Plan now to make tax-smart year-end gifts to loved ones
Are you feeling generous at year-end? Taxpayers can transfer substantial amounts free of gift taxes to their children or other recipients each year through the proper use of the annual exclusion.
The exclusion amount is adjusted for inflation annually, and for 2022, the amount is $16,000.
The exclusion covers gifts that an individual makes to each recipient each year. So a taxpayer with three children can transfer a total of $48,000 to the children this year free of federal gift taxes. If the only gifts during a year are made this way, there’s no need to file a federal gift tax return. If annual gifts exceed $16,000, the exclusion covers the first $16,000 and only the excess is taxable.
Note: This discussion isn’t relevant to gifts made to a spouse because they’re gift tax-free under separate marital deduction rules.
Gift splitting by married taxpayers
If you’re married, gifts made during a year can be treated as split between the spouses, even if the cash or asset is actually given to an individual by only one of you. Therefore, by gift splitting, up to $32,000 a year can be transferred to each recipient by a married couple because two exclusions are available. So for example, a married couple with three married children can transfer a total of $192,000 each year to their children and the children’s spouses ($32,000 times six).
If gift splitting is involved, both spouses must consent to it. This is indicated on the gift tax return (or returns) the spouses file. (If more than $16,000 is being transferred by a spouse, a gift tax return must be filed, even if the $32,000 exclusion covers total gifts.)
The “present interest” requirement
For a gift to qualify for the annual exclusion, it must be a “present interest” gift, meaning the recipient’s enjoyment of the gift can’t be postponed to the future. For example, let’s say you put cash into a trust and provide that your adult child is to receive income from it while your child is alive and your grandchild is to receive the principal at your child’s death. Your grandchild’s interest is a “future interest.” Special valuation tables determine the value of the separate interests you set up for each recipient. The gift of the income interest qualifies for the annual exclusion because enjoyment of it isn’t deferred, so the first $16,000 of its total value won’t be taxed. However, the “remainder” interest is a taxable gift in its entirety.
If the gift recipient is a minor and the terms of the trust provide that the income may be spent by or for the minor before he or she reaches age 21, and that any amount left is to go to the minor at age 21, then the annual exclusion is available. The present interest rule won’t apply.
“Unified” credit for taxable gifts
Even gifts that aren’t covered by the exclusion, and are therefore taxable, may not result in a tax liability. That’s because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $12.06 million for 2022. However, to the extent you use this credit against a gift tax liability, it reduces or eliminates the credit available for use against the federal estate tax at your death.
Questions? Contact us. We can also prepare a gift tax return for you if more than $16,000 is given to a single person this year.
Investing in the future with a 529 education plan
If you have a child or grandchild who’s going to attend college in the future, you’ve probably heard about qualified tuition programs, also known as 529 plans. These plans, named for the Internal Revenue Code section that provides for them, allow prepayment of higher education costs on a tax-favored basis.
There are two types of programs:
- Prepaid plans, which allow you to buy tuition credits or certificates at present tuition rates, even though the beneficiary (child) won’t be starting college for some time; and
- Savings plans, which depend on the investment performance of the fund(s) you place your contributions in.
You don’t get a federal income tax deduction for a contribution, but the earnings on the account aren’t taxed while the funds are in the program. (Contributors are eligible for state tax deductions in some states.) You can change the beneficiary or roll over the funds in the program to another plan for the same or a different beneficiary without income tax consequences.
Distributions from the program are tax-free up to the amount of the student’s “qualified higher education expenses.” These include tuition (including up to $10,000 in tuition for an elementary or secondary public, private or religious school), fees, books, supplies and required equipment. Reasonable room and board is also a qualified expense if the student is enrolled at least half time.
Distributions from a 529 plan can also be used to make tax-free payments of principal or interest on a loan to pay qualified higher education expenses of the beneficiary or a sibling of the beneficiary.
What about distributions in excess of qualified expenses? They’re taxed to the beneficiary to the extent that they represent earnings on the account. A 10% penalty tax is also imposed.
Eligible schools include colleges, universities, vocational schools or other postsecondary schools eligible to participate in a student aid program of the U.S. Department of Education. This includes nearly all accredited public, nonprofit and for-profit postsecondary institutions.
However, “qualified higher education expenses” also include expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private or religious school.
A school should be able to tell you whether it qualifies.
The contributions you make to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the gift tax exclusion amount ($16,000 for 2022, adjusted for inflation). If your contributions in a year exceed the exclusion amount, you can elect to take the contributions into account ratably over a five-year period starting with the year of the contributions. Thus, assuming you make no other gifts to that beneficiary, you could contribute up to $80,000 per beneficiary in 2022 without gift tax. (In that case, any additional contributions during the next four years would be subject to gift tax, except to the extent that the exclusion amount increases.) You and your spouse together could contribute $160,000 for 2022 per beneficiary, subject to any contribution limits imposed by the plan.
A distribution from a qualified tuition program isn’t subject to gift tax, but a change in beneficiary or rollover to the account of a new beneficiary may be. Contact us with questions about tax-saving ways to save and pay for college.
How to handle evidence in a fraud investigation at your business
Every business owner should establish strong policies, procedures and internal controls to prevent fraud. But don’t stop there. Also be prepared to act if indications arise that, despite your best efforts, wrongdoing has taken place at your company.
How you handle the evidence obtained could determine whether you’ll be able to prove the charges brought against the alleged perpetrator and win the case in court.
Protect the chain
Handling paper documents is relatively easy as long as you approach the task with care. Place any hard copies related to the possible fraud in a secure location. The fewer people who touch them, the better.
Don’t make notes on the relevant paper documents. Instead, write notations about when and where they were found, and how you preserved them, in a separate log. You can copy anything you need to continue operations and turn the originals over to your professional advisors or law enforcement for fingerprinting, handwriting analysis or other forensic testing.
Remember, a court case can be derailed if you don’t preserve the chain of evidence and can’t prove to a judge’s satisfaction that documents haven’t been tampered with.
Train IT staff
Digital evidence generally presents more challenges — especially if your IT staff isn’t trained to react to fraud incidents. Even if these employees are highly skilled at setting up and troubleshooting hardware and software, they’re unlikely to be fully aware of the legal ramifications of dealing with a computer or mobile device used to commit fraud.
To avoid the inadvertent destruction or alteration of evidence, arrange for specialized training that teaches IT employees to respond appropriately when fraud is suspected. They should be instructed to stop any routine data destruction immediately. If your system periodically deletes certain information, including emails, IT staff should suspend the process upon notification that something is amiss.
In many cases, it’s wise for businesses to engage a qualified computer forensics expert to assist in the investigation. These professionals can identify and restore:
- Deleted and altered records,
- Digital forgeries, and
- Intentionally corrupted files.
They also can access many password-protected files and pinpoint unauthorized system access.
Act immediately
According to the Association of Certified Fraud Examiners’ “Occupational Fraud 2022: A Report to the Nations,” a typical scam goes on for 12 months before detection, and the median loss amounts to $112,000.
The message is clear: Fraud can have a severe financial impact on your business and take a long time to recover from. Be sure you’re ready to act immediately if evidence arises. Let us help you set up defenses against fraud and assist you in any investigations that come up.
Self-employed? Build a nest egg with a solo 401(k) plan
Do you own a successful small business with no employees and want to set up a retirement plan? Or do you want to upgrade from a SIMPLE IRA or Simplified Employee Pension (SEP) plan? Consider a solo 401(k) if you have healthy self-employment income and want to contribute substantial amounts to a retirement nest egg.
This strategy is geared toward self-employed individuals including sole proprietors, owners of single-member limited liability companies and other one-person businesses.
Go it alone
With a solo 401(k) plan, you can potentially make large annual deductible contributions to a retirement account.
For 2022, you can make an “elective deferral contribution” of up to $20,500 of your net self-employment (SE) income to a solo 401(k). The elective deferral contribution limit increases to $27,000 if you’ll be 50 or older as of December 31, 2022. The larger $27,000 figure includes an extra $6,500 catch-up contribution that’s allowed for these older owners.
On top of your elective deferral contribution, an additional contribution of up to 20% of your net SE income is permitted for solo 401(k)s. This is called an “employer contribution,” though there’s technically no employer when you’re self-employed. (The amount for employees is 25%.) For purposes of calculating the employer contribution, your net SE income isn’t reduced by your elective deferral contribution.
For the 2022 tax year, the combined elective deferral and employer contributions can’t exceed:
- $61,000 ($67,500 if you’ll be 50 or older as of December 31, 2022), or
- 100% of your net SE income.
Net SE income equals the net profit shown on Form 1040 Schedule C, E or F for the business minus the deduction for 50% of self-employment tax attributable to the business.
Pros and cons
Besides the ability to make large deductible contributions, another solo 401(k) advantage is that contributions are discretionary. If cash is tight, you can contribute a small amount or nothing.
In addition, you can borrow from your solo 401(k) account, assuming the plan document permits it. The maximum loan amount is 50% of the account balance or $50,000, whichever is less. Some other plan options, including SEPs, don’t allow loans.
The biggest downside to solo 401(k)s is their administrative complexity. Significant upfront paperwork and some ongoing administrative efforts are required, including adopting a written plan document and arranging how and when elective deferral contributions will be collected and paid into the owner’s account. Also, once your account balance exceeds $250,000, you must file Form 5500-EZ with the IRS annually.
If your business has one or more employees, you can’t have a solo 401(k). Instead, you must have a multi-participant 401(k) with all the resulting complications. The tax rules may require you to make contributions for those employees. However, there’s an important loophole: You can exclude employees who are under 21 and employees who haven’t worked at least 1,000 hours during any 12-month period from 401(k) plan coverage.
Bottom line: For a one-person business, a solo 401(k) can be a smart retirement plan choice if:
- You want to make large annual deductible contributions and have the money,
- You have substantial net SE income, and
- You’re 50 or older and can take advantage of the extra catch-up contribution.
Before you establish a solo 401(k), weigh the pros and cons of other retirement plans — especially if you’re 50 or older. Solo 401(k)s aren’t simple, but they can allow you to make substantial and deductible contributions to a retirement nest egg. Contact us before signing up to determine what’s best for your situation.
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Want to see into the future? Delve deeper into forecasting
For a company to be truly successful, its ownership needs to attempt the impossible: see into the future. Forecasting key metrics — such as sales demand, receivables, payables and working capital — can help you manage overhead, offer competitive prices and keep your business on firm financial footing.
Although financial statements are often the starting point for forecasts, you’ll need to do more than just multiply last year’s numbers by a projected growth rate in today’s uncertain marketplace. Here are some tips to consider.
Pick your time frame
Forecasting is generally more accurate in the short term. The longer the period, the more likely it is that customer demand or market trends will change.
Quantitative methods, which rely on historical data, are typically the most accurate. However, they don’t work well for long-term predictions. If you’re planning to forecast over several years, try qualitative forecasting methods, which rely on expert opinions instead of company-specific data.
Define your demand
Weather, sales promotions, safety concerns and other factors can cause sales to fluctuate. For example, if you sell ski supplies and apparel, chances are good your sales tend to dip in the summer.
If demand for your products or services varies, consider forecasting with a quantitative method. One example is “time-series decomposition,” which examines historical data and allows you to adjust for market trends, seasonal trends and business cycles.
You also might want to invest in forecasting software. These solutions allow you to plug other variables into the equation, such as the short-term buying plans of key customers.
Assess your data
Quantitative forecasting techniques require varying amounts of historical information. For instance, you’ll need about three years of data to use “exponential smoothing,” a simple yet fairly accurate method that compares historical averages with current demand.
If you want to forecast for something you don’t have data for, such as a new product or service, you might use qualitative forecasting. Alternatively, you could base your forecast on historical data for a similar product or service in your lineup.
Get intensive for inventory
If you operate a business with extensive inventory, forecasting is particularly critical. As you’ve likely learned over time, you’ve got to establish accurate methods of counting inventory and adjust levels as appropriate to best manage cash flow.
For peak accuracy, take the average of multiple forecasting methods. To optimize inventory levels, consider forecasting demand by individual products as well as by geographic location.
Craft your crystal ball
The optimal forecasting approach for any business will depend on multiple factors, such as its industry and customer base. Contact us to discuss the forecasting practices that make the most sense for your company.
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Important considerations when engaging in a like-kind exchange
A business or individual might be able to dispose of appreciated real property without being taxed on the gain by exchanging it rather than selling it. You can defer tax on your gain through a “like-kind” or Section 1031 exchange.
A like-kind exchange is a swap of real property held for investment or for productive use in your trade or business for like-kind investment real property or business real property. For these purposes, “like-kind” is very broadly defined, and most real property is considered to be like-kind with other real property. However, neither the relinquished property nor the replacement property can be real property held primarily for sale. If you’re unsure whether the property involved in your exchange is eligible for a like-kind exchange, contact us to discuss the matter.
Here’s how the tax rules work
If it’s a straight asset-for-asset exchange, you won’t have to recognize any gain from the exchange. You’ll take the same “basis” (your cost for tax purposes) in the replacement property that you had in the relinquished property. Even if you don’t have to recognize any gain on the exchange, you still have to report the exchange on a form that is attached to your tax return.
However, the properties often aren’t equal in value, so some cash or other (non-like-kind) property is thrown into the deal. This cash or other property is known as “boot.” If boot is involved, you’ll have to recognize your gain, but only up to the amount of boot you receive in the exchange. In these situations, the basis you get in the like-kind replacement property you receive is equal to the basis you had in the relinquished property you gave up reduced by the amount of boot you received but increased by the amount of any gain recognized.
Here’s an example
Let’s say you exchange land (investment property) with a basis of $100,000 for a building (investment property) valued at $120,000 plus $15,000 in cash. Your realized gain on the exchange is $35,000: You received $135,000 in value for an asset with a basis of $100,000. However, since it’s a like-kind exchange, you only have to recognize $15,000 of your gain: the amount of cash (boot) you received. Your basis in the new building (the replacement property) will be $100,000, which is your original basis in the relinquished property you gave up ($100,000) plus the $15,000 gain recognized, minus the $15,000 boot received.
Note: No matter how much boot is received, you’ll never recognize more than your actual (“realized”) gain on the exchange.
If the property you’re exchanging is subject to debt from which you’re being relieved, the amount of the debt is treated as boot. The theory is that if someone takes over your debt, it’s equivalent to him or her giving you cash. Of course, if the replacement property is also subject to debt, then you’re only treated as receiving boot to the extent of your “net debt relief” (the amount by which the debt you become free of exceeds the debt you pick up).
Like-kind exchanges can be complex but they’re a good tax-deferred way to dispose of investment or trade or business assets. We can answer any additional questions you have or assist with the transaction.
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Weathering the storm of rising inflation
Like a slowly gathering storm, inflation has gone from dark clouds on the horizon to a noticeable downpour on both the U.S. and global economies. Is it time for business owners to panic?
Not at all. As of this writing, a full-blown recession is possible but not an absolute certainty. And the impact of inflation itself will vary depending on your industry and the financial strength of your company. Here are some important points to keep in mind during this difficult time.
Government response
For starters, don’t expect any dramatic moves by the federal government. Some smaller steps, however, have been taken.
For instance, the Federal Reserve has raised interest rates to “pump the brakes” on the U.S. economy. And the IRS recently announced an increase in the optional standard mileage rate tax deduction for the last six months of 2022 (July 1 through December 31). The rate for business travel is now 62.5 cents per mile — up from 58.5 cents per mile for the first half of 2022.
This is notable because the IRS usually adjusts mileage rates only once annually at year-end. The tax agency explained: “in recognition of recent gasoline price increases, [we’ve] made this special adjustment for the final months of 2022.”
Otherwise, major tax relief this year is highly unlikely. Some tax breaks are inflation-adjusted — for example, the Section 179 depreciation deduction. However, these amounts were calculated at the end of 2021, so they probably won’t keep up with 2022 inflation. What’s more, many other parts of the tax code aren’t indexed for inflation.
Strategic moves
So, what can you do? First, approach price increases thoughtfully. When inflation strikes, raising your prices might seem unavoidable. After all, if suppliers are charging you more, your profit margin narrows — and the risk of a cash flow crisis goes way up. Just be sure to adjust prices carefully with a close eye on the competition.
Second, take a hard look at your budget and see whether you can reduce or eliminate nonessential expenses. Inflationary times lead many business owners to try to run their companies as leanly as possible. In fact, if you can cut enough costs, you might not need to raise prices much, if at all — a competitive advantage in today’s environment.
Last, consider the bold strategy of taking a growth-oriented approach in response to inflation. That’s right; if you’re in a strong enough cash position, your business could increase its investments in marketing and production to generate more revenue and outpace price escalations. This is a “high risk, high reward” move, however.
Optimal moves
Again, the optimal moves for your company will depend on a multitude of factors related to your industry, size, mission and market. One thing’s for sure: Inflation to some degree is inevitable. Let’s hope it doesn’t get out of control. We can help you generate, organize and analyze the financial information you need to make sound business decisions.
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Are you ready for the 2021 gift tax return deadline?
If you made large gifts to your children, grandchildren or other heirs last year, it’s important to determine whether you’re required to file a 2021 gift tax return. And in some cases, even if it’s not required to file one, it may be beneficial to do so anyway.
Who must file?
The annual gift tax exclusion has increased in 2022 to $16,000 but was $15,000 for 2021. Generally, you must file a gift tax return for 2021 if, during the tax year, you made gifts:
- That exceeded the $15,000-per-recipient gift tax annual exclusion for 2021 (other than to your U.S. citizen spouse),
- That you wish to split with your spouse to take advantage of your combined $30,000 annual exclusion for 2021,
- That exceeded the $159,000 annual exclusion in 2021 for gifts to a noncitizen spouse,
- To a Section 529 college savings plan and wish to accelerate up to five years’ worth of annual exclusions ($75,000) into 2021,
- Of future interests — such as remainder interests in a trust — regardless of the amount, or
- Of jointly held or community property.
Keep in mind that you’ll owe gift tax only to the extent that an exclusion doesn’t apply and you’ve used up your lifetime gift and estate tax exemption ($11.7 million for 2021). As you can see, some transfers require a return even if you don’t owe tax.
Why you might want to file
No gift tax return is required if your gifts for 2021 consisted solely of gifts that are tax-free because they qualify as:
- Annual exclusion gifts,
- Present interest gifts to a U.S. citizen spouse,
- Educational or medical expenses paid directly to a school or health care provider, or
- Political or charitable contributions.
But if you transferred hard-to-value property, such as artwork or interests in a family-owned business, you should consider filing a gift tax return even if you’re not required to. Adequate disclosure of the transfer in a return triggers the statute of limitations, generally preventing the IRS from challenging your valuation more than three years after you file.
The deadline is April 18
The gift tax return deadline is the same as the income tax filing deadline. For 2021 returns, it’s April 18, 2022 — or October 17, 2022, if you file for an extension. But keep in mind that, if you owe gift tax, the payment deadline is April 18, regardless of whether you file for an extension. If you’re not sure whether you must (or should) file a 2021 gift tax return, contact us.
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There still may be time to cut your tax bill with an IRA
If you’re getting ready to file your 2021 tax return, and your tax bill is more than you’d like, there might still be a way to lower it. If you’re eligible, you can make a deductible contribution to a traditional IRA right up until the April 18, 2022, filing date and benefit from the tax savings on your 2021 return.
Do you qualify?
You can make a deductible contribution to a traditional IRA if:
- You (and your spouse) aren’t an active participant in an employer-sponsored retirement plan, or
- You (or your spouse) are an active participant in an employer plan, but your modified adjusted gross income (AGI) doesn’t exceed certain levels that vary from year-to-year by filing status.
For 2021, if you’re a joint tax return filer and you are covered by an employer plan, your deductible IRA contribution phases out over $105,000 to $125,000 of modified AGI. If you’re single or a head of household, the phaseout range is $66,000 to $76,000 for 2021. For married filing separately, the phaseout range is $0 to $10,000. For 2021, if you’re not an active participant in an employer-sponsored retirement plan, but your spouse is, your deductible IRA contribution phases out with modified AGI of between $198,000 and $208,000.
Deductible IRA contributions reduce your current tax bill, and earnings within the IRA are tax deferred. However, every dollar you take out is taxed in full (and subject to a 10% penalty before age 59½, unless one of several exceptions apply).
IRAs often are referred to as “traditional IRAs” to differentiate them from Roth IRAs. You also have until April 18 to make a Roth IRA contribution. But while contributions to a traditional IRA are deductible, contributions to a Roth IRA aren’t. However, withdrawals from a Roth IRA are tax-free as long as the account has been open at least five years and you’re age 59½ or older. (There are also income limits to contribute to a Roth IRA.)
Another IRA strategy that may help you save tax is to make a deductible IRA contribution, even if you don’t work. In general, you can’t make a deductible traditional IRA contribution unless you have wages or other earned income. However, an exception applies if your spouse is the breadwinner and you’re a homemaker. In this case, you may be able to take advantage of a spousal IRA.
How much can you contribute?
For 2021, if you’re eligible, you can make a deductible traditional IRA contribution of up to $6,000 ($7,000 if you’re 50 or over).
In addition, small business owners can set up and contribute to a Simplified Employee Pension (SEP) plan up until the due date for their returns, including extensions. For 2021, the maximum contribution you can make to a SEP is $58,000.
Contact us if you want more information about IRAs or SEPs. Or ask about them when we’re preparing your return. We can help you save the maximum tax-advantaged amount for retirement.
Getting a divorce? Be aware of tax implications if you own a business
If you’re a business owner and you’re getting a divorce, tax issues can complicate matters. Your business ownership interest is one of your biggest personal assets and in many cases, your marital property will include all or part of it.
Tax-free property transfers
You can generally divide most assets, including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).
Let’s say that under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding periods for the home and the stock would carry over to the person who receives them.
Tax-free transfers can occur before a divorce or at the time it becomes final. Tax-free treatment also applies to post-divorce transfers as long as they’re made “incident to divorce.” This means transfers that occur within:
- A year after the date the marriage ends, or
- Six years after the date the marriage ends if the transfers are made pursuant to your divorce agreement.
More tax issues
Later on, there will be tax implications for assets received tax-free in a divorce settlement. The ex-spouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies).
What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.
Note that the person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement.
In addition, the beneficial tax-free transfer rule is now extended to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in a divorce, these types of ordinary-income assets can also be transferred tax-free. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.
Plan ahead to avoid surprises
Like many major life events, divorce can have major tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher. We can help you minimize the adverse tax consequences of settling your divorce.