Month: November 2018

Lending money to a cash-strapped friend or family member is a noble and generous offer that just might make a difference. But before you hand over the cash, you need to plan ahead to avoid tax complications for yourself down the road.

Take a look at this example: Let’s say you decide to loan $5,000 to your daughter who’s been out of work for over a year and is having difficulty keeping up with the mortgage payments on her condo. While you may be tempted to charge an interest rate of zero percent, you should resist the temptation.

Here’s why:

When you make an interest-free loan to someone, you will be subject to “below-market interest rules.” IRS rules state that you need to calculate imaginary interest payments from the borrower. These imaginary interest payments are then payable to you, and you will need to pay taxes on these interest payments when you file a tax return. To complicate matters further, if the imaginary interest payments exceed $15,000 for the year, there may be adverse gift and estate tax consequences.

Exception: The IRS lets you ignore the rules for small loans ($10,000 or less), as long as the aggregate loan amounts to a single borrower are less than $10,000, and the borrower doesn’t use the loan proceeds to buy or carry income-producing assets.

As was mentioned above, if you don’t charge any interest, or charge interest that is below market rate (more on this below), then the IRS might consider your loan a gift, especially if there is no formal documentation (i.e., written agreement with payment schedule), and you go to make a nonbusiness bad debt deduction if the borrower defaults on the loan–or the IRS decides to audit you and decides your loan is really a gift.

Formal documentation generally refers to a written promissory note that includes the interest rate, a repayment schedule showing dates and amounts for all principal and interest, and security or collateral for the loan, such as a residence (see below). Make sure that all parties sign the note so that it’s legally binding.

As long as you charge an interest rate that is at least equal to the applicable federal rate (AFR) approved by the Internal Revenue Service, you can avoid tax complications and unfavorable tax consequences.

AFRs for term loans, that is, loans with a defined repayment schedule, are updated monthly by the IRS and published in the IRS Bulletin. AFRs are based on the bond market, which changes frequently. For term loans, use the AFR published in the same month that you make the loan. The AFR is a fixed rate for the duration of the loan.

Any interest income that you make from the term loan is included on your Form 1040. In general, the borrower, who in this example is your daughter, cannot deduct interest paid, but there is one exception: if the loan is secured by her home, then the interest can be deducted as qualified residence interest–as long as the promissory note for the loan was secured by the residence.

If you have any questions about the tax implications of loaning a friend or family member money, please contact the office.

• By Leon Clinton
• November 14, 2018

While similar to FSAs (Flexible Savings Plans) in that both allow pre-tax contributions, Health Savings Accounts or HSAs offer taxpayers several additional tax benefits such as contributions that roll over from year to year (i.e., no “use it or lose it”), tax-free interest on earnings, and when used for qualified medical expenses, tax-free distributions.

What is a Health Savings Account?

A Health Savings Account is a type of savings account that allows you to set aside money pre-tax to pay for qualified medical expenses. Contributions that you make to a Health Savings Account (HSA) are used to pay current or future medical expenses (including after you’ve retired) of the account owner, his or her spouse, and any qualified dependent.

Caution: Medical expenses that are reimbursable by insurance or other sources and do not qualify for the medical expense deduction on a federal income tax return are not eligible.

Caution: Insurance premiums for taxpayers younger than age 65 are generally not considered qualified medical expenses unless the premiums are for health care continuation coverage (such as coverage under COBRA), health care coverage while receiving unemployment compensation under federal or state law.

You cannot be covered by other health insurance with the exception of insurance for accidents, disability, dental care, vision care, or long-term care and you cannot be claimed as a dependent on someone else’s tax return. Spouses cannot open joint HSAs. Each spouse who is an eligible individual who wants an HSA must open a separate HSA.

An HSA can be opened through your bank or another financial institution. Contributions to an HSA must be made in cash. Contributions of stock or property are not allowed. As an employee may be able to elect to have money set aside and deposited directly into an HSA account; however, if this option is not offered by your employer, then you must wait until filing a tax return to claim the HSA contributions as a deduction.

High Deductible Health Plans.

A Health Savings Account can only be used if you have a High Deductible Health Plan (HDHP). Typically, high-deductible health plans have lower monthly premiums than plans with lower deductibles, but you pay more health care costs yourself before the insurance company starts to pay its share (your deductible).

A high-deductible plan can be combined with a health savings account, allowing you to pay for certain medical expenses with tax-free money that you have set aside. By using the pre-tax funds in your HSA to pay for qualified medical expenses before you reach your deductible and other out-of-pocket costs such as copayments, you reduce your overall health care costs.

Calendar year 2018. For calendar year 2018, a qualifying HDHP must have a deductible of at least $1,350 for self-only coverage or $2,700 for family coverage. Annual out-of-pocket expenses (e.g., deductibles, copayments, and coinsurance) of the beneficiary are limited to $6,650 for self-only coverage and $13,300 for family coverage. This limit doesn’t apply to deductibles and expenses for out-of-network services if the plan uses a network of providers. Instead, only deductibles and out-of-pocket expenses for services within the network should be used to figure whether the limit applies.

Last month rule. Under the last-month rule, you are considered to be an eligible individual for the entire year if you are an eligible individual on the first day of the last month of your tax year (December 1 for most taxpayers).

You can make contributions to your HSA for 2018 until April 15, 2019. Your employer can make contributions to your HSA between January 1, 2019, and April 15, 2019, that are allocated to 2018. The contribution will be reported on your 2019 Form W-2.

Summary of HSA Tax Advantages

• Tax deductible. You can claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you don’t itemize your deductions on Schedule A (Form 1040).
• Pre-tax dollars. Contributions to your HSA made by your employer (including contributions made through a cafeteria plan) may be excluded from your gross income.
• Tax-free interest on earnings. Contributions remain in your account until you use them and are rolled over year after year. Any interest or other earnings on the assets in the account are tax-free. Furthermore, an HSA is “portable” and stays with you if you change employers or leave the workforce.
• Tax-free distributions. Distributions may be tax-free if you pay qualified medical expenses.
• Additional contributions for older workers. Employees, aged 55 years and older are able to save an additional $1,000 per year.
• Tax-free after retirement. Distributions are tax-free at age 65 when used for qualified medical expenses including amounts used to pay Medicare Part B and Part D premiums, and long-term care insurance policy premiums. However, you cannot use money in an HSA to pay for supplemental insurance (e.g., Medigap) premiums.

If you have any questions about HSAs, help is just a phone call away.

• By Leon Clinton
• November 11, 2018

There are a number of end of year tax planning strategies that businesses can use to reduce their tax burden for 2018. Here are a few of them:

Deferring Income

Businesses using the cash method of accounting can defer income into 2019 by delaying end-of-year invoices, so payment is not received until 2019. Businesses using the accrual method can defer income by postponing delivery of goods or services until January 2019.

Purchase New Business Equipment

Section 179 Expensing. Business should take advantage of Section 179 expensing this year for a couple of reasons. First, is that in 2018 businesses can elect to expense (deduct immediately) the entire cost of most new equipment up to a maximum of $1 million for the first $2.5 million of property placed in service by December 31, 2018. Keep in mind that the Section 179 deduction cannot exceed net taxable business income. The deduction is phased out dollar for dollar on amounts exceeding the $2.5 million threshold and eliminated above amounts exceeding $3.5 million.

Caution: The new law removes computer or peripheral equipment from the definition of listed property. This change applies to property placed in service after December 31, 2017.

Tax reform legislation also expanded the definition of Section 179 property to allow the taxpayer to elect to include certain improvements made to nonresidential real property after the date when the property was first placed in service (see below). These changes apply to property placed in service in taxable years beginning after December 31, 2017.

1. Qualified improvement property, which means any improvement to a building’s interior. However, improvements do not qualify if they are attributable to:

• the enlargement of the building,
• any elevator or escalator or
• the internal structural framework of the building.

2. Roofs, HVAC, fire protection systems, alarm systems and security systems.

Bonus Depreciation. Businesses are allowed to immediately deduct 100% of the cost of eligible property placed in service after September 27, 2017, and before January 1, 2023, after which it will be phased downward over a four-year period: 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026.

Qualified Property

Qualified property is defined as property that you placed in service during the tax year and used predominantly (more than 50 percent) in your trade or business. Property that is placed in service and then disposed of in that same tax year does not qualify, nor does property converted to personal use in the same tax year it is acquired.

Note: Many states have not matched these amounts and, therefore, state tax may not allow for the maximum federal deduction. In this case, two sets of depreciation records will be needed to track the federal and state tax impact.

Please contact the office if you have any questions regarding qualified property.

If you plan to purchase business equipment this year, consider the timing. You might be able to increase your tax benefit if you buy equipment at the right time. Here’s a simplified explanation:

Conventions. The tax rules for depreciation include “conventions” or rules for figuring out how many months of depreciation you can claim. There are three types of conventions. To select the correct convention, you must know the type of property and when you placed the property in service.

1. 1. The half-year convention: This convention applies to all property except residential rental property, nonresidential real property, and railroad gradings and tunnel bores (see mid-month convention below) unless the mid-quarter convention applies. All property that you begin using during the year is treated as “placed in service” (or “disposed of”) at the midpoint of the year. This means that no matter when you begin using (or dispose of) the property, you treat it as if you began using it in the middle of the year.

Example: You buy a $70,000 piece of machinery on December 15. If the half-year convention applies, you get one-half year of depreciation on that machine.

1. 1. The mid-quarter convention: The mid-quarter convention must be used if the cost of equipment placed in service during the last three months of the tax year is more than 40 percent of the total cost of all property placed in service for the entire year. If the mid-quarter convention applies, the half-year rule does not apply, and you treat all equipment placed in service during the year as if it were placed in service at the midpoint of the quarter in which you began using it.
   2. The mid-month convention: This convention applies only to residential rental property, nonresidential real property, and railroad gradings and tunnel bores. It treats all property placed in service (or disposed of) during any month as placed in service (or disposed of) on the midpoint of that month.

If you’re planning on buying equipment for your business, call the office and speak with a tax professional who can help you figure out the best time to buy that equipment and take full advantage of these tax rules.

Other Year-End Moves to Take Advantage Of

Small Business Health Care Tax Credit. Small business employers with 25 or fewer full-time-equivalent employees with average annual wages of $50,000 indexed for inflation (e.g., $52,400 in 2017) may qualify for a tax credit to help pay for employees’ health insurance. The credit is 50 percent (35 percent for non-profits).

Business Energy Investment Tax Credits. Business energy investment tax credits are still available for eligible systems placed in service on or before December 31, 2022, and businesses that want to take advantage of these tax credits can still do so.

Business energy credits include geothermal electric, large wind (expires 2020), and solar energy systems used to generate electricity, to heat or cool (or to provide hot water for use in) a structure, or to provide solar process heat. Hybrid solar lighting systems, which use solar energy to illuminate the inside of a structure using fiber-optic distributed sunlight, are eligible; however, passive solar and solar pool-heating systems excluded are excluded. Utilities are allowed to use the credits as well.

Repair Regulations. Where possible, end of year repairs and expenses should be deducted immediately, rather than capitalized and depreciated. Small businesses lacking applicable financial statements (AFS) are able to take advantage of de minimis safe harbor by electing to deduct smaller purchases ($2,500 or less per purchase or per invoice). Businesses with applicable financial statements are able to deduct $5,000. Small business with gross receipts of $10 million or less can also take advantage of safe harbor for repairs, maintenance, and improvements to eligible buildings. Please call if you would like more information on this topic.

Qualified Business Income Deduction.

Under the Tax Cuts and Jobs Act non-corporations) may be entitled to a deduction of up to 20 percent of their qualified business income (QBI) from a qualified trade or business for tax years 2018 through 2025. To take advantage of the deduction, taxable income must be under $157,500 ($315,000 for joint returns).

The QBI is complex, and tax planning strategies can directly affect the amount of deduction, i.e., increase or reduce the dollar amount. As such it is especially important to speak with a tax professional before year’s end to determine the best way to maximize the deduction.

Caution: The QBI is also known as the Section 199A deduction, not to be confused with the Section 199 deduction for domestic production activities, which was repealed under tax reform for tax years starting in 2018.

Depreciation Limitations on Luxury, Passenger Automobiles and Heavy Vehicles

The new law changed depreciation limits for luxury passenger vehicles placed in service after December 31, 2017. If the taxpayer doesn’t claim bonus depreciation, the maximum allowable depreciation deduction is $10,000 for the first year.

For passenger autos eligible for the additional bonus first-year depreciation, the maximum first-year depreciation allowance remains at $8,000. It applies to new and used (“new to you”) vehicles acquired and placed in service after September 27, 2017, and remains in effect for tax years through December 31, 2022. When combined with the increased depreciation allowance above, the deduction amounts to as much as $18,000.

Under tax reform, heavy vehicles including pickup trucks, vans, and SUVs whose gross vehicle weight rating (GVWR) is more than 6,000 pounds are treated as transportation equipment instead of passenger vehicles. As such, heavy vehicles (new or used) placed into service after September 27, 2017, and before January 1, 2023, qualify for a 100 percent first-year bonus depreciation deduction as well.

Note: Deductions are based on a percentage of business use; i.e., a business owner whose business use of the vehicle is 100 percent can take a larger deduction than one whose business use of a car is only 50 percent.

Retirement Plans. Self-employed individuals who have not yet done so should set up self-employed retirement plans before the end of 2018. Call today if you need help setting up a retirement plan.

Dividend Planning. Reduce accumulated corporate profits and earnings by issuing corporate dividends to shareholders.

Call a Tax Professional First

These are just a few of the year-end planning tax moves that could make a substantial difference in your tax bill for 2018. If you’d like more information about tax planning for 2019, please call to schedule a consultation to discuss your specific tax and financial needs, and develop a plan that works for your business.

• By Leon Clinton
• November 8, 2018