Estate planning has a language all its own. While you may be familiar with common terms such as a will, a trust or an executor, you may not be as certain about others. For quick reference, here’s a glossary of key terms you may come across when planning your estate:

Administrator. An individual or fiduciary appointed by a court to manage an estate if no executor or personal representative has been appointed or the appointee is unable or unwilling to serve.

Ascertainable standard. The legal standard, typically relating to an individual’s health, education, maintenance and support, which is used to determine what distributions are permitted from a trust.

Attorney-in-fact. The individual named under a power of attorney as the agent to handle the financial and/or health affairs of another person.

Codicil. A legally binding document that makes minor modifications to an existing will without requiring a complete rewrite of the document.

Community property. A form of ownership in certain states in which property acquired during a marriage is presumed to be jointly owned regardless of who paid for it.

Credit shelter trust. A trust established to bypass the surviving spouse’s estate to take full advantage of each spouse’s federal estate tax exemption. It’s also known as a bypass trust or A-B trust.

Fiduciary. An individual or entity, such as an executor or trustee, designated to manage assets or funds for beneficiaries and legally required to exercise an established standard of care.

Grantor trust. A trust in which the grantor retains certain control so that it’s disregarded for income tax purposes and the trust’s assets are included in the grantor’s taxable estate.

Inter vivos. The legal phrase used to describe various actions (such as transfers to a trust) made by an individual during his or her lifetime.

Intestacy. When a person dies without a legally valid will, the deceased’s estate is distributed in accordance with the applicable state’s intestacy laws.

Joint tenancy. An ownership right in which two or more individuals (such as a married couple) own assets, often with rights of survivorship.

No-contest clause. A provision in a will or trust that ensures that an individual who pursues a legal challenge to assets will forfeit his or her inheritance or interest.

Pour-over will. A will used upon death to pass ownership of assets that weren’t transferred to a revocable trust.

Power of appointment. The power granted to an individual under a trust that authorizes him or her to distribute assets on the termination of his or her interest in the trust or on certain other circumstances.

Power of attorney (POA). A legal document authorizing someone to act as attorney-in-fact for another person, relating to financial and/or health matters. A “durable” POA continues if the person is incapacitated.

Probate. The legal process of settling an estate in which the validity of the will is proven, the deceased’s assets are identified and distributed, and debts and taxes are paid.

Qualified disclaimer. The formal refusal by a beneficiary to accept an inheritance or gift or to allow the inheritance or gift to pass to the successor beneficiary.

Qualified terminable interest property (QTIP). Property in a trust or life estate that qualifies for the marital deduction because the surviving spouse is the sole beneficiary during his or her lifetime. The assets of the QTIP trust are therefore included in the estate of the surviving spouse, that is, the spouse who is the beneficiary of the trust, not the estate of the spouse who created the trust.

Spendthrift clause. A clause in a will or trust restricting the ability of a beneficiary (such as a child under a specified age) to transfer or distribute assets.

Tenancy by the entirety. An ownership right between two spouses in which property automatically passes to the surviving spouse on the death of the first spouse.

Tenancy in common. An ownership right in which each person possesses rights and ownership of an undivided interest in the property.

Keep in mind that this is just a brief roundup of some estate planning terms. If you have questions about their meanings or others, contact us. We’d be pleased to provide context to any estate planning terms that you’re unfamiliar with.

© 2024

Choosing the right business entity has many implications, including the amount of your tax bill. The most common business structures are sole proprietorships, partnerships, limited liability companies, C corporations and S corporations.

In some cases, a business may decide to switch from one entity type to another. Although S corporations can provide substantial tax benefits over C corporations in some circumstances, there are potentially costly tax issues that you should assess before making the decision to convert from a C corporation to an S corporation.

Here are four considerations:

1. LIFO inventories. C corporations that use last-in, first-out (LIFO) inventories must pay tax on the benefits they derived by using LIFO if they convert to S corporations. The tax can be spread over four years. This cost must be weighed against the potential tax gains from converting to S status.

2. Built-in gains tax. Although S corporations generally aren’t subject to tax, those that were formerly C corporations are taxed on built-in gains (such as appreciated property) that the C corporation has when the S election becomes effective, if those gains are recognized within five years after the conversion. This is generally unfavorable, although there are situations where the S election still can produce a better tax result despite the built-in gains tax.

3. Passive income. S corporations that were formerly C corporations are subject to a special tax. It kicks in if their passive investment income (including dividends, interest, rents, royalties, and stock sale gains) exceeds 25% of their gross receipts, and the S corporation has accumulated earnings and profits carried over from its C corporation years. If that tax is owed for three consecutive years, the corporation’s election to be an S corporation terminates. You can avoid the tax by distributing the accumulated earnings and profits, which would be taxable to shareholders. Or you might want to avoid the tax by limiting the amount of passive income.

4. Unused losses. If your C corporation has unused net operating losses, they can’t be used to offset its income as an S corporation and can’t be passed through to shareholders. If the losses can’t be carried back to an earlier C corporation year, it will be necessary to weigh the cost of giving up the losses against the tax savings expected to be generated by the switch to S status.

Other issues to explore

These are only some of the factors to consider when switching a business from C to S status. For example, shareholder-employees of S corporations can’t get all the tax-free fringe benefits that are available as a C corporation. And there may be issues for shareholders who have outstanding loans from their qualified plans. These factors must be taken into account in order to understand the implications of converting from C to S status.

If you’re interested in an entity conversion, contact us. We can explain what your options are, how they’ll affect your tax bill and some possible strategies you can use to minimize taxes.

© 2024

A living will could provide peace of mind for both you and your family should the unthinkable occur. Yet many people neglect to draft this important estate planning document.

Will vs. living will

It’s not uncommon for a living will to be confused with a last will and testament, but they aren’t the same thing. These separate documents serve different, but vital, purposes.

A last will and testament is what many people think of when they hear the term “will.” This document details how your assets will generally be distributed when you die. A living will (or health care directive) details how life-sustaining medical treatment decisions would be made if you were to become incapacitated and unable to communicate them yourself.

The thought of becoming terminally ill or entering into a coma isn’t pleasant, which is one reason why many people put off creating a living will. However, it’s important to think through what you’d like to happen should this ever occur. A living will is the vehicle for ensuring your wishes are carried out.

For example, if you were in a permanent vegetative state due to an accident, with little or no medical chance of ever coming out of the coma, would you want your life to be artificially prolonged by machines and feeding tubes? Ideally, you’re the one who should make this decision, not grief-stricken relatives and loved ones who may not be sure what your wishes would be — or who might not abide by them.

Other important documents

Often, a living will is drafted in conjunction with two other documents: a durable power of attorney for property and a health care power of attorney.

The durable power of attorney identifies someone who can handle your financial affairs — paying bills and other routine tasks — should you become incapacitated. The health care power of attorney becomes effective if you’re incapacitated, but not terminal or in a vegetative state. Your designee can make medical decisions, but not life-sustaining ones, on your behalf if you’re unable to do so.

Seek assistance in drafting your living will

It’s important to work closely with an attorney in drafting your living will (as well as your durable power of attorney and power of attorney for health care). Be sure to also discuss the details of these important documents with your loved ones.

Keep in mind that these documents aren’t cast in stone. You can revoke them at any time if you change your mind about how you’d like life-sustaining decisions to be made or whom you’d like to handle financial and medical decisions.

© 2024

If you follow the news, you’ve probably heard a lot about artificial intelligence (AI) and how it’s slowly and steadily expanding into various aspects of our lives. One widely cited example is ChatGPT, an AI “chatbot” that can engage in conversations with users and create coherently written articles, as well as other content, when prompted.

ChatGPT and other similar chatbots are what’s known as “generative” AI. The operative word there refers to software that’s able to generate new content based on input from users and existing data either inputted during development or gathered from the internet.

Along with college students and the curious, more and more businesses are joining the ranks of generative AI users. Research and advisory firm Gartner surveyed more than 1,400 company leaders in September 2023. Two in five (40%) said their organizations were piloting generative AI programs — a substantial increase from the 15% results of the same survey conducted by Gartner about six months earlier.

Imagine the possibilities

Naturally, how companies are using generative AI depends on factors such as industry, mission, operational needs and strategic objectives. But it can be informative to look at a few examples.

In consumer goods and retail, for instance, businesses are using generative AI to create new product designs, optimize materials and align aesthetics with the latest trends. In the energy sector, it’s being used to improve supply chain logistics and better forecast demand. In health care, generative AI is helping accelerate scientific research and enhance medical imaging.

More generally, this technology could help many types of businesses:

• Generate marketing and advertising content,
• Analyze financial data and produce reports that assess risk or draw trendlines, and
• Develop chatbots or other means to automate customer service.

There’s no harm in letting your imagination run wild. Think about what types of content and knowledge AI could create for your company that, in years previous, would’ve probably only been possible to develop by hiring new employees or engaging consultants.

Be methodical

Of course, pondering the possibilities of generative AI should never translate to blindly throwing money at it. To start exploring the possibilities, sit down with your leadership group and discuss the topic.

If you’re wholly new to it, be sure everyone does some preliminary research. You might even ask an IT staffer or someone else knowledgeable about AI to do a presentation. As part of your research and discussion, make sure to learn about the potential legal and public relations liabilities.

Should everyone agree that pursuing generative AI is a good strategic decision, form a project team to identify “use cases” — that is, specific ways your business could use it to deliver practical, competitive functionalities. Prioritize the use cases you come up with and choose a winner to go after first.

You may be able to buy an AI product to fulfill this need. In such a case, you’d have to shop carefully, thoroughly train the appropriate staff members and cautiously roll out the solution. Doing so would be relatively simpler than developing your own AI app, but you’d need to manage the purchase and implementation with return on investment firmly in mind.

The other option is to indeed create your own proprietary generative AI app. This would likely be a much more costly and labor-intensive option, but you’d be able to customize the solution to your ultra-specific needs.

Prepare for the future

What can generative AI do for your business? Maybe a little, maybe a lot. One thing’s for sure, its influence on how business is done will only get stronger in the years ahead. We can help you assess the costs vs. benefits of this or any other technology.

© 2024

Let’s say you plan to use a C corporation to operate a newly acquired business or you have an existing C corporation that needs more capital. You should know that the federal tax code treats corporate debt more favorably than corporate equity. So for shareholders of closely held C corporations, it can be a tax-smart move to include in the corporation’s capital structure:

• Some third-party debt (owed to outside lenders), and/or
• Some owner debt.

Tax rate considerations

Let’s review some basics. The top individual federal income tax rate is currently 37%. The top individual federal rate on net long-term capital gains and qualified dividends is currently 20%. On top of this, higher-income individuals may also owe the 3.8% net investment income tax on all or part of their investment income, which includes capital gains, dividends and interest.

On the corporate side, the Tax Cuts and Jobs Act (TCJA) established a flat 21% federal income tax rate on taxable income recognized by C corporations.

Third-party debt

The non-tax advantage of using third-party debt financing for a C corporation acquisition or to supply additional capital is that shareholders don’t need to commit as much of their own money.

Even when shareholders can afford to cover the entire cost with their own money, tax considerations may make doing so inadvisable. That’s because a shareholder generally can’t withdraw all or part of a corporate equity investment without worrying about the threat of double taxation. This occurs when the corporation pays tax on its profits and the shareholders pay tax again when the profits are distributed as dividends.

When third-party debt is used in a corporation’s capital structure, it becomes less likely that shareholders will need to be paid taxable dividends because they’ll have less money tied up in the business. The corporate cash flow can be used to pay off the corporate debt, at which point the shareholders will own 100% of the corporation with a smaller investment on their part.

Owner debt

If your entire interest in a successful C corporation is in the form of equity, double taxation can arise if you want to withdraw some of your investment. But if you include owner debt (money you loan to the corporation) in the capital structure, you have a built-in mechanism for withdrawing that part of your investment tax-free. That’s because the loan principal repayments made to you are tax-free. Of course, you must include the interest payments in your taxable income. But the corporation will get an offsetting interest expense deduction — unless an interest expense limitation rule applies, which is unlikely for a small to medium-sized company.

An unfavorable TCJA change imposed a limit on interest deductions for affected businesses. However, for 2024, a corporation with average annual gross receipts of $30 million or less for the three previous tax years is exempt from the limit.

An example to illustrate

Let’s say you plan to use your solely owned C corporation to buy the assets of an existing business. You plan to fund the entire $5 million cost with your own money — in a $2 million contribution to the corporation’s capital (a stock investment), plus a $3 million loan to the corporation.

This capital structure allows you to recover $3 million of your investment as tax-free repayments of corporate debt principal. The interest payments allow you to receive additional cash from the corporation. The interest is taxable to you but can be deducted by the corporation, as long as the limitation explained earlier doesn’t apply.

This illustrates the potential federal income tax advantages of including debt in the capital structure of a C corporation. Contact us to explain the relevant details and project the tax savings.

© 2024

Does your estate plan call for making gifts to your grandchildren or other loved ones more than one generation below you? Or, perhaps to you want to leave assets to nonrelatives who are decades younger than you? If so, your plan must address not only gift and estate taxes, but also the generation-skipping transfer (GST) tax.

What is the GST tax?

The GST tax is one of the harshest in the Internal Revenue Code. It’s a flat 40% tax on asset transfers to “skip persons” — that is, your grandchildren, other family members who are more than one generation below you or nonfamily members who are more than 37½ years younger than you. The GST tax is calculated independently from, and is in addition to, gift and estate taxes, so it can take a significant bite out of your hard-earned wealth.

Fortunately, the law provides a generous GST tax exemption. Indeed, under the Tax Cuts and Jobs Act, for the estates of persons dying after December 31, 2017, and before January 1, 2026, the GST tax exemption amount is an inflation-adjusted $10 million ($13.61 million for 2024). Without congressional action, the exemption will revert to an inflation-adjusted $5 million beginning January 1, 2026.

Careful planning is required, however, to make the most of the exemption. In some cases, for an exemption to apply, you must allocate it to particular assets via an affirmative election on a timely filed gift tax return. In other cases, the exemption is allocated automatically (unless you opt out), which can lead to unwanted results if you prefer to allocate your exemption elsewhere.

To avoid costly mistakes, it’s a good idea to review each transfer for potential GST tax liability. Also, take steps to ensure that your exemption is allocated in the most advantageous manner.

What transfers are taxable?

The GST tax applies to direct gifts to skip persons, as well as to these two types of transfers involving trusts:

1. Taxable terminations. Trust assets pass to your grandchildren when your child dies and the trust terminates.
2. Taxable distributions. Trust income or principal is distributed to a skip person.

The GST tax doesn’t apply to direct gifts that are covered by the annual gift tax exclusion (currently, $18,000 per recipient or $36,000 for “split” gifts per recipient by a married couple).

What protection do automatic allocation rules provide?

The automatic allocation rules are intended to protect you against inadvertent loss of GST tax exemptions. For example, if you make a direct gift in excess of the annual gift tax exclusion to a grandchild or other skip person, your unused GST tax exemption is automatically applied to the gift without the need to make an allocation on a gift tax return. The exemption is also allocated automatically to “GST trusts.” The rules are complex, but in general, a trust is considered a GST trust if there’s a possibility it will benefit your grandchildren or other skip persons in the future.

In many cases, the automatic allocation rules work well, ensuring that the GST tax exemption is used where it’s needed most. But in some cases, the rules may lead to unintended — and potentially costly — results.

GST exemption amount isn’t permanent

Thanks to the currently high GST tax exemption amount, fewer families will be affected by the tax. But there are still reasons to plan for this tax. Indeed, after 2025, and without action from Congress, the GST tax exemption amount will be significantly less. Contact us with questions regarding the GST tax.

© 2024

For businesses, cost-effectively sponsoring a health insurance plan for employees is an ongoing battle. In the broadest sense, you have two options: fully insured or self-funded.

A fully insured plan is simply one you buy from an insurer. Doing so limits your financial risk while offering the most predictable costs. The other option is what’s commonly known as “self-insurance.” Under this approach, your company funds and manages the plan, usually with the help of a third-party administrator.

If you’re tired of dealing with big insurers, and you’re prepared to design your own plan and handle the claims process, self-insurance may be for you. However, bear in mind that your business will incur the full financial risk of a self-funded plan — and health care costs can be unpredictable and potentially catastrophic. That’s why, if you’re seriously considering self-insurance, you’ll also need to familiarize yourself with stop-loss coverage.

Basic features

Stop-loss coverage is essentially insurance for your health insurance. These high-deductible policies help protect against unpredictably high or catastrophic losses.

More specifically, stop-loss coverage kicks in once an individual claim and, if the self-insured policy is so designed, annual aggregate claims reach a contracted threshold known as the “attachment point.” Some stop-loss policies cover only individual claims — known as “specific” coverage — instead of providing both specific and aggregate claims protection.

Typically, the larger and more profitable the business, the higher the stop-loss deductible and attachment point. This is because larger companies are usually less financially vulnerable to an occasionally catastrophic medical claim. Self-insurance generally isn’t economically advantageous for companies with fewer than about 75 employees.

Claims and coverage

Aggregate claims protection typically works like this: You and your broker or claims administrator agree on an estimate of what total claims will be in the upcoming year, based on your recent claims experience. Let’s say it’s $1 million. The aggregate attachment point generally will be set at 125% of that amount — that is, claims will be covered when you have already paid out $1.25 million.

There can be a complicating factor, however, known as a “laser.” A stop-loss carrier, or you, might decide that an employee with a high medical risk profile needs to be “lasered” out of the terms that apply to other employees covered by the stop-loss policy. Instead, you’ll remain on the hook for a much higher amount before stop-loss protection kicks in. You might request a laser to lower your premium, or the stop-loss carrier might demand it to manage its risk.

What’s a typical specific coverage amount? As with the decision of whether to include an aggregate claims limit on your stop-loss coverage, the answer generally varies according to business size. Many stop-loss buyers pick an attachment point for individual claims at below $250,000, with some businesses setting the limit below $75,000. However, some set higher limits as well.

Basically, it’s a question of how much financial protection you’re willing to pay for. Going with a higher attachment gets you lower premiums. For example, a premium per covered employee with a $100,000 deductible might be around twice as high as it would be for one with a $200,000 deductible, and more than five times as high as one with a $500,000 attachment point.

Many challenges

As you can see, self-insurance has many challenges — starting with stop-loss coverage, which is a necessity. Nevertheless, it can be an effective approach under the right circumstances. We can help you assess the costs, risks and potential advantages of self-insuring vs. fully insuring.

© 2024

If your company has been in business for a while, you may not pay much attention to your payroll system so long as it’s running smoothly. But don’t get too complacent. Major payroll errors can pop up unexpectedly — creating huge disruptions costing time and money to fix, and, perhaps worst of all, compromising the trust of your employees.

For these reasons, businesses are well-advised to conduct payroll audits at least once annually to guard against the many risks inherent to payroll management. Here are seven such risks to be aware of:

1. Inaccurate recordkeeping. If you don’t keep detailed and accurate records, it will probably come back to haunt you. For example, the Fair Labor Standards Act (FLSA) requires businesses to maintain records of employees’ earnings for at least three years. Violations of the FLSA can trigger severe penalties. Be sure you and your staff know what records to keep and have sound policies and procedures in place for keeping them.

2. Employee misclassification. Given the widespread use of “gig workers” in today’s economy, companies are at high risk for employee misclassification. This occurs when a business engages independent contractors but, in the view of federal authorities, the company treats them like employees. Violating the applicable rules can leave you owing back taxes and penalties, plus you may have to restore expensive fringe benefits.

3. Manual processes. More than likely, if your business prepares its own payroll, it uses some form of payroll software. That’s good. Today’s products are widely available, relatively inexpensive and generally easy to use. However, some companies — particularly small ones — may still rely on manual processes to record or input critical data. Be careful about this, as it’s a major source of errors. To the extent feasible, automate as much as you can.

4. Privacy violations. You generally can’t manage payroll without data such as Social Security numbers, home addresses, birth dates and bank account numbers. Unfortunately, possessing such information puts you squarely in the sights of hackers and those pernicious purveyors of ransomware. Invest thoroughly in proper cybersecurity measures and regularly update these safeguards.

5. Internal fraud. Occupational (or internal) fraud remains a major threat to businesses. Schemes can range from “cheating” on timesheets by rank-and-file workers to embezzlement by those higher on the organizational chart. Among the most fundamental ways to protect your payroll function from fraud is to require segregation of duties. In other words, one employee, no matter how trusted, should never completely control the process. If you don’t have enough employees to segregate duties, consider outsourcing.

6. Legal compliance. As a business owner, you’re probably not an expert on the latest regulatory payroll developments affecting your industry. That’s OK; laws and regulations are constantly evolving. However, failing to comply with the current rules could cost you money and hurt your company’s reputation. So, be sure to have a trustworthy attorney on speed dial that you can turn to for assistance when necessary.

7. Tax compliance. Employers are responsible for calculating tax withholding on employee wages. In addition to deducting federal payroll tax from paychecks, your organization must contribute its own share of payroll tax. If you get it wrong, the IRS could investigate and potentially assess additional tax liability and penalties. That’s where we come in. For help conducting a payroll audit, reviewing your payroll costs and, of course, managing your tax obligations, contact us.

© 2024  

It’s not uncommon for people to address the fact that they may one day become physically incapacitated and unable to make critical medical decisions themselves. They do this by including health care powers of attorney or advance directives in their estate plans.

But what if your family has history of mental illness? Is there a way to memorialize your wishes in the event a psychiatric episode renders you unable to make decisions about your treatment? A psychiatric advance directive may be the answer.

Health care directives

To cover all the health care bases, it’s a good idea to have two documents: an advance health care directive (sometimes referred to as a “living will”) and a health care power of attorney (HCPA). Some states allow you to combine the two in a single document.

An advance directive expresses your preferences for the use of life-sustaining medical procedures — such as artificial feeding and breathing, surgery, invasive diagnostic tests, and pain medication — specifying the situations when these procedures should be used or withheld.

However, a document prepared in advance can’t account for every scenario or contingency so it’s wise to pair an advance directive with an HCPA. This allows you to authorize your spouse or other trusted representative to make medical decisions or consent to medical treatment on your behalf when you’re unable to do so. An HCPA can include specific instructions to your representative, as well as general guidelines or principles to follow in dealing with complex medical decisions or unanticipated circumstances.

Psychiatric advance directive

Many states allow generic HCPAs and advance directives to address mental as well as physical health issues. But some states limit or prohibit mental health treatment decisions by general health care representatives. Around half of the states have psychiatric advance directive statutes, which authorize special advance directives to outline one’s wishes with respect to mental health care and appoint a representative to make decisions regarding that care.

A psychiatric advance directive may address a variety of mental health care issues, including:

• Preferred hospitals or other providers,
• Treatment therapies and medications that may be administered,
• Treatment therapies and medications that may not be administered, such as electroconvulsive therapy or experimental drugs,
• A statement of general values, principles or preferences to follow in making mental health care decisions, and
• Appointment of a representative authorized to make decisions and carry out your wishes with respect to mental health care in the event you’re incapacitated.

Although requirements vary from state to state, to be effective, a psychiatric advance directive must be signed by you and your chosen representative, and in some states by two witnesses. Be sure to discuss the terms of the psychiatric advance directive with your family, close friends, physicians and mental health care providers.

Ease your concerns

If you’re concerned about the possibility of mental illness and want to properly address it in your estate plan, a psychiatric advance directive is worth looking into. Consider one if it’s available in your state or look into options for using generic advance directives and HCPAs to address mental health care.

© 2024

If you operate a business, or you’re starting a new one, you know records of income and expenses need to be kept. Specifically, you should carefully record expenses to claim all the tax deductions to which you’re entitled. And you want to make sure you can defend the amounts reported on your tax returns in case you’re ever audited by the IRS.

Be aware that there’s no one way to keep business records. On its website, the IRS states: “You can choose any recordkeeping system suited to your business that clearly shows your income and expenses.” But there are strict rules when it comes to deducting legitimate expenses for tax purposes. And certain types of expenses, such as automobile, travel, meal and home office costs, require extra attention because they’re subject to special recordkeeping requirements or limitations on deductibility.

Ordinary and necessary

A business expense can be deducted if a taxpayer establishes that the primary objective of the activity is making a profit. To be deductible, a business expense must be “ordinary and necessary.” In one recent case, a married couple claimed business deductions that the IRS and the U.S. Tax Court mostly disallowed. The reasons: The expenses were found to be personal in nature and the taxpayers didn’t have adequate records for them.

In the case, the husband was a salaried executive. With his wife, he started a separate business as an S corporation. His sideline business identified new markets for chemical producers and connected them with potential customers. The couple’s two sons began working for the business when they were in high school.

The couple then formed a separate C corporation that engaged in marketing. For some of the years in question, the taxpayers reported the income and expenses of the businesses on their joint tax returns. The businesses conducted meetings at properties the family owned (and resided in) and paid the couple rent for the meetings.

The IRS selected the couple’s returns for audit. Among the deductions the IRS and the Tax Court disallowed:

• Travel expenses. The couple submitted reconstructed travel logs to the court, rather than records kept contemporaneously. The court noted that the couple didn’t provide “any documentary evidence or other direct or circumstantial evidence of the time, location, and business purpose of each reported travel expense.”
• Marketing fees paid by the S corporation to the C corporation. The court found that no marketing or promotion was done. Instead, the funds were used to pay several personal family expenses.
• Rent paid to the couple for the business use of their homes. The court stated the amounts “were unreasonable and something other than rent.”

Retirement plan deductions allowed

The couple did prevail on deductions for contributions to 401(k) accounts for their sons. The IRS contended that the sons weren’t employees during one year in which contributions were made for them. However, the court found that 401(k) plan documents did mention the sons working in the business and the father “credibly recounted assigning them research tasks and overseeing their work while they were in school.” Thus, the court ruled the taxpayers were entitled to the retirement plan deductions. (TC Memo 2023-140)

Lessons learned

As this case illustrates, a business can’t deduct personal expenses, and scrupulous records are critical. Make sure to use your business bank account for business purposes only. In addition, maintain meticulous records to help prepare your tax returns and prove deductible business expenses in the event of an IRS audit.

Contact us if you have questions about retaining adequate business records.

© 2024