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Helpful Articles Tax

When do valuable gifts to charity require an appraisal?

If you donate valuable items to charity and you want to deduct them on your tax return, you may be required to get an appraisal. The IRS requires donors and charitable organizations to supply certain information to prove their right to deduct charitable contributions.

How can you protect your deduction?

First, be aware that in order to deduct charitable donations, you must itemize deductions. Due to today’s relatively high standard deduction amounts, fewer taxpayers are itemizing deductions on their federal returns than before the Tax Cuts and Jobs Act became effective in 2018.

If you clear the itemizing hurdle and donate an item of property (or a group of similar items) worth more than $5,000, certain appraisal requirements apply. You must:

  • Get a “qualified appraisal,”
  • Receive the qualified appraisal before your tax return is due,
  • Attach an “appraisal summary” to the first tax return on which the deduction is claimed,
  • Include other information with the return, and
  • Maintain certain records.

Keep these definitions in mind. A “qualified appraisal” is a complex and detailed document. It must be prepared and signed by a qualified appraiser. An “appraisal summary” is a summary of a qualified appraisal made on Form 8283 and attached to the donor’s return.

While courts have allowed taxpayers some latitude in following these rules, you should aim for exact compliance.

The qualified appraisal isn’t submitted to the IRS in most cases. Instead, the appraisal summary, which is a separate statement prepared on an IRS form, is attached to the donor’s tax return. However, a copy of the appraisal must be attached for gifts of art valued at $20,000 or more and for all gifts of property valued at more than $500,000, other than inventory, publicly traded stock and intellectual property. If an item of art has been appraised at $50,000 or more, you can ask the IRS to issue a “Statement of Value” that can be used to substantiate the value.

What if you don’t comply with the requirements?

The penalty for failing to get a qualified appraisal and attach an appraisal summary to the return is denial of the charitable deduction. The deduction may be lost even if the property was valued correctly. There may be relief if the failure was due to reasonable cause.

Are there exceptions to the requirements?

A qualified appraisal isn’t required for contributions of:

  • A car, boat or airplane for which the deduction is limited to the charity’s gross sales proceeds,
  • Stock in trade, inventory or property held primarily for sale to customers in the ordinary course of business,
  • Publicly traded securities for which market quotations are “readily available,” and
  • Qualified intellectual property, such as a patent.

Also, only a partially completed appraisal summary must be attached to the tax return for contributions of:

  • Nonpublicly traded stock for which the claimed deduction is greater than $5,000 and doesn’t exceed $10,000, and
  • Publicly traded securities for which market quotations aren’t “readily available.”

What if you have more than one gift?

If you make gifts of two or more items during a tax year, even to multiple charitable organizations, the claimed values of all property of the same category or type (such as stamps, paintings, books, stock that isn’t publicly traded, land, jewelry, furniture or toys) are added together in determining whether the $5,000 or $10,000 limits are exceeded.

The bottom line is you must be careful to comply with the appraisal requirements or risk disallowance of your charitable deduction. Contact us if you have any further questions or want to discuss your charitable giving plans. © 2024

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General Helpful Articles Tax

Timelines: 3 Ways Business Owners Should Look at Succession Planning

Business owners are rightly urged to develop succession plans so their companies will pass on to the next generation, or another iteration of ownership, in a manner that best ensures continued success.

Ideally, the succession plan you develop for your company will play out over a long period that allows everyone plenty of time to adjust to the changes involved. But, as many business owners learned during the pandemic, life comes at you fast. That’s why succession planning should best be viewed from three separate but parallel timelines:

1. Long Term

If you have many years to work with, use this gift of time to identify one or more talented individuals who share your values and have the aptitude to successfully run the company. This is especially important for keeping a family-owned business in the family.

As soon as you’ve identified a successor, and that person is ready, you can begin mentoring the incoming leader to competently run the company and preserve your legacy. Meanwhile, you can carefully determine how to best fund your retirement and structure your estate plan.

2. Short Term

Many business owners wake up one day and realize that they’re almost ready to retire, or move on to another professional endeavor, but they’ve spent little or no time putting together a succession plan. In such a case, you may still be able to choose and train a successor. However, you’ll likely also want to explore alternatives such as selling the company to a competitor or other buyer. Sometimes, even a planned liquidation is the optimal move financially.

In any case, the objective here is less about maintaining the strategic direction of the company and more about ensuring you receive an equitable payout for your ownership share. If you’re a co-owner, drafting a buy-sell agreement is highly advisable. It’s also critical to set a firm departure date and work with a qualified team of professional advisors.

3. In Case of Emergency

As mentioned, the pandemic brought renewed attention to emergency succession planning. True to its name, this approach emphasizes enabling businesses to maintain operations immediately after unforeseen events such as an owner’s death or disability.

If your company doesn’t yet have an emergency succession plan, you should probably create one before you move on to a longer-term plan. Name someone who can take on a credible leadership role if you become seriously ill or injured. Formulate a plan for communicating and delegating duties during a crisis. Make sure everyone knows about the emergency succession plan and how it will affect day-to-day operations, if executed.

As with any important task, the more time you give yourself to create a succession plan, the fewer mistakes or oversights you’re likely to make. Our firm can help you create or refine a plan that suits your financial needs, personal wishes and vision for your company. Contact us. © 2024

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Helpful Articles Tax

The Tax Advantages of Including Debt in a C Corporation Capital Structure

Let’s say you plan to use a C corporation to operate a newly acquired business or you have an existing C corporation that needs more capital. You should know that the federal tax code treats corporate debt more favorably than corporate equity. So, for shareholders of closely held C corporations, it can be a tax-smart move to include in the corporation’s capital structure:

  • Some third-party debt (owed to outside lenders), and/or
  • Some owner debt.

Tax rate considerations

Let’s review some basics. The top individual federal income tax rate is currently 37%. The top individual federal rate on net long-term capital gains and qualified dividends is currently 20%. On top of this, higher-income individuals may also owe the 3.8% net investment income tax on all or part of their investment income, which includes capital gains, dividends and interest.

On the corporate side, the Tax Cuts and Jobs Act (TCJA) established a flat 21% federal income tax rate on taxable income recognized by C corporations.

Third-party debt

The non-tax advantage of using third-party debt financing for a C corporation acquisition or to supply additional capital is that shareholders don’t need to commit as much of their own money.

Even when shareholders can afford to cover the entire cost with their own money, tax considerations may make doing so inadvisable. That’s because a shareholder generally can’t withdraw all or part of a corporate equity investment without worrying about the threat of double taxation. This occurs when the corporation pays tax on its profits and the shareholders pay tax again when the profits are distributed as dividends.

When third-party debt is used in a corporation’s capital structure, it becomes less likely that shareholders will need to be paid taxable dividends because they’ll have less money tied up in the business. The corporate cash flow can be used to pay off the corporate debt, at which point the shareholders will own 100% of the corporation with a smaller investment on their part.

Owner debt

If your entire interest in a successful C corporation is in the form of equity, double taxation can arise if you want to withdraw some of your investment. But if you include owner debt (money you loan to the corporation) in the capital structure, you have a built-in mechanism for withdrawing that part of your investment tax-free. That’s because the loan principal repayments made to you are tax-free. Of course, you must include the interest payments in your taxable income. But the corporation will get an offsetting interest expense deduction — unless an interest expense limitation rule applies, which is unlikely for a small to medium-sized company.

An unfavorable TCJA change imposed a limit on interest deductions for affected businesses. However, for 2024, a corporation with average annual gross receipts of $30 million or less for the three previous tax years is exempt from the limit.

An example to illustrate

Let’s say you plan to use your solely owned C corporation to buy the assets of an existing business. You plan to fund the entire $5 million cost with your own money — in a $2 million contribution to the corporation’s capital (a stock investment), plus a $3 million loan to the corporation.

This capital structure allows you to recover $3 million of your investment as tax-free repayments of corporate debt principal. The interest payments allow you to receive additional cash from the corporation. The interest is taxable to you but can be deducted by the corporation, as long as the limitation explained earlier doesn’t apply.

This illustrates the potential federal income tax advantages of including debt in the capital structure of a C corporation. Contact us to explain the relevant details and project the tax savings. © 2024

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Helpful Articles News Tax

Scams Taxpayers Should Be Aware of This Filing Season

Among the many scams taxpayers should be aware of this filing season is one involving Form 7202, Credits for Sick Leave and Family Leave for Certain Self-Employed Individuals. Some filers have been falsely encouraged to claim the credits based on employee (not self-employment) income.

These credits aren’t even available for 2022. In a similar scheme, taxpayers have invented household workers and filed Schedule H (Form 1040), Household Employment Taxes, claiming they paid their fictitious workers sick and family leave wages. The goal of both scams is to trigger a tax refund.

The IRS encourages anyone who has filed false information to amend their returns. Contact us for help.

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Tax-Wise Ways To Save For College

If you’re a parent or grandparent with college-bound children, you may want to save to fund future education costs. Here are several approaches to take maximum advantage of the tax-favored ways to save that may be available to you. 

Savings bonds 

Series EE U.S. savings bonds offer two tax-saving opportunities when used to finance college expenses: You don’t have to report the interest on the bonds for federal tax purposes until the bonds are cashed in, and Interest on “qualified” Series EE (and Series I) bonds may be exempt from federal tax if the bond proceeds are used for qualified college expenses. To qualify for the college tax exemption, you must purchase the bonds in your own name (not the child’s) or jointly with your spouse. The proceeds must be used for tuition, fees, etc. — not room and board. If only some proceeds are used for qualified expenses, only that part of the interest is exempt. If your modified adjusted gross income (MAGI) exceeds certain amounts, the exemption is phased out. For bonds cashed in 2023, the exemption begins to phase out when joint MAGI hits $137,800 for married joint filers ($91,850 for other returns) and is completely phased out if MAGI is $167,800 or more for joint filers ($106,850 or more for others). 

Qualified tuition programs or 529 plans

Typically known as a “529 plans,” these programs allow you to buy tuition credits or make contributions to an account set up to meet a child’s future higher education expenses. 529 plans are established by state governments or private institutions. Contributions aren’t deductible and are treated as taxable gifts to the child. But they’re eligible for the annual gift tax exclusion ($17,000 in 2023). A donor who contributes more than the annual exclusion limit for the year can elect to treat the gift as if it were spread out over a five-year period. Earnings on the contributions accumulate tax-free until the college costs are paid from the funds. Distributions from 529 plans are tax-free to the extent the funds are used to pay “qualified higher education expenses,” which can include up to $10,000 in tuition for an elementary or secondary school. Distributions of earnings that aren’t used for “qualified higher education expenses” are generally subject to income tax plus a 10% penalty. 

Coverdell education savings accounts (ESAs)

You can establish a Coverdell ESA and make contributions of up to $2,000 for each child under age 18. This age limitation doesn’t apply to beneficiaries with special needs. The right to make contributions begins to phase out once AGI is over $190,000 on a joint return ($95,000 for single taxpayers). If the income limit is an issue, the child can make a contribution to his or her own account. Although contributions aren’t deductible, income in the account isn’t taxed, and distributions are tax-free if spent on qualified education expenses. If the child doesn’t attend college, the money must be withdrawn when the child turns 30 and any earnings will be subject to tax plus a penalty. However, unused funds can be transferred tax-free to a Coverdell ESA of another member of the family who hasn’t reached age 30. The age 30 requirement doesn’t apply to individuals with special needs. 

 

Contact one of our experts if you would like to discuss these and other possible tax breaks.

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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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The Inflation Reduction Act: what’s in it for you?

You may have heard that the Inflation Reduction Act (IRA) was signed into law recently. While experts have varying opinions about whether it will reduce inflation in the near future, it contains, extends, and modifies many climate and energy-related tax credits that may be of interest to individuals. 

 

Nonbusiness energy property

Before the IRA was enacted, you were allowed a personal tax credit for certain nonbusiness energy property expenses. The credit applied only to property placed in service before January 1, 2022. The credit is now extended for energy-efficient property placed in service before January 1, 2033. The new law also increases the credit for a tax year to an amount equal to 30% of the amount paid or incurred by you for qualified energy efficiency improvements installed during the year, and the amount of the residential energy property expenditures paid or incurred during that year. The credit is further increased for amounts spent for a home energy audit (up to $150). In addition, the IRA repeals the lifetime credit limitation and instead limits the credit to $1,200 per taxpayer, per year. There are also annual limits of $600 for credits with respect to residential energy property expenditures, windows, and skylights, and $250 for any exterior door ($500 total for all exterior doors). A $2,000 annual limit applies with respect to amounts paid or incurred for specified heat pumps, heat pump water heaters, and biomass stoves/boilers.

 

The residential clean-energy credit

Prior to the IRA being enacted, you were allowed a personal tax credit, known as the Residential Energy Efficient Property (REEP) Credit, for solar electric, solar hot water, fuel cell, small wind energy, geothermal heat pump, and biomass fuel property installed in homes before 2024. The new law makes the credit available for property installed before 2035. It also makes the credit available for qualified battery storage technology expenses. 

 

New Clean Vehicle Credit

Before the enactment of the law, you could claim a credit for each new qualified plug-in electric drive motor vehicle placed in service during the tax year. The law renames the credit the Clean Vehicle Credit and eliminates the limitation on the number of vehicles eligible for the credit. Also, final assembly of the vehicle must now take place in North America. Beginning in 2023, there will be income limitations. No Clean Vehicle Credit is allowed if your modified adjusted gross income (MAGI) for the year of purchase or the preceding year exceeds $300,000 for a married couple filing jointly, $225,000 for a head of household, or $150,000 for others. In addition, no credit is allowed if the manufacturer’s suggested retail price for the vehicle is more than $55,000 ($80,000 for pickups, vans, or SUVs). Finally, the way the credit is calculated is changing. The rules are complicated, but they place more emphasis on where the battery components (and critical minerals used in the battery) are sourced. The IRS provides more information about the Clean Vehicle Credit here: https://www.irs.gov/businesses/plug-in-electric-vehicle-credit-irc-30-and-irc-30d 

 

Credit for used clean vehicles

A qualified buyer who acquires and places in service a previously owned clean vehicle after 2022 is allowed a tax credit equal to the lesser of $4,000 or 30% of the vehicle’s sale price. No credit is allowed if your MAGI for the year of purchase or the preceding year exceeds $150,000 for married couples filing jointly, $112,500 for a head of household, or $75,000 for others. In addition, the maximum price per vehicle is $25,000.

Contact us if you have questions about taking advantage of these new and revised tax credits. © 2022

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Optimizing and Embracing Best Practices for Finance and Accounting

As market fluctuations and rising interest rates put added stress on internal finance departments, it is wise for organizations to step back and reassess their finance and accounting (F&A) processes and systems. These assessments can help determine whether F&A workflows are enabling timely outputs for reporting, budget forecasting, internal processes like payroll, and other important tasks. Among the many benefits of analyzing and improving internal F&A processes, cost effectiveness and efficiency are paramount.

Balancing Cost and Efficiency

Cost reduction strategies that initially seem intuitive could yield unexpected and counterproductive outcomes. For example, some F&A departments might put policies in place to discourage unnecessary spending. Despite the benefit of cost savings, implementing cumbersome spending parameters can complicate and delay F&A reconciliation and expense processes, which could impact productivity, damage employee morale and increase the risk of employee burnout at a time when attracting and retaining talent is increasingly difficult.

When processes are not running efficiently, your gut reaction may be to hire more employees in an attempt to fill gaps. However, a more cost-effective and employee-centric option is to examine your F&A department’s overall posture and effectiveness, with a particular focus on systems and technology that may no longer be working. Try asking questions such as:

  • Which manual processes can be automated?

Automation can reduce the time your employees have to spend on tedious tasks. This not only helps to balance their workloads, but also allows employees to better invest their time in other high-value services.

  • How can financial reporting be improved?

Organizations are better equipped to make decisions when they are armed with more insightful reporting. This includes setting benchmarks based on industry-specific metrics and reassessing them regularly for accuracy. Assessing internal processes for diligence and efficiency can also help an organization more successfully meet reporting deadlines.

 

Finding the Right Solution

With new F&A tools and technology entering the market every day, the issue is not whether a solution exists to match your organization’s needs, but how to sift through the available options and implement the right choice.

While this may appear to be a daunting process, it is not one that any organization has to go through alone. Rather than jumping to invest in more internal resources, organizations should first examine existing operations to determine which changes can be handled internally and which may benefit from external assistance.

Third-party finance and accounting professionals can help organizations set up robust controls, align spending, optimize financial reporting and find new opportunities to adopt automated technologies and processes.

Click here to find a location closest to you.

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Recent Court Decision Reaffirms Importance of Adequately Documenting Deductible Management Fees

In October 2021, the Internal Revenue Service (IRS) formally launched the Large Partnership Compliance (LPC) Pilot Program. The LPC program represents a focused effort on the part of the U.S. Treasury Department and IRS to improve partnership compliance. Not surprisingly, we are beginning to see an uptick in the number of partnerships under IRS exam.

One area of focus for these examinations that the IRS has identified is the deductibility of management fees paid by portfolio companies to their private equity fund owners. Although not specifically dealing with private equity funds, a recently decided case nonetheless highlights the relevant issues and presents a cautionary tale for funds and their portfolio companies when structuring these arrangements. Moreover, the court’s decision provides an implicit documentation and substantiation framework for taxpayers looking to enter into similar management fee arrangements.

In the case, Aspro, Inc. v. Commissioner, issued April 26,  the U.S. Court of Appeals for the Eight Circuit upheld a Tax Court holding that recast a corporation’s deductible “management fees” as disguised dividends. Although the taxpayer argued that at least a portion of the fees were reasonably deductible business expenses, the circuit court agreed with the lower court that the taxpayer failed to demonstrate that any portion of the amounts paid was reasonable compensation for services provided.

‘Management fees’ paid to owners but no dividends

The taxpayer, Aspro, is an Iowa-based C corporation in the asphalt-paving business. During the years at issue, 2012–2014, it had three shareholders – two were corporations and one was an individual, who was also the president of the company. Over a twenty-year period, Aspro consistently paid its shareholders “management fees” purporting to be for services provided in connection with the overall management and growth of the business. During this same period, and despite the company’s profitability, Aspro paid no dividends.

Aspro initially sought to deduct the management fees in the three years at issue, but the IRS denied the deductions, contending they were, in fact, profit distributions. The Tax Court agreed with the IRS that the claimed management fees were not deductible as ordinary and necessary business expenses, concluding that Aspro failed, “to connect the dots between the services performed and the management fees it paid.” Instead, the court held that the payments were disguised, non-deductible earnings distributions. In reaching its decision, the Tax Court considered whether the management fees were purely for services (Payment for Services Requirement) and whether the payments were reasonable in nature and amount (Reasonableness Requirement).

Failure to establish deductibility of fees

With respect to the Payment for Services Requirement, the Tax Court concluded that the evidence presented indicated a disguised distribution rather than a deductible expense. The Tax Court based its conclusion on the following considerations:

  1. Despite its annual profitability, Aspro made no distributions to its shareholders but paid management fees each year.
  2. The management fee payments roughly corresponded with the shareholder’s ownership interests.
  3. The management fees were paid as lump sums at the end of each year rather than over the course of the year as the purported services were performed.
  4. The managements fee deductions eliminated virtually all of Aspro’s taxable income.
  5. The process of setting management fees was unstructured and had little, if any, relation to the services performed.

In addition, the Tax Court concluded that Aspro failed to satisfy the Reasonableness Requirement. Aspro failed to provide documentation supporting the existence of a service relationship between the parties. At a most basic level, there were no written management service agreements. In addition, there was no documentation outlining the cost or value of any purported service, and no bills or invoices were provided in connection with the purported management services. Additionally, Aspro failed to provide evidence showing how the amount of the management fees was determined.

To establish that the fees were actually paid for valuable services performed, Aspro offered two expert witnesses – a contractor in the taxpayer’s industry and an accountant. However, the Tax Court excluded both witnesses, concluding that neither provided expert knowledge based on scientific methods.  Instead, the court believed that each witness merely offered their personal opinions based on their familiarity with the industry and the taxpayer. The circuit court agreed that these exclusions were reasonable.

In deciding the whether the amount of management fees paid by Aspro was reflective of reasonable compensation for the services performed, the Court considered both an independent investor standard and a multi-factor standard. An independent investor standard evaluates the fee arrangement on the basis of whether an independent investor earning returns after deduction of the management fees would view the quantum of fees as reasonable; a multi-factor standard looks to various criteria such as the nature of work performed and the prevailing rates of compensation for non-shareholders providing similar services to similar businesses. Under both standards, the court noted that the management fee arrangement breached the reasonable compensation threshold, and, thus, Aspro failed to satisfy the Reasonableness Requirement.

 

Insights

The IRS is increasing its audit of large partnerships and is increasingly scrutinizing the validity and deductibility of management fee arrangements. The Aspro case offers a warning to taxpayers, including private equity and venture capital funds seeking to establish similar arrangements with their portfolio companies. But perhaps more importantly, this case provides a roadmap for taxpayers to follow when structuring and documenting these arrangements. Proper documentation and support, including transfer-pricing work done to support the quantum of the fees to be charged pursuant to such an arrangement, is an essential element of sound tax planning in this regard.

The circuit court’s opinion makes clear that the substantiation of such management fees arrangements requires taxpayers to satisfy the Payment for Services Requirement and the Reasonableness Requirement. To satisfy these requirements, taxpayers should base the economic terms of any such arrangement on some sort of scientific method that transcends mere industry knowledge. Moreover, even in circumstances where the level of management fees is demonstrably reasonable in light of the services provided, failure to adequately document the arrangements will leave taxpayers vulnerable to losing their deductions.

Written by David Newberry, Justin Follis and Veranda Graham. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com