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Ashleigh Laabs 4/27/22 Ashleigh Laabs 4/27/22

Congress eyes further retirement savings enhancements

In 2019, the bipartisan Setting Every Community Up for Retirement Enhancement Act (SECURE Act) — the first significant legislation related to retirement savings since 2006 — became law. Now Congress appears ready to build on that law to further increase Americans’ retirement security.

The U.S. House of Representatives passed the Securing a Strong Retirement Act by a 414-5 vote. Also known as SECURE 2.0, the bill contains numerous provisions that — if enacted — would affect both individuals and employers, including in the following areas.

Catch-up contributions

Currently, qualified individuals age 50 or older can make catch-up contributions, on top of the standard contribution limits, to certain retirement accounts — an extra $6,500 for 401(k) plan accounts and $3,000 for SIMPLE plans. Beginning in 2024, SECURE 2.0 would boost those figures for individuals age 62 to 64 to $10,000 for 401(k)s and $5,000 for SIMPLE plans (indexed for inflation). In addition, the $1,000 annual catch-up for IRAs, which hasn’t changed in years, would be indexed going forward.

The bill also would change the taxation of catch-up contributions, reducing the upfront tax savings for those who max out their annual contributions. Such contributions would be treated as post-tax Roth contributions starting in 2023. Under existing law, you can choose whether to make catch-up contributions on a pre- or post-tax basis. SECURE 2.0 would also allow you to determine whether your employer’s matching contributions should be treated as pre- or post-tax. Currently, these contributions can be pre-tax only.

RMDs

The SECURE Act eased the rules for required minimum distributions (RMDs) from traditional IRAs and other qualified plans. It generally raised the age at which you must begin to take your RMDs — and pay taxes on them — from 70½ to 72.

SECURE 2.0 would increase the age over the course of a decade. As of 2023, RMDs wouldn’t be mandated until age 73, going up to age 74 in 2030 and age 75 in 2033. This would give you more time to grow your retirement savings tax-free, bearing in mind that delayed RMDs may translate to larger withdrawal requirements down the road.

The bill would relax the penalty for failing to take full RMDs, too. Currently, the failure results in a 50% excise tax of the amount that should have been withdrawn. SECURE 2.0 would reduce the tax to 25% beginning in 2023. If corrected in a “timely” manner, the penalty would further drop to 10%.

QCDs

Some taxpayers use qualified charitable distributions (QCDs) to satisfy both their RMD requirements and their philanthropic inclinations. With a QCD, you can distribute up to $100,000 per year directly to a 501(c)(3) charity after age 70½. You can’t claim a charitable deduction for this donation, but the distribution is removed from taxable income.

The bill would make this option more attractive. It would annually index the $100,000 limit for inflation. It also would allow you to make a one-time QCD transfer of up to $50,000 through a charitable gift annuity or charitable remainder trust (as opposed to directly to the charity). Both provisions would take effect in the taxable year following enactment of the law.

Automatic enrollment

The House bill would require employers to automatically enroll all newly eligible employees in their 401(k) plans at a deduction rate of at least 3% (but no more than 10%) of the employee’s pay, increasing it by 1% each year until the employee is contributing 10%. Employees could opt out or change their contribution rates.

Annuities

Annuities can help reduce the risk that retirees run out of money during their lifetimes. The SECURE Act encouraged reluctant employers to offer annuities by immunizing them from breach of fiduciary duty liability if they choose an annuity provider that meets certain requirements.

But an actuarial test in the regulations for RMDs has interfered with the availability of annuities. For example, the test commonly prohibits annuities with guaranteed annual increases of only 1% to 2%, return of premium death benefits and period-certain guarantees. Without such guarantees, though, many individuals are hesitant to choose an annuity option in a defined contribution plan or IRA. SECURE 2.0 would specify that these guarantees are allowed. The changes would take effect upon enactment of the law.

Matching contributions on student loan payments

SECURE 2.0 recognizes that many employees are unable to contribute to their retirement accounts because of student loan payment responsibilities. Such employees miss out on matching contributions from their employers.

The bill would allow employers to contribute to certain retirement plans for employees who are making qualified student loan payments. If enacted, this would take effect for contributions made for plan years beginning after 2022.

Part-time employee eligibility

The SECURE Act generally requires employers to allow part-time employees who work at least 500 hours for three consecutive years to participate in their 401(k) plans. Under SECURE 2.0, part-time employees would need to work at least 500 hours for only two consecutive years to be eligible for their employer’s 401(k) plan. The provision would be effective for plan years beginning after 2022.

Small business tax credits

SECURE 2.0 would create or enhance some tax credits for small businesses for tax years after 2022. For example, the SECURE Act increased the potential amount of the credit for retirement plan startup costs by capping it at $5,000 (up from $500). The three-year credit currently is available for 50% of “qualified startup costs” for employers with no more than 100 employees.

The new bill hikes the credit to 100% of qualified costs for employers with up to 50 employees. It provides an additional credit, too, except for defined benefit plans. The additional amount generally is a percentage of the amount the employer contributes on behalf of employees, up to $1,000 per employee. The full additional credit is limited to employers with 50 or fewer employees, gradually phasing out for employers with 51 to 100 employees.

Next steps

While the odds for passage of some form of retirement savings reform seem high in light of the bipartisan support for the SECURE Act and the new House bill, it remains to be seen what form it’ll take. The Senate is working its own bill, and the two would need to be reconciled before it reaches President Biden’s desk. The final legislation could add to, revise or remove the provisions described above. We’ll keep you up to date.

Ashleigh Laabs 4/19/22 Ashleigh Laabs 4/19/22

Careful planning required for beneficiaries to borrow from a trust

Intrafamily loans allow you to provide financial assistance to loved ones — often at favorable terms — while potentially reducing gift and estate taxes. But what about families that lack the liquid assets to make such loans? Are there other options if they have a trust?

One lesser-known possibility is for trust beneficiaries to borrow money from a trust. This strategy requires careful planning, however, because the trustee must consider his or her fiduciary duty to the trust and its other beneficiaries in approving and structuring such a loan.

Benefits of intrafamily loans

An intrafamily loan can be a great way to help out your children or other family members financially while also transferring significant amounts of wealth, free of gift and estate tax. Why not simply make an outright gift? Actually, a gift is the better option, so long as your unused exemption is enough to cover it and you don’t need the funds or the interest income. But if transfer taxes are an issue or you’re not prepared to part with the money just yet, a loan can be an attractive alternative.

Generally, to pass muster with the IRS, the interest rate on an intrafamily loan must be at least the applicable federal rate for the month in which the loan is made. Otherwise, the IRS may view the loan as a disguised distribution, which can result in a variety of unpleasant tax complications. The loan should also be documented by a promissory note and otherwise treated as an arm’s-length transaction.

Trust loans vs. distributions

If an intrafamily loan isn’t an option, it may be possible for a trust beneficiary to obtain a loan from the trust. You might wonder why a beneficiary would borrow from the trust rather than take a distribution. There are several situations in which a loan may be necessary or desirable, including:

The trust’s terms place conditions on distributions that aren’t currently satisfied,
The borrower seeks an amount that exceeds limits on distributions imposed by the trust (an income-only trust, for example),
The trust has multiple beneficiaries and the borrower seeks an amount that would be unfair to other beneficiaries if taken as a distribution, or
A loan is preferable for tax planning purposes.

Be sure to check whether trust loans are permissible. Many trust instruments explicitly authorize loans.

Handle with care

There’s a critical difference between intrafamily loans and trust loans: The trustee has a fiduciary duty to manage the trust in a prudent and impartial manner. If you lend money to family members from your personal assets, you’re generally permitted to structure the transaction as you see fit.

However, a trustee considering a loan request must act in the best interests of the trust and all of its beneficiaries. So, for example, a trustee who approves a loan to a current beneficiary who’s a bad credit risk is likely breaching his or her fiduciary duty to the remainder beneficiaries.

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FMD’s estate planning team will work with you and your legal and financial advisers to design plans that align with your goals and objectives. When it comes to estate planning and wealth preservation, every one of our clients receives the quality of service and personal attention that are the hallmarks of FMD. To learn more about how we can help address your estate planning and wealth preservation needs, contact us today.

Ashleigh Laabs 4/19/22 Ashleigh Laabs 4/19/22

What estate planning strategies are available for non-U.S. citizens?

Are you, or is your spouse, a non-U.S. citizen? If so, several traditional estate planning techniques won’t be available to you. However, if you’re a U.S. resident, but not a citizen, the IRS will treat you similarly to a U.S. citizen.

If you’re considered a resident, you’re subject to federal gift and estate taxes on your worldwide assets, but you also enjoy the benefits of the $12.06 million federal gift and estate tax exemption and the $16,000 per recipient annual exclusion in 2022. And you can double the annual exclusion to $32,000 through gift-splitting with your spouse, so long as your spouse is a U.S. citizen or resident. Special rules apply to the marital deduction, however.

Understanding residency

Residency is a complicated subject. IRS regulations define a U.S. resident for federal estate tax purposes as someone who had his or her domicile in the United States at the time of death. A person acquires a domicile in a place by living there, even briefly, with a present intention of making that place a permanent home.

Whether you have your domicile in the United States depends on an analysis of several factors, including the relative time you spend in the United States and abroad, the locations and relative values of your residences and business interests, visa status, community ties, and the location of family members.

Estate tax law for nonresident aliens

If you’re a nonresident alien — that is, if you’re neither a U.S. citizen nor a U.S. resident — there’s good news and bad news in regard to estate tax law. The good news is that you’re subject to U.S. gift and estate taxes only on property that’s “situated” in the United States. Also, you can take advantage of the $16,000 annual exclusion (although you can’t split gifts with your spouse).

The bad news is that your estate tax exemption drops from $12.06 million to a miniscule $60,000, so substantial U.S. property holdings can result in a big estate tax bill. Taxable property includes U.S. real estate as well as tangible personal property (such as cars, boats and artwork) located in the United States.

Determining the location of intangible property — such as stocks, bonds, partnership interests or other equity or debt interests — is more complicated. For example, if a nonresident alien makes a gift of stock in a U.S. corporation, the gift is exempt from U.S. gift tax. But a bequest of that same stock at death is subject to estate tax. On the other hand, a gift of cash on deposit in a U.S. bank is subject to gift tax, while a bequest of the same cash would be exempt from estate tax.

We can help you determine which property is situated in the United States and explore strategies for minimizing your tax exposure.

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Ashleigh Laabs 4/19/22 Ashleigh Laabs 4/19/22

Power up your trust with Crummey powers

The unified gift and estate tax exemption is set at an inflation-adjusted $12.06 million for 2022, up from $11.7 million for 2021. This means that for many families, estate tax liability isn’t a factor. However, for others, the annual gift tax exclusion continues to be an important estate planning strategy — especially since future tax law changes could lower the gift and estate tax exemption. For this reason, using a Crummey trust in your estate plan remains an important estate planning strategy. Here’s why.

Using the annual exclusion

Under the annual gift tax exclusion, you can give gifts to each recipient, valued up to a specific limit, without incurring any gift tax. The limit for 2022 is $16,000 per recipient. (This amount is indexed for inflation, but only in $1,000 increments.)

Therefore, if you have, for example, three adult children and seven grandchildren, you can give each one $16,000 this year, for a total of $160,000, and pay zero gift tax. The exclusion is per donor, meaning that for a married couple the amount is doubled.

If you give outright gifts, however, you run the risk that the money or property could be squandered, especially if the recipient is young or irresponsible. Alternatively, you can transfer assets to a trust and name a child as a beneficiary. With this setup, the designated trustee manages the assets until the child reaches a specified age.

But there’s a catch. To qualify for the annual exclusion, a gift must be a transfer of a “present interest.” This is defined as an unrestricted right to the immediate use, possession or enjoyment of the property or the income from it. Without certain provisions in the trust language, a gift to the trust doesn’t qualify as a gift of a present interest. Instead, it’s treated as a gift of a “future interest” that’s not eligible for the annual gift tax exclusion.

Giving Crummey powers to a trust

This is where a Crummey trust can come to the rescue. It satisfies the rules for gifts of a present interest without requiring the trustee to distribute the assets to the beneficiary.

Typically, periodic contributions of assets to the trust are coordinated with an immediate power giving the beneficiary the right to withdraw the contribution for a limited time. However, the expectation of the donor is that the power won’t be exercised. (The trust document cannot expressly provide this.)

As a result, the beneficiary’s limited withdrawal right allows the gift to the trust to be treated as a gift of a present interest. Thus, it qualifies for the annual gift tax exclusion. Note that it’s the existence of the legal power — not the exercise of it — that determines the tax outcome.

Avoiding pitfalls

To pass muster with the IRS, the beneficiary must be given actual notice of the withdrawal right, along with a reasonable period to exercise it. Generally, at least 30 days is required. Contact us with additional questions regarding the use of a Crummey trust.

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Ashleigh Laabs 3/25/22 Ashleigh Laabs 3/25/22

ERISA and EAPs: What’s the deal?

In recent years, more and more businesses have increased efforts to support the well-being of their employees. This means not only providing health care benefits, but also offering other initiatives designed to help workers cope with challenges such as substance dependence, financial planning, legal woes and mental health issues.

Among the options usually considered is an employee assistance program (EAP). These programs typically offer a set of benefits intended to address circumstances and challenges that might adversely affect employees’ ability to work. Benefits may include short-term mental health or substance abuse counseling or referral services, as well as financial counseling and legal services.

When considering an EAP, many business owners eventually ask a common question: Will the program be subject to the Employee Retirement Income Security Act (ERISA)?

Medical care

The answer depends on how the EAP is structured and what benefits it provides. Generally, an arrangement is an ERISA welfare benefit plan if it’s a plan, fund or program established or maintained by an employer to provide ERISA-listed benefits, which include medical services.

Indeed, the category of ERISA-listed benefits most likely to be provided by an EAP is medical care or benefits. Mental health counseling — whether for substance abuse, stress or other issues — is considered medical care. Accordingly, an EAP providing mental health counseling will probably be subject to ERISA. On the other hand, an EAP that provides only referrals and general information, and isn’t staffed by trained counselors, likely isn’t an ERISA plan.

Even if an EAP primarily uses referrals, it could still be considered to provide medical benefits if the individuals handling initial phone consultations and making the referrals are trained in an applicable field, such as psychology or social work. If the EAP provides any benefit subject to ERISA, then the entire EAP must comply with the law — even if it also provides non-ERISA benefits.

Beyond ERISA

When considering an EAP, you should first determine whether it will be subject to ERISA. The law’s provisions address critical compliance matters such as:

Creating a plan document and Summary Plan Description,
Performing fiduciary duties,
Following claims procedures, and
Filing IRS Form 5500.

However, an EAP that’s considered a group health plan will also be subject to the Consolidated Omnibus Budget Reconciliation Act (commonly known as “COBRA”) and certain other group health plan mandates, including mental health parity.

Another point to keep in mind: EAPs that receive medical information from participants — even if they only make referrals and don’t provide medical care — must comply with privacy and security rules under the Health Insurance Portability and Accountability Act (HIPAA).

An EAP might not be subject to other group health plan requirements. One that meets specified criteria can be defined as an “excepted benefit” not subject to HIPAA portability and certain Affordable Care Act requirements.

A worthy idea

The idea of offering your employees an EAP is well worth considering. This is particularly true now that businesses are under increased pressure to retain their workers. We can help you assess the costs, advantages and risks of one of these programs.

Ashleigh Laabs 3/25/22 Ashleigh Laabs 3/25/22

360-degree feedback helps business owners see the big picture

Business owners are regularly urged to “see the big picture.” In many cases, this imperative applies to a pricing adjustment or some other strategic planning idea. However, seeing the big picture also matters when it comes to managing the performance of your staff.

Perhaps the best way to get a fully rounded perspective on how all your employees are performing is through a 360-degree feedback program. Under such an initiative, feedback is gathered from not only supervisors rating employees, but also from employees rating supervisors and employees rating each other. Sometimes even customers or vendors are asked to contribute.

Designing a survey

As you might have guessed, a critical element of a 360-degree feedback program is the written survey that you distribute to participants when gathering feedback. You can inadvertently sabotage the entire effort early on if this survey is poorly written or difficult to complete.

For starters, keep it as brief as possible. Generally, a participant should be able to fill out the survey in about 15 to 20 minutes. Ask concise questions that have a clear point. Be sure the language is unbiased; avoid words such as “excellent” or “always.” Ensure the questions and performance criteria are job-related and not personal in nature.

If using a rating scale, offer seven to 10 points that ask to what extent the person being rated exhibits a given behavior, rather than how often. It’s a good idea to use a dual-rating scale that includes both quantitative and qualitative performance questions.

Another good question is: To what extent should the person exhibit the behavior described, given his or her job role? By comparing the answers, you basically perform a gap analysis that helps interpret the results and reduces a rater’s bias to score consistently high or low.

Encouraging buy-in

To optimize the statistical validity of 360-degree feedback results, you need the largest sample size possible. Tell feedback providers how you’ll analyze their input, assuring them that their time will be well spent.

Also, emphasize the importance of being objective and avoiding invalid observations that might arise from their own prejudices. Ask providers to comment only on aspects of the subject employee’s performance that they’ve been able to observe.

Even with anonymous feedback, you should require some accountability. Incorporate a mechanism that would enable someone other than the subject of the evaluation — for instance, a senior HR manager — to address any abuse of the program. And, of course, ensure that subjects of the feedback process can work with their supervisors to act on the input they receive.

Taking it slowly

If a 360-degree feedback program sounds like something that could genuinely help your business, don’t rush into it. Discuss the idea with your leadership team and take the time to design a program with strong odds of success. Finally, bear in mind that you’ll likely have to fine-tune the program in years ahead to get the most useful data.

Ashleigh Laabs 3/25/22 Ashleigh Laabs 3/25/22

A beneficiary designation or joint title can override your will

Inattention to beneficiary designations and jointly titled assets can quickly unravel your estate plan. Suppose, for example, that your will provides for all of your property to be divided equally among your three children. But what if your IRA, which names the oldest child as beneficiary, accounts for half of the estate? In that case, the oldest child will inherit half of your estate plus a one-third share of the remaining assets — hardly equal.

The same goes for jointly owned property. When you die, the surviving owner takes title to the property regardless of the terms of your will. Unfortunately, many people don’t realize that their wills don’t control the disposition of nonprobate assets.

What are nonprobate assets?

Nonprobate assets generally are transferred automatically at death according to a beneficiary designation or contract. So they override your will. They include life insurance policies, retirement plans and IRAs, as well as joint bank or brokerage accounts. Even savings bonds come with beneficiary forms.

To ensure that your estate plan reflects your wishes, review beneficiary designations and property titles regularly, particularly after significant life events such as a marriage or divorce, the birth of a child, or the death of a loved one.

What about POD and TOD designations?

Payable-on-death (POD) and transfer-on-death (TOD) designations provide a simple and inexpensive way to transfer assets outside of probate. POD designations can be used for bank accounts and certificates of deposit. TOD designations can be used for stocks, bonds, brokerage accounts and, in many states, even real estate.

Setting one up is as easy as providing a signed POD or TOD beneficiary designation form. When you die, your beneficiaries just need to present a certified copy of the death certificate and their identification to the bank or brokerage, and the money or securities are theirs.

However, just like other beneficiary designations, POD and TOD designations can backfire if they’re not carefully coordinated with the rest of your estate plan. Too often, people designate an account as POD or TOD as an afterthought, without considering whether it may conflict with their wills, trusts or other estate planning documents.

Another potential problem with POD and TOD designations is that, if you use them for most of your assets, the assets left in your estate may be insufficient to pay debts, taxes or other expenses. Your executor would then have to initiate a proceeding to bring assets back into the estate.

Whether you have large retirement accounts or life insurance policies, hold joint accounts or use POD or TOD designations as part of your estate plan, we can review the rest of your plan to identify potential conflicts.

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Ashleigh Laabs 3/22/22 Ashleigh Laabs 3/22/22

Defined-value gifts: Plan carefully to avoid unpleasant tax surprises

For 2022, the federal gift and estate tax exemption has reached its highest level ever. In fact, you can transfer up to $12.06 million by gift or bequest without triggering federal transfer taxes. This is a limited time offer, however, as the exemption amount is scheduled to drop to $5 million (adjusted for inflation) in 2026. (However, Congress could pass legislation to reduce it even sooner or to extend it longer.)

Many are considering making substantial gifts to the younger generation to take advantage of the current exemption while it lasts. Often, these gifts consist of hard-to-value assets — such as interests in a closely held business or family limited partnership (FLP) — which can be risky. A defined-value gift may help you avoid unexpected tax liabilities.

Hedging your bets

Simply put, a defined-value gift is a gift of assets that are valued at a specific dollar amount rather than a certain number of stock shares or FLP units or a specified percentage of a business entity.

Structured properly, a defined-value gift ensures that the gift won’t trigger an assessment of gift taxes down the road. The key to this strategy is that the defined-value language in the transfer document is drafted as a “formula” clause rather than an invalid “savings” clause.

A formula clause transfers a fixed dollar amount, subject to adjustment in the number of shares or units necessary to equal that dollar amount (based on a final determination of the value of those shares or units for federal gift and estate tax purposes). A savings clause, in contrast, provides for a portion of the gift to be returned to the donor if that portion is ultimately determined to be taxable.

Language matters

For a defined-value gift to be effective, it’s critical to use precise language in the transfer documents. In one recent case, the U.S. Tax Court rejected an intended defined-value gift of FLP interests and upheld the IRS’s assessment of gift taxes based on percentage interests. The documents called for the transfer of FLP interests with a defined fair market value “as determined by a qualified appraiser” within a specified time after the transfer.

The court found that the transfer documents failed to achieve a defined-value gift, because fair market value was determined by a qualified appraiser. The documents didn’t provide for an adjustment in the number of FLP units if their value “is finally determined for federal gift tax purposes to exceed the amount described.”

Seek professional advice

If you plan to make substantial gifts of interests in a closely held business, FLP or other hard-to-value asset, a defined-value gift can help you avoid unwanted gift tax consequences. Turn to us before taking action because to be effective, the transfer documents must contain specific language that provides for adjustment of the number of shares or units to convey the desired value. We’d be pleased to help.

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Ashleigh Laabs 3/9/22 Ashleigh Laabs 3/9/22

Business owners, lean into sales staff retention

Although there have been some positive signs for the U.S. economy thus far in 2022, many businesses are still reeling from last year’s “Great Resignation.” This trend of a historic number of workers voluntarily leaving their jobs, combined with the difficulty of hiring new employees, didn’t spare sales teams. However, one could say that the Great Resignation only threw gasoline on an existing fire.

Historically, sales departments have always trended toward higher turnover rates. Maybe you’ve grown accustomed to salespeople coming and going, and you believe there’s not much you can do about it. Or can you? By leaning into sales staff retention a little harder, you could avoid the worst of today’s uncomfortably tight job market and hang on to your top sellers.

Improve hiring and onboarding

Retention efforts shouldn’t begin with those already on the payroll; it should start during hiring and ramp up when onboarding. A rushed, confusing or cold approach to hiring can get things off on a bad foot. In such cases, new hires tend to enter the workplace cautiously or skeptically, with their eyes on the exit sign rather than the “upper floors” of a company.

Onboarding is also immensely important. Many salespeople can tell horror stories of being shown to a cubicle with nothing but a telephone on the desk and told to “Get to it.” Today, with so many people working remotely, a new sales hire might not even get that much attention. Welcome new employees warmly, provide ample training, and perhaps give them a mentor to help them get comfortable with your business and its culture.

Reward loyalty

Even when hiring and onboarding go well, most employees will still consider a competitor’s offer if the price is right. So, to improve your chances of retaining top sales producers and their customers, consider financial incentives.

Offering retention bonuses and rewards for maintaining and increasing sales — in addition to existing compensation plans — can help. Make such incentives easy to understand and clearly achievable. Although interim bonus programs might be expensive in the near term, they can stabilize sales and prevent sharp declines. When successful, a bonus program will help you generate more long-term revenue to offset the immediate costs.

Encourage ideas

Because they work in the trenches, salespeople often have good ideas for capitalizing on your company’s strengths and shoring up its weaknesses. Look into forming a sales leadership team to evaluate the potential benefits and risks of strategic objectives. The team should include two to four top sellers who are taken off their regular responsibilities and tasked with retaining customers and maintaining sales momentum during strategic planning efforts.

The sales leadership team can also serve as a clearinghouse for customer concerns and competitor strategies. It could help with communications to clear up confusion over current or upcoming product or service offerings. And it might be able to contribute to the development of new products or services based on customer feedback and demand.

Buck the trend

Sales departments in many industries will likely continue to have relatively high turnover rates, but that doesn’t mean your business can’t buck the trend. Give your salespeople a little more attention and input, and you could retain the staff needed to maintain and improve your company’s competitive edge.

Ashleigh Laabs 3/7/22 Ashleigh Laabs 3/7/22

Clarity counts when it comes to estate planning documents

Precise language is critical in wills, trusts and other estate planning documents. A lack of clarity may be an invitation to litigation. An example of this is the dispute that arose after Tom Petty’s death, between his widow and his two daughters from a previous marriage. (The two parties have since resolved their differences and dismissed all litigation matters.)

Interpreting “equal participation”

Details of the musician’s estate plan aren’t entirely clear. But it appears that his trust appointed his widow as a “directing trustee,” while providing that she and his daughters were entitled to “participate equally” in the management of his extensive music catalog and other assets. Unfortunately, the trust failed to spell out the meaning of “equal participation,” resulting in litigation between Petty’s widow and daughters over control of his assets.

There are several plausible interpretations of “equal participation.” One interpretation is that each of the three women has an equal vote, giving the daughters the ability to rule by majority.

Another interpretation is that each has an opportunity to participate in the decision-making process, but Petty’s widow has the final say as the directing trustee. Yet another possibility is that Petty intended for the women to make decisions by unanimous consent.

Determining intent

If the two parties hadn’t settled their differences out of court, it would have been up to the court to provide an answer based on evidence of Petty’s intent. But the time, expense and emotional strain of litigation may have been avoided by including language in the trust that made that intent clear.

If you’re planning your estate, the Petty case illustrates the importance of using unambiguous language to ensure that your wishes are carried out. And if you anticipate that one or more of your beneficiaries will perceive your plan as unfair, sit down with them to explain your reasoning. This discussion can go a long way toward avoiding future disputes.

Review and revise to make your intent crystal clear

If your estate plan has already been drafted and you have concerns regarding the language used, contact your attorney. He or she can review your documents to determine if more precise wording is necessary to make your intentions crystal clear for your family after your death.

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Ashleigh Laabs 3/2/22 Ashleigh Laabs 3/2/22

The IRS again eases Schedules K-2 and K-3 filing requirements for 2021

The IRS has announced additional relief for pass-through entities required to file two new tax forms — Schedules K-2 and K-3 — for the 2021 tax year. Certain domestic partnerships and S corporations won’t be required to file the schedules, which are intended to make it easier for partners and shareholders to find information related to “items of international tax relevance” that they need to file their own returns.

In 2021, the IRS released guidance providing penalty relief for filers who made “good faith efforts” to adopt the new schedules. The IRS has indicated that its latest, more sweeping move comes in response to continued concern and feedback from the tax community and other stakeholders.

A tough tax season for the IRS

The announcement of additional relief comes as IRS Commissioner Charles Rettig has acknowledged that the agency faces “enormous challenges” this tax season. For example, millions of taxpayers are still waiting for prior years’ returns to be processed.

To address such issues, he says, the IRS has taken “extraordinary measures,” including mandatory overtime for IRS employees, the creation and assignment of “surge teams,” and the temporary suspension of the mailing of certain automated compliance notices to taxpayers. In addition, the partial suspension of the Schedules K-2 and K-3 filing requirements might ease the burden for both affected taxpayers and the IRS.

K-2 and K-3 filing requirements

Provisions of the Tax Cuts and Jobs Act, which was enacted in 2017, require taxpayers to provide significantly more information to calculate their U.S. tax liability for items of international tax relevance. The Schedule K-2 reports such items, and the Schedule K-3 reports a partner’s distributive share of those items. These schedules replace portions of Schedule K and numerous unformatted statements attached to earlier versions of Schedule K-1.

Schedules K-2 and K-3 generally must be filed with a partnership’s Form 1065, “U.S. Return of Partnership Income,” or an S corporation’s Form 1120-S, “U.S. Income Tax Return for an S Corporation.” Previously, partners and S corporation shareholders could obtain the information that’s included on the schedules through various statements or schedules the respective entity opted to provide, if any. The new schedules require more detailed and complete reporting than the entities may have provided in the past.

In January of 2022, the IRS surprised many in the tax community when it posted changes to the instructions for the schedules. Under the revised instructions, an entity may need to report information on the schedules even if it had no foreign partners, foreign source income, assets generating such income, or foreign taxes paid or accrued.

For example, if a partner claims a credit for foreign taxes paid, the partner might need certain information from the partnership to file his or her own tax return. Although some narrow exceptions apply, this change substantially expanded the pool of taxpayers required to file the schedules.

Good faith exception

IRS Notice 2021-39 exempted affected taxpayers from penalties for the 2021 tax year if they made a good faith effort to comply with the filing requirements for Schedules K-2 and K-3. When determining whether a filer has established such an effort, the IRS considers, among other things:

The extent to which the filer has made changes to its systems, processes and procedures for collecting and processing the information required to file the schedules,
The extent the filer has obtained information from partners, shareholders or a controlled foreign partnership or, if not obtained, applied reasonable assumptions, and
The steps taken by the filer to modify the partnership or S corporation agreement or governing instrument to facilitate the sharing of information with partners and shareholders that’s relevant to determining whether and how to file the schedules.

The IRS won’t impose the relevant penalties for any incorrect or incomplete reporting on the schedules if it determines the taxpayer exercised the requisite good faith efforts.

Latest exception

Under the latest guidance, announced in early February, partnerships and S corporations need not file the schedules if they satisfy all of the following requirements:

For the 2021 tax year:
- The direct partners in the domestic partnership aren’t foreign partnerships, corporations, individuals, estates or trusts, and
- The domestic partnership or S corporation has no foreign activity, including 1) foreign taxes paid or accrued, or 2) ownership of assets that generate, have generated or may reasonably be expected to generate foreign-source income.
For the 2020 tax year, the domestic partnership or S corporation didn’t provide its partners or shareholders — nor did they request — information regarding any foreign transactions.
The domestic partnership or S corporation has no knowledge that partners or shareholders are requesting such information for the 2021 tax year.

Entities that meet these criteria generally aren’t required to file Schedules K-2 and K-3. But there’s an important caveat. If such a partnership or S corporation is notified by a partner or shareholder that it needs all or part of the information included on Schedule K-3 to complete its tax return, the entity must provide that information.

Moreover, if the partner or shareholder notifies the entity of this need before the entity files its own return, the entity no longer satisfies the criteria for the exception. As a result, it must provide Schedule K-3 to the partner or shareholder and file the schedules with the IRS.

Temporary reprieves

The IRS guidance on the exceptions to the Schedules K-2 and K-3 filing requirement explicitly refers to 2021 tax year filings. In the absence of additional or updated guidance, partnerships and S corporations should expect and prepare to file the schedules for current and future tax years. We can help ensure you have the necessary information on hand.

Ashleigh Laabs 3/2/22 Ashleigh Laabs 3/2/22

5 ways to control your business insurance costs

Common sense dictates that every company, no matter how small, should carry various forms of business insurance. But that doesn’t mean you should pay unnecessarily high premiums just to retain the coverage you need. Here are five ways to better control your insurance costs without sacrificing the quality of your policies:

1. Review coverage periodically. Make sure existing policies reflect your current circumstances. For example, if you’ve sold or sunset some equipment, remove it from your schedule of current assets. If you’ve reduced the number of workers on your payroll, adjust workers’ compensation estimates accordingly. (We’ll address this further below.) On the other hand, if you’ve added equipment, vehicles or staff, see that they’re appropriately covered.

2. Shop around. Spend some time and effort to compare coverage and costs of various insurers. Investigate whether you qualify for any discounts that you’re not getting. To facilitate the process, you might want to engage an insurance specialist in your industry. The right expert can help you weigh the total, true costs of various policies and advise you without a vested interest in selling you a particular product.

3. Actively manage workers’ compensation coverage. In some industries, such as construction and manufacturing, workers’ comp is a major focus. In others, business owners might pay little attention to it if accidents rarely occur. Be sure that you keep up with the costs of this coverage and make regular adjustments as the nature of work changes.

Workers’ compensation insurers assign risk classification codes to employees based on their duties, responsibilities, and level of exposure to the risk of injury or illness. Higher risk means higher premiums so, at least annually, check that you’re classifying employees accurately. For example, if an employee who now works from home is still classified as someone who travels regularly or works in a higher risk location, your premiums may be needlessly inflated.

4. Consider higher deductibles. If you’re comfortable assuming some additional risk, and your cash flow is strong enough, calculate whether you can save on premiums by raising the deductibles on certain policies. It could be worth paying a higher deductible so long as the premium savings is enough to cover a claim or two if they do occur.

5. Prioritize safety. Keeping employees safe is a worthy goal in and of itself, of course. But emphasizing the importance of safety to managers, supervisors, employees and any independent contractors you might have on-site can also positively affect your company’s insurance costs. After all, the premiums you pay are based in part on your claims history. There are various steps that every business should take to avoid injuries and illness:

Provide safety training to new hires,
Conduct drills and refresher training for current employees,
Issue personal protective equipment, as appropriate, and
Strictly enforce safe work practices with no exceptions.

By keeping your employees safe, and promoting wellness in every respect, you’ll not only decrease the likelihood of costly insurance claims, but you’ll also likely contribute to higher morale and more robust productivity. We can help you measure and assess your insurance costs so you can make the right adjustments without incurring unnecessary risk.

Ashleigh Laabs 2/25/22 Ashleigh Laabs 2/25/22

Owning real estate in more than one state may multiply probate costs

One goal of estate planning is to avoid or minimize probate. This is particularly important if you own real estate in more than one state. Why? Because each piece of real estate titled in your name must go through probate in the state where the property is located.

Cost and time can become issues

Probate is a court-supervised administration of your estate. If probate proceedings are required in several states, the process can become expensive.

For example, your representative will need to engage a probate lawyer in each state, file certain documents in each state and comply with other redundant administrative requirements. In addition to the added expense, the process may also delay the settlement of your estate.

Place all real estate into a revocable trust

If you have a revocable trust (sometimes called a “living trust”), the simplest way to avoid multiple probate proceedings is to ensure that the trust holds the title to all of your real estate. Generally, this involves preparing a deed transferring each property to the trust and recording the deed in the county where the property is located. Property held in a revocable trust generally doesn’t have to go through probate.

Before you transfer real estate to a revocable trust, we can help determine if doing so will have negative tax or estate planning implications. For example, will transferring a residence to a trust affect your eligibility for homestead exemptions from property taxes or other tax breaks? Will the transfer affect any mortgages on the property? Will it be subject to any real property transfer taxes?

It’s also important to consider whether transferring title to property will affect the extent to which it’s shielded from the claims of creditors. Please contact us with any questions.

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Ashleigh Laabs 2/25/22 Ashleigh Laabs 2/25/22

Should your business address retirement plan leakage?

Under just about any circumstances, the word “leakage” has negative connotations. And so it follows that this indeed holds true for retirement planning as well.

In this context, leakage refers to early, pre-retirement withdrawals from an account. Now, as a business owner who sponsors a qualified retirement plan, you might say, “Well, that’s my participants’ business, not mine.”

However, there are valid reasons to care about the issue and perhaps address it with employees who participate in your plan.

Why it matters

For starters, leakage can lead to higher plan expenses. Fees are often determined on a per-account or per-participant basis. When a plan loses funds to leakage, total assets and individual account sizes shrink, which tends to hurt administrative efficiency and raise costs.

More broadly, if your employees are taking pre-retirement withdrawals, it could indicate they’re facing unusual financial challenges. These usually have a negative impact on productivity and work quality. What’s more, workers who raid their accounts may be unable to retire when they reach retirement age.

Of course, the COVID-19 pandemic has put many people in difficult financial positions that have led them to consider withdrawing some funds from their retirement accounts. More recently, “the Great Resignation” might have some account holders pondering whether they should quit their jobs and pull out some retirement funds to live on temporarily or use to start a gig or business of their own.

What you might do

Perhaps the most important thing business owners can do to limit leakage is educate and remind employees about how pre-retirement withdrawals can diminish their accounts and delay their anticipated retirement dates. While you’re at it, provide broader financial education to help workers better manage their money, amass savings, and minimize or avoid the need for an early withdrawal.

Some companies offer emergency loans that are repayable through payroll deductions, thus providing an avenue around the use of retirement funds. Others have revised their plan designs to reduce the number of situations under which plan participants can take out hardship withdrawals or loans.

Minimize the impact

“Roughly 22% of net contributions made by those 50 or younger leaks out of the retirement savings system in a given year,” according to a 2021 report released by the Joint Committee on Taxation.

Some percentage of retirement plan leakage will probably always occur to some extent. Nonetheless, being aware of the problem and taking steps to minimize it are worthy measures for any business that sponsors a qualified plan. We can answer any questions you might have about leakage or other aspects of plan administration and compliance.

Ashleigh Laabs 2/21/22 Ashleigh Laabs 2/21/22

Use the net gift technique to reduce your gift tax rate

If you’re concerned about the impact of transfer taxes on your gifts, consider making “net gifts” to your loved ones. A net gift is simply a gift for which the recipient agrees to pay the gift tax, thereby reducing the value of the gift for tax purposes. It may also be possible to reduce its value further through the “net, net gift” technique.

The technique in action

The easiest way to demonstrate the benefits of a net gift is through an example. Suppose you’d like to make a $1 million gift to your adult son. For purposes of this example, also assume that you’ve already exhausted your federal gift and estate tax exemption amount, so the gift is fully taxable. At the current 40% marginal rate, the tax on your $1 million gift would be $400,000. However, if your son agrees to pay the gift tax as a condition of receiving the gift, then the value of the gift would be reduced by the amount of tax, which in turn would reduce the amount of gift tax owed.

Rather than get caught up in an endless loop of calculating the tax, reducing the gift’s value, recalculating the tax, and so on, there’s a simple formula for determining your son’s tax liability: Gift tax = tentative tax/(1 + tax rate). In our example, the tentative tax is $400,000 (the tax that would’ve been owed on an outright gift), so the gift tax on the net gift would be $400,000/1.4 = $285,714.

You can confirm that the math works out by assuming that you give your son $1 million and that he agrees to pay $285,714 in gift taxes. That tax liability reduces the gift to $1 million - $285,714 = $714,287, resulting in a tax liability of .40 x $714,287 = $285,714.

By using a net gift technique, you reduce the effective tax rate on the $1 million transfer from 40% to only 28.57%. Note that if the gift is in the form of appreciated assets rather than cash, the recipient’s payment of the tax liability can result in capital gains taxes for the donor.

Taking it up a notch

It may be possible to further reduce the effective gift tax rate by using a net, net gift. Under this technique, in addition to assuming liability for gift taxes, the recipient also agrees to pay any estate tax liability that might arise by virtue of the so-called “three-year rule.”

Under that rule, gifts made within three years of death are pulled back into the donor’s estate and subject to estate taxes. The U.S. Tax Court has effectively given its blessing to the net, net gift technique, allowing the value of a gift to be reduced by the actuarial value of the recipient’s contingent obligation to pay estate taxes that would be owed if the donor were to die within three years of making the gift.

If you’re considering the net gift technique, consult with us before taking any action.

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Ashleigh Laabs 2/17/22 Ashleigh Laabs 2/17/22

Prudent technology upgrades call for some soul searching

By now, most business owners view technology upgrades as inevitable. Whether hardware or software, the tech your company relies on to operate will need to change slightly or even drastically for you to stay competitive.

Strange as it may sound, technology upgrades demand a bit of soul searching. That is, before spending the money, you need to dig deep for insights about what your business really needs and whether your employees or customers will appreciate your efforts.

Ask the right questions

Begin the decision process with a series of inquiries. That is, sit down with your leadership team and ask questions such as:

What are the specific functionalities that we need?
Do we need hardware, software or both?
If software, are we looking at an entirely new platform or a smaller upgrade within our existing systems?

Assuming you already have a technology infrastructure in place, compatibility is an issue, too. If you’re using an older operating system, new software could be buggy or flat-out incompatible. In either case, you could incur substantial additional costs to update or replace your operating system, which might involve new hardware and impact other software.

When deciding whether to upgrade internal systems, get input from your staff. For example, your accounting personnel should be able to tell you what types of reports they would want from upgraded financial management software. From there, you can establish criteria for comparing different packages.

If you’re considering changes to a “front-facing” system, you might want to first survey customers to determine whether the upgrade would improve their experience. Ask them questions about what works and what doesn’t to assess whether major or minor changes are needed.

Create a “hot list”

As you’re no doubt aware, there’s no shortage of hardware and software vendors out there. So, just as you’d do your homework on a major asset purchase or the lease of a large office space, do it for a technology upgrade as well.

Generally, longevity is a plus. Look for companies that have been in business for at least five to 10 years, have a track record of successful implementations and can provide references from satisfied customers. Also find out what kind of technical support is included with your purchase.

For example, if you’re doing a software upgrade, is training part of the package? If not, you’ll likely need to send one or more IT staffers out for training or engage a third-party trainer, both of which will cost you additional dollars. And keep in mind that, if you buy a top-of-the-line system but the vendor’s customer service is nonexistent, you and your employees probably won’t be happy.

Your goal is to create a “hot list” of top vendors. With this list in hand, you can get down to the serious business of comparing the various bids. To aid you in this critical decision, ask for free trial periods or online demos to help you choose the best product for your company.

Ensure a happy ending

You’ve likely heard horror stories of businesses that haphazardly attempted to upgrade their technology only to lose time, money and morale fixing the resulting problems. Approach this task cautiously to ensure your upgrade story has a happy ending. For help estimating the costs and projecting the financial impact of a tech upgrade, please contact us.

Ashleigh Laabs 2/11/22 Ashleigh Laabs 2/11/22

The donor-advised fund: A powerful vehicle for charitable giving

If charitable giving is important to you, consider a donor-advised fund (DAF). A DAF — typically sponsored and managed by a community foundation or commercial investment company — offers many of the benefits of a private foundation at a fraction of the cost.

Upsides of a DAF

A DAF allows you to make tax-deductible contributions to an investment account and to advise the fund regarding which charities your contributions and earnings should be used to support. Tax regulations require the sponsor to have the final say on how your charitable dollars are spent, but in most cases the fund will follow your recommendations.

The advantages of a DAF include:

Immediate charitable deductions. The ability to set up a DAF quickly and secure an immediate charitable income tax deduction, without the need to identify a specific charitable beneficiary, is attractive to many donors. Why does this matter? Perhaps this is an ideal year for you — from a tax perspective — to make significant charitable donations, but you haven’t determined which charities you want to support.

Simplicity and low cost. Setting up a DAF is nearly as cheap and easy as opening a mutual fund account. Minimum contributions average around $25,000, although some DAFs allow you to open an account with as little as $5,000.

Private foundations, on the other hand, usually involve six- or seven-figure contributions, take several months to set up, and come with significant legal fees and other expenses. And while a DAF’s sponsor handles investment management and administration, a private foundation requires you to establish a board, hold periodic board meetings, keep meeting minutes and file tax returns.

Higher deduction limits. Cash contributions to DAFs, like donations to other public charities, are deductible up to 60% of your adjusted gross income (AGI). Noncash contributions are deductible up to 30% of AGI. Deduction limits for private foundations are 30% and 20%, respectively.

Privacy. Unlike private foundations and other charitable giving vehicles, a DAF allows you to remain anonymous if you so desire. Technically, when a DAF sponsor donates to a charity, it’s distributing its own assets, so you can elect to keep your name out of it. Alternatively, you can name your DAF after your mission — for example, the Fund for Alzheimer’s Research.

Downsides of a DAF

Once you contribute assets to a DAF, they become the sponsor’s property. Your role in directing distributions is, as the name indicates, strictly advisory, and you have little or no control over investment management.

Evaluate the costs and benefits

Whether a DAF is right for you depends on how much you plan to give to charity, the amount of time and resources you wish to commit to philanthropic activities, your need to retain control over your charitable assets, and other estate planning objectives. We can help you evaluate the relative costs and benefits to determine if a DAF is right for you.

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Ashleigh Laabs 2/10/22 Ashleigh Laabs 2/10/22

Approach turnaround acquisitions with due care

Economic changes wrought by the COVID-19 pandemic, along with other factors, drove historic global mergers and acquisitions (M&A) activity in 2021. Experts expect 2022 to be another busy year for dealmaking.

In many cases, M&A opportunities arise when a business adversely affected by economic circumstances decides that getting acquired by another company is the optimal — or only — way to remain viable. If you get the chance to acquire a distressed business, you might indeed be able to expand your company’s operational scope and grow its bottom line. But you’ll need to take due care before closing the deal.

Looking at the long term

Although so-called “turnaround acquisitions” can yield substantial long-term rewards, acquiring a troubled target can also pose greater risks than buying a financially sound business. The keys are choosing a company with fixable problems and having a detailed plan to address them.

Look for a business with hidden value, such as untapped market opportunities, poor leadership or excessive costs. Also consider cost-saving or revenue-building synergies with other companies that you already own. Assess whether the return on investment will likely exceed the acquisition’s immediate costs and ongoing risks.

Doing your homework

Successful turnaround acquisitions start by understanding the target company’s core business — specifically, its profit drivers and roadblocks.

If you rush into the acquisition, or let emotions cloud your judgment, you could misread the company’s financial statements, misjudge its financial condition and, ultimately, devise an ineffective course of rehabilitative action. This is why so many successful turnarounds are conducted by buyers in the same industry as the sellers or by investors, such as private equity funds, that specialize in a particular sector.

During the due diligence phase, pinpoint the source(s) of your target’s distress. Common examples include:

Excessive fixed costs,
Lack of skilled labor,
Decreased demand for its products or services, and
Overwhelming debt.

Then determine what, if any, corrective measures can be taken. Don’t be surprised to find hidden liabilities — such as pending legal actions or deferred tax liabilities — beyond those you already know about.

You also might find potential sources of value, such as tax breaks or proprietary technologies. Benchmarking the company’s performance against that of its industry peers can help reveal where the potential for profit lies.

Identifying cash flows

Another critical step in due diligence is identifying cash flows, both in and out. Determine what products or services drive revenue and which costs hinder profitability. Does it make sense to divest the business of unprofitable products, services, subsidiaries, divisions or real estate?

Implementing a long-term cash-management plan and developing a forecast based on receipts and disbursements is also critical. Revenue-generating and cost-cutting measures — such as eliminating excessive overtime pay, lowering utility bills, and collecting unbilled or overdue accounts receivable — can often be achieved following a thorough evaluation of accounting controls and procedures.

Reliable due diligence hinges on whether the target company’s accounting and financial reporting systems can produce the appropriate data. If these systems don’t accurately capture transactions, and fully list assets and liabilities, you’ll likely encounter some unpleasant surprises and struggle to turn around the business.

Structuring the deal

Parties to a business acquisition generally structure the deal as a sale of either assets or stock. Buyers generally prefer asset deals, which allow them to select the most desirable items from the target company’s balance sheet. In addition, the buyer receives a step-up in basis on the acquired assets, which lowers future tax obligations. And the buyer gets to negotiate new contracts, licenses, titles and permits.

On the other hand, sellers typically prefer to sell stock, not assets. Selling stock simplifies the deal, and tax obligations are usually lower for the seller. However, stock sales may be riskier for buyers because the business continues to operate uninterrupted, and the buyer takes on all debts and legal obligations. The buyer also inherits the seller’s existing depreciation schedules and tax basis in the company’s assets.

Developing a plan

Current market conditions will likely continue to generate turnaround acquisition opportunities in many industries. We can help you conduct data-driven due diligence and develop a strategic M&A plan that minimizes potential risks and maximizes long-term value.

Ashleigh Laabs 2/3/22 Ashleigh Laabs 2/3/22

New tax reporting requirements for payment apps could affect you

If you run a business and accept payments through third-party networks such as Zelle, Venmo, Square or PayPal, you could be affected by new tax reporting requirements that take effect for 2022. They don’t alter your tax liability, but they could add to your recordkeeping burden, as well as the number of tax-related documents you receive every January in anticipation of tax-filing season.

Form 1099-K primer

Form 1099-K, “Payment Card and Third-Party Network Transactions,” is an information return that reports certain payment transactions to the IRS and the taxpayer who receives the payments. Since it was first introduced in 2012, the form has been used to report payments:

From payment card transactions (for example, debit, credit or stored-value cards), and
In settlement of third-party network transactions, when above a certain minimum threshold amount.

For 2021 and prior years, the threshold was defined as gross payments that exceeded $20,000 and more than 200 such transactions. Note that no minimum threshold applies to payment card transactions — all such payments must be reported.

Taxpayers should receive a Form 1099-K from each “payment settlement entity” (PSE) from which they received payments in settlement of reportable payment transactions (that is, a payment card or third-party network transaction) during the tax year. Form 1099-K reports the gross amount of all reportable transactions for the year and by month. The dollar amount of each transaction is determined on the transaction date.

In the case of third-party network payments, the gross amount of a reportable payment doesn’t include any adjustments for credits, cash equivalents, discounts, fees, refunds or other amounts. In other words, the full amount reported might not represent the taxable amount.

Businesses (including independent contractors) should consider the amounts reported when calculating their gross receipts for income tax purposes. Depending on filing status, the amounts generally should be reported on Schedule C (Form 1040), “Profit or Loss From Business, Sole Proprietorship;” Schedule E (Form 1040), “Supplemental Income and Loss;” Schedule F (Form 1040), “Profit or Loss From Farming;” or the appropriate return for partnerships or corporations.

Understanding the new rules

The American Rescue Plan Act (ARPA), which was signed into law in March of 2021, brought significant changes to the requirements regarding Form 1099-K. The changes are intended to improve voluntary tax compliance.

Beginning in 2022, the number of transactions component of the threshold for reporting third-party network transactions is eliminated, and the gross payments threshold drops to only $600. The change is expected to boost the number of Forms 1099-K many businesses receive in January 2023 for the 2022 tax year and going forward.

The ARPA also includes an important clarification. Since Form 1099-K was introduced, stakeholders have been uncertain about which types of third-party network transactions should be included. The ARPA makes clear that these transactions are reportable only if they’re for goods and services. Payments for royalties, rent and other transactions settled through a third-party network are reported on Form 1099-MISC, “Miscellaneous Information.”

The ARPA changes heighten only the reporting obligations of third-party payment networks; they don’t affect individual taxpayer requirements. They might, however, reduce your odds of inadvertently underreporting income and paying the price down the road.

Taking steps toward accurate reporting

While the increased reporting doesn’t require any specific changes of affected taxpayers, you’d be wise to institute some measures to ensure the reporting is accurate. For example, consider monitoring your payments and the amounts so you know whether you should receive a Form 1099-K from a particular PSE. Notably, you’re required to report the associated income regardless of whether you receive the form.

You’ll also want to step up your recordkeeping to allow you to reconcile any Forms 1099-K with the actual amounts received. If you have multiple sources of income, track and report each separately even if you receive a single Form 1099-K with gross payments for all of the businesses. For example, if you process both retail sales and rent payments on the same card terminal, your tax preparer would report the retail sales on Schedule C and the rent on Schedule E.

If you permit customers to get cash back when using debit cards for purchases, the cash back amounts will be included on Form 1099-K. Those amounts generally aren’t included in your gross receipts or businesses expenses, though, making it critical that you track cash-back activity to prevent inclusion.

Amounts reported could be inaccurate if you share a credit card terminal with another person or business. Where required, consider filing and furnishing the appropriate information return (for example, Form 1099-K or Form 1099-MISC) for each party with whom you shared a card terminal. In addition, keep records of payments issued to every party sharing your terminal, including shared terminal written agreements and cancelled checks.

Other potential landmines include:

Incorrect amounts due to mid-tax year changes in entity type (for example, from a sole proprietorship to a partnership),
Forms issued to you as an individual, with your Social Security number, rather than to your C corporation, S corporation or partnership, with its taxpayer identification number,
Incorrect amounts due to a mid-tax year sale or purchase of a business, and
Duplicate payments that appear on both a Form 1099-K and either a Form 1099-MISC or a Form 1099-NEC, “Nonemployee Compensation.”

If you receive a form with errors in your taxpayer identification number or payment amount, request a corrected form from the PSE and maintain records of all related correspondence.

Don’t dawdle

It may seem tempting to put off the steps necessary to establish solid recordkeeping procedures for payments from third-party networks, but that would be a mistake. We can help you set up the necessary processes and procedures now so you’re in compliance and not scrambling at tax time.

Ashleigh Laabs 2/3/22 Ashleigh Laabs 2/3/22

The 2021 gift tax return deadline is almost here, too

April 18, 2022, is the deadline for filing your federal income tax return. Keep in mind that the gift tax return deadline is on the very same date. So, if you made large gifts to family members or heirs last year, it’s important to determine whether you’re required to file Form 709.

Filing requirements

Generally, you must file a gift tax return for 2021 if, during the tax year, you made gifts that exceeded the $15,000-per-recipient annual gift tax exclusion (other than to your U.S. citizen spouse). (For 2022, the exclusion amount has increased to $16,000 per recipient or $32,000 if you split gifts with your spouse.)

You also need to file if you made gifts to a Section 529 college savings plan and wish to accelerate up to five years’ worth of annual exclusions ($75,000) into 2021. Other reasons to file include making gifts:

That exceeded the $159,000 (for 2021) annual exclusion for gifts to a noncitizen spouse,
Of future interests (such as remainder interests in a trust) regardless of the amount, or
Of jointly held or community property.

Keep in mind that you’ll owe gift tax only to the extent an exclusion doesn’t apply and you’ve used up your federal gift and estate tax exemption ($11.7 million for 2021). As you can see, some transfers require a return even if you don’t owe tax.

No return required

No gift tax return is required if your gifts for the year consist solely of gifts that are tax-free because they qualify as annual exclusion gifts, present interest gifts to a U.S. citizen spouse, educational or medical expenses paid directly to a school or health care provider, or political or charitable contributions.

But if you transferred hard-to-value property, such as artwork or interests in a family-owned business, consider filing a gift tax return even if you’re not required to. Adequate disclosure of the transfer in a return triggers the statute of limitations, generally preventing the IRS from challenging your valuation more than three years after you file.

Be ready

If you’re unsure whether you need to file a gift tax return or if you owe gift tax to the IRS, we can help. Act quickly, though, because the filing deadline is fast approaching.

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