Start Paying Your Children

If you can get your children to work for your business or work around the house, start paying them.

The pay must be fair for the services provided.

If the work is for your trade or business, you obtain a tax deduction for the compensation. The Federal and State tax savings may be approximately 40% to 50% of the amount paid.

If your business is a sole proprietorship or a partnership owned by you and your spouse, no FICA taxes are due until they reach age 18.

They could use the money to fund a Roth IRA or pay for college.

The maximum Roth IRA contribution for 2015 is $5,500. Just think of the funds they could accumulate in a tax free vehicle, if this is done every year.

Under current law, they can earn $6,300 before paying any federal tax.

If they are in college and you don’t claim them as a dependent, they can earn about $26,000 without paying federal tax after a $2,500 tuition credit.

Many taxpayers don’t receive any benefit for claiming a dependent exemption for a child due to the phase out rules. Also, many don’t receive any tuition credit for their children’s college tuition due to the income threshold requirements.

This is a no brainier. Don’t miss the opportunity.  Get the kids working and on the payroll.

 

June and July Stones Tour

The Stones are back, all in their 70s, but still rocking. Funny, my first concert was in the 70s. Who would have thought?

The US tour will be in June and July this year.  I am ready to go, right after getting everyone’s second quarter tax estimates out by June 15th. This time the grandkids are coming too. I will have to beg and/or bribe them.

Work Enough to Avoid 3.8% Investment Income Medicare Tax

How many hours do you need to work for a trade or business to avoid the 3.8% Investment Income Medicare tax?

Most believe it is greater than 500 hours per year. This is not necessarily true.

Internal Revenue Code (IRC) section 1411 assesses a 3.8% Medicare tax on certain types of investment income that exceed certain income level thresholds.

One of the types of investment income is passive activity trade or business income as defined in IRC section 469.

Basically, IRC section 469 indicates that income from a trade or business operated as a sole proprietorship, partnership/LLC or S-Corporation is passive if the taxpayer doesn’t materially participate in the activity.

Generally, material participation requires one to work more than 500 hours per year for the trade or business activity. There are several special rules that treat one as materially participating at a lower level of hours.

There are also special rules that specify if certain activities generate income they are not passive (and therefore not subject to the 3.8% Investment Income Medicare tax), but if they generate a loss they are passive.

One of the rules requires if one participates more than 100 hours in a year for a trade or business  activity, and all that person’s “100 plus hour and less than 501 hour trade or businesses activities” don’t exceed 500 hours in total, the income from the activity is not passive. Therefore, it is also not subject to the 3.8% Investment Income Medicare tax. This rule gets missed a lot. It should be fairly easy to get 101 hours. That is 2 hours a week.

One should review all trade or business activity income reflected on their tax returns and determine how many hours they need to work to “materially participate” or qualify for the above special 100 plus hours rule.

Note, if one has large passive losses, treating income activities as passive may result in more tax savings, than avoiding the 3.8% Investment Income Medicare tax.

Antigua

Jan and I just spent a week in Antigua, sailing with Becky, Bill, Dick, Cathy, Bill and Pam. Awesome time. Relaxed, snorkeled, and read (tax stuff of course). Saw Eric Clapton’s spot. Wish it was Mick Jagger’s. I would have climbed the cliff to get in.

ROTH TIME

It is time to fund Roth IRAs. A Roth IRA is an awesome tax free investment vehicle. Anything that is tax free should be considered.

One can contribute the lower of their earned income or $5,500 in 2014 and 2015 and an additional $1,000 each if age 50 or older.

If you haven’t done it for 2014, you have up to April 15, 2015 to do it. I also recommend doing the 2015 contribution as soon as possible. Why wait?

If one’s income is below a certain level, he/she can fund a Roth IRA. If it is at or above the level, the amount one can contribute gets reduced, ultimately to zero. The phase out rule.

The income level and phase out ranges are as follows:

  • 2015
    • Married Filing Jointly: AGI $183,000-$193,000
    • Head of Household or Single: AGI $116,000-$131,000
  • 2014
    • Married Filing Jointly: AGI $181,000-$191,000
    • Head of Household or Single: AGI $114,000-$129,000
  • 2015 and 2014
    • Married Filing Separately: AGI $0-$10,000

If one’s income exceeds the above, there is still a way to fund a Roth IRA.

Consider making a traditional non-deductible IRA contribution and converting it to a Roth shortly thereafter. This strategy may not make sense if you already have funds in a traditional IRA, SEP, SAR-SEP or Simple IRA. The rules treat a portion of the converted amount as coming from all IRA accounts and therefore some of the conversion could be taxable.

Like the regular contribution to a Roth IRA, If you haven’t done the conversion technique for 2014, you have up to April 15, 2015 to do it. I also recommend doing the 2015 contribution and conversion as soon as possible. Why wait?

Also, consider funding a Roth IRA for your children or grandchildren, subject to the same limits above. If they don’t have earned income, consider having them perform household duties and pay them by funding the Roth IRA. Unless they are using their own funds or you are paying them for household services with the contribution, the contribution will be considered a gift.

Again, If you haven’t done it for them for 2014, you have up to April 15, 2015 to do it. I also recommend doing the 2015 contribution as soon as possible. Why wait?


FLORIDA

I am out of the freezing cold in Minnesota and at The View in Florida for a few days. It’s sunny, warm weather and lots of fun. Nothing better.  Well maybe.  I can’t wait for tax season to start. That is better.

Congress Does It Again: A Short-Term Extender Bill

Several tax law provisions expired on December 31, 2013.  We have been waiting for legislation extending these expired provisions all year.  We finally got it last week.

It is good news and bad news.  The good news is the expired provisions were extended.  The bad news is they are only extended through December 31, 2014.

Some of the major items extended include the following:

  • Research and Development tax credit
  • Work Opportunity and Empowerment Zone tax credit
  • New Markets tax credit
  • Various energy tax credits
  • $500,000 Section 179 expensing limit
  • 50% Bonus Depreciation
  • Section 179D expensing for certain energy efficient commercial building property
  • S-Corporation 5 year Built-in gains recognition period
  • Tax free transfers from IRAs to Charities

I think what Congress did is ridiculous. They continue to play games with small businesses by failing to make these provisions permanent and/or waiting all year to extend them.  Bonus depreciation was a provision added to the law to spur investment to help the economy. What good does it do to pass it in mid-December and have it expire on December 31?

I understand my clients that can use the extended provisions, welcome them.  However, how can they do tax planning?  Come on Congress!  Let us know what tax law we can expect sooner than later.  In the past, they extended the provsions for at least two years.  Now, we all need to wait again to see what the rules will be in 2015.

Some believe the short term extension was done so we don’t have the law fixed for 2015.  This way congressman Ryan, the new Chairman of the House Ways and Means Committee, can try to get overall tax reform passed in 2015.

I am sitting on the edge of my seat waiting.  (That was a joke.)

We will see what happens.

 

Merry Christmas

Merry Christmas to all!  I hope you have a great Christmas week.  I know I am.

My entire family will be at our house on Christmas Eve; 3 parents, 4 children, assuming our Son in the Military can come (he returned to the USA last week after serving in Afghanistan for several months), and 9 grandchildren.  It will be awesome.

Tax Gossip – Rumors on Section 179 Expensing and Bonus Depreciation

My colleague recently attended an event where a Congressman who is on the U.S. House of Representatives Ways and Means Committee said it is very likely that 179 expensing and bonus depreciation will be extended in early December before the session break or in early January and applied retroactively.

I hope so. We will see.

For now, I recommend you run year-end planning calculations under both scenarios – no extension of the rules and if they are extended.

YEAR END PLANNING

It is time for year-end tax planning. This should be started in November, not late December.  The following are some of the issues that should be discussed with your advisor.

  1. Deferring or accelerating income
  2. Deferring or accelerating deductions
  3. Purchasing assets before year-end
  4. Selling assets before year-end
  5. Proper documentation and policies for accruing and deducting bonuses
  6. Inventory costing methods
  7. Writing off bad debts
  8. Maximizing the domestic production deduction
  9. Loss planning to make sure losses are not limited under the basis, at risk or passive activity rules
  10. Entity structure for new ventures and 831(b) captive instance planning.
  11. Other items that may reduce you tax burden.

Each of these categories have several tax planning techniques that can be implemented. One must consider the business and economic impact of them in addition to the tax savings.

Also, have your advisor prepare a tax projection for 2014 and illustrate the impact of the planning techniques.

Get on it as soon as you can.

DISNEY and TAXES

I am off to Orlando for a great tax conference. I can’t wait. I am like a kid heading to Disney World. In fact, Cammy and Patrick, our two oldest grandkids, are coming along. Disney at night and on the weekend. I refuse to skip out of the conference. It is going to be a good week.

LLC Members Self Employment Tax

Many tax professionals are changing their stance on how to treat business income allocated to LLC Members for Self Employment Tax (SET) purposes.

In general, per Internal Revenue Code Section (IRC) 1402(a), taxpayers who are allocated business income from an entity taxed as a partnership (e.g., general partnership, limited partnership, LLCs) are subject to SET on such income. However, an exception applies for income allocated to Limited Partners (IRC section 1402(a)13). This exception does not apply to payments for services to such partners as “guaranteed payments.”

That being said, the treatment of LLC members has been somewhat controversial. Are they Limited Partners for purposes of these rules? The IRS has attempted to issue regulations twice, but has never finalized them. The IRS has provided very little guidance on this matter. There have been some recent court cases and a new Chief Council Advice (201436049) that address specific taxpayers’ situations.

It appears that both the courts and the IRS are looking at the type of business income as well as the taxpayers’ role (active vs investor), but not their status as a limited partner under state law. In essence, the IRS and certain courts are applying a special definition of “Limited Partner” under section 1402(a)(13), based on the intent of the law, not their status under State law.

So what do we do?  

Many professionals are treating all Limited Liability Company members’ business income as exempt from SET. Some treat only business service income as subject to SET and some treat all business income as subject to SET.

I believe each situation needs to be reviewed to determine the best position to take. Whether the income is a return on investment or a result of the owner’s services is a key factor. The type of income also matters (service vs. other.) There is no specific rule here. One might want to look at the passive loss rules and apply the material participation test. This type of concept is in the proposed regulation issued by the IRS that was never finalized.

At a minimum, make sure owners who are providing services to the entity are paid a reasonable “guaranteed payment” for such service.

Some advisors recommend using S-Corporations to minimize the SET. Subject to a requirement to pay reasonable compensation, S-Corporation income is not subject to SET. However, the partnership tax rules are generally much better and more flexible compared to the S-Corporation rules. When all else is equal, I always recommend creating entities that can use the partnership tax rules.

One may consider setting up separate S-Corporations for each LLC member to hold their LLC units. This should help avoid the Self Employment Tax on the LLC income and also allow the LLC to treat its taxpayers as employees.

This issue should be part of year-end planning discussions.

 

Personal Update

There’s been lots going on lately. Our Stillwater Condo overlooking the St. Croix River has been expanded by adjoining the small one next door. What a project that was – Jan blew my budget away. Fall has arrived and the boat in Minnesota is put away for the year, but the one in Florida is all ready to go! Our Grandkid’s dancing and hockey activities are in full swing now, lots of fun spectating to look forward to there.

And of course, I’m still reading tax articles daily. Life is good!!

Business Succession Planning

What is business succession planning, and why do it? If you conduct a Google search on this topic, you will get many different answers to these two questions.  But succession planning isn’t all about selling the company; that’s just one of the many solutions.

Before deciding on a solution, there are some important questions you need to ask yourself. For example, will you transfer the business or choose another strategy? To whom should the business be transferred? What is the right timing to proceed with the transition?

In my eyes, there is one guiding theme to answer all of the above questions. Simply ask yourself, what achieves the owners’ goals with regards to the future ownership of the business? By contemplating this, you will come up with the best solution for you and the company at large.

Nothing can be accomplished until the owners spend time determining and communicating their goals with regards to the future ownership of the business.

Make sure the following areas are consistent with such goals:

  • The governance system
  • The management team and its succession
  • The strategic planning system
  • The ownership’s plan and expectations
  • The owners’ estate plans

Failure to get these addressed and aligned can result in various ramifications such as family disharmony, loss of key personnel, lawsuits, forced sales, excess taxes and most importantly, inability to achieve the owner’s goals.

I believe each owner should assemble a team to address the succession plan, and allow those involved to hold ownership accountable for their part of the process. Easy to say, hard for entrepreneurs to do.

If you don’t put in the effort, don’t complain about the consequences.

 

9/11

This week was the anniversary of the September 11th attacks, a tough day for many Americans who lost loved ones. But also a proud day for our nation as we pulled together to deal with the tragedy.

My wife and I have a son serving and deployed in Afghanistan, continuing the fight. We are so proud of all the young courageous members of our military. God bless them all.

Cash Method, Accrual Method, or Both?

Most taxpayers adopt either the cash method or accrual method of accounting for their businesses tax reporting.

I very rarely see both methods applied to different segments of business. If a taxpayer (entity or individual) has two or more trades or businesses that are separate and distinct, each can adopt separate methods of accounting that are allowed, or required, for the specific type of business activity.  Separate books and records must be maintained for each business activity.

This is definitely a planning opportunity. If a business qualifies as separate and distinct for the other business activity of the taxpayer, a change in the accounting method can be requested even if separate methods weren’t used in the past. For most accounting method changes, the IRS has provided automatic consent to change in Revenue Rulings and Procedures.

If you do have separate and distinct businesses owned by yourself or one entity, I recommend operating them through separate LLCs. This helps illustrate the separation from other business activities.

This concept was recently addressed in the taxpayers favor in Chief Counsel Advice 201430013.

Ask your advisor whether you should be separating your distinct business activities and adopting a different method of accounting for some or all of your business activities before year end.

 

Golf Weekend

Just spent three wonderful days with my buddy, Marty, at the Spring Hill Founders Cup golf tournament. What a great host, course, and membership. All first class.

Marty even allowed me to sport my Keith Richards t-shirt at his place on the porch, where we did a little dancing with Patty, Lesley and Mike (to the Rolling Stones, obviously.)

Classic case of the east-sider bringing down the Edina neighborhood.

My claim is that I was the worst golfer in the field. That’s why I boat.