Should You File a Joint Tax Return for the Year of Your Spouse’s Death?

The death of a spouse is a devastating, traumatic experience. And when it happens, dealing with taxes and other financial and legal obligations are probably the last things on your mind. Unfortunately, many of these obligations can’t wait and may have to be addressed in the months to follow. One important issue for the surviving spouse to consider is whether to file a joint or separate income tax return for the year of death.

Final tax return

When someone dies, his or her personal representative is responsible for filing an income tax return for the year of death (as well as any unfiled returns for previous years). For purposes of the final return, the tax year generally begins on January 1 and ends on the date of death. The return is due by April 15 of the following calendar year.

Income that’s included on the final return is determined according to the deceased’s usual tax accounting method. So, for example, if he or she used the cash method, the income tax return would only report income actually or constructively received before death and only deduct expenses paid before death. Income and expenses after death are reported on an estate tax return.

The surviving spouse, together with the personal representative, may file a joint return. And the surviving spouse alone can elect to file a joint return if a personal representative hasn’t yet been appointed by the filing due date. (However, a court-appointed personal representative may later revoke that election.)

Pros and cons of a joint return

In the year of death, the surviving spouse is generally deemed to be married for the entire calendar year, so he or she can file a joint return with the estate’s cooperation. If a joint return is filed, it’ll include the deceased’s income and deductions from the beginning of the tax year to the date of death, and the surviving spouse’s income and deductions for the entire tax year.

Possible advantages of filing a joint tax return include:

• Depending on your income and certain other factors, you may enjoy a lower tax rate.

• Certain tax credits are larger on a joint return or are unavailable to married taxpayers filing separately.

• IRA contribution limits, as well as the amount allowed as a deduction, may be higher for joint filers.

There may also be disadvantages to filing jointly. For example, higher adjusted gross income (AGI) may reduce the tax benefits of expenses, such as medical bills, that are deductible only to the extent that they exceed a certain percentage of AGI.

Crunch the numbers

To determine the best approach, let us assess your tax liability based on both joint and separate returns. While married filing separately might be the only filing option available to you, other possibilities — depending on the facts — include qualifying widow(er) and head-of-household status.

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Drafting Your Estate Plan Isn’t a Do-It-Yourself Project

There’s no shortage of online do-it-yourself (DIY) tools that promise to help you create an “estate plan.” But while these tools can generate wills, trusts and other documents relatively cheaply, they can be risky except in the simplest cases. If your estate is modest in size, your assets are in your name alone, and you plan to leave them to your spouse or other closest surviving family member, then using an online service may be a cost-effective option. Anything more complex can expose you to a variety of costly pitfalls.

Your plan’s details count

Part of the problem is that online services can help you create individual documents — the good ones can even help you comply with applicable laws, such as ensuring the right number of witnesses to your will — but they can’t help you create an estate plan. Putting together a plan means determining your objectives and coordinating a collection of carefully drafted documents designed to achieve those objectives. And in most cases, that requires professional guidance.

For example, let’s suppose Ken’s estate consists of a home valued at $500,000 and a mutual fund with a $500,000 balance. He uses a DIY tool to create a will that leaves the home to his daughter and the mutual fund to his son. It seems like a fair arrangement. But suppose that by the time Ken dies, he’s sold the home and invested the proceeds in his mutual fund. Unless he amended his will, he will disinherit his daughter. An experienced estate planning advisor would have anticipated such contingencies and ensured that Ken’s plan treated both children fairly, regardless of the specific assets in his estate.

Professional experience vs. technical expertise

DIY tools also fall short when a decision demands a professional’s experience rather than mere technical expertise. An online service makes it easy to name a guardian for your minor children, for example, but it can’t help you evaluate the many characteristics and factors that go into selecting the best candidate.

FMD will gladly any of your estate planning questions and help draft your documents.

© 2022

M&A on the Way? Consider a QOE Report

Whether you’re considering selling your business or acquiring another one, due diligence is a must. In many mergers and acquisitions (M&A), prospective buyers obtain a quality of earnings (QOE) report to evaluate the accuracy and sustainability of the seller’s reported earnings. Sometimes sellers get their own QOE reports to spot potential problems that might derail a transaction and identify ways to preserve or even increase the company’s value. Here’s what you should know about this critical document.

Different from an audit

QOE reports are not the same as audits. An audit yields an opinion on whether the financial statements of a business fairly present its financial position in accordance with Generally Accepted Accounting Principles (GAAP). It’s based on historical results as of the company’s fiscal year end.

In contrast, a QOE report determines whether a business’s earnings are accurate and sustainable, and whether its forecasts of future performance are achievable. It typically evaluates performance over the most recent interim 12-month period.

EBITDA effects

Generally, the starting point for a QOE report is the company’s earnings before interest, taxes, depreciation and amortization (EBITDA). Many buyers and sellers believe this metric provides a better indicator of a business’s ability to generate cash flow than net income does. In addition, EBITDA helps filter out the effects of capital structure, tax status, accounting policies and other strategic decisions that may vary depending on who’s managing the company.

The next step is to “normalize” EBITDA by:

• Eliminating certain nonrecurring revenues and expenses,

• Adjusting owners’ compensation to market rates, and

• Adding back other discretionary expenses.

Additional adjustments are sometimes needed to reflect industry-based accounting conventions. Examples include valuing inventory using the first-in, first-out (FIFO) method rather than the last-in, first-out (LIFO) method, or recognizing revenue based on the percentage-of-completion method rather than the completed-contract method.

Continued viability

A QOE report identifies factors that bear on the business’s continued viability as a going concern, such as operating cash flow, working capital adequacy, related-party transactions, customer concentrations, management quality and supply chain stability. It’s also critical to scrutinize trends to determine whether they reflect improvements in earnings quality or potential red flags.

For example, an upward trend in EBITDA could be caused by a positive indicator of future growth, such as increasing sales, or a sign of fiscally responsible management, such as effective cost-cutting. Alternatively, higher earnings could be the result of deferred spending on plant and equipment, a sign that the company isn’t reinvesting in its future capacity. In some cases, changes in accounting methods can give the appearance of higher earnings when no real financial improvements were made.

A powerful tool

If an M&A transaction is on your agenda, a QOE report can be a powerful tool no matter which side of the table you’re on. When done right, it goes beyond financials to provide insights into the factors that really drive value. Let us help you explore the feasibility of a deal.

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Life Insurance Still Plays an Important Role in Estate Planning

Because the federal gift and estate tax exemption amount currently is $12.06 million, fewer people need life insurance to provide their families with the liquidity to pay estate taxes. But life insurance can still play an important part in your estate plan, particularly in conjunction with charitable remainder trusts (CRTs) and other charitable giving strategies.

Home for highly appreciated assets

CRTs are irrevocable trusts that work like this: You contribute property to a CRT during your life or upon your death and the trust makes annual distributions to you or your beneficiary (typically, your spouse) for a specified period of time. When that period ends, the remainder goes to a charity of your choice.

These instruments may be useful when you contribute highly appreciated assets, such as stock or real estate, and want to reduce capital gains tax exposure. Because the CRT is tax-exempt, it can sell the assets and reinvest the proceeds without currently triggering the entire capital gain. Another benefit is that, if you opt to receive annual distributions from your trust, that income stream generally will be taxed at a lower rate than other income using a formula that combines ordinary taxable income, tax-exempt income, capital gains and other rates.

Here’s where life insurance comes in. Because CRT assets eventually go to charity — usually after both you and your spouse have died — you won’t have as much to leave to your children or other heirs. A life insurance policy can replace that “lost” wealth in a tax advantaged way.

Charities as beneficiaries

CRTs are ideal for philanthropically minded individuals. But there are other ways to use life insurance to fund charitable gifts and enjoy tax benefits. You might, for example, transfer your policy to a nonprofit organization and take a charitable income tax deduction (subject to certain limitations) for it. If you continue to pay premiums on the policy after the charity becomes its owner and beneficiary, you can take additional charitable deductions.

Another scenario is to just name a charity as your policy’s beneficiary. Because you retain ownership, you can’t take charitable income tax deductions during your life. But when you die, your estate will be entitled to an estate tax charitable deduction.

Wealth replacement tool

Life insurance can be used to replace wealth in many circumstances — not only when you’re donating to charity. For instance, if you’ve decided to forgo long term care (LTC) insurance and pay any LTC-related expenses (such as home nursing services or care in a nursing facility) out of pocket, you may not have as much to leave your heirs. Life insurance can help ensure that you provide your family with an inheritance.

Multiple benefits 

Federal estate tax liability may no longer be a concern if your estate is valued at less than $12.06 million. But, depending on your goals, life insurance can help you make charitable gifts, leave money to your heirs and realize tax advantages. We can explain the types of policies that might be appropriate for estate planning purposes.

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Inflation Reduction Act Expands Valuable R&D Payroll Tax Credit

When President Biden signed the Inflation Reduction Act (IRA) into law in August, most of the headlines covered the law’s climate change and health care provisions. But the law also enhances an often overlooked federal tax break for qualifying small businesses.

The IRA more than doubles the amount a qualified business can potentially claim as a research and development (R&D) tax credit to offset its payroll tax for tax years starting after 2022 — to a maximum of $2.5 million over five years. The credit allows a qualified business to leverage the substantial R&D tax benefit even if it has little to no income tax liability, potentially freeing up significant cash flow.

Background on the pre-IRA credit

The Protecting Americans from Tax Hikes (PATH) Act created a permanent incentive for eligible start-up companies to pursue R&D activities within the United States. The Section 41 tax credit for qualifying in-house and contract research activities already existed, but early-stage companies that hadn’t yet incurred income tax liability couldn’t take advantage of it.

The PATH Act revised the Sec. 41 credit to allow taxpayers to elect to apply up to $250,000 of the credit against their share of the Social Security, or FICA, tax for their employees, rather than against income tax. The revision became effective for tax years that began after Dec. 31, 2015.

The payroll tax election is available to taxpayers with 1) gross receipts of less than $5 million for the tax year, and 2) no gross receipts for any tax year more than five years prior to the end of the current tax year. The latter requirement essentially limits the payroll tax credit to start-up companies. If the taxpayer had a tax year of less than 12 months, the gross receipts must be annualized for a full year.

Be aware that not all research is eligible. To qualify for the credit, the research must be:

• Performed to eliminate technical uncertainty about the development or improvement of a product or process, including computer software, techniques, formulas and inventions,

• Undertaken to discover information that’s technological in nature (meaning based on physical, biological, engineering or computer science principles),

• Intended for use in developing a new or improved business product or process, and

• Elements of a process of experimentation relating to a new or improved function, performance, reliability or quality.

Qualifying research expenses include wages for employees involved with the research, supplies to conduct it and amounts paid for the use of computers. They also include 65% of the amounts paid or incurred for contractors.

The credit equals the smallest amount of 1) the current year Sec. 41 credit, 2) an elected amount not exceeding $250,000, or 3) the general business credit carryforward for the tax year (before application of the payroll tax credit for the year). Note that the general business credit carryforward limit doesn’t apply to S corporations or partnerships.

The IRA expansion

Under the PATH Act, a qualified small business could elect to apply its R&D credit against only the 6.2% Social Security tax. Beginning with the 2023 tax year, eligible businesses will be allowed to apply an additional $250,000 against their 1.45% Medicare tax liability.

While the total maximum credit is now $500,000, that amount is bifurcated. You can apply no more than $250,000 against each prong of payroll tax liability — FICA and Medicare, respectively.

As under the PATH Act, you can claim the credit for no more than five years. Existing aggregation rules, which treat related entities as a single taxpayer for purposes of determining gross receipts, also continue to apply. Any credit is allocated among the entities, but each entity must make the election separately.

Claiming the credit

You can make a payroll tax credit election by having us complete the appropriate portion of Form 6765, “Credit for Increasing Research Activities,” and submit it with your income tax return. To then claim the credit, complete Form 8974, “Qualified Small Business Payroll Tax Credit for Increasing Research Activities” and attach it to your employment tax return.

You can apply the credit to offset payroll tax no earlier than the first quarter after you file the return reporting the election. The credit can’t exceed the amount of tax imposed for any calendar quarter. Unused amounts can be carried forward.

What if you were eligible for the R&D credit previously but didn’t claim it because you were unaware of it or for another reason? The IRS recently tightened the requirements to claim a refund of the R&D credit.

To be considered sufficient, a refund claim must:

• Identify all the business products and processes to which the Sec. 41 research credit claim relates for the relevant year.

• For each business product and process, identify all research activities performed, all individuals who performed each research activity and all of the information each individual sought to discover.

• Provide the total qualified employee wage expenses, total qualified supply expenses and total qualified contract research expenses for the claim year. (This may be done using Form 6765.)

These so called “items of information” must be submitted when the refund claim is filed, along with a declaration signed under penalty of perjury verifying their accuracy. If your refund claim is deemed deficient, you’ll receive a letter providing 45 days to cure the deficiency.

More to come

The IRS is expected to issue guidance on the expanded small business R&D tax credit, as well as revised tax forms for 2023. Contact us if you think you may qualify, now or in the past.

© 2022

Shine a Light on Sales Prospects to Brighten the Days Ahead

When it comes to sales, most businesses labor under two major mandates: 1) Keep selling to existing customers, and 2) Find new ones.

To accomplish the former, your sales staff probably gets some help from the marketing and customer service departments. Succeeding at the latter may be more difficult. Yet perhaps the most discernible way a sales department can help boost a company’s bottom line is to win over prospects consistently and manageably.

Laser focus on lead generation

Does your marketing department help you generate leads by doing things such as maintaining an easily searchable database of potential customers for your products or services? If not, it’s probably time to refine or possibly even overhaul your lead generation process.

Customer relationship management (CRM) software can help. When salespeople have a clear picture of a likely buyer, they’ll be able to better focus their efforts. If you haven’t invested in CRM software, or significantly upgraded yours in a while, this is something to strongly consider.

Reduce wasted time and effort

There’s really no aspect of a business that can’t be improved by waste reduction. Effective salespeople spend their time with prospects who are the most likely to buy from them, not with those who might maybe buy something someday but will take a monumental effort to win over.

A worthy prospect generally has clearly discernible and fulfillable needs, a readily available decision maker, strong and verifiable financials, and a timely need or desire to buy. Apply these qualifications to any person or entity with whom you’re considering doing business. If a sale appears highly doubtful from the get-go, it’s probably best to move on.

Ask the right questions, then listen

When talking with prospects, your sales team must know what draws buyers to your company. Sales staffers who make great presentations but don’t ask effective questions about prospects’ needs are typically doomed to mediocrity.

They say the most effective salespeople spend 20% of their time talking and 80% listening. Whether these percentages are completely accurate is hard to say but, after making their initial pitch, a good salesperson actively listens to the prospect’s responses and then asks insightful questions based on solid research.

Be a problem solver

Your sales staff needs to know — going in — how your product or service can solve a prospect’s problem or accomplish a goal. Without a clear offer of a solution, what motivation does the prospect really have to spend money?

Preparation is key. Be sure you’re adequately investing in industry and market research, as well as the continued education of your sales team, to position yourself as a problem solver for your customer base.

The sales are out there

Businesses face great challenges right now in the form of inflation, rising interest rates and persistent supply chain slowdowns. Nonetheless, the economy soldiers on and there are customers out there looking to buy. Contact us for help quantifying your sales process so you can identify feasible ways to improve it.

© 2022

Trust in a Trust to Keep Assets Secure

Whether the economic climate is stable or volatile, one thing never changes: the need to protect your assets from risk. Hazards may occur as a result of factors entirely outside of your control, such as the stock market or the economy. It’s even possible that dangers lie closer to home, including the behavior of your heirs and creditors. In any case, it’s wise to consider taking steps to mitigate potential peril. One such step is to set up a trust.

Make sure it’s irrevocable

A trust can be a great way to protect your assets — but it must become the owner of the assets and be irrevocable. That is, you as the grantor can’t modify or terminate the trust after it has been set up. This is the opposite of a revocable trust, which allows the grantor to modify the trust.

Once you transfer assets into an irrevocable trust, you’ve effectively removed all of your rights of ownership to the assets and the trust. The benefit is that, because the property is no longer yours, it’s unavailable to satisfy claims against you.

Placing assets in a trust won’t allow you to sidestep responsibility for any debts or claims that are already outstanding at the time you fund the trust. There may also be a substantial “look-back” period that could negate the protection that would otherwise be provided.

Consider a spendthrift trust

If you’re concerned about what will happen to your assets after they pass to the next generation, you may want to consider a “spendthrift” trust. Despite the name, a spendthrift trust does more than just protect your heirs from themselves. It can protect your family’s assets against dishonest business partners or unscrupulous creditors.

The trust also protects loved ones in the event of relationship changes. For example, if your son divorces, his spouse generally won’t be able to claim a share of the trust property in the divorce settlement.

Several trust types can be designated as a spendthrift trust — you just need to add a spendthrift clause to the trust document. This type of clause restricts a beneficiary’s ability to assign or transfer his or her interests in the trust, and it restricts the rights of creditors to reach the trust assets. But a spendthrift trust won’t avoid claims from your own creditors unless you relinquish any interest in the trust assets.

Bear in mind that the protection offered by a spendthrift trust isn’t absolute. Depending on applicable law, it’s possible for government agencies to reach the trust assets to, for example, satisfy a delinquent tax debt.

You can gain greater protection against creditors’ claims if you give your trustee more discretion over trust distributions. If the trust requires the trustee to make distributions for a beneficiary’s support, for example, a court may rule that a creditor can reach the trust assets to satisfy support-related debts. For increased protection, give the trustee full discretion over whether and when to make distributions. You’ll need to balance the potentially competing objectives of having the access you want and preventing others from having access against your wishes.

Secure your assets

Obviously, you can choose from many types of trusts, depending on your particular circumstances. Talk to us to help you determine which type of trust is best for you going forward.

© 2022

Formalizing Your Business’s BYOD Policy

When the pandemic hit about two and a half years ago, thousands of employees suddenly found themselves working from home. In many cases, this meant turning to personal devices to access their work email, handle documents and perform other tasks. Even before COVID, more and more businesses were allowing employees to use their own phones, tablets and laptops to get stuff done.

By now, many companies have established firm bring-your-own-device (BYOD) policies. Other businesses, however, have taken a more informal approach, allowing their policies to evolve with minimal documentation. Whichever camp your company falls into, it’s a good idea to regularly review and, if necessary, formalize your BYOD policy.

Key questions

A comprehensive BYOD policy needs to anticipate a multitude of situations. What if a voluntary or involuntary termination occurs? What if a device is lost, shared or recycled? What if it’s infected by a virus or malware? How about if a device is synced on an employee’s home cloud? Other key questions to address include:

Who pays the bill? Payment policies vary widely. For example, an employer might pay for an unlimited data plan for employees. Any charges above that amount are the employee’s responsibility.

Who owns an employee’s cell phone number? This is a big deal for salespeople and service representatives — especially if they leave to work for a competitor. Customers may continue to call a rep’s cell phone, leading to lost sales for your business.

Are employees properly password-protecting their devices? A policy should require employees to not only use passwords, but also implement two-factor authentication if feasible. In addition, users need to set up their devices to lock if left idle for more than a few minutes.

Legal ramifications

A BYOD policy needs to address the fact that using a personal device for work inevitably opens the door for an employer to access personal information, such as text messages and photos. State that the company will never intentionally view protected items on a device, such as privileged communications with attorneys, protected health information or complaints against the employer that are permitted under the National Labor Relations Act.

In case your business becomes involved in a lawsuit, its data retention policies should address how data is stored on mobile devices and gathered during litigation. Keep in mind that Rule 34 of the Federal Rules of Civil Procedure covers all devices, including personal ones that access a company’s network.

Financial impact

Formalizing your BYOD policy should involve spelling it out in a written user’s agreement that all participants must sign. Consult a qualified attorney in drafting such an agreement. Contact us for help assessing the tax and financial impact of allowing employees to use personal devices vs. buying technology assets and providing them to your workforce.

© 2022

If You’re Moving Out of State, Review Your Estate Plan

Are you planning to move to a different state? It may be due to a change in jobs, a desire for a better climate, an opportunity to downsize or to be closer to your kids. In any event, you’ll have to cope with some hassles, including securing motor vehicle registrations, finding new physicians and updating financial records.

In addition to these tasks, here’s some practical advice: Don’t forget to amend your will and other estate planning documents. It doesn’t have to be the first thing you do, but it shouldn’t be the last, either.

Different state, different laws

Remember that the laws governing wills, as well as most other estate planning documents, vary from state to state. Although your will is still generally valid, you may need to take extra steps to ensure complete enforcement. For example, depending on your situation, you might consider appointing a different executor.

Furthermore, state laws for estate planning are constantly changing. This could adversely affect the implementation of your will, trusts, powers of attorney and medical directives. You may no longer be able to achieve the intended results or you might have to forfeit certain tax benefits. In a worst-case scenario, your documents could be rendered obsolete. Also, consider the state tax impact on pensions and other retirement plan accounts.

Review and revise before you relocate

The optimal approach is to review your estate plan before relocating to determine if any changes will be needed. We can help you revise your estate planning documents as necessary.

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