Author: Alexis Long

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Tax

Plan Now to Make Tax-Smart Year-End Gifts to Loved Ones

Are you feeling generous at year-end? Taxpayers can transfer substantial amounts free of gift taxes to their children or other recipients each year through the proper use of the annual exclusion. The exclusion amount is adjusted for inflation annually, and for 2022, the amount is $16,000. The exclusion covers gifts that an individual makes to each recipient each year. So a taxpayer with three children can transfer a total of $48,000 to the children this year free of federal gift taxes. If the only gifts are made this way during a year, there’s no need to file a federal gift tax return. If annual gifts exceed $16,000, the exclusion covers the first $16,000 and only the excess is taxable.

 Note: This discussion isn’t relevant to gifts made to a spouse because they’re gift tax-free under separate marital deduction rules.

Gift splitting by married taxpayers

If you’re married, gifts made during a year can be treated as split between the spouses, even if the cash or asset is actually given to an individual by only one of you. Therefore, by gift splitting, up to $32,000 a year can be transferred to each recipient by a married couple because two exclusions are available. So for example, a married couple with three married children can transfer a total of $192,000 each year to their children and the children’s spouses ($32,000 times six). If gift splitting is involved, both spouses must consent to it. This is indicated on the gift tax return (or returns) of the spouses’ file. (If more than $16,000 is being transferred by a spouse, a gift tax return must be filed, even if the $32,000 exclusion covers total gifts.) 

The “present interest” requirement

For a gift to qualify for the annual exclusion, it must be a “present interest” gift, meaning the recipient’s enjoyment of the gift can’t be postponed to the future. For example, let’s say you put cash into a trust and provide that your adult child is to receive income from it while your child is alive and your grandchild is to receive the principal at your child’s death. Your grandchild’s interest is a “future interest.” Special valuation tables determine the value of the separate interests you set up for each recipient. The gift of the income interest qualifies for the annual exclusion because the enjoyment of it isn’t deferred, so the first $16,000 of its total value won’t be taxed. However, the “remainder” interest is a taxable gift in its entirety. If the gift recipient is a minor and the terms of the trust provide that the income may be spent by or for the minor before he or she reaches age 21 and that any amount left is to go to the minor at age 21, then the annual exclusion is available. The present interest rule won’t apply.

“Unified” credit for taxable gifts

Even gifts that aren’t covered by the exclusion, and are therefore taxable, may not result in a tax liability. That’s because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $12.06 million for 2022. However, to the extent you use this credit against a gift tax liability, it reduces or eliminates the credit available for use against the federal estate tax at your death. 

Contact your ATA representative if you are interested in making year-end gifts to your loved ones or if you have any questions about tax planning.

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Helpful Articles

401(k) and Profit Sharing Limits for 2022 & 2023

In the downloadable file below, you can find 401(k) and profit sharing limits for 2022 & 2023.

 

Important information for those with a 401(k) account or those considering opening an account:

Required Minimum Distribution (RMD) rules apply to all employer-sponsored retirement plans. RMD rules require those with Traditional and Roth 401(k)s to withdraw a certain amount from their account each year once they turn 72. If the RMD is not withdrawn by the applicable deadline, the individual will be taxed 50% on the amount not withdrawn; individuals can withdraw more than the minimum amount. These withdrawals are considered taxable income. To find your RMD, use this worksheet from the IRS.

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Helpful Articles

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.

Contact one of our experts to discuss more about M&A.

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Tax

Sen. John Thune and Sen. Ben Cardin Recently Introduced the Athlete Opportunity and Taxpayer Integrity Act

More than a year ago, the U.S. Supreme Court ruled that student-athletes can be compensated for the use of their names, images, or likenesses (NIL). Now, a new bipartisan bill would eliminate a tax incentive for contributions to tax-exempt affiliates of colleges and universities. Since the ruling, groups of college boosters (third-party entities that promote a program’s interests) have formed what are known as NIL collectives. Sen. John Thune (R-SD) and Sen. Ben Cardin (D-MD) recently introduced the Athlete Opportunity and Taxpayer Integrity Act, which would bar individuals and organizations from claiming tax deductions for donations used by collectives for NIL payouts to student-athletes.

Contact one of our experts with all your tax-related questions.

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Tax

Deducting Eligible Medical Expenses

Taxpayers that itemize may be able to deduct eligible medical expenses they incurred for themselves, their spouses, and dependents, subject to limits. Taxpayers bear the burden to prove the expenses, to show they were paid during the tax year and weren’t reimbursed by insurance. 

 

One corporate executive and her husband deducted medical expenses of $41,648 on behalf of her father. They claimed the medical bills were paid by intrafamily loans but provided no proof that the loans had been repaid or that insurance hadn’t reimbursed them. Their records, they stated, were lost due to a hurricane and other setbacks. The U.S. Tax Court partially disallowed the deduction. (TC Memo 2022-99)

 

Contact one of our experts to discuss what expenses are eligible for deduction.

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Tax

Hurricane Ian Victims in Florida Qualify for Tax Relief

-UPDATE-

Hurricane Ian is likely to rank as one of the most destructive storms in U.S. history. The federal government has announced tax relief for all of Florida’s residents and businesses. If you’ve been affected by Hurricane Ian, visit the IRS’s dedicated webpage for details, updates, and resources: https://bit.ly/3rqYnyI

–

The IRS has provided return filing and payment extensions to taxpayers who are located in FEMA-designated areas of Florida affected by Hurricane Ian. The relief postpones various deadlines that occurred starting Sept. 23, 2022, until Feb. 15, 2023. This means individuals who have a valid extension to file their 2021 tax returns due to run out on Oct. 17, 2022, now have until Feb. 15, 2023, to file. The IRS noted, however, that because tax payments related to these 2021 returns were due on April 18, 2022, those payments aren’t eligible for this relief. For more information: https://bit.ly/3BWZyL0

Categories
Tax

Year-End Tax Planning Ideas for Individuals

Now that fall is officially here, it’s a good time to start taking steps that may lower your tax bill for this year and next. One of the first planning steps is to ascertain whether you’ll take the standard deduction or itemize deductions for 2022. Many taxpayers won’t itemize because of the high 2022 standard deduction amounts ($25,900 for joint filers, $12,950 for singles and married couples filing separately, and $19,400 for heads of household). Also, many itemized deductions have been reduced or abolished under current law. If you do itemize, you can deduct medical expenses that exceed 7.5% of adjusted gross income (AGI), state and local taxes up to $10,000, charitable contributions, and mortgage interest on a restricted amount of debt, but these deductions won’t save taxes unless they’re more than your standard deduction.

Bunching, pushing, pulling

Some taxpayers may be able to work around these deduction restrictions by applying a “bunching” strategy to pull or push discretionary medical expenses and charitable contributions into the year where they’ll do some tax good. For example, if you’ll be able to itemize deductions this year but not next, you may want to make two years’ worth of charitable contributions this year.

Here are some other ideas to consider: Postpone income until 2023 and accelerate deductions into 2022 if doing so enables you to claim larger tax breaks for 2022 that are phased out over various levels of AGI. These include deductible IRA contributions, child tax credits, education tax credits and student loan interest deductions. Postponing income also is desirable for taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. However, in some cases, it may pay to accelerate income into 2022. For example, that may be the case if you expect to be in a higher tax bracket next year. If you’re eligible, consider converting a traditional IRA into a Roth IRA by year-end. This is beneficial if your IRA invested in stocks (or mutual funds) that have lost value. Keep in mind that the conversion will increase your income for 2022, possibly reducing tax breaks subject to phaseout at higher AGI levels. High-income individuals must be careful of the 3.8% net investment income tax (NIIT) on certain unearned income. The surtax is 3.8% of the lesser of: 1) net investment income (NII), or 2) the excess of modified AGI (MAGI) over a threshold amount. That amount is $250,000 for joint filers or surviving spouses, $125,000 for married individuals filing separately and $200,000 for others. As year-end nears, the approach taken to minimize or eliminate the 3.8% surtax depends on your estimated MAGI and NII for the year. Keep in mind that NII doesn’t include distributions from IRAs or most retirement plans.

It may be advantageous to arrange with your employer to defer, until early 2023, a bonus that may be coming your way. If you’re age 70½ or older by the end of 2022, consider making 2022 charitable donations via qualified charitable distributions from a traditional IRA — especially if you don’t itemize deductions. These distributions are made directly to charities from your IRA and the contribution amount isn’t included in your gross income or deductible on your return. Make gifts sheltered by the annual gift tax exclusion before year-end. In 2022, the exclusion applies to gifts of up to $16,000 made to each recipient. These transfers may save your family taxes if income-earning property is given to relatives in lower income tax brackets who aren’t subject to the kiddie tax. These are just some of the year-end steps that may save taxes.

Contact one of our experts to work on a plan that is best for you.

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Financial Institutions and Banking

Bank Wire

New ACH rules issued for “micro-entries”

Earlier this year, the National Automated Clearing House Association (Nacha) adopted rule changes regarding micro-entries — the small ACH credits and debits originators or third-party senders use to validate customer account information. The changes are designed to standardize practices and formatting of micro-entries in order to improve the effectiveness of micro-entries as a means of account validation; better enable identification and monitoring of micro-entries; and improve ACH Network quality.

Effective September 16, 2022, micro-entries are defined as ACH credits of less than one dollar — and any offsetting debits — used for account validation. Credit amounts must equal or exceed debit amounts, and credits and debits must be transmitted to settle at the same time. Originators must use “ACCTVERIFY” in the company entry description field. In addition, the company name must be easily recognizable and similar to the name used in subsequent entries.

Effective March 17, 2023, originators must use commercially reasonable fraud detection, including monitoring micro-entry forward and return volumes.

Proposal would modernize Community Reinvestment Act

Under the Community Reinvestment Act (CRA), federal banking agencies periodically evaluate community banks’ records in meeting their communities’ needs and make those evaluations available to the public. They also consider a bank’s CRA rating when reviewing requests to approve mergers or acquisitions, charters, branch openings, and deposit facilities. Recently, the agencies issued a proposal to modernize their CRA regulations. Among other things, the proposed regulations would: 1) promote expanded access to credit, investment, and basic banking services in low- and moderate-income communities, 2) update CRA assessment areas to include activities associated with online and mobile banking, branchless banking, and hybrid models, and 3) provide greater clarity and consistency by adopting a metrics-based approach to CRA evaluations of retail lending and community development financing.

Black box credit models don’t excuse ECOA non-compliance

The Consumer Financial Protection Bureau (CFPB) has issued a warning to banks and other lenders that use complex algorithms (popularly known as “black box” models) to make credit decisions. A recent CFPB circular warned that the use of these models doesn’t allow lenders to avoid their obligations under the Equal Credit Opportunity Act (ECOA). The act requires lenders to provide applicants with specific reasons for the denial of credit or other adverse actions. The circular makes clear that a lender isn’t relieved of this obligation, even if a black box model prevents it from accurately identifying the specific reasons for an adverse action. According to the circular, “A creditor’s lack of understanding of its own methods is … not a cognizable defense against liability for violating ECOA.”

Contact one of our experts if you have any questions about the new ACH rules, the Community Reinvestment Act, or the Equal Credit Opportunity Act.

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Financial Institutions and Banking

Is Blockchain the Future of Banking?

Blockchain, the technology behind Bitcoin and other cryptocurrencies, has been in the news a great deal in recent months. Headlines about the volatility of cryptocurrencies and their relative lack of regulatory oversight have generated widespread skepticism about the technology. But the uses of blockchain go well beyond cryptocurrency. And its potential benefits for banks have led many to believe that blockchain is poised to transform the industry.

What is blockchain?

The technology that powers blockchain is complex. But the concept is relatively simple: A blockchain is a distributed database (or “ledger”) that’s shared among thousands or even millions of computers or servers, called “nodes,” maintained by independent third parties (individuals or organizations).

The lack of centralized storage or control makes it extremely difficult for someone to tamper with the ledger. It can accept new transactions only if they’re verified by these third parties through established consensus protocols. As a result, the ledger is highly resistant to errors or fraud. In addition, the technology uses encryption and digital signatures to protect participants’ identities.

How can it be used in banking?

Blockchain generates validated, immutable records that are readily available to all parties. This helps establish trust while minimizing the need for intermediaries to authenticate or certify transactions. It’s well suited, therefore, for a variety of banking functions. Here are a few examples:

Processing payments and transfers. Payments and bank transfers, especially international transactions, can be costly and time-consuming. A simple bank transfer must wind its way through a complex system of correspondent banks, custodians, and other intermediaries to reach its destination, adding time and fees to the process. Blockchain makes it possible to clear and settle these transactions almost instantly, often outside traditional banking hours, without the need for multiple intermediaries. Most blockchain-based payments and transfers are made using stablecoins — cryptocurrencies that are tied to the value of a fiat currency, such as the U.S. dollar, thereby limiting volatility.

Verifying customers’ identities. “Know your customer” requirements can make it costly and cumbersome for banks to verify their customers’ identities. By storing customer information on a blockchain, the process can be streamlined. It allows various financial institutions, as well as business units within those institutions, to access and verify customer information while protecting customer privacy.

Processing mortgages and other loans. Blockchain has the potential to streamline loan processing. Using “smart contract” technology to create, store and execute documents, blockchain avoids confusion and errors by ensuring that everyone is working off of the same version of a document. It also prevents anyone from modifying it without alerting others. And if a change or correction is required, it’s added to the blockchain, together with supporting documentation, creating a permanent audit trail.

Blockchain also can greatly speed up the transaction process by automating some tasks. For example, funds can automatically be released from escrow upon verification of specific preconditions, such as title clearances or loan approvals.

Ready for prime time?

These examples are just a few potential uses of blockchain in the banking industry. The technology is still relatively new and might not be quite ready for prime time, especially for community banks. But given the potential benefits — in terms of efficiency, security, and cost savings — it’s definitely worth exploring further.

Contact one of our experts if you have questions about blockchain.

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Financial Institutions and Banking

Stay On Top of Liquidity Risk

In an uncertain economy, with rampant inflation and other significant economic headwinds, it’s a good idea for community banks to ensure their loans are based on sound funding sources and that the degree of liquidity risk they’re carrying is reasonable and manageable for the foreseeable future. This means your bank needs to have adequate procedures in place to mitigate risk and stay solvent through tough times.

What are the problems?

The recent economic downturn is just one reason for the increase in liquidity risk. It’s also tied to loan growth accompanied by shrinking liquid asset holdings and increasing reliance on noncore and wholesale sources — such as borrowings, brokered deposits, internet deposits, deposits obtained through listing services and uninsured deposits — to fund loan growth.

Typically, these alternative funding sources are more expensive and volatile than insured core deposits. And they’re subject to legal, regulatory, and counterparty requirements that can create liquidity stress, particularly if a bank has credit quality issues or deteriorating capital levels.

The Federal Deposit Insurance Corporation (FDIC) recognizes that alternative funding sources can be an important component of a well-managed bank’s liquidity and funding strategy. But these sources can be problematic if a bank relies on them too heavily. Incorporating a balanced funding strategy into a comprehensive liquidity risk management plan is key to success.

How can you manage liquidity risk?

The FDIC urges banks to consult the federal banking regulators’ Interagency Policy Statement on Funding and Liquidity Risk Management, which outlines the essential elements of sound liquidity risk management. The statement notes that banks should balance the use of alternative funding sources “with prudent capital, earnings, and liquidity considerations through the prism of the institution’s approved risk tolerance.” Specifically, they should:

  • Ensure effective board and management oversight,
  • Adopt appropriate strategies, policies, procedures, and limits to manage and mitigate liquidity risk,
  • Implement appropriate liquidity risk measurement and monitoring systems,
  • Actively manage intraday liquidity and collateral,
  • Have a diverse mix of existing and potential future funding sources, and
  • Hold adequate levels of highly liquid marketable securities that are free of legal, regulatory, or operational impediments.

What’s the backup plan?

Banks also should design a comprehensive contingency funding plan (CFP) that sufficiently addresses potential adverse liquidity events and emergency cash flow requirements. Finally, they need to set up appropriate internal controls and internal audit processes.

For banks that rely heavily on volatile funding sources, it’s important to ensure that the banks’ risk tolerances and recovery strategies are reflected in their asset-liability management programs and CFPs. A well-developed CFP should help a bank manage a range of liquidity stress scenarios by establishing clear lines of responsibility and articulating implementation, escalation, and communication procedures. It also needs to address triggering mechanisms, early warning indicators, and remediation steps that cover the use of contingent funding sources.

CFPs should identify alternative liquidity sources and ensure ready access to contingent funding because liquidity pressures can spread during a period of significant stress. Examples of backup funds providers include federal home loan banks, correspondent institutions, and others that facilitate repurchase agreements or money market transactions.

An independent party should regularly review and evaluate the various components of a bank’s liquidity management process. The review should match the process against regulatory guidance and industry best practices as adjusted for the bank’s liquidity risk profile. The reviewer then should report the results to management and the board of directors.

How do you stay afloat?

Clearly, for community banks, managing liquidity risk is key to staying solvent and profitable. Without appropriate strategies in place for dealing with potential funding source issues, your bank could be left to flounder in an ocean of problems. Help your bank stay afloat by ensuring you have robust practices in place.

Contact one of our experts if you need help staying on top of liquidity risk.