Holiday parties and gifts can help show your appreciation and provide tax breaks

With Thanksgiving behind us, the holiday season is in full swing. At this time of year, your business may want to show its gratitude to employees and customers by giving them gifts or hosting holiday parties. It’s a good idea to understand the tax rules associated with these expenses. Are they tax deductible by your business and is the value taxable to the recipients?

Customer and client gifts

If you make gifts to customers and clients, the gifts are deductible up to $25 per recipient per year. For purposes of the $25 limit, you don’t need to include “incidental” costs that don’t substantially add to the gift’s value, such as engraving, gift wrapping, packaging or shipping. Also excluded from the $25 limit is branded marketing collateral — such as small items imprinted with your company’s name and logo — provided they’re widely distributed and cost less than $4.

The $25 limit is for gifts to individuals. There’s no set limit on gifts to a company (for example, a gift basket for all team members of a customer to share) as long as they’re “reasonable.”

Employee gifts

In general, anything of value that you transfer to an employee is included in his or her taxable income (and, therefore, subject to income and payroll taxes) and deductible by your business. But there’s an exception for noncash gifts that constitute a “de minimis” fringe benefit.

These are items small in value and given infrequently that are administratively impracticable to account for. Common examples include holiday turkeys or hams, gift baskets, occasional sports or theater tickets (but not season tickets), and other low-cost merchandise.

De minimis fringe benefits aren’t included in your employee’s taxable income yet they’re still deductible by your business. Unlike gifts to customers, there’s no specific dollar threshold for de minimis gifts. However, many businesses use an informal cutoff of $75.

Important: Cash gifts — as well as cash equivalents, such as gift cards — are included in an employee’s income and subject to payroll tax withholding regardless of how small and infrequent.

Throwing a holiday party

Under the Tax Cuts and Jobs Act, certain deductions for business-related meals were reduced and the deduction for business entertainment was eliminated. However, there’s an exception for certain recreational activities, including holiday parties.

Holiday parties are fully deductible (and excludible from recipients’ income) so long as they’re primarily for the benefit of non-highly-compensated employees and their families. If customers, and others also attend, holiday parties may be partially deductible.

Spread good cheer

Contact us if you have questions about giving holiday gifts to employees or customers or throwing a holiday party. We can explain the tax rules.


What is your taxpayer filing status?

For tax purposes, December 31 means more than New Year’s Eve celebrations. It affects the filing status box that will be checked on your tax return for the year. When you file your return, you do so with one of five filing statuses, which depend in part on whether you’re married or unmarried on December 31.

More than one filing status may apply, and you can use the one that saves the most tax. It’s also possible that your status options could change during the year.

Here are the filing statuses and who can claim them:

  1. Single. This status is generally used if you’re unmarried, divorced or legally separated under a divorce or separate maintenance decree governed by state law.
  2. Married filing jointly. If you’re married, you can file a joint tax return with your spouse. If your spouse passes away, you can generally file a joint return for that year.
  3. Married filing separately. As an alternative to filing jointly, married couples can choose to file separate tax returns. In some cases, this may result in less tax owed.
  4. Head of household. Certain unmarried taxpayers may qualify to use this status and potentially pay less tax. The special rules that apply are described below.
  5. Qualifying widow(er) with a dependent child. This may be used if your spouse died during one of the previous two years and you have a dependent child. Other conditions also apply.

Head of household status

Head of household status is generally more favorable than filing as a single taxpayer. To qualify, you must “maintain a household” that, for more than half the year, is the principal home of a “qualifying child” or other relative that you can claim as your dependent.

A “qualifying child” is defined as someone who:

  • Lives in your home for more than half the year,
  • Is your child, stepchild, foster child, sibling, stepsibling or a descendant of any of these,
  • Is under 19 years old or a student under age 24, and
  • Doesn’t provide over half of his or her own support for the year.

Different rules may apply if a child’s parents are divorced. Also, a child isn’t a “qualifying child” if he or she is married and files jointly or isn’t a U.S. citizen or resident.

Maintaining a household

For head of household filing status, you’re considered to maintain a household if you live in it for the tax year and pay more than half the cost of running it. This includes property taxes, mortgage interest, rent, utilities, property insurance, repairs, upkeep, and food consumed in the home. Don’t include medical care, clothing, education, life insurance or transportation.

Under a special rule, you can qualify as head of household if you maintain a home for a parent of yours even if you don’t live with the parent. To qualify, you must be able to claim the parent as your dependent.

Marital status

You must generally be unmarried to claim head of household status. If you’re married, you must generally file as either married filing jointly or married filing separately, not as head of household. However, if you’ve lived apart from your spouse for the last six months of the year and a qualifying child lives with you and you “maintain” the household, you’re treated as unmarried. In this case, you may be able to qualify as head of household.

If you have questions about your filing status, contact us.


TCJA Tax Strategies 2: Capital Gains – accessing the 0% and 15% capital gain rates and tax planning for capital transactions.

Often clients inquire with our office with questions like “What is my capital gains rate?” or “How much will I be taxed on a sale of <insert asset here> in 2019?”

While it is important to understand the amount of tax to be paid on any given transaction, it is even more important to understand the new opportunities afforded to those with capital transactions under the Tax Cuts and Jobs Act. The TCJA significantly expanded the 0% and 15% capital gain rate brackets. By pushing the 20% capital gain rate into higher territory – taxpayers with higher income can access the more favorable rates on their capital sale transactions. By expanding the 15% capital gain rate bracket more gain can also be fit into those brackets allowing for more gains to be taxed at lower rates. Based on historical tax rates and brackets, it’s a pretty great deal.

Capital Gains in General

When considering capital gains, you must first separate your short and long-term gains. Long-term, for these purposes, means gains or losses from investments you held for more than a year. Gains and losses from investments held for one year or less are short-term. Once you isolate your long and short term gains, you must separate your long-term gains and losses into three rate groups:

  • the 28% group, consisting of:
    1. capital gains and losses from collectibles (including works of art, rugs, antiques, metals, gems, stamps, coins, and alcoholic beverages) held for more than one year;
    2. long-term capital loss carryovers; and
    3. section 1202 gain (gain from the sale of certain small business stock held for more than five years that's eligible for a 50% exclusion from gross income).
  • the 25% group, consisting of “unrecaptured section 1250 gain”—that is, gain on the sale of depreciable real property that's attributable to the depreciation of that property (there are no losses in this group); and
  • the 20%/15%/0% group, consisting of long-term capital gains and losses that aren't in the 28% or 25% group—that is, most gains and losses from assets held for more than one year.

While the 28% and 25% rate groups are relevant for many taxpayers, the majority of capital transactions still fall into category #3. As such, this article will focus on planning opportunities for most standard capital transactions.

Once you arrive at a net gain or loss from the three long-term categories above, you must net and apply short term and long term losses to the above:

  • Short-term capital losses (including short-term capital loss carryovers) are applied first to reduce short-term capital gains, if any, otherwise taxable at ordinary rates. If you have a net short-term capital loss, it reduces any net long-term gain from the 28% group, then gain from the 25% group, and finally reduces net gain from the 20%/15%/0% group.
  • Long-term capital gains and losses are handled as follows. A net loss from the 28% group (including long-term capital loss carryovers) is used first to reduce gain from the 25% group, then to reduce net gain from the 20%/15%/0% group. A net loss from the 20%/15%/0% group is used first to reduce gain from the 28% group, then to reduce gain from the 25% group.

If, after the above netting, you have any long-term capital gain, the gain that's attributable to a particular rate group is taxed at that group's marginal tax rate—28% for the 28% group, 25% for the 25% group, and the following rates for the 20%/15%/0% group:

0%

For 2019, the 0% capital gains tax rate applies to adjusted net capital gain of up to:

  • $78,750 for joint filers and surviving spouses;
  • $52,750 for heads of household;
  • $39,375 for single filers; and,
  • $39,375 for married taxpayers filing separately.

15%

For 2019, the 15% tax rate applies to adjusted net capital gain over the amount subject to the 0% rate, and up to:

  • $488,850 for joint filers and surviving spouses;
  • $244,425 for married taxpayers filing separately;
  • $461,700 for heads of household; and,
  • $434,550 for single filers.; i.e., for 2018, the 15% tax rate applies to adjusted net capital gain over the amount subject to the 0% rate, and up to: $479,000 for joint filers and surviving spouses; $239,500 for married taxpayers filing separately; $452,400 for heads of household; and, $425,800 for single filers);

20%

Gain that otherwise would be taxed in excess of the amount taxed under the 0% and 15%

A 3.8% tax on net investment income applies to taxpayers with modified adjusted gross income (MAGI) that exceeds $250,000 for joint returns and surviving spouses, $200,000 for single taxpayers and heads of household, or $125,000 for married taxpayers filing separately. After the 3.8% tax is factored in, the top rate on capital gain is 23.8%.

If, after the above netting, you're left with short-term losses or long-term losses (or both), you can use the losses to offset ordinary income, subject to a limit. The maximum annual deduction against ordinary income for the year is $3,000 ($1,500 for married taxpayers filing separately). Any loss not absorbed by the deduction in the current year is carried forward to later years, until all of it is either offset against capital gains or deducted against ordinary income in those years, subject to the $3,000 limit. If you have both net short-term losses and net long-term losses, the net short-term losses are used to offset ordinary income before the net long-term losses are used.

Planning for the 0% and 15% capital gain rate

The first thing to remember is that the 0% and 15% rate brackets apply to LONG-TERM gains only (see above for definition of long-term gains). So make sure when you’re analyzing a transaction that you know the holding period of the asset in question. The holding period starts (usually) when you acquire the asset – the simplest way to think about it is a stock purchase; the holding period begins when you buy the stock. Long-term gains (and reduced rates) are for assets with a holding period of one year or more.

The second important thing to understand is the interaction of your ordinary income and capital income – meaning, how do we actually “access” the preferential rates?

Let’s do an example. Say you know that you’re a Married Filing Joint filer. Say that you also know that you have ordinary income from wages of about $250,000 between you and your spouse. Say you take the standard deduction and have no other adjustments or deductions. Lastly, say you’re planning to sell some company stock that you were awarded a few years ago that has appreciated significantly. How do you know when to sell it and how to you access those beneficial lower tax rates??

For purposes of this example, we’ll say that you have about 10,000 shares of company stock in Startup Co (your employer). You were awarded this stock about 3 years ago when the stock price was $1. The company has done well and the stock is currently trading at $31 per share.

Your basis (investment) in the stock is $10,000 (10,000 shares times the $1 FMV at time of award).

In a potential sale, you have proceeds of $310,000 - if you sell all of the stock.

The potential gain is $310,000 (proceeds) minus $10,000 (basis) = $300,000 of long-term capital gain.

Here’s a rough summary of how you would do the calculation (for simplicity we used the 2018 brackets):

Taxable Income (before gains): Wages $250,000 less standard deduction of $24,000 equals $226,000

Dividends: $0

Capital Gains: $300,000

Taxable income exceeds the 0% rate bracket for joint filers ($77,200 for 2018) before considering capital gains so none of the gains are taxed at 0%.

Since the 15% capital gain rate bracket is available until $479,000 then $253,000 of capital gain income can be taxed at 15%. How does that work? Simply subtract your other taxable income (per above) of $226,000 from the full rate bracket of $479,000. The difference is how much “room” is left in the 15% capital gain rate bracket.

So $253,000 of gains can be taxed at 15%.

The remaining gain of $47,000 ($300K total gain less $253K gain taxed at 15%) is taxed at 20%.

How can we do better?

One of the simplest planning methods is to split the gain into two years. How does this work?

If you sell half the stock in Year 1 – you will have only $150K of gain. This gain will not make it all the way to the 20% rate bracket and the entire gain will be taxed at 15%.

If you sell the other half of the stock in Year 2 – you will get to have another run at the 15% rate bracket. With only $150K of gains (assuming all other income is about the same), you’ll stay within the 15% rate bracket in year two.

The difference?

With planning: You pay $45,000 in capital gains taxes (not considering the NIIT) on your sale.

Without planning: You pay $47,350 in capital gains taxes (not considering the NIIT) on your sale.

Savings: $2,350

This example is minor and involves a modest amount of gain. However, the bigger the gain, the bigger the stakes. Splitting gain over multiple years is a tried and true method. Other planning options include netting and harvesting losses and structuring sales to coincide with other income and loss events. More advanced strategies like the 1031 exchange or qualified opportunity zone funds can also be considered. If you’re selling your primary residence, don’t forget about the primary residence gain exclusion.

Dividends taxed at long-term capital gains rates

Dividends that you receive from domestic corporations and “qualified foreign corporations” are taxed at the same rates that apply to the 20%/15%/0% group mentioned above. However, these dividends aren't actually part of that group, and aren't subject to the grouping and netting rules discussed above. The 3.8% tax on net investment income applies to dividends. With dividends, proper planning can also help keeping those taxed at the 0% or 15% rate. Some planning actions may be to consider the timing of capital transactions and dividend transactions.

Some other planning suggestions. Since losses can only be used against gains (or up to $3,000 additionally), in many cases, matching up gains and losses can save you taxes. For example, suppose you've already realized $20,000 in capital gains this year and are holding investments on which you've lost $20,000. If you sell the loss items before the end of the year, they will “absorb” the gains completely. If you wait to sell the loss items next year, you'll be fully taxed on this year's gains and will only be able to deduct $3,000 of your losses (if you have no other gains next year against which to net the losses).

Another technique is to seek to “isolate” short-term gains against long-term losses. For example, say you have $10,000 in short-term gains in Year 1 and $10,000 in long-term losses as well. You're in the highest tax bracket in all relevant years (assume that's a 37% bracket for Year 1). Your other investments have been held more than one year and have gone up $10,000 in value, but you haven't sold them. If you sell them in Year 1, they will be netted against the long-term losses and leave you short-term gains to be taxed at 37%. Alternatively, if you can hold off and sell them in Year 2 (assuming no other Year 2 transactions), the losses will “absorb” the short-term gains in Year 1. In Year 2, the long-term gains will then be taxed at only 20% (unless the gains belong in the 25% or 28% group).

Alternative minimum tax. The favorable rates that apply to long-term capital gain (and qualified dividend income) for regular tax purposes also apply for alternative minimum tax (AMT) purposes. In spite of this, any long-term capital gains you recognize in a year might trigger an AMT liability. This can happen if the capital gains increase your total income enough so that your AMT exemption phases out. The extra income from capital gains may also affect your entitlement to various exemptions, deductions, and credits, and the amounts of those AMT preferences and adjustments, that depend on the amount of your income.

Want to learn more about planning for capital transactions and accessing the preferential rates? Please contact us by submitting the form on our site or give us a call at 617 651 0531.