Weighing the risks vs. rewards of a mezzanine loan

To say that most small to midsize businesses have at least
considered taking out a loan this year would probably be an understatement. The
economic impact of the COVID-19 pandemic has lowered many companies’ revenue
but may have also opened opportunities for others to expand or pivot into more
profitable areas.

If your company needs working capital to grow, rather than
simply survive, you might want to consider a mezzanine loan. These arrangements
offer relatively quick access to substantial funding but with risks that you
should fully understand before signing on the dotted line.

Equity on the table

Mezzanine financing works by layering a junior loan on top of a
senior (or primary) loan. It combines aspects of senior secured debt from a
bank and equity-based financing obtained from direct investors. Sources of
mezzanine financing can include private equity groups, mutual funds, insurance
companies and buyout firms.

Unlike bank loans, mezzanine debt typically is unsecured by the
borrower’s assets or has liens subordinate to other lenders. So, the cost of
obtaining financing is higher than that of a senior loan.

However, the cost generally is lower than what’s required to
acquire funding purely from equity investment. Yet most mezzanine instruments
do enable the lender to participate in the borrowing company’s success — or
failure. Generally, the lower your interest rate, the more equity you must

Flexibility at a price

The primary advantage of mezzanine financing is that it can
provide capital when you can’t obtain it elsewhere or can’t qualify for the
amount you’re looking for. That’s why it’s often referred to as a “bridge” to
undertaking ambitious objectives such as a business acquisition or desirable
piece of commercial property. But mezzanine loans aren’t necessarily an option
of last resort; many companies prefer their flexibility when it comes to
negotiating terms.

Naturally, there are drawbacks to consider. In addition to
having higher interest rates, mezzanine financing carries with it several other
potential disadvantages. Loan covenants can be restrictive. And though some
lenders are relatively hands-off, they may retain the right to a significant
say in company operations — particularly if you don’t repay the loan in a
timely manner.

If you default on the loan, the lender may either sell its stake
in your company or transfer that equity to another entity. This means you could
suddenly find yourself with a co-owner who you’ve never met or intended to work

Mezzanine financing can also make an M&A deal more
complicated. It introduces an extra interested party to the negotiation table and
can make an already tricky deal that much harder.

Explore all options

Generally, mezzanine loans are best suited for businesses with
clear and even aggressive growth plans. Our firm can help you fully explore the
tax, financial and strategic implications of any lending arrangement, so you
can make the right decision.

© 2020

Tax implications of working from home and collecting unemployment

COVID-19 has changed our lives in many ways, and some of the changes
have tax implications. Here is basic information about two common situations.

1. Working from home.

Many employees have been told not to come into their workplaces
due to the pandemic. If you’re an employee who “telecommutes” — that is, you
work at home, and communicate with your employer mainly by telephone,
videoconferencing, email, etc. — you should know about the strict rules that
govern whether you can deduct your home office expenses.

Unfortunately, employee home office expenses aren’t currently
deductible, even if your employer requires you to work from home. Employee
business expense deductions (including the expenses an employee incurs to
maintain a home office) are miscellaneous itemized deductions and are
disallowed from 2018 through 2025 under the Tax Cuts and Jobs Act.

However, if you’re self-employed and work out of an office in
your home, you can be eligible to claim home office deductions for your related
expenses if you satisfy the strict rules.

2. Collecting unemployment

Millions of Americans have lost their jobs due to COVID-19 and
are collecting unemployment benefits. Some of these people don’t know that
these benefits are taxable and must be reported on their federal income tax
returns for the tax year they were received. Taxable benefits include the
special unemployment compensation authorized under the Coronavirus Aid, Relief
and Economic Security (CARES) Act.

In order to avoid a surprise tax bill when filing a 2020 income
tax return next year, unemployment recipients can have taxes withheld from
their benefits now. Under federal law, recipients can opt to have 10% withheld
from their benefits to cover part or all their tax liability. To do this,
complete Form W4-V, Voluntary Withholding Request, and give it to the agency
paying benefits. (Don’t send it to the IRS.)

We can help

We can assist you with advice about whether you qualify for home
office deductions, and how much of these expenses you can deduct. We can also
answer any questions you have about the taxation of unemployment benefits as
well as any other tax issues that you encounter as a result of COVID-19.

© 2020

2020 Q4 tax calendar: Key deadlines for businesses and other employers

Here are some of the key tax-related deadlines affecting
businesses and other employers during the fourth quarter of 2020. Keep in mind
that this list isn’t all-inclusive, so there may be additional deadlines that
apply to you. Contact us to ensure you’re meeting all applicable deadlines and
to learn more about the filing requirements.

Thursday, October 15

  • If a calendar-year C corporation that filed an
    automatic six-month extension:

    • File a 2019 income tax return (Form 1120) and pay any
      tax, interest and penalties due.
    • Make contributions for 2019 to certain
      employer-sponsored retirement plans.

Monday, November 2

  • Report income tax withholding and FICA taxes for third
    quarter 2020 (Form 941) and pay any tax due. (See exception below under
    “November 10.”)

Tuesday, November 10

  • Report income tax withholding and FICA taxes for third
    quarter 2020 (Form 941), if you deposited on time (and in full) all of the
    associated taxes due.

Tuesday, December 15

  • If a calendar-year C corporation, pay the fourth
    installment of 2020 estimated income taxes.

Thursday, December 31

  • Establish a retirement plan for 2020 (generally other
    than a SIMPLE, a Safe-Harbor 401(k) or a SEP).

© 2020

Prioritize customer service now more than ever

You’d be hard-pressed to find a business that doesn’t value its
customers, but tough times put many things into perspective. As companies have
adjusted to operating during the COVID-19 pandemic and the resulting economic
fallout, prioritizing customer service has become more important than ever.

Without a strong base of loyal buyers, and a concerted effort to
win over more market share, your business could very well see diminished profit
margins and an escalated risk of being surpassed by competitors. Here are some
foundational ways to strengthen customer service during these difficult and
uncertain times.

Get management involved

As is the case for many things in business, success starts at
the top. Encourage your management team and fellow owners (if any) to regularly
interact with customers. Doing so cements customer relationships and
communicates to employees that cultivating these contacts is part of your
company culture and a foundation of its profitability.

Moving down the organizational chart, cultivate customer-service
heroes. Post articles about the latest customer service achievements on your
internal website or distribute companywide emails celebrating successes.
Champion these heroes in meetings. Public praise turns ordinary employees into
stars and encourages future service excellence.

Just be sure to empower employees to make timely decisions.
Don’t just talk about catering to customers unless your staff can really take
the initiative to act accordingly.

Systemize your responsiveness

Like everyone in today’s data-driven world, customers want
immediate information. So, strive to provide instant or at least timely
feedback to customers with a highly visible, technologically advanced response system.
This will let customers know that their input matters and you’ll reward them
for speaking up.

The specifics of this system will depend on the size, shape and
specialty of the business itself. It should encompass the right combination of
instant, electronic responses to customer inquiries along with phone calls and,
where appropriate, face-to-face (or direct virtual) interactions that reinforce
how much you value their business.

Continue to adjust

By now, you’ve likely implemented a few adjustments to serving
your customers during the COVID-19 pandemic. Many businesses have done so, with
common measures including:

  • Explaining what you’re doing to cope with the crisis,
  • Being more flexible with payment plans and deadlines,
  • Exercising greater patience and empathy.

As the months go on, don’t rest on your laurels. Continually
reassess your approach to customer service and make adjustments that suit the
changing circumstances of not only the pandemic, but also your industry and
local economy. Seize opportunities to help customers and watch out for mistakes
that could hurt your company’s reputation and revenue.

Don’t give up

This year has put everyone under unforeseen amounts of stress
and, in turn, providing world-class customer services has become even more
difficult. Keep at it — your extra efforts now could lay the groundwork for a
much stronger customer base in the future. Our firm can help you assess your
customer service and calculate its impact on revenue and profitability.

© 2020

Homebuyers: Can you deduct seller-paid points?

Despite the COVID-19 pandemic, the National Association of
Realtors (NAR) reports that existing home sales and prices are up nationwide,
compared with last year. One of the reasons is the pandemic: “With the sizable
shift in remote work, current homeowners are looking for larger homes…” according
to NAR’s Chief Economist Lawrence Yun.

If you’re buying a home, or you just bought one, you may wonder
if you can deduct mortgage points paid on your behalf by the seller. Yes, you
can, subject to some important limitations described below.

Points are upfront fees charged by a mortgage lender, expressed
as a percentage of the loan principal. Points, which may be deductible if you
itemize deductions, are normally the buyer’s obligation. But a seller will
sometimes sweeten a deal by agreeing to pay the points on the buyer’s mortgage

In most cases, points a buyer pays are a deductible interest
expense. And IRS says that seller-paid points may also be deductible.

Suppose, for example, that you bought a home for $600,000. In
connection with a $500,000 mortgage loan, your bank charged two points, or
$10,000. The seller agreed to pay the points in order to close the sale.

You can deduct the $10,000 in the year of sale. The only
disadvantage is that your tax basis is reduced to $590,000, which will mean
more gain if — and when — you sell the home for more than that amount. But that
may not happen until many years later, and the gain may not be taxable anyway.
You may qualify for an exclusion for up to $250,000 ($500,000 for a married
couple filing jointly) of gain on the sale of a principal residence.

Some limitations

There are some important limitations on the rule allowing a
deduction for seller-paid points. The rule doesn’t apply:

  • To points that are allocated to the part of a mortgage
    above $750,000 ($375,000 for marrieds filing separately) for tax years
    2018 through 2025 (above $1 million for tax years before 2018 and after
  • To points on a loan used to improve (rather than buy) a
  • To points on a loan used to buy a vacation or second
    home, investment property or business property; and
  • To points paid on a refinancing, home equity loan or
    line of credit.

Your situation

We can review with you in more detail whether the points in your
home purchase are deductible, as well as discuss other tax aspects of your

© 2020

Employers have questions and concerns about deferring employees’ Social Security taxes

The IRS has provided guidance to employers regarding the recent presidential
action to allow employers to defer the withholding, deposit and payment of
certain payroll tax obligations.

The three-page guidance in Notice 2020-65 was issued to
implement President Trump’s executive memorandum signed on August 8.

Private employers still have questions and concerns about
whether, and how, to implement the optional deferral. The President’s action
only defers the employee’s share of Social Security taxes; it doesn’t forgive
them, meaning employees will still have to pay the taxes later unless Congress
acts to eliminate the liability. (The payroll services provider for federal
employers announced that federal employees will have their taxes

Deferral basics

President Trump issued the memorandum in light of the COVID-19
crisis. He directed the U.S. Secretary of the Treasury to use his authority
under the tax code to defer the withholding, deposit and payment of certain
payroll tax obligations.

For purposes of the Notice, “applicable wages” means wages or
compensation paid to an employee on a pay date beginning September 1,
2020, and ending December 31, 2020, but only if the amount paid for a
biweekly pay period is less than $4,000, or the equivalent amount with respect
to other pay periods.

The guidance postpones the withholding and remittance of the
employee share of Social Security tax until the period beginning on
January 1, 2021, and ending on April 30, 2021. Penalties, interest
and additions to tax will begin to accrue on May 1, 2021, for any unpaid taxes.

“If necessary,” the guidance states, an employer “may make
arrangements to collect the total applicable taxes” from an employee. But it
doesn’t specify how.

Be aware that under the CARES Act, employers can already
defer paying their portion of Social Security taxes through December 31,
2020. All 2020 deferred amounts are due in two equal installments — one at the
end of 2021 and the other at the end of 2022. 

Many employers opting out

Several business groups have stated that their members won’t
participate in the deferral. For example, the U.S. Chamber of Commerce and more
than 30 trade associations sent a letter to members of Congress and the U.S.
Department of the Treasury calling the deferral “unworkable.”

The Chamber is concerned that employees will get a temporary
increase in their paychecks this year, followed by a decrease in take-home pay
in early 2021. “Many of our members consider it unfair to employees to make a
decision that would force a big tax bill on them next year… Therefore, many of
our members will likely decline to implement deferral, choosing instead to
continue to withhold and remit to the government the payroll taxes required by
law,” the group explained.

Businesses are also worried about having to collect the taxes
from employees who may quit or be terminated before April 30, 2021. And
since some employees are asking questions about the deferral, many employers
are also putting together communications to inform their staff members about
whether they’re going to participate. If so, they’re informing employees what
it will mean for next year’s paychecks.

How to proceed

Contact us if you have questions about the deferral and how to
proceed at your business. 

© 2020

ESOPs offer businesses a variety of potential benefits

Wouldn’t it be great if your employees worked as if they owned
the company? An employee stock ownership plan (ESOP) could make this a reality.

Under an ESOP, employee participants take part ownership of the
business through a retirement savings arrangement. Meanwhile, the business and
its existing owner(s) can benefit from some tax breaks, an extra-motivated
workforce and a clearer path to a smooth succession.

How they work

To implement an ESOP, you establish a trust fund and either:

  • Contribute shares of stock or money to buy the stock
    (an “unleveraged” ESOP), or
  • Borrow funds to initially buy the stock, and then
    contribute cash to the plan to enable it to repay the loan (a “leveraged”

The shares in the trust are allocated to individual employees’
accounts, often using a formula based on their respective compensation. The
business must formally adopt the plan and submit plan documents to the IRS,
along with certain forms.

Tax impact

Among the biggest benefits of an ESOP is that contributions to
qualified retirement plans (including ESOPs) are typically tax-deductible for
employers. However, employer contributions to all defined contribution plans,
including ESOPs, are generally limited to 25% of covered payroll. But
C corporations with leveraged ESOPs can deduct contributions used to pay
interest on the loans. That is, the interest isn’t counted toward the 25%

Dividends paid on ESOP stock passed through to employees or used
to repay an ESOP loan may be tax-deductible for C corporations, so long as
they’re reasonable. Dividends voluntarily reinvested by employees in company
stock in the ESOP also are usually deductible by the business. (Employees,
however, should review the tax implications of dividends.)

In another potential benefit, shareholders in some closely held
C corporations can sell stock to the ESOP and defer federal income taxes
on any gains from the sales, with several stipulations. One is that the ESOP
must own at least 30% of the company’s stock immediately after the sale. In
addition, the sellers must reinvest the proceeds (or an equivalent amount) in
qualified replacement property securities of domestic operation corporations
within a set period.

Finally, when a business owner is ready to retire or otherwise
depart the company, the business can make tax-deductible contributions to the
ESOP to buy out the departing owner’s shares or have the ESOP borrow money to
buy the shares.

Risks to consider

An ESOP’s tax impact for entity types other than
C corporations varies somewhat from what we’ve discussed here. And while
these plans do offer many potential benefits, they also present risks such as
complexity of setup and administration and a strain on cash flow in some
situations. Please contact us to discuss further. We can help you determine
whether an ESOP would make sense for your business.

© 2020

Back-to-school tax breaks on the books

Despite the COVID-19 pandemic, students are going back to school
this fall, either remotely, in-person or under a hybrid schedule. In any event,
parents may be eligible for certain tax breaks to help defray the cost of

Here is a summary of some of the tax breaks available for

1. Higher education tax credits.
Generally, you may be able to claim either one of two tax credits for higher
education expenses — but not both.

  • With the American Opportunity Tax Credit (AOTC), you
    can save a maximum of $2,500 from your tax bill for each full-time college
    or grad school student. This applies to qualified expenses including
    tuition, room and board, books and computer equipment and other supplies.
    But the credit is phased out for moderate-to-upper income taxpayers. No
    credit is allowed if your modified adjusted gross income (MAGI) is over
    $90,000 ($180,000 for joint filers).
  • The Lifetime Learning Credit (LLC) is similar to the
    AOTC, but there are a few important distinctions. In this case, the
    maximum credit is $2,000 instead of $2,500. Furthermore, this is the
    overall credit allowed to a taxpayer regardless of the number of students
    in the family. However, the LLC is also phased out under income ranges
    even lower than the AOTC. You can’t claim the credit if your MAGI is
    $68,000 or more ($136,000 or more if you file a joint return).

For these reasons, the AOTC is generally preferable to the LLC.
But parents have still another option.

2. Tuition-and-fees deduction. As an
alternative to either of the credits above, parents may claim an above-the-line
deduction for tuition and related fees. This deduction is either $4,000 or
$2,000, depending on the taxpayer’s MAGI, before it is phased out. No deduction
is allowed for MAGI above $80,000 for single filers and $160,000 for joint

The tuition-and-fees deduction, which has been extended numerous
times, is currently scheduled to expire after 2020. However, it’s likely to be
revived again by Congress.

In addition to these tax breaks, there are other ways to save
and pay for college on a tax advantaged basis. These include using Section 529
plans and Coverdell Education Savings Accounts. There are limits on
contributions to these saving vehicles.

Note: Thanks to a provision in
the Tax Cuts and Jobs Act, a 529 plan can now be used to pay for up to $10,000
annually for a child’s tuition at a private or religious elementary or
secondary school.

Final lesson

Typically, parents are able to take advantage of one or more of
these tax breaks, even though some benefits are phased out above certain income
levels. Contact us to maximize the tax breaks for your children’s education.

© 2020

5 key points about bonus depreciation

You’re probably aware of the 100% bonus depreciation tax break
that’s available for a wide range of qualifying property. Here are five
important points to be aware of when it comes to this powerful tax-saving tool.

1. Bonus depreciation is scheduled to phase

Under current law, 100% bonus depreciation will be phased out in
steps for property placed in service in calendar years 2023 through 2027. Thus,
an 80% rate will apply to property placed in service in 2023, 60% in 2024, 40%
in 2025, and 20% in 2026, and a 0% rate will apply in 2027 and later years.

For certain aircraft (generally, company planes) and for the
pre-January 1, 2027 costs of certain property with a long production period,
the phaseout is scheduled to take place a year later, from 2024 to 2028.

Of course, Congress could pass legislation to extend or revise
the above rules.

2. Bonus depreciation is available for
new and most used property

In the past, used property didn’t qualify. It currently
qualifies unless: 

  • The taxpayer previously used the property and
  • The property was acquired in certain forbidden
    transactions (generally acquisitions that are tax free or from a related
    person or entity).

3. Taxpayers should sometimes make the
election to turn down bonus depreciation

Taxpayers can elect to reject bonus depreciation for one or more
classes of property. The election out may be useful for sole proprietorships,
and business entities taxed under the rules for partnerships and S
corporations, that want to prevent “wasting” depreciation deductions by
applying them against lower-bracket income in the year property was placed in
service — instead of against anticipated higher bracket income in later years.

Note that business entities taxed as “regular” corporations (in
other words, non-S corporations) are taxed at a flat rate.

4. Bonus depreciation is available for
certain building improvements

Before the 2017 Tax Cuts and Jobs Act (TCJA), bonus depreciation
was available for two types of real property: 

  • Land improvements other than buildings, for example
    fencing and parking lots, and
  • “Qualified improvement property,” a broad category of
    internal improvements made to non-residential buildings after the
    buildings are placed in service.

The TCJA inadvertently eliminated bonus depreciation for
qualified improvement property.

However, the 2020 Coronavirus Aid, Relief and Economic Security
Act (CARES Act) made a retroactive technical correction to the TCJA. The
correction makes qualified improvement property placed in service after
December 31, 2017, eligible for bonus depreciation.

5. 100% bonus depreciation has reduced the
importance of “Section 179 expensing”

If you own a smaller business, you’ve likely benefited from
Sec. 179 expensing. This is an elective benefit that — subject to dollar
limits — allows an immediate deduction of the cost of equipment, machinery,
off-the-shelf computer software and some building improvements. Sec. 179
has been enhanced by the TCJA, but the availability of 100% bonus depreciation
is economically equivalent and has greatly reduced the cases in which
Sec. 179 expensing is useful.

We can help

The above discussion touches only on some major aspects of bonus
depreciation. This is a complex area with tax implications for transactions
other than simple asset acquisitions. Contact us if you have any questions
about how to proceed in your situation.

© 2020

Helping employees understand their health care accounts

Many businesses now offer, as part of their health care
benefits, various types of accounts that reimburse employees for medical
expenses on a tax-advantaged basis. These include health Flexible Spending
Accounts (FSAs), Health Reimbursement Arrangement (HRAs) and Health Savings
Account (HSAs, which are usually offered in conjunction with a high-deductible
health plan).

For employees to get the full value out of such accounts, they
need to educate themselves on what expenses are eligible for reimbursement by a
health FSA or HRA, or for a tax-free distribution from an HSA. Although an
employer shouldn’t provide tax advice to employees, you can give them a
heads-up that the rules for reimbursements or distributions vary depending on
the type of account.

Pub. 502

Unfortunately, no single publication provides an exhaustive list
of official, government-approved expenses eligible for reimbursement by a
health FSA or HRA, or for a tax-free distribution from an HSA. IRS Publication
502 — “Medical and Dental Expenses” (Pub. 502) comes the closest, but it should
be used with caution.

Pub. 502 is written largely to help taxpayers determine what
medical expenses can be deducted on their income tax returns; it’s not meant to
address the tax-favored health care accounts in question. Although the rules
for deductibility overlap in many respects with the rules governing health
FSAs, HRAs and HSAs, there are some important differences. Thus, employees
shouldn’t use Pub. 502 as the sole determinant for whether an expense is
reimbursable by a health FSA or HRA, or eligible for tax-free distribution from
an HSA.

Various factors

You might warn health care account participants that various
factors affect whether and when a medical expense is reimbursable or a
distribution allowable. These include:

Timing rules. Pub. 502
notes that expenses may be deducted only for the year in which they were paid,
but it doesn’t explain the different timing rules for the tax-favored accounts.
For example, a health FSA can reimburse an expense only for the year in which
it was incurred, regardless of when it was paid.

Insurance restrictions.
Taxpayers may deduct health insurance premiums on their tax returns if certain
requirements are met. However, reimbursement of such premiums by health FSAs,
HRAs and HSAs is subject to restrictions that vary according to the type of
tax-favored account.

Over-the-counter (OTC) drug documentation. OTC drugs
other than insulin aren’t tax-deductible, but they may be reimbursed by health
FSAs, HRAs and HSAs if substantiation and other requirements are met.

Greater appreciation

The pandemic has put a renewed emphasis on the importance of
employer-provided health care benefits. The federal government has even passed
COVID-19-related relief measures for some tax-favored accounts.

As mentioned, the more that employees understand these benefits,
the more they’ll be able to effectively use them — and the greater appreciation
they’ll have of your business for providing them. Our firm can help you fully
understand the tax implications, for both you and employees, of any type of
health care benefit.

© 2020