.1 These costs are likely to increase in the future.

Parents should take the time to look into the various tax benefits that can help reduce the costs of sending a child to college. Getting an early start on tax planning for college expenses can help reduce some of the anxiety surrounding the whole issue of trying to figure out how to pay for college. Here are some areas worth further investigation.

Savings Programs

Parents have several education savings opportunities that come with built-in tax benefits. Section 529 plans have grown in popularity over the years, but Coverdell education savings accounts also offer valuable tax benefits.

Section 529 Savings Plans

Section 529 college savings plans* are specifically designed for educational saving. You can invest a little at a time or contribute a larger lump sum, whatever approach works best for you. You choose how you want your contributions invested; your plan investments are then professionally managed. These plans offer several features that parents may find appealing:

  • Investment earnings accumulate tax deferred and won’t be subject to federal income taxes when withdrawn for your child’s qualifying educational expenses. (Excess withdrawals are subject to tax and a potential 10% penalty.)
  • Some states offer their residents tax incentives for investing in an in-state plan. New York taxpayers (both resident and non-resident) may deduct up to $5,000 from the NY income taxes for contributions to 529 plans ($10,000 for married filing joint taxpayers)
  • As a parent, you retain control of the money in the account even after the child turns 18.
  • If your child does not attend college or deplete the fund, you can change the account beneficiary to another qualifying family member without losing tax benefits.

Coverdell Education Savings Accounts

Annual contributions to these accounts are limited to $2,000 per child. This maximum phases out (is gradually reduced to zero) for taxpayers with modified adjusted gross income (AGI) between $95,000 and $110,000 (between $190,000 and $220,000 for joint filers).

Your contributions accumulate tax deferred at the federal level and earnings are tax free when used for qualified educational expenses such as tuition, room and board, and books. If you make withdrawals from the account for non-educational expenses, the earnings portion of the withdrawal may be subject to federal income tax and an additional 10% penalty.

What are the advantages of a Coverdell ESA? The Coverdell ESA allows you to self-direct your investments. Also, in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition.

Scholarships

Young adults who demonstrate high academic promise or who possess certain desirable skills may receive scholarships that can defray a percentage of the cost of attending college. Scholarships are generally exempt from income tax if the scholarship is not compensation for services and is used for tuition, fees, books, supplies, and similar items (and not for room and board).

Tuition Tax Credits

A tax credit gives you a dollar-for-dollar reduction against the taxes you owe the IRS. The following two education tax credits can help eligible parents alleviate the costs of educating a child.

American Opportunity Tax Credit (AOTC) 

This credit is worth up to $2,500 per year for each eligible student in your family. It’s for the payment of tuition, required enrollment fees, and course materials for the first four years of post-secondary education. The credit is allowed for 100% of the first $2,000 of qualifying expenses, plus 25% of the next $2,000. Were the credit to exceed the amount of tax you owe, you may be eligible for a refund of up to 40% of the credit. The available credit is phased out for single taxpayers with modified AGI between $80,000 and $90,000, and for married couples with modified AGI between $160,000 and $180,000.

Lifetime Learning Credit (LLC)

This credit can be as much as $2,000 a year (per tax return) for the payment of tuition and required enrollment fees at an eligible educational institution. It is calculated as 20% of the first $10,000 of expenses. You cannot claim the credit for a student if you are claiming the AOTC for the student that year. Unlike the AOTC, qualified expenses for the LLC do not include academic supplies and no portion of the credit is refundable. The LLC is phased out (in 2018) for single taxpayers with modified AGI between $57,000 and $67,000, and for married couples with modified AGI between $114,000 and $134,000.

Student Loan Interest Deduction

A tax deduction lowers your tax liability by reducing the amount of income on which you pay tax. You can deduct interest on qualified loans you take out to pay for your child’s post-secondary education. The maximum deduction is $2,500 per year, but it phases out for taxpayers who are married filing jointly with AGI between $135,000 and $165,000 (between $65,000 and $80,000 for single filers). The deduction is available even if you don’t itemize deductions on your return.

*Certain 529 plan benefits may not be available unless specific requirements (e.g., residency) are met. There also may be restrictions on the timing of distributions and how they may be used. Before investing, consider the investment objectives, risks, and charges and expenses associated with municipal fund securities. The issuer’s official statement contains more information about municipal fund securities, and you should read it carefully before investing.

Questions about college savings opportunities? Please call us to discuss. It is never too early to start saving for junior’s college.