Tax

I hope this message finds you well. I am writing to provide valuable insights regarding the tax implications of business meals.

As you may already be aware, there is a contradiction in the tax laws regarding personal living expenses, specifically personal meals and business meal tax deductions.

This is best illustrated by what tax professionals call the “Sutter rule.” Dr. Sutter, from whom the rule takes its name, lost the deductions for his chamber of commerce lunches and his lunches while serving on a hospital board, all because the cost of those business lunches did not exceed his personal meal costs.

The IRS invokes the Sutter rule without any specific standard, generally focusing on what it perceives as abuse or a disproportionately high number of business meals deducted. Interestingly, the IRS has applied this rule only to in-town business meals, not to those consumed while traveling for business.

Given this complex landscape, it is important to formulate an effective defense strategy. This essentially involves two elements: logic and legislation.

• The logic defense involves demonstrating that your business meals are more expensive than your personal meals.
• The legislative defense rests on the lawmakers who reduced business meal deductions to 80 percent and later to 50 percent, thereby accounting for the personal benefits.

To ensure your meal deductions, it’s critical to have the following:

• Receipts showing the purchases (food and drinks consumed)
• Proof of payment (credit card receipt/statement or canceled check)
• Names of the people with whom you had the meals
• A record of the business reason for the meal

For example, if you and a client, Harry Smith, have a Dutch-treat dinner that costs you $100, you should keep the receipt showing the food and drink as well as the second receipt showing the $100 charge to your credit card. On the receipt, you should write: “Harry Smith, client, $100 (my half), maintain relationship.”

Note in our example that you did not have to pay for Harry’s dinner to deduct your dinner. You simply had to have an ordinary business reason for dinner with Harry. But both Dutch-treat and business meals where you pick up the tab for all face the Sutter rule.

Understanding the Sutter rule, identifying its triggers, and building a defense are crucial steps in managing your business meal deductions. Please feel free to call me on my direct line if you would like to discuss the Sutter rule.

• By Leon Clinton
• September 15, 2023

The individual coverage health reimbursement arrangement (ICHRA) allows businesses of all sizes, from large corporations to small businesses like yours, to reimburse employees for their personally purchased health insurance expenses.

The ICHRA is particularly beneficial for businesses with fewer than 50 employees because they are not obligated to provide health benefits under the Affordable Care Act. But when they do provide coverage, they expose themselves to a $100-per-day penalty for each employee. The ICHRA avoids this penalty.

The ICHRA offers several benefits to the employer, including

• the flexibility to choose the reimbursement limits,
• the ability to offer different plans to different employees based on classifications, and
• the ability to offer a cafeteria plan that allows employees to pay pre-tax for additional insurance coverage above what the ICHRA reimburses.

There are restrictions on who can participate. Employees eligible for an ICHRA are those enrolled in individual Exchange coverage, other individual insurance coverage, or Medicare. More-than-2-percent S corporation shareholders, their family members, and Form 1040, Schedule C taxpayers are not eligible to participate in an ICHRA.

If you plan to offer an ICHRA, you need to provide your employees with at least a 90-day notice before the beginning of the plan year. We encourage you to start planning now if you wish to offer an ICHRA on January 1, 2024, as this gives you a target date for the ICHRA notice of October 2, 2023.

As your trusted advisor, I am here to guide you through these changes and help you make the best decision for your business. I recommend we discuss whether the ICHRA could be a suitable option for your organization. If this sounds good, please call me on my direct line at 408-778-9651, and we’ll set up a meeting.

• By Leon Clinton
• September 12, 2023

We have some critical updates on the pass-through entity tax (PTET), which has recently become the rule in most states rather than the exception.

The PTET enables owners of pass-through businesses, such as S corporations and multi-member LLCs, to navigate around the $10,000 annual limit on state and local taxes (SALT).

How PTET Works

The PTET process is relatively straightforward. A pass-through entity (PTE) can choose to pay state income tax on its business income, which would otherwise pass on to its owners.

The PTE then claims a federal business expense deduction for these state income tax payments. Next, the states allow the owners to claim a credit or a deduction for these taxes, which avoids the SALT limit.

Consequently, owners benefit from the federal deduction against their state income tax and avoid the $10,000 SALT limit on some or all of their pass-through income.

State Updates

Currently, 36 of the 41 states imposing income taxes have adopted some form of PTET. So far, in 2023, Hawaii, Indiana, Iowa, Kentucky, Montana, Nebraska, and West Virginia have enacted a PTET.

Of these, Indiana, Iowa, Kentucky, and West Virginia have made their PTET retroactive to 2022, while Nebraska’s new PTET is retroactive to 2018. Hawaii’s and Montana’s PTETs are not retroactive.

Eligibility

In all states with a PTET, partnerships, S corporations, and multi-member LLCs taxed as partnerships or S corporations are eligible to elect to pay a state PTET. Sole proprietorships, single-member LLCs taxed as sole proprietorships, C corporations, trusts in most states, and LLCs taxed as C corporations are not eligible.

Deadline for PTET Election

No state (except Connecticut) requires a PTE to pay a state PTET; the PTE must elect to do so. The due dates for making the PTET election vary from state to state.

PTET Opt-Outs

In most states, a PTET election is binding on all the PTE’s owners, and individual owners cannot opt out. The only exceptions are Arizona, California, New York, and Utah.

Please call me directly at 408-778-9651 if you have questions about the PTET.

• By Leon Clinton
• September 10, 2023