Maximize the QBI deduction before it’s gone

The qualified business income (QBI) deduction is available to eligible businesses through 2025. After that, it’s scheduled to disappear. So if you’re eligible, you want to make the most of the deduction while it’s still on the books because it can potentially be a big tax saver.

Deduction basics

The QBI deduction is written off at the owner level. It can be up to 20% of:

  • QBI earned from a sole proprietorship or single-member LLC that’s treated as a sole proprietorship for tax purposes, plus
  • QBI from a pass-through entity, meaning a partnership, LLC that’s treated as a partnership for tax purposes or S corporation.

How is QBI defined? It’s qualified income and gains from an eligible business, reduced by related deductions. QBI is reduced by: 1) deductible contributions to a self-employed retirement plan, 2) the deduction for 50% of self-employment tax, and 3) the deduction for self-employed health insurance premiums.

Unfortunately, the QBI deduction doesn’t reduce net earnings for purposes of the self-employment tax, nor does it reduce investment income for purposes of the 3.8% net investment income tax (NIIT) imposed on higher-income individuals.

Limitations

At higher income levels, QBI deduction limitations come into play. For 2024, these begin to phase in when taxable income before any QBI deduction exceeds $191,950 ($383,900 for married joint filers). The limitations are fully phased in once taxable income exceeds $241,950 or $483,900, respectively.

If your income exceeds the applicable fully-phased-in number, your QBI deduction is limited to the greater of: 1) your share of 50% of W-2 wages paid to employees during the year and properly allocable to QBI, or 2) the sum of your share of 25% of such W-2 wages plus your share of 2.5% of the unadjusted basis immediately upon acquisition (UBIA) of qualified property.

The limitation based on qualified property is intended to benefit capital-intensive businesses such as hotels and manufacturing operations. Qualified property means depreciable tangible property, including real estate, that’s owned and used to produce QBI. The UBIA of qualified property generally equals its original cost when first put to use in the business.

Finally, your QBI deduction can’t exceed 20% of your taxable income calculated before any QBI deduction and before any net capital gain (net long-term capital gains in excess of net short-term capital losses plus qualified dividends).

Unfavorable rules for certain businesses 

For a specified service trade or business (SSTB), the QBI deduction begins to be phased out when your taxable income before any QBI deduction exceeds $191,950 ($383,900 for married joint filers). Phaseout is complete if taxable income exceeds $241,950 or $483,900, respectively. If your taxable income exceeds the applicable phaseout amount, you’re not allowed to claim any QBI deduction based on income from a SSTB.

Other factors

Other rules apply to this tax break. For example, you can elect to aggregate several businesses for purposes of the deduction. It may allow someone with taxable income high enough to be affected by the limitations described above to claim a bigger QBI deduction than if the businesses were considered separately.

There also may be an impact for claiming or forgoing certain deductions. For example, in 2024, you can potentially claim first-year Section 179 depreciation deductions of up to $1.22 million for eligible asset additions (subject to various limitations). For 2024, 60% first-year bonus depreciation is also available. However, first-year depreciation deductions reduce QBI and taxable income, which can reduce your QBI deduction. So, you may have to thread the needle with depreciation write-offs to get the best overall tax result.

Use it or potentially lose it

The QBI deduction is scheduled to disappear after 2025. Congress could extend it, but don’t count on it. So, maximizing the deduction for 2024 and 2025 is a worthy goal. We can help.

© 2024


Beware of a stealth tax on Social Security benefits

Some people mistakenly believe that Social Security benefits are always free from federal income tax. Unfortunately, that’s often not the case. In fact, depending on how much overall income you have, up to 85% of your benefits could be hit with federal income tax.

While the truth about the federal income tax bite on Social Security benefits may be painful, it’s better to understand it. Here are the rules.

Calculate provisional income

The amount of Social Security benefits that must be reported as taxable income on your tax return depends on your “provisional income.” To arrive at provisional income, start with your adjusted gross income (AGI), which is the number that appears on Page 1, Line 11 of Form 1040. Then, subtract your Social Security benefits to arrive at your adjusted AGI for this purpose.

Next, take that adjusted AGI number and add the following:

  1. 50% of Social Security benefits,
  2. Any tax-free municipal bond interest income,
  3. Any tax-free interest on U.S. Savings Bonds used to pay college expenses,
  4. Any tax-free adoption assistance payments from your employer,
  5. Any deduction for student loan interest, and
  6. Any tax-free foreign earned income and housing allowances, and certain tax-free income from Puerto Rico or U.S. possessions.

The result is your provisional income.

Find your tax scenario

Once you know your provisional income, you can determine which of the following three scenarios you fall under.

Scenario 1: All benefits are tax-free

If your provisional income is $32,000 or less, and you file a joint return with your spouse, your Social Security benefits will be federal-income-tax-free. But you might owe state income tax.

If your provisional income is $25,000 or less, and you don’t file jointly, the general rule is that Social Security benefits are totally federal-income-tax-free. However, if you’re married and file separately from your spouse who lived with you at any time during the year, you must report up to 85% of your Social Security benefits as income unless your provisional income is zero or a negative number, which is unlikely.

Having federal-income-tax-free benefits is nice, but, as you can see, this favorable outcome is only allowed when provisional income is quite low.

Scenario 2: Up to 50% of your benefits are taxed

If your provisional income is between $32,001 and $44,000, and you file jointly with your spouse, up to 50% of your Social Security benefits must be reported as income on Form 1040.

If your provisional income is between $25,001 and $34,000, and you don’t file a joint return, up to 50% of your benefits must be reported as income.

Scenario 3: Up to 85% of your benefits are taxed

If your provisional income is above $44,000, and you file jointly with your spouse, you must report up to 85% of your Social Security benefits as income on Form 1040.

If your provisional income is above $34,000, and you don’t file a joint return, the general rule is that you must report up to 85% of your Social Security benefits as income.

As mentioned earlier, you also must report up to 85% of your benefits if you’re married and file separately from your spouse who lived with you at any time during the year — unless your provisional income is zero or a negative number.

Turn to us

This is only a very simplified explanation of how Social Security benefits are taxed. With the necessary information, we can precisely calculate the federal income tax, if any, on your Social Security benefits.

© 2024


B2B businesses: Assess customer credit carefully

Does your company operate in the business-to-business (B2B) marketplace? If so, you’re no doubt aware of the double-edged sword that is customer credit.

On the one hand, it’s common practice. Most customers likely expect to be offered a credit option when engaging in B2B transactions. On the other, credit arrangements inevitably come with risk of late payments or nonpayment, which can lead to cash flow problems for you.

To manage this risk, it’s critical to keep a close eye on how your B2B business is handling customer credit. A good place to start is at the beginning — with credit assessment.

Gather the pertinent data

Presumably, you already ask new customers to complete a credit application. If you’ve been using the same form for a while, reevaluate it to see whether you should add questions or update the design. The application should request basic information such as each customer’s:

  • Business name,
  • Physical address and website URL,
  • General phone number and email address, and
  • Employer Identification Number for tax purposes.

Bear in mind that you can request additional specifics. For example, perhaps inquire into how long the business has been operating, under what entity type it operates and whether it has a parent company.

If the company is privately owned, consider asking for a set of its most recent financial statements — or, at the very least, its latest income statement and balance sheet. (Financial statements of publicly owned businesses are published in their annual reports.)

On the income statement, analyze financial data such as after-tax profit margin, which can be calculated by dividing net income by net sales. Ideally, this metric will have remained steady or increased over the course of the year. The company’s profit margin also should be similar to that of other businesses in its industry.

From the balance sheet, you can determine current ratio, which can be calculated by dividing the company’s current assets by its current liabilities. The higher this ratio is, the more likely the business will be able to cover its bills.

Check references … and more

Along with the information mentioned above, references are key. Ensure someone on your staff is following up on these.

Begin with the company’s bank reference to learn or verify its checking and savings account balances, as well as the amount available on its line of credit (if it has one). Find out whether the business has recently violated any of its loan covenants.

Next, contact multiple trade references for the company. Establish the length of time that each reference has worked with the potential customer, as well as the approximate size of each of the accounts. Also inquire about the potential customer’s payment history with each reference.

In addition, order a credit report on the business from one of the major credit rating agencies. The report will describe the company’s payment histories with various creditors and reveal whether it has filed for bankruptcy or had a lien or judgment against it.

Last, consider using “adverse media screening” in your due diligence process. This is when a prospective borrower is “screened against” various media sources to determine whether the person or entity has been a party to any suspicious, unethical or illegal activities. It can also reveal worrisome news, such as stories about impending lawsuits or plans to shut down a division.

Improve the odds

As a B2B company, you don’t have to accept customer credit problems, and the resulting negative cash flow impact, as a “cost of doing business.” By continuously improving your approach to credit assessment, you’ll stand a better chance of avoiding unreliable payers. We can help you review your process and choose the optimal metrics.

© 2024


Bartering is a taxable transaction even if no cash is exchanged

If your small business is strapped for cash (or likes to save money), you may find it beneficial to barter or trade for goods and services. Bartering isn’t new — it’s the oldest form of trade — but the internet has made it easier to engage in with other businesses.

However, if your business begins bartering, be aware that the fair market value of goods that you receive in these types of transactions is taxable income. And if you exchange services with another business, the transaction results in taxable income for both parties.

Fair market value

Here are some examples of an exchange of services:

  • A computer consultant agrees to offer tech support to an advertising agency in exchange for free advertising.
  • An electrical contractor does repair work for a dentist in exchange for dental services.

In these cases, both parties are taxed on the fair market value of the services received. This is the amount they would normally charge for the same services. If the parties agree to the value of the services in advance, that will be considered the fair market value unless there’s contrary evidence.

In addition, if services are exchanged for property, income is realized. For example:

  • If a construction firm does work for a retail business in exchange for unsold inventory, it will have income equal to the fair market value of the inventory.
  • If an architectural firm does work for a corporation in exchange for shares of the corporation’s stock, it will have income equal to the fair market value of the stock.

Joining a club

Many businesses join barter clubs that facilitate barter exchanges. These clubs generally use a system of “credit units,” which are awarded to members who provide goods and services. The credits can be redeemed for goods and services from other members.

In general, bartering is taxable in the year it occurs. But if you participate in a barter club, you may be taxed on the value of credit units at the time they’re added to your account, even if you don’t redeem them for actual goods and services until a later year. For example, let’s say that you earn 2,500 credit units one year, and that each unit is redeemable for $2 in goods and services. In that year, you’ll have $5,000 of income. You won’t pay additional tax if you redeem the units the next year, since you’ve already been taxed on that income.

If you join a barter club, you’ll be asked to provide your Social Security number or Employer Identification Number. You’ll also be asked to certify that you aren’t subject to backup withholding. Unless you make this certification, the club is required to withhold tax from your bartering income at a 24% rate.

Tax reporting

By January 31 of each year, a barter club will send participants a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” which shows the value of cash, property, services and credits that you received from exchanges during the previous year. This information will also be reported to the IRS.

Exchanging without exchanging money

By bartering, you can trade away excess inventory or provide services during slow times, all while hanging on to your cash. You may also find yourself bartering when a customer doesn’t have the money on hand to complete a transaction. As long as you’re aware of the federal and state tax consequences, these transactions can benefit all parties involved. Contact us if you need assistance or would like more information.

© 2024


Key 2024 inflation-adjusted tax parameters for small businesses and their owners

The IRS recently announced various inflation-adjusted federal income tax amounts. Here’s a rundown of the amounts that are most likely to affect small businesses and their owners.

Rates and brackets

If you run your business as a sole proprietorship or pass-through business entity (LLC, partnership or S corporation), the business’s net ordinary income from operations is passed through to you and reported on your personal Form 1040. You then pay the individual federal income tax rates on that income.

Here are the 2024 inflation adjusted bracket thresholds.

  • 10% tax bracket: $0 to $11,600 for singles, $0 to $23,200 for married joint filers, $0 to $16,550 for heads of household;
  • Beginning of 12% bracket: $11,601 for singles, $23,201 for married joint filers, $16,551 for heads of household;
  • Beginning of 22% bracket: $47,151 for singles, $94,301 for married joint filers, $63,101 for heads of household;
  • Beginning of 24% bracket: $100,526 for singles, $201,051 for married joint filers, $100,501 for heads of household;
  • Beginning of 32% bracket: $191,951 for singles, $383,901 for married joint filers, $191,951 for heads of household;
  • Beginning of 35% bracket: $243,726 for singles, $487,451 for married joint filers and $243,701 for heads of household; and
  • Beginning of 37% bracket: $609,351 for singles, $731,201 for married joint filers and $609,351 for heads of household.

Key Point: These thresholds are about 5.4% higher than for 2023. That means that, other things being equal, you can have about 5.4% more ordinary business income next year without owing more to Uncle Sam.

Section 1231 gains and qualified dividends

If you run your business as a sole proprietorship or a pass-through entity, and the business sells assets, you may have Section 1231 gains that passed through to you to be included on your personal Form 1040. Sec. 1231 gains are long-term gains from selling business assets that were held for more than one year, and they’re generally taxed at the same lower federal rates that apply to garden-variety long-term capital gains (LTCGs), such as stock sale gains. Here are the 2024 inflation-adjusted bracket thresholds that will generally apply to Sec. 1231 gains recognized by individual taxpayers.

  • 0% tax bracket: $0 to $47,025 for singles, $0 to $94,050 for married joint filers and $0 to $63,000 for heads of household;
  • Beginning of 15% bracket: $47,026 for singles, $94,051 for joint filers, $63,001 for heads of household; and
  • Beginning of 20% bracket: $518,901 for singles, $583,751 for married joint filers and $551,351 for heads of household.

If you run your business as a C corporation, and the company pays you qualified dividends, they’re taxed at the lower LTCG rates. So, the 2024 rate brackets for qualified dividends paid to individual taxpayers will be the same as above.

Self-employment tax

If you operate your business as a sole proprietorship or as a pass-through entity, you probably have net self-employment (SE) income that must be reported on your personal Form 1040 to calculate your SE tax liability. For 2024, the maximum 15.3% SE tax rate will apply to the first $166,800 of net SE income (up from $160,200 for 2023).

Section 179 deductions

For tax years beginning in 2024, small businesses can potentially write off up to $1,220,000 of qualified asset additions in year one (up from $1,160,000 for 2023). However, the maximum deduction amount begins to be phased out once qualified asset additions exceed $3,050,000 (up from $2,890,000 for 2023). Various limitations apply to Sec. 179 deductions.

Side Note: Under the first-year bonus depreciation break, you can deduct up to 60% of the cost of qualified asset additions placed in service in calendar year 2024. For 2023, you could deduct up to 80%.

Just the beginning

These are only the 2024 inflation-adjusted amounts that are most likely to affect small businesses and their owners. There are others that may potentially apply, including: limits on qualified business income deductions and business loss deductions, income limits on various favorable exceptions such as the right to use cash-method accounting, limits on how much you can contribute to your self-employed or company-sponsored tax-favored retirement account, limits on tax-free transportation allowances for employees, and limits on tax-free adoption assistance for employees. Contact us with questions about your situation.


Should your business change its health care plan for next year?

Open enrollment for most health care plans is many months away. That makes now a good time for businesses to consider changing their employer-sponsored coverage for next year, or perhaps to think about launching a plan for the very first time.

If you’re going to do either, you’ll have many details to sort through. To simplify matters a bit, let’s look at a few “big picture” factors that can serve as good starting points for contemplating the size and shape of your plan.

Funding approach

As you’re likely aware, there are two broad types of employer-sponsored health insurance plans: fully insured and self-funded (also known as self-insured). A fully insured plan is simply one you buy from an insurer. This is the most common approach for small to midsize businesses because it limits financial risk while offering the most predictable costs.

Under a self-funded plan, your company funds and administers the insurance, usually with the help of a third-party administrator. This approach may save money if your business can design its own plan and manage the claims process. However, you assume financial risk for the plan — costs can be unpredictable and potentially catastrophic.

Size of network

The size of a plan’s network determines how many options employees have when picking providers and how much they’ll pay out of pocket. A smaller network of preferred providers often grants the most coverage with lower out-of-pocket costs for employees when they visit those providers. Participants can typically still pick out-of-network services, but they’ll usually pay more out of pocket. Rightsizing your network is critical to participant satisfaction.

Tax-advantaged accounts

Although technically not insurance, widely used tax-advantaged accounts can be strong additions to a benefits package. These include Health Savings Accounts (HSAs), which must be offered in conjunction with high-deductible health plans, and Flexible Spending Accounts (FSAs).

HSAs and FSAs let employees set aside pretax dollars from their paychecks to use for eligible medical expenses. HSA funds remain in participants’ accounts until used, while FSA dollars typically must be spent within the year or lost (though a plan can provide for a grace period of up to 2½ months after the end of the plan year). A third option is a Health Reimbursement Arrangement (HRA). This is an employer-funded plan under which participants submit out-of-pocket medical expenses, such as deductibles and copays, for tax-free reimbursement.

Availability of government assistance

If your business happens to be considered a small business for health insurance purposes, you may want to check out the Small Business Health Options Program (SHOP). This federal marketplace is designed for small-business owners looking for health care plans. To qualify, a company typically must:

  • Have one to 50 employees,
  • Provide health benefits to all staffers working 30 or more hours per week,
  • Reach plan enrollment of at least 70% of employees,
  • Maintain an office or have an employee in the state of the SHOP used.

Every state runs its own SHOP marketplace, but they’re similar. Your state’s SHOP may be a good place to start if you’re ready to sponsor a plan but aren’t sure where to begin.

A major decision

Making changes to an existing health care plan or launching a new one is a major business decision, so be sure to go about it carefully. Hold honest discussions with your leadership team. Perhaps survey your employees to get a better idea of what plan features they value and whether there are any you should add. Consider engaging an insurance broker for assistance. For help identifying the costs and tax impact of health insurance, or any employer-sponsored benefit, contact us.

© 2024


Key 2024 inflation-adjusted tax amounts for individuals

The IRS recently announced various 2024 inflation-adjusted federal tax amounts that affect individual taxpayers.

Most of the federal income tax rate bracket thresholds are about 5.4% higher than for 2023. That means that you can generally have about 5.4% more income next year without owing more to the federal government.

Standard deduction 

Here are the inflation-adjusted standard deduction numbers for 2024 for those who don’t itemize:

  • $14,600 if you’re single or use married filing separate status (up from $13,850 in 2023).
  • $29,200 if you’re married and file jointly (up from $27,700).
  • $21,900 if you’re a head of household (up from $20,800).

Older taxpayers and those who are blind are entitled to additional standard deduction allowances. In 2024 for those age 65 or older or blind, the amounts will be: $1,550 for a married taxpayer (up from $1,500 in 2023) and $1,950 for a single filer or head of household (up from $1,850 for 2023).

For an individual who can be claimed as a dependent on another taxpayer’s return, the 2024 standard deduction will be the greater of: 1) $1,300 (up from $1,250 for 2023) or 2) $450 (up from $400 for 2023) plus the individual’s earned income, not to exceed $14,600 (up from $13,850 for 2023).

Ordinary income and short-term capital gains

Here are the 2024 inflation-adjusted bracket thresholds for ordinary income and net short-term capital gains:

  • 10% tax bracket: $0 to $11,600 for singles, $0 to $23,200 for married joint filers, $0 to $16,550 for heads of household;
  • Beginning of 12% bracket: $11,601 for singles, $23,201 for married joint filers, $16,551 for heads of household;
  • Beginning of 22% bracket: $47,151 for singles, $94,301 for married joint filers, $63,101 for heads of household;
  • Beginning of 24% bracket: $100,526 for singles, $201,051 for married joint filers, $100,501 for heads of household;
  • Beginning of 32% bracket: $191,951 for singles, $383,901 for married joint filers, $191,951 for heads of household;
  • Beginning of 35% bracket: $243,726 for singles, $487,451 for married joint filers and $243,701 for heads of household; and
  • Beginning of 37% bracket: $609,351 for singles, $731,201 for married joint filers and $609,351 for heads of household.

Long-term capital gains and dividends

Here are the 2024 inflation-adjusted bracket thresholds for net long-term capital gains and qualified dividends:

  • 0% tax bracket: $0 to $47,025 for singles, $0 to $94,050 for married joint filers, and $0 to $63,000 for heads of household;
  • Beginning of 15% bracket: $47,026 for singles, $94,051 for married joint filers, and $63,001 for heads of household; and
  • Beginning of 20% bracket: $518,901 for singles, $583,751 for married joint filers and $551,351 for heads of household.

Gift and estate tax

The annual exclusion for gifts made in 2024 will be $18,000 (up from $17,000 for 2023). That means you can give away up to $18,000 to as many individuals as you wish without incurring gift tax or using up any of your unified federal gift and estate tax exemption.

In 2024, the unified federal gift and estate tax exemption will be $13,610,000 (up from $12,920,000 for 2023).

For gifts made in 2024, the annual exclusion for gifts to a noncitizen spouse will be $185,000 (up from $175,000 in 2023).

Conclusion

This article only covers some of the inflation-adjusted tax amounts. There are others that may potentially apply, including: alternative minimum tax parameters, kiddie tax amounts, limits on the refundable amount of the Child Tax Credit, limits on the adoption credit, IRA contribution amounts, contributions to your company’s retirement plan and health savings account amounts. Various other inflation-adjusted amounts may affect your tax situation if you own an interest in a sole proprietorship or a pass-through business. Contact us with questions.


How renting out a vacation property will affect your taxes

Are you dreaming of buying a vacation beach home, lakefront cottage or ski chalet? Or perhaps you’re fortunate enough to already own a vacation home. In either case, you may wonder about the tax implications of renting it out for part of the year.

Count the days

The tax treatment depends on how many days it’s rented and your level of personal use. Personal use includes vacation use by your relatives (even if you charge them market rate rent) and use by nonrelatives if a market rate rent isn’t charged.

If you rent the property out for less than 15 days during the year, it’s not treated as “rental property” at all. In the right circumstances, this can produce significant tax benefits. Any rent you receive isn’t included in your income for tax purposes (no matter how substantial). On the other hand, you can only deduct property taxes and mortgage interest — no other operating costs and no depreciation. (Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.)

If you rent the property out for more than 14 days, you must include the rent you receive in income. However, you can deduct part of your operating expenses and depreciation, subject to several rules. First, you must allocate your expenses between the personal use days and the rental days. For example, if the house is rented for 90 days and used personally for 30 days, then 75% of the use is rental (90 days out of 120 total days). You would allocate 75% of your maintenance, utilities, insurance, etc. costs to rental. You would allocate 75% of your depreciation allowance, interest and taxes for the property to rental as well. The personal use portion of taxes is separately deductible. The personal use portion of interest on a second home is also deductible if the personal use exceeds the greater of 14 days or 10% of the rental days. However, depreciation on the personal use portion isn’t allowed.

Income and expenses

If the rental income exceeds these allocable deductions, you report the rent and deductions to determine the amount of rental income to add to your other income. If the expenses exceed the income, you may be able to claim a rental loss. This depends on how many days you use the house personally.

Here’s the test: if you use it personally for the greater of more than 14 days, or 10% of the rental days, you’re using it “too much,” and you can’t claim a loss. In this case, you can still use your deductions to wipe out rental income, but you can’t go beyond that to create a loss. Any unused deductions are carried forward and may be usable in future years.

If you’re limited to using deductions only up to the amount of rental income, you must use the deductions allocated to the rental portion in the following order:

  • Interest and taxes,
  • Operating costs, and
  • Depreciation.

If you “pass” the personal use test (that is, you don’t use the property personally more than the greater of the figures listed above), you must still allocate your expenses between the personal and rental portions. In this case, however, if your rental deductions exceed rental income, you can claim a loss. (The loss is “passive,” however, and may be limited under the passive loss rules.)

Plan ahead for best results

As you can see, the rules are complex. Contact us if you have questions or would like to plan ahead to maximize deductions in your situation.


Smaller companies: Explore pooled employer plans for retirement benefits

Most businesses today need to offer a solid benefits package. Failing to do so could mean falling behind in the competition to hire and retain talent in today’s tight job market.

When it comes to retirement benefits, however, smaller companies may struggle with the financial and administrative burdens of sponsoring their own plans. The good news is, thanks to the Setting Every Community Up for Retirement Enhancement Act of 2019, a relatively new solution is available: pooled employer plans (PEPs).

Meet the MEP

PEPs are a variation on an existing retirement plan model: multiple employer plans (MEPs). MEPs are qualified defined contribution plans, typically 401(k)s, maintained by two or more employers. MEP sponsors may be one of the participating employers or a third party, such as a trade association or professional employer organization.

MEPs offer several advantages. Group purchasing power and other economies of scale tend to lower plan sponsorship costs. Also, participating employers avoid time-consuming and often disruptive administrative tasks. Plus, they can shift some — though not all — of their fiduciary duties and liability exposure to the MEP sponsor.

MEP sponsors are responsible for plan design and day-to-day management. This includes:

  • Coordinating with various third-party service providers,
  • Handling compliance issues, and
  • Overseeing annual audit and reporting requirements.

Sponsors can also provide participating employers with access to expertise and advanced technology that the participants might otherwise be unable to afford.

MEP drawbacks

However, traditional MEPs have some drawbacks. For one thing, to be treated as a single employer plan for reporting, audit and administrative purposes, a MEP must be “closed.” That is, its members must share some “commonality of interest,” such as being in the same industry or geographical location.

Employers that join “open” MEPs, which don’t require a commonality of interest, are treated as if they maintained separate plans with their own reporting, audit and other compliance responsibilities. (Note: Certain smaller plans — generally, those with fewer than 100 participants — aren’t subject to audit requirements.)

Another drawback of traditional MEPs is the “one-bad-apple” rule. Under this rule, a compliance failure by one participating employer can expose the entire MEP to the risk of disqualification.

PEPs step up

Properly designed PEPs avoid both the commonality-of-interest requirement and the one-bad-apple rule. PEPs are treated like single employer plans for reporting, audit and other compliance purposes — even if they allow unrelated employers to join. One participating employer’s compliance failure won’t jeopardize a PEP’s qualified status so long as the plan contains certain procedures for dealing with a participant’s noncompliance.

PEPs are available from “pooled plan providers,” which include financial services companies, insurers, third-party administrators and other firms that meet certain requirements. Although PEPs eliminate some of the obstacles that make traditional MEPs impractical for many companies, they’re not without disadvantages. For instance, PEPs have limited flexibility to customize plan designs or investment options to meet the needs of specific employers.

Also, while one of the advantages of PEPs is cost savings, they may increase one type of cost for some participants. That is, though small employers generally aren’t subject to annual audit requirements, PEPs are. So, small businesses that join a PEP will have to bear annual audit costs they otherwise wouldn’t. These costs can, however, be spread out among participants.

Dip your toes in

If you’re intrigued by the prospect of a PEP, dip your toes in slowly. Discuss the idea with your leadership team and professional advisors before you dive in. We’d be happy to help you estimate the costs and potential cost savings involved.


Don’t forget to empty out your flexible spending account

If you have a tax-saving flexible spending account (FSA) with your employer to help pay for health or dependent care expenses, there’s an important date coming up. You may have to use the money in the account by year-end or you’ll lose it (unless your employer has a grace period).

Health FSA 

A pre-tax contribution of $3,050 to a health FSA is permitted in 2023. This amount will be increasing to $3,200 in 2024. You save taxes in these accounts because you use pre-tax dollars to pay for medical expenses that might not be deductible. For example, expenses won’t be deductible if you don’t itemize deductions on your tax return. Even if you do itemize, medical expenses must exceed a certain percentage of your adjusted gross income in order to be deductible. Additionally, the amounts that you contribute to a health FSA aren’t subject to FICA taxes.

Your employer’s plan should have a list of qualifying items and any documentation from a medical provider that may be needed to get reimbursed for these expenses.

FSAs generally have a “use-it-or-lose-it” rule, which means you must incur qualifying medical expenditures by the last day of the plan year (December 31 for a calendar year plan) — unless the plan allows an optional grace period. A grace period can’t extend beyond the 15th day of the third month following the close of the plan year (March 15 for a calendar year plan).

What if you don’t spend the money before the last day allowed? You forfeit it.

Take a look at your year-to-date expenditures now. It will show you what you still need to spend. What are some ways to use up the money? Before year end (or the extended date, if permitted), schedule certain elective medical procedures, visit the dentist or buy new eyeglasses.

Dependent care FSA 

Some employers also allow employees to set aside funds on a pre-tax basis in dependent care FSAs. A $5,000 maximum annual contribution is permitted ($2,500 for a married couple filing separately).

FSAs are for:

  • A child who qualifies as your dependent and who is under age 13, or
  • A dependent or spouse who is physically or mentally incapable of self-care and who has the same principal place of abode as you for more than half of the tax year.

Like health FSAs, dependent care FSAs are subject to a use-it-or-lose-it rule, but the grace period relief may apply. Therefore, it’s a good time to review your expenses to date.

Other rules and exceptions may apply. Your HR department can answer any questions about your specific plan. Contact us with any questions you have about the tax implications.