Your businesses may have a choice between using the cash or accrual method of accounting for tax purposes. The cash method often provides significant tax benefits for those that qualify. However, some businesses may be better off using the accrual method. Therefore, you need to evaluate the tax accounting method for your business to ensure that it’s the most beneficial approach.

The current situation

“Small businesses,” as defined by the tax code, are generally eligible to use either cash or accrual accounting for tax purposes. (Some businesses may also be eligible to use various hybrid approaches.) Before the Tax Cuts and Jobs Act (TCJA) took effect, the gross receipts threshold for classification as a small business varied from $1 million to $10 million depending on how a business was structured, its industry and whether inventory was a material income-producing factor.

The TCJA simplified the definition of a small business by establishing a single gross receipts threshold. It also increased the threshold to $25 million (adjusted for inflation), expanding the benefits of small business status to many more companies. For 2024, a small business is one whose average annual gross receipts for the three-year period ending before the 2024 tax year are $30 million or less (up from $29 million in 2023).

In addition to eligibility for the cash method of accounting, small businesses enjoy simplified inventory accounting, exemption from the uniform capitalization rules and the business interest deduction limit, and several other tax advantages. Be aware that some businesses are eligible for cash accounting even if their gross receipts are above the threshold, including S corporations, partnerships without any C corporation partners, farming businesses and certain personal service corporations. Also, tax shelters are ineligible for the cash method, regardless of size.

Potential advantages

For most businesses, the cash method provides significant tax advantages. Because cash-basis businesses recognize income when it’s received and deduct expenses when they’re paid, they have greater control over the timing of income and deductions. For example, they can defer income by delaying invoices until the following tax year or shift deductions into the current year by accelerating the payment of expenses.

In contrast, accrual-basis businesses recognize income when it’s earned and deduct expenses when they’re incurred, without regard to the timing of cash receipts or payments. That means they have little flexibility to time the recognition of income or expenses for income tax purposes.

The cash method also provides cash flow benefits. Because income is taxed in the year it’s received, it helps ensure that a business has the funds it needs to pay its tax bill.

For some businesses, however, the accrual method may be preferable. For instance, if a company’s accrued income tends to be lower than its accrued expenses, the accrual method may result in lower tax liability than the cash method. Other potential advantages of using the accrual method include the abilities to deduct year-end bonuses paid within the first 2½ months of the following tax year and to defer taxes on certain advance payments.

Issues when switching methods

Even if your business would enjoy a tax advantage by switching from the accrual method to the cash method, or vice versa, it’s important to consider the administrative costs involved in making the change. For example, if your business prepares its financial statements in accordance with U.S. Generally Accepted Accounting Principles (GAAP), it’s required to use the accrual method for financial reporting purposes.

Does that mean you can’t use the cash method for tax purposes? No, but it would require the business to maintain two sets of books. Changing accounting methods for tax purposes may also require IRS approval. Contact us to learn more about each method.

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The IRS has published new regulations relevant to taxpayers subject to the “10-year rule” for required minimum distributions (RMDs) from inherited IRAs or other defined contribution plans. The final regs, which take effect in 2025, require many beneficiaries to take annual RMDs in the 10 years following the deceased’s death.

SECURE Act ended stretch IRAs

The genesis of the new regs dates back to the 2019 enactment of the Setting Every Community Up for Retirement Enhancement (SECURE) Act. One of the many changes in that tax law was the elimination of so-called “stretch IRAs.”

Previously, all beneficiaries of inherited IRAs could stretch RMDs over their entire life expectancies. Younger heirs in particular benefited by taking smaller distributions for decades, deferring taxes while the accounts grew. These heirs also could pass on the IRAs to later generations, deferring the taxes even longer.

The SECURE Act created limitations on which heirs can stretch IRAs. These limits are intended to force beneficiaries to take distributions and expedite the collection of taxes. Specifically, for IRA owners or defined contribution plan participants who died in 2020 or later, only “eligible designated beneficiaries” (EDB) are permitted to stretch out payments over their life expectancies. The following heirs are considered eligible for this favorable treatment:

• Surviving spouses,
• Children younger than “the age of majority,”
• Individuals with disabilities,
• Chronically ill individuals, and
• Individuals who are no more than 10 years younger than the account owner.

All other heirs (known as designated beneficiaries) are required to take the entire balance of the account within 10 years of the death, regardless of whether the deceased died before, on or after the required beginning date (RBD) of his or her RMDs.

Note: In 2023, under another law, the age at which account owners must begin taking RMDs increased from 72 to 73, pushing the RBD date to April 1 of the year after the account owner turns 73. The age is slated to jump to 75 in 2033.

Proposed regs muddied the waters

In February 2022, the IRS issued proposed regs addressing the 10-year rule — and they brought some bad news for many affected heirs. The proposed regs provided that, if the deceased dies on or after the RBD, designated beneficiaries must take their taxable RMDs in years one through nine after death (based on their life expectancies), receiving the balance in the tenth year. A lump-sum distribution at the end of 10 years wouldn’t be allowed.

The IRS soon heard from confused taxpayers who had recently inherited IRAs or defined contribution plans and didn’t know when they were required to start taking RMDs. Beneficiaries could have been hit with a penalty based on the amounts that should have been distributed but weren’t. This penalty was 50% before 2023 but was lowered to 25% starting in 2023 (or 10% if a corrective distribution was made in a timely manner). The plans themselves could have been disqualified for failing to make RMDs.

As a result, the IRS issued a series of waivers on enforcement of the 10-year rule. With the release of the final regulations, the waivers will come to an end after 2024.

Final regs settle the matter

The IRS reviewed comments on the proposed regs suggesting that if the deceased began taking RMDs before death, the designated beneficiaries shouldn’t be required to continue the annual distributions as long as the remaining account balance is fully distributed within 10 years of death. The final regs instead require these beneficiaries to continue receiving annual distributions.

If the deceased hadn’t begun taking his or her RMDs, though, the 10-year rule is somewhat different. While the account has to be fully liquidated under the same timeline, no annual distributions are required. That gives beneficiaries more opportunity for tax planning.

To illustrate, let’s say that a designated beneficiary inherited an IRA in 2021 from a family member who had begun to take RMDs. Under the waivers, the beneficiary needn’t take RMDs for 2022 through 2024. The beneficiary must, however, take annual RMDs for 2025 through 2030, with the account fully distributed by the end of 2031. Had the deceased not started taking RMDs however, the beneficiary would have the flexibility to not take any distributions in 2025 through 2030. So long as the account was fully liquidated by the end of 2031, the beneficiary would be in compliance.

Additional proposed regs

The IRS released another set of proposed regs regarding other RMD-related changes made by SECURE 2.0, including the age when individuals born in 1959 must begin taking RMDs. Under the proposed regs, the “applicable age” for them would be 73 years.

They also include rules addressing:

• The purchase of an annuity with part of an employee’s defined contribution plan account,
• Distributions from designated Roth accounts,
• Corrective distributions,
• Spousal elections after a participant’s death,
• Divorce after the purchase of a qualifying longevity annuity contract, and
• Outright distributions to a trust beneficiary.

The proposed regs would take effect in 2025.

Timing matters

It’s important to realize that even though RMDs from an inherited IRA aren’t yet required, that doesn’t mean a beneficiary shouldn’t take distributions. If you’ve inherited an IRA or a defined contribution plan and are unsure of whether you should be taking RMDs, contact us. We’d be pleased to help you determine the best course of action for your tax situation.

© 2024

When creating estate plans, people generally take their children and grandchildren into consideration and plan accordingly. For those who would like to plan beyond the next two generations, using a dynasty trust may be the answer.

A dynasty trust can preserve substantial amounts of wealth — and potentially shelter it from federal gift, estate and generation-skipping transfer (GST) taxes — for generations to come. Plus, it can provide various other benefits and protections for families for an extended period (perhaps forever).

Establishing and funding a dynasty trust

A dynasty trust can be established during your lifetime, as an inter vivos trust, or part of your will as a testamentary trust. With an inter vivos transfer, you’ll avoid estate tax on any appreciation in value from the time of the transfer until your death. Generally though, with an inter vivos transfer, the assets won’t be eligible for step-up in basis at your death.

Because the emphasis is on protecting appreciated property, consider funding the trust with securities, real estate, life insurance policies and business interests. Ensure you retain enough assets in your personal accounts to continue to enjoy your lifestyle.

Factoring in taxes

Previously, dynasty trusts were primarily used to minimize transfer tax between generations. Without one, if a family patriarch or matriarch leaves assets to adult children, the bequests are subject to federal estate tax at the time of the initial transfer to the second generation, and then taxed again when the assets pass from the children to the grandchildren, and so on. Although the federal gift and estate tax exemption can shield the bulk of assets from tax for most families, the top federal estate tax rate on the excess is 40% — a hefty amount.

Furthermore, the GST tax applies to certain transfers made to grandchildren, thereby discouraging transfers that skip a generation. The GST tax exemption and 40% GST tax rate are the same as they are for regular gift and estate tax.

With a dynasty trust, assets are taxed just once, when they’re initially transferred to the trust. There’s no estate or GST tax due on any subsequent appreciation in value. This can save some families millions of tax dollars over the durations of their trusts.

When the assets are subsequently sold, any gain will be taxable. Note that the basis of the assets will be determined at the time of the initial transfer, although depending on the circumstances, the “step-up in basis” rules may help reduce the taxable amount.

Recognizing nontax benefits

Regardless of the tax implications, there are many nontax reasons to set up a dynasty trust. For example, you can designate the trust’s beneficiaries spanning multiple generations. Typically, you might provide for the assets to follow a line of descendants, such as your children, grandchildren, great-grandchildren, etc. You can also impose certain restrictions, for example, limiting access to funds until a beneficiary graduates from college.

Planning for your family’s future

A dynasty trust creates a legacy that will live on long after you’re gone. Be aware, however, that a dynasty trust is irrevocable. In other words, you can’t undo the arrangement if you have a sudden change of heart. If you’re going to chart the course for future generations, you must have the courage of your convictions. Contact us for guidance.

© 2024

Let’s say you own real estate that has been held for more than one year and is sold for a taxable gain. Perhaps this gain comes from indirect ownership of real estate via a pass-through entity such as an LLC, partnership or S corporation. You may expect to pay Uncle Sam the standard 15% or 20% federal income tax rate that usually applies to long-term capital gains from assets held for more than one year.

However, some real estate gains can be taxed at higher rates due to depreciation deductions. Here’s a rundown of the federal income tax issues that might be involved in real estate gains.

Vacant land

The current maximum federal long-term capital gain tax rate for a sale of vacant land is 20%. The 20% rate only hits those with high incomes. Specifically, if you’re a single filer in 2024, the 20% rate kicks in when your taxable income, including any land sale gain and any other long-term capital gains, exceeds $518,900. For a married joint-filing couple, the 20% rate kicks in when taxable income exceeds $583,750. For a head of household, the 20% rate kicks when your taxable income exceeds $551,350. If your income is below the applicable threshold, you won’t owe more than 15% federal tax on a land sale gain. However, you may also owe the 3.8% net investment income tax (NIIT) on some or all of the gain.

Gains from depreciation

Gain attributable to real estate depreciation calculated using the applicable straight-line method is called unrecaptured Section 1250 gain. This category of gain generally is taxed at a flat 25% federal rate, unless the gain would be taxed at a lower rate if it was simply included in your taxable income with no special treatment. You may also owe the 3.8% NIIT on some or all of the unrecaptured Section 1250 gain.

Gains from depreciable qualified improvement property

Qualified improvement property (QIP) generally means any improvement to an interior portion of a nonresidential building that’s placed in service after the date the building is placed in service. However, QIP does not include expenditures for the enlargement of the building, elevators, escalators or the building’s internal structural framework.

You can claim first-year Section 179 deductions or first-year bonus depreciation for QIP. When you sell QIP for which first-year Section 179 deductions have been claimed, gain up to the amount of the Section 179 deductions will be high-taxed Section 1245 ordinary income recapture. In other words, the gain will be taxed at your regular rate rather than at lower long-term gain rates. You may also owe the 3.8% NIIT on some or all of the Section 1245 recapture gain.

What if you sell QIP for which first-year bonus depreciation has been claimed? In this case, gain up to the excess of the bonus depreciation deduction over depreciation calculated using the applicable straight-line method will be high-taxed Section 1250 ordinary income recapture. Once again, the gain will be taxed at your regular rate rather than at lower long-term gain rates, and you may also owe the 3.8% NIIT on some or all of the recapture gain.

Tax planning point: If you opt for straight-line depreciation for real property, including QIP (in other words, you don’t claim first-year Section 179 or first-year bonus depreciation deductions), there won’t be any Section 1245 ordinary income recapture. There also won’t be any Section 1250 ordinary income recapture. Instead, you’ll only have unrecaptured Section 1250 gain from the depreciation, and that gain will be taxed at a federal rate of no more than 25%. However, you may also owe the 3.8% NIIT on all or part of the gain.

Plenty to consider

As you can see, the federal income tax rules for gains from sales of real estate may be more complicated than you thought. Different tax rates can apply to different categories of gain. And you may also owe the 3.8% NIIT and possibly state income tax, too. We will handle the details when we prepare your tax return. Contact us with questions about your situation.

© 2024

Divorce entails difficult personal issues, and taxes are probably the farthest thing from your mind. However, several tax concerns may need to be addressed to ensure that taxes are kept to a minimum and that important tax-related decisions are properly made. Here are six issues to be aware of if you’re in the process of getting a divorce.

1. Personal residence sale

In general, if a couple sells their home in connection with a divorce or legal separation, they should be able to avoid tax on up to $500,000 of gain (as long as they’ve owned and used the home as their principal residence for two of the previous five years). If one former spouse continues to live in the home and the other moves out (but they both remain owners of the home), they may still be able to avoid gain on the future sale of the home (up to $250,000 each), but special language may have to be included in the divorce decree or separation agreement to protect this tax exclusion for the spouse who moves out.

If the couple doesn’t meet the two-year ownership and use tests, any gain from the sale may qualify for a reduced exclusion due to unforeseen circumstances.

2. Pension benefits

A spouse’s pension benefits are often part of a divorce property settlement. In these cases, the commonly preferred method to handle the benefits is to get a “qualified domestic relations order” (QDRO). This gives one former spouse the right to share in the pension benefits of the other and taxes the former spouse who receives the benefits. Without a QDRO, the former spouse who earned the benefits will still be taxed on them even though they’re paid out to the other former spouse.

3. Filing status

If you’re still married at the end of the year, but in the process of getting divorced, you’re still treated as married for tax purposes. We’ll help you determine how to file your 2024 tax return — as married filing jointly or married filing separately. Some separated individuals may qualify for “head of household” status if they meet the requirements.

4. Alimony or support payments

For alimony under divorce or separation agreements that are executed after 2018, there’s no deduction for alimony and separation support payments for the former spouse making them. And the alimony payments aren’t included in the gross income of the former spouse receiving them. (The rules are different for divorce or separation agreements executed before 2019.) This was a change made in the Tax Cuts and Jobs Act. However, unlike some provisions of the law that are temporary, the repeal of alimony and support payment deduction is permanent.

5. Child support and child-related tax return filing

No matter when the divorce or separation instrument is executed, child support payments aren’t deductible by the paying former spouse (or taxable to the recipient). You and your ex-spouse will also need to determine who will claim your child or children on your tax returns in order to claim related tax breaks.

6. Business interests

If certain types of business interests are transferred in connection with divorce, care should be taken to make sure “tax attributes” aren’t forfeited. For example, interests in S corporations may result in “suspended” losses (losses that are carried into future years instead of being deducted in the year they’re incurred). When these interests change hands in a divorce, the suspended losses may be forfeited. If a partnership interest is transferred, a variety of more complex issues may arise involving partners’ shares of partnership debt, capital accounts, built-in gains on contributed property and other complex issues.

A range of tax challenges

These are just some of the issues you may have to cope with if you’re getting a divorce. In addition, you may need to adjust your income tax withholding, and you should notify the IRS of any new address or name change. There are also estate planning considerations. We can help you tackle the financial issues involved in divorce.

© 2024

The current estate tax exemption amount ($13.61 million in 2024) has led many people to feel they no longer need to be concerned about federal estate tax. Before 2011, a much smaller exemption resulted in many people with more modest estates attempting to avoid it. But since many estates won’t currently be subject to estate tax, it’s a good time to devote more planning to income tax saving for your heirs.

Important: Keep in mind that the federal estate tax exclusion amount is scheduled to sunset at the end of 2025. Beginning on January 1, 2026, the amount is due to be reduced to $5 million, adjusted for inflation. Of course, Congress could act to extend the higher amount or institute a new amount.

Here are some strategies to consider in light of the current large exemption amount.

Using the annual exclusion

One of the benefits of using the gift tax annual exclusion to make transfers during your lifetime is to save estate tax. This is because both the transferred assets and any post-transfer appreciation generated by those assets are removed from your (the donor’s) estate.

As mentioned, estate tax savings may not be an issue because of the large exemption amount. Further, making an annual exclusion transfer of appreciated property carries a potential income tax cost because the recipient receives your basis upon transfer. Thus, the recipient could face income tax, in the form of capital gains tax, on the sale of the gifted property in the future. If there’s no concern that an estate will be subject to estate tax, even if the gifted property grows in value, then you might want to base the decision to make a gift on other factors.

For example, gifts may be made to help a relative buy a home or start a business. But a donor shouldn’t gift appreciated property because of the capital gains that could be realized on a future sale by the recipient. If the appreciated property is held until the donor’s death, under current law, the heir will get a step-up in basis that will wipe out the capital gains tax on any pre-death appreciation in the property’s value.

Spouses now have more flexibility

Years ago, spouses often undertook complicated strategies to equalize their estates so that each could take advantage of the estate tax exemption amount. In many cases, a two-trust plan was established to minimize estate tax. “Portability,” or the ability to apply the decedent’s unused exclusion amount to the surviving spouse’s transfers during life and at death, became effective for estates of decedents dying after 2010. As long as the election is made, portability allows the surviving spouse to apply the unused portion of a decedent’s applicable exclusion amount (the deceased spousal unused exclusion amount) as calculated in the year of the decedent’s death. The portability election gives married couples more flexibility in deciding how to use their exclusion amounts.

Valuation discounts

Be aware that it may no longer be worth pursuing some estate exclusion or valuation discount strategies to avoid inclusion of property in an estate. It may be better to have the property included in the estate or not qualify for valuation discounts so that the property receives a step-up in basis. For example, the special use valuation — the valuation of qualified real property used for farming or in a business, based on the property’s actual use rather than on its highest and best use — may not save enough, or any, estate tax to justify giving up the step-up in basis that would otherwise occur for the property.

If you want to discuss estate planning or income tax saving strategies, contact us.

© 2024

If you’re a philanthropic individual who is also obligated to take required minimum distributions (RMDs) from a traditional IRA, you may want to consider a tax-saving strategy. It involves making a qualified charitable distribution (QCD).

How it works

To reap the possible tax advantages of a QCD, you make a cash donation to an IRS-approved charity out of your IRA. This method of transferring IRA assets to charity leverages the QCD provision that allows IRA owners who are age 70½ or older to direct up to $105,000 of their IRA distributions to charity in 2024. (For married couples, each spouse can make QCDs for a possible total of $210,000.) When making QCDs, the money given to charity counts toward your RMDs but doesn’t increase your adjusted gross income (AGI) or generate a tax bill.

Keeping the donation amount out of your AGI may be important for several reasons. When distributions are taken directly out of traditional IRAs, federal income tax of up to 37% in 2024 will have to be paid. State income taxes may also be owed. That tax is avoided with a QCD. Here are some other potential benefits of a QCD:

1. It can help you qualify for other tax breaks. For example, having a lower AGI can reduce the threshold for itemizers who can deduct medical expenses, which are only deductible to the extent they exceed 7.5% of AGI.
2. You can avoid rules that can cause some or all of your Social Security benefits to be taxed, and some or all of your investment income to be hit with the 3.8% net investment income tax.
3. It can help you avoid a high-income surcharge for Medicare Part B and Part D premiums, which kick in if AGI is over certain levels.

Keep in mind: You can’t claim a charitable contribution deduction for a QCD not included in your income. Also keep in mind that the age after which you must begin taking RMDs is now 73, but the age you can begin making QCDs is 70½.

To benefit from a QCD for 2024, you must arrange for a distribution to be paid directly from the IRA to a qualified charity by December 31, 2024. You can use QCDs to satisfy all or part of the amount of your RMDs from your IRA. For example, if your 2024 RMDs are $20,000 and you make a $10,000 QCD, you’d have to withdraw another $10,000 to satisfy your 2024 RMDs.

Other rules and limits may apply. QCDs aren’t right for everyone. Contact us to see whether this strategy would make sense in your situation.

© 2024

While many facets of the economy have improved this year, the rising cost of living and other economic factors have caused many businesses to close their doors. If this is your situation, we can help you, including taking care of various tax responsibilities.

To start with, a business must file a final federal income tax return and some other related forms for the year it closes its doors. The type of return that must be filed depends on the type of business you have. For example:

• Sole Proprietors will need to file the usual Schedule C, “Profit or Loss from Business,” with their individual returns for the year they close their businesses. They may also need to report self-employment tax.
• Partnerships must file Form 1065, “U.S. Return of Partnership Income,” for the year they close. They also must report capital gains and losses on Schedule D. They indicate that this is the final return and do the same on Schedule K-1, “Partner’s Share of Income, Deductions, Credits, etc.”
• All Corporations need to file Form 966, “Corporate Dissolution or Liquidation,” if they adopt a resolution or plan to dissolve an entity or liquidate any of its stock.
• C Corporations must file Form 1120, “U.S. Corporate Income Tax Return,” for the year they close. They report capital gains and losses on Schedule D and indicate this is the final return.
• S Corporations need to file Form 1120-S, “U.S. Income Tax Return for an S Corporation,” for the year of closing. They report capital gains and losses on Schedule D. The “final return” box must be checked on Schedule K-1.
• All Businesses may need to be filed other tax forms to report sales of business property and asset acquisitions if they sell the business.

Tying up loose ends with workers

If you have employees, you must pay them final wages and compensation owed, make final federal tax deposits and report employment taxes. Failure to withhold or deposit employee income, Social Security and Medicare taxes can result in full personal liability for what’s known as the Trust Fund Recovery Penalty.

If you’ve paid any contractors at least $600 during the calendar year in which you close your business, you must report those payments on Form 1099-NEC, “Nonemployee Compensation.”

You may face more obligations

If your business has a retirement plan for employees, you’ll generally need to terminate the plan and distribute benefits to participants. There are detailed notice, funding, timing and filing requirements that must be met when terminating a plan. There are also complex requirements related to flexible spending accounts, Health Savings Accounts, and other programs for employees.

We can assist you with many other complicated tax issues related to closing your business, including debt cancellation, use of net operating losses, freeing up any remaining passive activity losses, depreciation recapture, and possible bankruptcy issues.

You also must cancel your Employer Identification Number (EIN) and close your IRS business account. In addition, you need to keep business records for a certain amount of time.

If your business is unable to pay all the taxes it owes, we can explain the available payment options to you. Contact us to discuss these responsibilities and get answers to any questions.

© 2024