Category: Uncategorized

Preface: “That’s the thing about December: it goes by you in a flash. If you just close your eyes, it’s gone. And it’s like you were never there.” — Donal Ryan

Recordkeeping | Common Requirements for Personal Taxes

We previously explained the importance of keeping records so that your tax return can be properly prepared and so that claimed items can be backed up in the event of an audit. (Despite a popular misconception that the IRS Reform Act of 1998 shifted “the burden of proof” on audits to the IRS, the law does not relieve any taxpayer of the obligation to keep proper records to substantiate deductions and tax basis.) Here, we focus on common records that are needed in connection with taxes on your personal income.

You should keep records of expenses that can be claimed as itemized deductions. Thus, you should keep records of unreimbursed medical and dental expenses, including receipts showing the dates you paid them and receipts for transportation primarily for, and essential to, medical care; payments of state income tax including any Forms W-2 from employment and canceled checks of payments of state estimated tax and of any additional state tax paid with your return (which also should be retained); records and canceled checks showing interest payments on your home mortgage and payments of real estate and personal property taxes.

You also need records of charitable contributions. For cash contributions of any amount, keep a canceled check or a receipt from the charity showing the amount and date of the contribution. For a contribution of $250 or more, you need a written acknowledgment from the charity containing very specific information and you generally must get this before you file. Additional records are needed for contributions of property other than cash. If you perform services for a charity, keep records showing your out-of-pocket expenses. If you give clothing or household goods, you need proof that they are of “good or better” condition or they are not deductible at all.

You must keep records of stocks, mutual funds, bonds and other similar investment property. Retain information on how and when any such assets were acquired, including additional shares purchased by reinvesting dividends. For these items and other types of assets, you must keep track of your basis, which is used to measure your tax gain or loss when you sell an item. Basis is ordinarily your cost but is different for property acquired by gift or inheritance or in a divorce. It is especially important to keep records of the basis in your home, which you may not sell for several years. Records of sales also need to be kept, along with commissions and other selling charges.

If you have any questions about any of the matters in this letter or any particular transaction you are concerned with, please give us a call.

Preface: “I was at this restaurant. The sign said ‘Breakfast Anytime.’ So I ordered French Toast in the Renaissance.” – Steven Wright

2022 Tax Planning: Meals and Entertainment Expenses

Many businesses consider the occasional dining of customers and clients just to stay in touch with them to be a necessary cost of doing business. The same goes for taking business associates or even employees out to lunch once in a while after an especially tough assignment has been completed successfully. It’s easy to think of these entertainment costs as deductible business expenses. However, due to a recent change in the tax law, many of those expenses may not be deductible.

 Entertainment Expense Deduction Limited

 Congress has eliminated the deduction for most entertainment expenses paid or incurred after December 31, 2017. Entertainment includes fees or dues associated with any social, athletic, sporting club or organization. However, your company may still be able to deduct the cost of meals as a business expense if detailed substantiation and recordkeeping requirements are met.

 Business Meals

 As a general rule, your company can deduct 50 percent of the cost of meals as a business expense if the following requirements are met: 

• • • • the expense must be ordinary and necessary and paid in carrying on a trade or business;
      • the expense may not be lavish or extravagant;
      • the taxpayer or an employee must be present when the food or beverages are furnished;
      • food and beverages must be provided to the taxpayer or a business associate; and
      • if the food and beverages are provided during or at an entertainment activity, separate invoicing is required.

 The food or beverages must be provided to a person with whom the taxpayer could reasonably expect to engage or deal in the active conduct of the taxpayer’s trade or business such as the taxpayer’s customer, client, supplier, employee, agent, partner, or professional adviser, whether established or prospective. This definition is applied to employer-provided food or beverage expenses by considering employees as a type of business associate as well as to the deduction for expenses for meals provided by a taxpayer to both employees and non-employee business associates at the same event.

 Coronavirus (COVID-19) pandemic. Congress provides for the temporary allowance of 100% deduction for business meal food and beverage expenses provided by a restaurant that are paid or incurred in 2021 and 2022.

Special rule for per diem rates. For a taxpayer properly utilizing for meal expenses, the IRS provides a special rule that allows the taxpayer to treat the full meal portion of a per diem rate or allowance as being attributable to food or beverages from a restaurant beginning in 2021 and 2022.

 Invoicing. Food and beverage expenses deductibility and treatment depends on how invoiced. Food and beverage expenses include delivery fees, tips, and sale tax. For food or beverages provided at or during an entertainment activity, the amount charged for food or beverages on a bill, invoice, or receipt must reflect the venue’s usual selling cost for those items if they were to be purchased separately from the entertainment, or must approximate the reasonable value of those items. However, if the invoices are not stated separately and no allocation can be made, the entire amount is nondeductible.

Please call our office and to discuss how your company’s typical meal and entertainment expenses fare under the new deduction rules and suggest changes to your meal and entertainment policies. We can also show you how to comply with the recordkeeping requirements.

Preface: “Life is either a daring adventure, or nothing at all” – Helen Keller

Can You Handle Travel Costs More Easily

As you likely have discovered, travel expenses are a stressing task for your company. Besides the cost of the actual travel, you also must navigate budgeting for travel costs that vary from destination to destination, the administrative hassle of tracking actual expenditures from employee-maintained records, paying directly for the expenses or providing employees with advances or reimbursements, and keeping track of which expenses are completely deductible (lodging and round-trip travel) and those that yield only a 50-percent deduction (meals while the employee is on travel status).

Fortunately, the IRS may be able to help you work out an alternative plan of action that puts strict limits on your travel expenses, encourages employees to be frugal, and involves a bare minimum of tax complications. In a nutshell, the plan involves paying employees a flat daily or per-diem rate for meals, incidental expenses, and lodging costs while they are out-of-town on company business.

If employees pay more for their meals and lodging than the per-diem rate, they must personally pay for the difference; if they pay less than the per-diem, they pocket the difference. Along with costs, recordkeeping is cut, too, if the per-diem rate does not exceed the per-diem rate that the federal government pays its employees traveling to the same destination as your employees. All employees need to do to substantiate the travel expenses for tax purposes and keep the per-diem payroll- and income tax-free, is to submit a written log of the time, place, and business purpose of the travel. Receipts and to-the-penny recordkeeping of actual travel expenses are not required.

Your business may deduct 100 percent of the lodging portion of the per-diem and 50 percent of the meals expense portion. However, Congress provides for the temporary allowance of 100% deduction for business meal food and beverage expenses provided by a restaurant that are paid or incurred in 2021 and 2022.

To make the per-diem program work, you need a list of the federal government’s per-diem reimbursement schedule, which varies year to year as well as locality to locality. We’ll be glad to make this schedule available to you, as well as full details on this trouble-free reimbursement plan.

A simpler version of the per-diem travel reimbursement program is available. Regardless of the actual government reimbursement rate for a particular locality within the lower 48 states, your company can reimburse travel to “low cost” travel destinations at one rate and use a higher rate for all “high cost” travel destinations. These so-called “high-low” rates are changed periodically.

Call us for the current list of high-cost areas available to you and work out a detailed guide that will help you control travel and recordkeeping costs without adversely affecting your deductions for employee travels.

Preface: “The question isn’t at what age I want to retire, it’s at what income.” -George Foreman

2022 Tax Planning: Benefits of Lowering Adjusted Gross Income

Planning to reduce your income can reduce your overall tax burden. Individual taxpayers may be able to reduce their taxable income through deductions if they meet the qualifications and income limitations. Saving for retirement and for future medical costs is an important way for an individual may achieve financial security and prepare to save for future expenses. This blog focuses on the background and tax benefits on reducing adjusted gross income by contributing to retirement plans, contributing to a health savings account, and opportunities for a student loan interest deduction.

 Traditional IRA. Any individual, regardless of whether or not covered under other qualified retirement plans, can establish an individual retirement account (IRA). Whether an individual is employed or self-employed, they may also take advantage of a variety of employer-sponsored retirement plans.

These options not only provide security for the future, but also may provide opportunities for current tax savings. Traditional IRAs allow an individual with earned income to make tax-deductible contributions to a savings plan under which the gains and earnings are not taxed until they are distributed.

 Contributions to a traditional IRA are generally deductible on the taxpayer’s individual income tax return, to the extent that they do not exceed the lesser of the individual’s compensation for the year or the maximum contribution limit for the year and subject to income limits. In addition, nondeductible contributions from after-tax income may be made to traditional IRAs.  

For 2022, total contributions to all of a taxpayer’s traditional and Roth IRAs cannot be more than the lesser of $6,000 ($7,000 if they are age 50 or older) or their taxable compensation for the year. The prior maximum age limitation of 70 ½ to contribute to an IRA ended effective for contributions after December 31, 2019.

 SEP Plan. A SEP is a type of IRA for small business owners or self-employed individuals. A SEP IRA allows the employer to make contributions to the accounts set up for employees. Self-employed individuals choosing a SEP must include all employees who satisfy the following requirements: at least 21 years of age; were employed during any three of the preceding five years; and earned at least $650 in the current year.

Contributions to a SEP plan are tax-deductible and earnings are not taxable until withdrawal. One advantage of the SEP IRA is the higher contribution limit. For 2022, employers can contribute the lesser of up to 25% of income (limited to $305,000) or $61,000.

SIMPLE Plan. Any employer that had no more than 100 employees with $5,000 or more in compensation during the preceding calendar year can establish a SIMPLE IRA plan. Self-employed individuals who received earned income from the taxpayer and leased employees are taken into account for purposes of the 100-employee limitation.

Employers must also make contributions whether or not an employee elects to defer a portion of their income to the plan. Contributions are tax deductible and investments grow tax deferred until the owner is ready to make withdrawals in retirement. For 2022 an employee may defer up to $14,000. If the individual age 50 or over, there is a $3,000 catch up contribution allowed, for a total of $17,000.

Health Savings Account (HSA). Health savings accounts (HSAs) are available for individuals who have a high deductible health plan and may be funded by the individual or the individual’s employer.

The benefits of an HSA include: 

• • • • • • taxpayers can claim a tax deduction for contributions you or someone other than your employer make to your HSA,
          • contributions to your HSA made by your employer may be excludable from income, and
          • the contributions remain in your account until you use them.

 For 2022, the maximum contribution to an HSA is the lesser of: the annual deductible under the individual’s high deductible health plan; or $3,700 for an individual with self-only coverage and $7,400 for an individual with family coverage.

Student loan interest deduction. Interest paid by an individual taxpayer during the tax year on any qualified education loan is deductible from gross income in calculating adjusted gross income. The student loan must be incurred by the taxpayer solely to pay qualified higher education expenses. The maximum deductible amount of interest is $2,500, but the deduction is phased out or reduced based on the taxpayer’s modified adjusted gross income.

 If you would like to evaluate the tax advantages of retirement plans, health savings account, or education benefits with to your individual income tax situation, please contact us to review potential tax opportunities for you to reduce your 2022 taxable income or tax liability. 

Preface: “We make a living by what we get, but we make a life by what we give.” ―Winston Churchill

Guidance on Tax-Free IRA Distributions to Charity

If you generally receive distributions from your IRA and make charitable contributions during the year, you may benefit from arranging a qualified charitable distribution (QCD). A QCD is generally a nontaxable distribution made directly by the trustee of your IRA (other than a SEP or SIMPLE IRA) to a charitable organization.

A QCD counts towards your required annual minimum distribution from your IRA. The amount of the distribution that is transferred directly to the charity you designate is not included in your adjusted gross income. On the other hand, you can’t claim a charitable contribution deduction for any QCD not included in income. However, by making a QCD, you receive the full benefit of the charitable contribution even if you don’t itemize. Hence the tax benefits options. In addition, this may reduce the tax impact of other income and deductions, such as the amount of taxable social security benefits.

You must be at least age 70 1/2 when the QCD distribution is made. The maximum annual exclusion for QCDs is $100,000. Any QCD in excess of the $100,000 exclusion limit is included in income as any other distribution. If you file a joint return, your spouse can also have a QCD and exclude up to $100,000. The amount of the QCD is limited to the amount of the distribution that would otherwise be included in income. If your IRA includes nondeductible contributions, the distribution is first considered to be paid out of otherwise taxable income.

Although a charitable contribution may be motivated by charitable reasons rather than by tax considerations, it is, nevertheless, wise to take tax considerations into account when making a IRA QCD contribution. Please call us to discuss the QCD option if interested in its pertinence to your charitable tax planning.

Preface: “Happiness isn’t something you experience; it’s something you remember.” – Oscar L.

Year-End 2022 Tax Planning

The tax space for the 2022 year is adapted with some new provisional tax law changes that differ somewhat from the prior 2021 tax year. Firstly, several COVID Era tax laws have completely lapsed for taxpayers. Additionally, The Inflation Reduction Act of 2022 introduces a number of new tax law attributes for individuals and businesses. Any further tax proposals or tax changes between now and December 31 are yet obscured. The following are some highlighted features for 2022 tax planning.

Standard Deduction

The standard deduction is inflation adjusted for 2022 for joint filers at $25,900 and individual taxpayers $12,950 and head of households $19,400.

Non-Profit Contributions

The tax provisions for above the line charitable deduction for non-itemizers introduced in 2020 was effective only for tax years 2020 and 2021. Unless modifications are introduced to 2022 tax codes, it is completely phased-out for the 2022 tax year. Therefore, only those itemizing deductions can obtain charitable contribution benefits for taxes in 2022.

Mileage Rates

For tax year 2022, there has been a mid-year change to the applicable standard mileage rate for inflation adjusted vehicle expenses that skyrocketed during the 2022 tax year. Taxpayers will need to sort mileage logs for a bifurcated calculation on effective 2022 mileage rate changes. From January 1 to June 30, the 2022 standard mileage rate for business driving is 58.5¢ per mile. From July 1 to December 31, the 2022 mileage rate for business purposes rises to 62.5¢ per mile.

Gift and Estates Taxes

The annual gift tax exclusion for 2022 increases from $15,000 to $16,000 per taxpayers. So, an individual can give up to $16,000 ($32,000 with spouse) to each child, grandchild or any other taxpayer in 2022 without being required to file a gift tax return. The lifetime estate and gift tax exemption for 2022 increases from $11.700 million to $12.060 million or $24.120 million for couples.

Capital Gain Tax Rates

For 2022, similar to prior years a 0% capital gain tax rate applies for individual taxpayers with up to $41,675 of taxable earnings (joint filers $80,800). A 3.8% surtax on net investment income continues in 2022 for individual taxpayers with taxable income above $200,000 and joint filers above $250,000 of AGI.

Enhanced Child Tax Credit Expired

The enhanced Child Tax Credit legislated into law during the Covid Pandemic in 2020 has also expired for 2022. Although legislators have constructed work to extend the enhanced child tax credit, thus far all efforts have been futile.

Energy Efficient Home Improvement Credit

The Energy Efficient Home Improvement Credit has been extended through 2022. Payments to install qualifying electric, water heating, or temperature control systems for your home that use solar, wind, geothermal, biomass or fuel cell power qualify for an energy credit increased to 30% starting in 2022.

Research and Development Expenditures

The tax benefit for for-profit businesses to currently write off research and development costs from the Tax Cuts and Jobs Act also expired at the end of 2021, Thus for 2022 tax laws will require businesses to amortize these research and development payments. Retroactive tax law amendments are still a possibility.

Educator Deductions

Teachers receive an inflation adjusted above-the-line educator deduction for qualify classroom expenses adjusted to $300 for 2022 or $600 for joint teaching couples. An “eligible educator” is any taxpayers who is a kindergarten through 12th grade teacher, instructor, counselor, principal, or aide in a school for at least 1,000 hours during a school year. Homeschooling educational expenses do not qualify.

IRA Required Minimum Distributions

Revised calculations are now in effect for required minimum distributions in 2022. The 2022 contribution limit for traditional IRAs and Roth IRAs has no changes at $6,000, with a $1,000 additional catch-up contribution for individuals age 50 and up. Taxable income ceilings on Roth IRA contributions increased for contributions phase out in 2022 at adjusted gross incomes (AGIs) of $204,000 to $214,000 for joint filers and $129,000 to $144,000 for individual taxpayers.

Scheduled income phaseouts for traditional IRAs also begin at an increased levels in 2022, from AGIs of $109,000 to $129,000 for couples and $68,000 to $78,000 for single filers. If only one spouse is covered by a plan, the phaseout level for deducting a contribution for the uncovered spouse starts at $204,000 of AGI to $214,000.

Adoption of a Child

For 2022, the adoption credit is available for up to $14,890 of qualified expenses. The full credit is available for a special-needs adoption, even if the adoption costs less. The credit begins to phase out for taxpayers with adjusted AGIs above $223,410 to $263,410.

Student Loan Forgiveness

President Biden’s program to revised student loan forgiveness program will provide non-taxable income for taxes from cancellation of student debt from qualifying loans.

Digital Assets

The draft Form 1040 for 2022 includes an updated question for material ownership of “digital assets” rather than “virtual currency.”

Summary

Further to these tax planning items for the 2022 tax year, the typical year-end tax planning strategies also are applicable including year-end qualifying gifts and qualifying contributions, deferring taxable income and accelerating tax deductions, maximizing qualified retirement contributions, and managing taxable gains and losses from investments.

Preface: Time is more valuable than money. You can get more money, but you cannot get more time. -Jim Rohn

2022 Tax Planning: Retirement Savings for the Self-Employed

Many tax-favored options are available to self-employed individuals to provide for their retirement. Tax planning for retirement can include deductible contributions to a traditional or Roth IRA, SEP plan, SIMPLE plan or a one-person 401(k) plan. You may wish to consider implementing one of these plans for yourself and/or your employees to benefit from a current tax year deduction and accumulate tax-deferred retirement savings.

 Each of these plans has advantages and disadvantages, and some may not be applicable to your situation. For example, a sole-owner 401(k) retirement plan allows a contribution for you as both an employer and as an employee. Therefore, a sole-owner 401(k) plan may provide for the largest deductible contribution. However, a sole-owner 401(k) is not available to the self-employed with employees other than a spouse or relative. As an alternative, a SEP or SIMPLE plan may have less administrative costs. Ultimately, the choice of savings vehicle will depend on factors related to your business and your retirement needs. Regardless of which plan you qualify for or what your retirement needs are, it is important to begin planning now for your retirement.

 Solo 401(k)s

 A one-participant or solo 401(k) plan is similar to a traditional 401(k), except that it covers only the business owner or owner plus spouse. These plans have the same rules and requirements (for the most part) as any other 401(k) plan. They can include the owner’s spouse, or partners and their spouses.

 The business owner is both employee and employer in a 401(k) plan, and contributions can be made to the plan in both capacities. The owner can contribute both: 

• Elective deferrals up to 100 percent of compensation (earned income in the case of a self-employed individual) up to the annual contribution limit ($20,500 for 2022 and $19,500 for 2021, plus $6,500 if age 50 or older); and

• Employer nonelective contributions up to 25 percent of compensation as defined by the plan (for self-employed individuals the amount is determined by using an IRS worksheet and in effect limits the deduction to 20 percent of earned income).

For 2022, the Solo 401(k) total contribution limit is $61,000 or $67,500 if you are age 50 or older. 

Traditional or Roth IRA 

A traditional IRA allows a taxpayer to deduct contributions on their income tax return or elect to treat those contributions as nondeductible. Earnings in the IRA are allowed to grow tax-deferred and are only subject to income tax when they are distributed. There is no age limit for making contributions. Distributions are required to be taken annually when the IRA owner reaches age 72. For 2021 and 2022, total contributions to a taxpayer’s traditional and Roth IRAs cannot be more than, the lesser of $6,000 ($7,000 if they are age 50 or older), or their taxable compensation for the year. In addition, the taxpayer may not be able to deduct all contributions if the taxpayer or the taxpayer’s spouse participates in another retirement plan at work. 

A Roth IRA is generally subject to the rules that apply to a traditional IRA. Unlike a traditional IRA, however, a taxpayer cannot deduct contributions to a Roth IRA and qualified distributions from a Roth IRA are tax free. For 2021 and 2022, total contributions to a taxpayer’s traditional and Roth IRAs cannot be more than the lesser of $6,000 ($7,000 if they are age 50 or older) or their taxable compensation for the year. In addition, the taxpayer’s Roth IRA contribution can also be limited based on filing status and income. 

Simplified Employee Pensions (SEPs)

 A SEP (Simplified Employee Pension Plan) IRA is a type of IRA for small business owners or self-employed individuals. This type of IRA allows the employer to make contributions to the accounts set up for employees. Contributions are tax-deductible and earnings are not taxable until withdrawal. One advantage of this type of IRA is the higher contribution limit. For 2022, employers can contribute up to 25% of income or $61,000, whichever is less.

 SIMPLE IRA Plan

 A SIMPLE (Savings Incentive Match Plan for Employees) IRA Plan is a plan, set up by an employer, in which employees can make contributions of a portion of their pre-tax wages. Employers must also make contributions whether or not an employee elects to defer a portion of their income to the plan. Contributions are tax deductible and investments grow tax deferred until the owner is ready to make withdrawals in retirement. It follows the same investment, distribution and rollover rules as traditional IRAs. SIMPLE IRAs have higher contribution limits than traditional and Roth IRAs and, unlike a SEP IRA, employees can make contributions to their accounts. Any employer that had no more than 100 employees with $5,000 or more in compensation during the preceding calendar year can establish a SIMPLE IRA plan. An employee may defer up to $14,000 in 2022 ($17,000 for employees age 50 or over).

 Please contact us to discuss the various retirement plan options and how they might apply to your business.

Preface: “Farming looks mighty easy when your plow is a pencil and you’re a thousand miles from the cornfield.” – Dwight D. Eisenhower.

2022 Industry Planning: Income Averaging for Farmers and Fishermen

Expectations with many of the farmers and fishermen in the United States, is that income has fluctuated widely during the past several years. Due to the extremely uncertain variables that affect farming revenues, including weather, drought, and other uncontrollable factors, it is common to have very little income in a poor year, with a large amount of income the subsequent year. By electing income averaging and spreading your farming income from a profitable year over a three-year period, you may be able to lower your tax liability for the successful year by avoiding the higher tax brackets. For example, if you have a high profit year after low-income years you would benefit as your farm income which otherwise would be taxed at the 25 percent rate or higher would be shifted to the 15 percent bracket for the prior years, thus saving taxes.

There are a number of rules you should understand in order to decide whether to make this election. You may make the tax election if you are a sole proprietor in a farming or fishing business, a partner in a partnership engaged in farming or fishing, or a shareholder of an S corporation engaged in farming or fishing. An estate or a trust may also not be selective with this election.

Under the election, the tax imposed in any tax year will equal the sum of the tax computed on your taxable income, reduced by the amount of farm income elected for averaging, plus the increase in tax that would result if taxable income for each of the three prior tax years were increased by an amount equal to one-third of your elected farm income. Your elected farm income is the amount of taxable income attributable to any farming business and which you specify under the election. Elected farming income can include gains from the sale or disposition of property or equipment, other than land, which you were regularly operating for a substantial period in your farming business.

For purposes of the income averaging election, a farming business includes operating a nursery or sod farm, raising or harvesting of trees bearing fruit, nuts or other crops or ornamental trees, or raising animals. Note that a farming business does not include the harvesting of crops grown by another person or the buying and reselling of plants or animals that are grown or raised by another person.

Although income averaging allows you to range the latitude of your farm income from a high-income year over the three prior years, it does not always result in a lower tax for the election year. In some cases, when the tax for a base year is calculated on the taxable income for that year plus one-third of the elected farm income, a higher tax rate may apply. Additionally, once the election is made, it can only be revoked only with the permission of the IRS, therefore it is important that all the relevant tax factors be considered.

Please contact our office if you would like to further discuss how income averaging might work for you as a farmer or fisherman.

Preface: Control your expenses better than your competition. This is where you can always find the competitive advantage. -Sam Walton

Spending on Equipment and Saving on Taxes

Credit: Jacob M. Dietz, CPA

Do you like to save on taxes? Most taxpayers do. Do you enjoy having the right equipment for the job? In some cases, taxpayers get the double blessing of purchasing the right equipment to run their business and sending in less taxes to the government. Although “depreciation” might sound like a boring word, the tax savings are not boring. Working hard with the right equipment does not have to be boring either.

Business taxpayers depreciate, or expense, fixed assets on their tax return. Certain things that businesses buy, such as expensive equipment, buildings, and so on, cannot simply be written off as an ordinary expense. Instead, it must be capitalized as an asset, and then expensed as depreciation. This depreciation is normally over a period of years. In some cases, the IRS allows the business to deduct it all in one year using bonus depreciation or section 179 expense.

Normally a business has a depreciation schedule that lists their fixed assets, when they bought it, what it cost, how much is being depreciated this year, and so on. Often the tax preparer maintains this schedule.
The complexity of depreciation could put some to sleep and irritate others. This article will not dive into all the details but cover certain areas of depreciation. For further information, or for help falling asleep, consider reading all 112 pages of IRS Publication 946 “How to Depreciate Property.”

In Service

Taxpayers should place property in service before depreciating it. IRS Publication 946 explains that it is in service “when it is ready and available for a specific use.” The “Farmer’s Tax Guide”, which is Publication 225, gives the example of a planter purchased in December. Since the planter was “ready and available” depreciation starts in December even though it is not planting season and the planter will not be used until spring.
The “Farmer’s Tax Guide” goes on to explain that if the planter was not assembled when it arrived, and the farmer does not assemble it until the next year, then depreciates starts in the year it is assembled. If you are still awake after reading IRS Publication 946, consider reading the 94 pages of the “Farmer’s Tax Guide” to help with insomnia.

Determining which year to start depreciation can sometimes be difficult. Another problem that can arise is a taxpayer might order a piece of equipment in one year, but it does not arrive until a future year is already well underway. In that situation, the equipment most likely is not ready and available for service in the year ordered. If you are counting on the depreciation from a large purchase to reduce your taxes, considering confirming with your accountant before the year is over to see if your equipment will qualify. If you are a taxpayer in Pennsylvania, and your equipment is sailing across the Atlantic from Europe on December 31st, then it probably is not ready and available for service. If your business is either fishing or recovery of sunken treasure, however, the answer may be different.

Getting in a Pattern

If your business operates multiple pieces of equipment that periodically wear out, you may want to consider a purchasing pattern. For example, suppose your business operates 5 forklifts. You expect them to last about 5 years. One option would be to buy 5 new forklifts every five years. That could put a strain on the finances in that 5th year. It could also give you a large depreciation deduction in that year.

Alternatively, you may want to develop a pattern of replacing a forklift about once a year. That would spread out the cash needs. It would potentially allow you to optimize the depreciation deduction each year. If you happened to have a bad year, you could consider delaying, if possible, the purchase until the next year when the tax deduction might be more helpful, and when you might have more income. On the other hand, if you were having an exceptionally good year, you might choose to accelerate your pattern and buy 2 forklifts in the same year.

Bonus Depreciation and 179 Expense

Although depreciation can take years, and in some cases decades, for the taxpayer to expense their costs, the tax code provides some taxpayer-friendly ways to accelerate the deduction. One is section 179 expense. Another is bonus depreciation. I will not go into all the complexities and details and differences of these two options, but I will say they can be very beneficial for a taxpayer looking for a quick tax deduction. Not all purchases qualify, however. If you are hoping to take bonus depreciation or to expense under section 179, you may want to talk with your accountant before the year ends and confirm if your property qualifies.

Election to Capitalize Repair and Maintenance Costs

The IRS provides an option to capitalize repair and maintenance costs. If a taxpayer elects to do so, they may capitalize and depreciate repairs and maintenance instead of expensing them as a repairs and maintenance. Why would a taxpayer make such an election? There could be multiple reasons. One reason would be to increase their income for that year and reduce it in future years with depreciation expense when the expense would be more helpful.

For example, suppose a business had a rough year and income is down. The business expects profits will pick up in the future. The business owner may see limited benefits of getting his income too low this year, but the owner might benefit more from the deduction in a future year. This election allows the owner to do that. If in the future the taxpayer is in a higher tax bracket, then each dollar of deduction might save more in taxes in the future.

De Minimis Safe Harbor Election

Have you ever studied a depreciation schedule? If so, perhaps your eyes glazed over. Now, imagine if that depreciation schedule were twice as long. That could be a challenge to track.

Fortunately, the IRS has a de minimis rule for amounts too trivial to worry about. Taxpayers can elect on their tax return to deduct certain amounts without capitalizing and depreciating them. The amounts that are considered de minimis can vary. $2,500 is a common threshold used.
How does that work? Suppose a business taxpayer buys a generator for $2,000 that will last for 5 years. Under the general rules of depreciation, that generator should be capitalized and depreciated. If the taxpayer is using the $2,500 de minimis safe harbor, however, then the taxpayer deducts that generator without ever putting it on the fixed asset schedule. Over a period of years, this threshold can keep a lot of de minimis tools from cluttering the depreciation schedule.

Tax Planning

Depreciation can play a significant role in tax planning. If a taxpayer had a good year, then the tax bill might be enough to cause a significant dip in the checking account. Placing equipment in service by the end of the year can significantly decrease taxes if section 179 or bonus depreciation is taken.
Caution should be exercised, however, before simply buying equipment to save on taxes.

First, will the purchase qualify for bonus depreciation or section 179 in the year you wish it would qualify? Sometimes an asset will not qualify for reasons such as what type of asset it is, or when it was placed in service, or from whom it was purchased. For example, the code prohibits taking section 179 expense on purchases from certain related parties.
Secondly, you will spend more money on equipment than you save in taxes. The exact percentage you pay in taxes will vary depending on multiple factors, including your level of income and the state in which you reside.

Let’s suppose someone is in a 30% tax bracket for federal, state, and local income tax combined. Suppose their accountant estimates their taxes for them in December, and the projected tax causes concern. What can be done? The business taxpayer could rush out and buy equipment costing $10,000. In that case, they just saved $3,000 (30% of $10,000) and they spent $10,000. The net result is decreased cash of $7,000. If the taxpayer doesn’t have a use for that equipment, then that could be a waste of $7,000. On the other hand, if the taxpayer had a good use for that equipment, then they essentially received $10,000 worth of equipment for an effective price of $7,000.

If you run a business that purchases significant amounts of equipment, then you are probably already aware of the benefits of both having the right equipment and depreciation. Buy wisely and depreciate wisely. Enjoy working hard with your new equipment and enjoy the tax savings from depreciation.

Proverbs 21:5 “The thoughts of the diligent tend only to plenteousness; but of every one that is hasty only to want.”

This article is general in nature, and it does not contain legal advice. Contact your advisors to discuss your specific situation.

Preface: “And just remember, every dollar we spend on outsourcing is spent on US goods or invested back in the US market. That’s accounting. – Arthur Laffer

What Is A Strong Balance Sheet?

Credit: Donald J. Sauder, CPA | CVA

A sage banker recently advised his client to have a strong balance sheet to prepare for the numerous developing shifts in regional and global marketplaces. Why? Because a business with a strong balance sheet is more likely to weather any overcast recessionary effects and be positioned to gain market share once fair-weather reemerges.

Most accountants will agree that assets = liabilities + equity. So the basic assumption of a strong balance sheet is to have more equity and fewer liabilities. Yet, there is much more to a strong balance sheet than equity.
As long a business can obtain a net profit for the year or quarter during a recessionary climate, the equity should hold fairly steady, albeit the business doesn’t require substantial distributions to finance owner personal obligations and investments (e.g., rental properties, funding for other debt such personal mortgage, taxes, or standard of living cash flows). Guarding against excess non-deductibles (owner draws, debt payments. etc.) helps insulate a balance sheet from atrophy.

Therefore, one of the primary considerations for a strong balance sheet is to analyze ongoing and recurring cashflow requirements for both business and personal obligations, e.g., non-deductible cash uses. What percent of business operating cashflows are available for financing activities, what allocations are discretionary, and what amounts are non-discretionary?

For instance, I recently heard a CPA talking about some quick analysis calculations for several clients to answer questions on appraising strong balance sheets with some back-of-the-envelope projections of what cashflows could look like if top-line sales ebbed 20% to 40% depending on the challenges expected with shifting economic winds in the marketplace.

In contrast, the worse thing a company can do is run out of money. Interestingly, based on increased interest costs, cashflow requirements for debt payments, and a caveat of higher taxes rates, it appears that some banks are willing to extend 20% or more in debt financing than can be comfortably managed in such trough scenarios by some borrowers, i.e., the companies could still be marginally profitable, and yet be in special assets situations in such scenarios, because their balance sheets are too unwieldy.

Another feature in analyzing a solid balance sheet is looking at working capital. Working capital is current assets – current liabilities. How much of your working capital is tied up in inventory, how much is cash, and what $ | % is allocable? Astute financial managers monitor working capital levels constantly and regularly prioritize optimization.

Experienced managers are proactive in balance sheet management and divest excess cash-intensive assets with low ROIs before they become a business detractor or decrease in value, e.g., surplus equipment, trucks, and vehicles. Business is not speculation. However, many business owners approach to inventory and asset management as such. It is best to remember that such speculative rewards are often simply a matter of time and chance. It’s like the Monopoly Chance card to pay for houses and hotels. It’s not a problem in the game of Monopoly unless someone speculates without considering the odds.

Although the definition of a strong balance sheet varies, the banker advising such in the second half of 2022 is astute. Do you have a strong balance sheet in your business (say 80%+ equity to assets), Congratulations! If you don’t know, talk with an advisor who can help you analyze and suggest actions to develop a plan to implement any necessary improvements.