Category: Helpful Articles

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Helpful Articles Paris, TN Tax

Still Have Tax Questions? You’re Not Alone 

By Elizabeth Russell Owen, CPA | Private Client Tax Services Practice Leader  

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Executive Summary 

Even after filing a federal income tax return, many individuals still face important follow-up items. From tracking refunds, organizing records, and responding to IRS correspondence, this article outlines five post-filing priorities to help you stay organized, informed, and prepared. Our team remains available year-round to support you beyond tax season. 

Key Highlights 

  • Track Your Refund: Use the IRS “Where’s My Refund?” tool with your Social Security number, filing status, and exact refund amount. 
  • Record Retention: Keep supporting tax documents for at least six years; some should be stored indefinitely. Use cloud storage to back up essential files. 
  • Amendment Window: Did you miss any deductions or credits? File Form 1040-X within three years of filing or two years of payment to receive a refund. 

Even after submitting your federal return, there are often a few loose ends to tie up. Below are some of the top things our clients ask about and what to do next. 

  1. Wondering when your refund will arrive?

Use the IRS’s “Where’s My Refund?” tool at IRS.gov to track the status. Have the following ready: 

  • Your Social Security number 
  • Filing status 
  • Exact refund amount 

Once submitted, the tracker will show whether your refund has been received, approved, or issued. 

  1. How long should you hold on to tax records?

At a minimum, keep records associated with your tax return for as long as the IRS has the authority to audit or assess additional taxes. In most cases, this period is known as the statute of limitations, which is three years from the date you filed your return. That means you can typically remove most supporting documentation related to 2021 and earlier years, unless you filed late or with an extension (if you filed an extended 2021 return, wait at least three years from the filing date before removing records). 

However, that time frame can extend to six years if more than 25% of your gross income was omitted from a return. In rare cases, such as failing to file a return or filing a fraudulent one, the IRS has no time limit to act. Hence, keeping supporting tax return documents for at least six years is recommended.  

Certain records should be kept longer: 

  • Keep all filed tax returns indefinitely to confirm your filing history. 
  • Upload older records to secure cloud storage before discarding physical files, ensuring you maintain access if needed later. This approach helps reduce clutter while preserving key documents in case of a future inquiry. 
  • Other types of documents should be kept longer or permanently in some cases. Examples include but are not limited to business and payroll documentation, estate and trust records, and property basis support. Consult with an ATA professional for details. 
  1. Think you missed a deduction or credit?

You may still be eligible for a refund by filing an amended return (Form 1040-X). In most cases, you have: 

  • Three years from the original filing date, or 
  • Two years from the date you paid the tax — whichever is later 

In limited situations, additional time may be available, such as up to seven years to claim a bad debt deduction. 

While the IRS has time limits for assessment of additional taxes, if income was omitted or understated, the IRS will usually accept an amended return past the three-year window if the amendment results in a balance due. It is best to file the amended return as soon as the discrepancy is discovered to minimize interest and penalties.  

  1. Received a notice from the IRS?

If the IRS needs additional information or adjusts your return, you’ll be contacted by mail only. Be aware: the IRS will never call, text, or email you to discuss your return. If you receive a letter from the IRS, reach out to us, and we’ll help you review the notice and respond appropriately.

  1. Moved recently? Don’t forget to update your address.

To avoid missing important IRS correspondence, complete Form 8822 to officially report a change of address. 

We’re Here for You Year-Round 

Tax questions don’t stop after April 15 and neither do we. Whether you’re facing a notice, amending a return, or preparing for next year, our team is here to help every step of the way. 

Need More Help? Contact your ATA tax advisor today. 

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Helpful Articles Memphis, TN Tax

What Income Tax Documents Should You Keep and What Can You Discard? 

By Mark Puckett, CPA | Tax Principal 

Key Highlights 

  • Keep income tax returns forever as proof of filing. 
  • Hold supporting documents for six years, depending on your situation. 
  • Retain property and investment records until six years after the asset is sold. 
  • In divorce or separation, keep copies of joint returns and custody agreements. 
  • Protect documents using cloud storage or a fireproof safe. 

Once your 2024 tax return is filed, it may be tempting to clear out your files. But before you reach for the shredder or delete old digital folders, consider this: certain documents can still protect you in the event of an IRS audit or help establish the value of assets you sell in the future. 

Keep Your Tax Returns — Indefinitely 

Your filed tax returns serve as the cornerstone of your financial records. These should always be kept permanently. While most supporting documents (like receipts or canceled checks) only need to be retained temporarily, the return itself is essential for confirming what was filed and when. 

Supporting Documentation — Hold for at Least Six Years 

In general, the IRS has three years from the due date of your return (or the actual filing date, if later) to audit you, unless exceptions apply. During this window, you should keep supporting records such as: 

  • W-2s and 1099s 
  • Receipts and invoices 
  • Bank and credit card statements 
  • Charitable donation records 
  • Medical expense documentation 

If you understated income by more than 25%, the IRS has six years to assess taxes. And if you never file a return, there’s no time limit. Keep signed copies of all returns to prove filing. 

Property and Investment Records — Keep Until Six Years After Sale 

Some documents tie to transactions that span decades. For example, if you: 

  • Bought a home in 2009 
  • Made improvements in 2016 
  • Sold the home in 2024 

For this example, you’ll need to retain documentation from 2009 and 2016 to prove your cost basis on your 2024 tax return. This includes: 

  • Purchase documents 
  • Receipts for renovations 
  • Closing statements 

This same rule applies to investment assets, such as stocks or mutual funds, especially if dividends are reinvested over time. Each reinvestment counts as a separate purchase and should be documented. 

Special Circumstances — Divorce or Separation 

If you’re going through a divorce or separation, secure copies of all joint tax returns and related documents. Access to these records may be difficult later, and both spouses remain jointly liable for taxes filed on a joint return. Also retain custody agreements and any documents stating which parent can claim dependents. 

Protect Your Records from Loss 

Fire, theft, and natural disasters can destroy paper records. To keep your information safe: 

  • Use a fireproof safe or bank safe deposit box 
  • Maintain digital backups in encrypted cloud storage 
  • Organize records in a central location for quick evacuation if needed 

We’re Here to Help 

If you’re unsure about what records to keep and for how long, our team can guide you. Thoughtful record keeping today can help you avoid stress, penalties, and lost deductions tomorrow. Contact your ATA representative for guidance.  

 

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Helpful Articles Henderson, KY

The Importance of Employee Theft and Dishonesty Insurance and Extra Expense Coverage

By Malcolm E. “Mac” Neel III, CPA, CFE | Forensic-Litigation Practice Leader 

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Executive Summary 

In today’s fast-paced business environment, internal risks can be as damaging as external threats, yet they are often overlooked. Two essential but often underutilized insurance protections are Employee Theft and Dishonesty Insurance and Extra Expense Coverage. These policies help businesses recover from internal fraud, embezzlement, and associated investigative costs. This article outlines why these coverages matter, what they include, and how they can provide critical financial protection for organizations of all sizes. 

Key Highlights 

  • Internal fraud poses a significant risk, costing organizations an estimated 5% of their annual revenue, according to the Association of Certified Fraud Examiners. 
  • No business is immune — even trusted, long-time employees may act dishonestly under personal or financial pressure. 
  • Coverage is affordable: A $100,000 policy typically costs between $600 and $750 per year. 
  • Extra Expense Coverage pays for legal and investigative costs related to financial misconduct, providing an added layer of protection. 
  • Work with a trusted advisor to determine the appropriate level of coverage for your business. 

Protecting Against Internal Risks Via Employee Theft and Dishonesty Coverage 

Employee Theft and Dishonesty Insurance, also known as fidelity bond or commercial crime insurance, provides crucial protection against financial losses. This coverage safeguards businesses from financial loss due to fraudulent or dishonest acts committed by employees, including theft of money, securities, property, embezzlement, forgery, and fraud. A well-structured insurance policy offers peace of mind and a financial safety net. Again, recent research indicates that $100,000 in coverage typically costs between $600 and $750 per year. The level of coverage your business ideally should have in place is best determined by consultation with your insurance agent or advisor. 

Extra Expense Coverage 

This policy covers investigative and legal costs resulting from internal financial crimes, such as embezzlement or misappropriation of funds. It complements employee theft coverage and is also relatively inexpensive given the level of protection it offers. 

True Story-Sad Story 

Thirty years ago, when I was a young staff accountant performing a review for a client, I noticed a few odd items of documentation provided to us which led to more questions. Secondly, the bookkeeper, in answering our standard inquiries, provided responses which were thoroughly illogical and made absolutely no sense. We made further inquiry of the owner and president of the business, providing him the documents we were given, and he asked us to dig a bit deeper into the matter.  

After gathering additional information, we noticed more inconsistencies and documentation which appeared to have been altered and checks which appeared to be signed by someone forging the owner’s name. In summary, the secretary-bookkeeper had embezzled approximately $190,000. The business had no Employee Theft and Dishonesty Coverage, and the company filed for bankruptcy as it was unable to meet its obligations. Had adequate coverage been in place, the company would have been made whole. 

Schedule a Consultation 

If you’re unsure whether your business is adequately protected against internal risks, our team can help you evaluate your insurance strategy and recommend next steps. Let’s make sure you have the safeguards in place to protect what you’ve built. Schedule a 30-minute complimentary consultation with me by filling out our contact form. 

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General Helpful Articles

AI Hype vs. Risk: What Every Business Should Know 

By Jon Joyner, Cybersecurity Practice Leader

The Top Line

If the first two months of the year are any indication, 2025 is shaping up to be the year of Artificial Intelligence (AI). AI is revolutionizing industries by enhancing efficiency, streamlining operations, and enabling data-driven decision-making. However, as businesses increasingly integrate AI into their operations, they also expose themselves to significant risks, including data breaches, regulatory violations, and reputational damage.

Without proper safeguards, AI can become more of a liability than an asset. This is why having a robust IT security strategy is essential. This article explores the key risks AI presents to businesses and the steps organizations can take to mitigate them.

Breaking It Down – The Growing Risks of AI in Business
  1. Data Breaches and Privacy Concerns

AI systems rely on vast amounts of data to function effectively. If not properly secured, sensitive information—such as customer records, financial details, or proprietary business insights—can be exposed to hackers. A single breach can result in financial losses and erode customer trust.

Just as AI can optimize business operations, bad actors can also use AI to enhance their attacks. Your systems need to be on high alert to counter these evolving threats.

  1. Cybersecurity Vulnerabilities

AI-powered automation can be exploited by cybercriminals if not adequately protected. Attackers may leverage AI to launch sophisticated phishing scams, deepfake frauds, or automated hacking attempts. As AI becomes more integrated into business processes, companies must strengthen their cybersecurity defenses to stay ahead of emerging threats.

  1. Bias and Compliance Issues

AI models can inadvertently reflect biases present in training data, leading to discriminatory outcomes that may result in regulatory penalties or lawsuits. Businesses must ensure their AI systems adhere to ethical and legal standards, which require continuous monitoring and adjustments.

AI will also impact administrative controls such as Acceptable Use or Mobile Device policies. Many organizations are unaware that AI is subject to lawsuits, data retention policies, eDiscovery, and insurance claims. AI platforms should be governed and controlled much like email and file systems.

  1. AI-Powered Fraud

Criminals are leveraging AI to commit fraud at an unprecedented scale. From AI-generated phishing emails to automated financial fraud, businesses must prepare to defend against threats that are becoming more sophisticated by the day.

Social engineering threats are particularly concerning. Imagine a scenario where a bad actor creates an AI-generated video impersonating someone, using it to extort or manipulate their target. These threats highlight the urgent need for businesses to implement AI-specific security measures.

  1. Operational Risks and AI Malfunctions

AI-driven automation can fail if models are not properly trained or updated. Incorrect predictions, data errors, or AI system malfunctions can disrupt operations, leading to downtime and financial setbacks. Businesses must ensure their AI is reliable, continuously monitored, and updated to maintain accuracy and efficiency.

Much like technical and security controls, having the right personnel with the necessary skill set, knowledge, and experience is crucial to maximizing the effectiveness and security of AI platforms.

Does Your Business Face These Risks?

If any of these concerns sound familiar, your business may be at risk. Ask yourself:

  • Are you handling large volumes of sensitive customer data?
  • Do you rely on AI for automation, decision-making, or fraud detection?
  • Have you experienced cybersecurity threats or compliance challenges in the past?

If you answered yes to any of these, it may be time to consider a risk assessment. Our introductory risk assessment will help you gain a clearer understanding of the true risks AI poses to your business.

What This Means for You

AI is a powerful tool, but without the right security measures, it can expose businesses to significant risks. Companies that fail to address AI vulnerabilities may face financial losses, reputational damage, and regulatory scrutiny.

Don’t wait for an incident to take action—proactively managing AI risk ensures business continuity, security, and compliance.

If you are interested in learning how ATA can help manage your AI risk, schedule a 30 minute complimentary consultation with me by filling out our contact form. 

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General Helpful Articles Tax

What Might Be Ahead as Many Tax Provisions Are Scheduled to Expire?

Buckle up, America: Major tax changes are on the horizon. The reason has to do with tax law and the upcoming elections.

Our current situation

The Tax Cuts and Jobs Act (TCJA), which generally took effect in 2018, made sweeping changes. Many of its provisions are set to expire on December 31, 2025.

With this date getting closer each day, you may wonder how your federal tax bill will be affected in 2026. The answer isn’t clear because the outcome of this November’s presidential and congressional elections is expected to affect the fate of many expiring provisions. A new political landscape in Washington could also mean other tax law changes.

Corporate vs. individual taxes

The TCJA cut the maximum corporate tax rate from 35% to 21%. It also lowered rates for individual taxpayers, with the highest tax rate reduced from 39.6% to 37%. But while the individual rate cuts expire in 2025, the law made the corporate tax cut “permanent.” (In other words, there’s no scheduled expiration date. Tax legislation could still change the corporate tax rate.)

In addition to lowering rates, the TCJA revised tax law in many other ways. On the individual side, standard deductions were increased, significantly reducing the number of taxpayers who benefit from itemizing deductions for certain expenses, such as charitable donations and medical costs. (You benefit from itemizing on your federal income tax return only if your total allowable itemized write-offs for the year exceed your standard deduction.)

In addition, through 2025, certain itemized deductions are eliminated. Others are more limited, including those for home mortgage interest and state and local tax (SALT).

For small business owners, one of the most significant changes is the potential expiration of the Section 199A qualified business income (QBI) deduction. This is the write-off for up to 20% of QBI from noncorporate pass-through entities, including S corporations and partnerships, as well as from sole proprietorships.

The expiring provisions will affect many taxpayers’ tax bills in 2026, unless legislation extending them is signed into law.

Possible scenarios

The outcome of the presidential election in less than five months, as well as the balance of power in Congress, will determine the TCJA’s future. Here are four possible scenarios:

  1. All of the TCJA provisions scheduled to expire will actually expire at the end of 2025.
  2. All of the TCJA provisions scheduled to expire will be extended past 2025 (or made permanent).
  3. Some TCJA provisions will be allowed to expire, while others will be extended (or made permanent).
  4. Some or all of the temporary TCJA provisions will expire — and new laws will be enacted that provide different tax breaks and/or different tax rates.

How your tax bill will be affected in 2026 will partially depend on which one of these scenarios becomes reality and whether your tax bill went down or up when the TCJA became effective back in 2018. That was based on a number of factors including your income, your filing status, where you live (the SALT limitation negatively affects more taxpayers in certain states), and whether you have children or other dependents.

Your tax situation will also be affected by who wins the presidential election and who controls Congress. Democrats and Republicans have competing visions about how to proceed when it comes to taxes. Proposals can become law only if tax legislation passes both houses of Congress and is signed by the President (or there are enough votes in Congress to override a presidential veto).

The tax horizon

As the TCJA provisions get closer to expiring, it’s important to know what might change and what tax-wise moves you can make if the law does change. We’ll keep you informed about what’s ahead. We’re here to answer any questions you may have. Contact us.

© 2024

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General Helpful Articles Tax

Social Security Tax Update: How High Can It Go?

Employees, self-employed individuals and employers all pay Social Security tax, and the amounts can get bigger every year. And yet, many people don’t fully understand the Social Security tax they pay.

If you’re an employee

If you’re an employee, your wages are hit with the 12.4% Social Security tax up to the annual wage ceiling. Half of the Social Security tax bill (6.2%) is withheld from your paychecks. The other half (also 6.2%) is paid by your employer, so you never actually see it. Unless you understand how the Social Security tax works and closely examine your pay statements, you may be blissfully unaware of the size of the tax. It’s potentially a lot!

The Social Security tax wage ceiling for 2024 is $168,600 (up from $160,200 for 2023). If your wages meet or exceed that ceiling, the Social Security tax for 2024 will be $20,906 (12.4% x $168,600). Half of that comes out of your paychecks and your employer pays the other half.

If you’re self employed

Self-employed individuals (sole proprietors, partners and LLC members) know all too well how hard the Social Security tax can hit. That’s because they must pay the entire Social Security tax bill out of their own pockets, based on their net self-employment income.

For 2024, the Social Security tax ceiling for net self-employment income is $168,600 (same as the wage ceiling for employees). So, if your net self-employment income for 2024 is $168,600 or more, you’ll pay the maximum $20,906 Social Security tax.

Projected future ceilings

The Social Security tax on your 2024 income is expensive enough, but it could get worse in future years — much worse, according to Social Security Administration (SSA) projections. That’s because the Social Security tax ceiling will continue to go up based on the inflation factor that’s used to determine the increases. In turn, maximum Social Security tax bills for higher earners will go up. The latest SSA projections for Social Security tax ceilings for the next nine years are:

  • $174,900 for 2025,
  • $181,800 for 2026,
  • $188,100 for 2027,
  • $195,900 for 2028,
  • $204,000 for 2029,
  • $213,600 for 2030,
  • $222,900 for 2031,
  • $232,500 for 2032 and
  • $242,700 for 2033.

These projected ceilings are not always accurate (they could be higher or lower). If the projected numbers pan out, the maximum Social Security tax on wages and net self-employment income in 2033 will be $30,095 (12.4% x $242,700).

Your future benefits

Despite what you pay in, you might receive more in Social Security benefits than you pay into the system. An Urban Institute report looked at some average situations. For example, a single man who earned average wages every year of his adult life and retired at age 65 in 2020 would have paid about $466,000 in Social Security and Medicare taxes.

But he can expect to receive about $640,000 in benefits during retirement. Of course, there are many factors involved and each situation is unique. Plus, these calculations don’t account for the interest the Social Security tax dollars would have earned over the years.

Some people think the government has set up an account with their name on it to hold money to pay their future Social Security benefits. After all, that must be where those Social Security taxes on wages and self-employment income go. Sorry, but this is incorrect. There are no individual accounts — just a promise from the government.

Is the Social Security system financially solid? It’s on shaky ground. Congress has known that for years and has done nothing about it (although there have been many proposals on how to fix things).

A Social Security Administration report states that “benefits are now expected to be payable in full on a timely basis until 2037, when the trust fund reserves are projected to become exhausted. At the point where the reserves are used up, continuing taxes are expected to be enough to pay 76% of scheduled benefits.”

The agency adds that “Congress will need to make changes to the scheduled benefits and revenue sources for the program in the future.” These changes could include a higher age to receive full benefits, additional Social Security tax hikes in the form of higher rates, some tax-law revision that effectively implements higher ceilings or a combination of these.

Stay tuned

The Social Security tax paid by many individuals will continue to go up. If you operate a small business, there may be some strategies than can potentially cut your Social Security tax bill. If you’re an employee, you need to take Social Security into account in your financial planning. Contact us for details.

© 2024

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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.