Changes to Fringe Benefits, Entertainment Expenses

BY Reidar Gullicksrud

Changes to Fringe Benefits, Entertainment Expenses

The tax reform legislation that Congress signed into law on December 22, 2017, was the largest change to the tax system in over 3 decades. The new tax code contains many provisions that will affect individual, estate, and corporate taxpayers. One of those changes, the elimination of a business-related deduction used for entertainment, amusement or recreation expenses, will make it costlier for business owners to entertain clients.

Previously, if an entertainment or meal expense was related to or associated with the active conduct of a trade or business, it was deductible up to 50 percent. Under the new tax code, these expenses are now considered the cost of doing business. In the chart below, we have highlighted the major changes.

Activity 2017 Old Rules 2018 New Rules
Qualified client meal expenses 50% deductible 50% deductible
Qualified employee meal expenses 50% deductible 50% deductible
Meals provided for employer convenience (incl water, coffee and snacks at the office for employees) 100% deductible 50% deductible (not deductible after 2025)
Client entertainment expenses

Event tickets

Qualified charitable events

50% deductible

50% deductible at face value of ticket

100% deductible

No deduction for entertainment expenses
Office holiday parties 100% deductible 100% deductible

 

The elimination of this deduction will impact business owners who are accustomed to treating clients to golf outings or providing clients with tickets to sporting events or concerts. Businesses will have to re-evaluate their entertainment expenses related to their trade or business, as these items are no longer 50 percent deductible.

In consideration of the elimination of this deduction, we recommend creating separate accounts for meals and entertainment expenses. Educating employees to separate their expenses will be vital as business meals will remain 50 percent deductible until 2025.

The IRS recently issued guidance regarding the business expense deduction for meals and entertainment expenses:

Taxpayers may continue to deduct 50 percent of the cost of business meals if the taxpayer (or an employee of the taxpayer) is present and the food or beverages are not considered lavish or extravagant. The meals may be provided to a current or potential business customer, client, consultant or similar business contact.

Furthermore, food and beverages that are provided during entertainment events will not be considered entertainment if purchased separately from the event.

The Department of the Treasury and the IRS expect to publish proposed regulations clarifying when business meal expenses are deductible and what constitutes entertainment. Until the proposed regulations are effective, taxpayers can rely on guidance in Notice 2018-76.

Entertainment expenses are notoriously targeted by auditors. Considering the law change, we anticipate these expenses to be a heightened area of concern during an audit. The professionals at Bauman Associates can help ensure you are in compliance, call us today at (715) 834-2001.

 

Sales Tax — What the Overturn of the Physical Presence Standard Means for Your Business

BY Chad Ryder

On June 21, 2018, The U.S. Supreme Court issued its highly anticipated decision in the South Dakota v. Wayfair case. The verdict, declaring that states can impose sales tax nexus without requiring a seller’s physical presence in the state, will have serious implications for all sellers, not just online retailers.

The decision overturns the Supreme Court precedent in Quill Corp. v. Dakota which required retailers to have a physical presence in a state before a state could require the seller to collect sales taxes from in-state customers.

The court’s decision sides with states like South Dakota, that were ultimately missing out on billions of dollars in income by not collecting sales tax from online retailers who lacked a physical presence in their state. According to the U.S. Government Accountability Office, state and local governments could have gained up to $13 billion in 2017 if states were given authority to require sales tax collection from all remote sellers.

Historical Perspective

In 1992, North Dakota attempted to require Quill Corporation, a retailer with no physical presence in North Dakota, to collect and pay sales tax for doing business in the state. Having done business through mail orders and by phone, Quill was able to successfully argue that they should not be required to pay taxes in a state in which they had no physical presence. The courts agreed, and thus the physical presence standard was born.

Since then, states have enacted a variety of nexus provisions to counteract the loss of revenue by out of state businesses that do not collect sales tax for the state. These types of provisions, which require remote sellers to collect tax or provide information about in-state customers, are known as remote seller nexus. This chart maps out the states that have passed legislation.

In the 1990’s, no one could have anticipated how predominate online sales and e-commerce would become. What was once a fraction of interstate sales had become a $450 billion industry. Supreme Court Justice Anthony Kennedy displayed willingness to revisit the Quill case, recognizing the decision had become dated. South Dakota identified the window of opportunity to re-challenge the 1992 Quill verdict. In a 5-4 ruling, the Supreme Court overturned Quill’s physical presence standard in Dakota v. Wayfair.

Who Will This Impact?

It is important to note that all sellers, not just online retailers, will be impacted by the overturn of the physical presence standard. This ruling will result in increased complexities for consumers, brick-and-mortar retailers, online retailers, accountants, and the technology companies that develop accounting software.

If your business sells products or services in multiple states, this ruling should warrant your attention. It will be imperative to be proactive; start by determining what the impact will be and plan accordingly.

Looking Forward

While states aren’t required to collect tax from out of state retailers, many states are expected to follow South Dakota’s path since these standards were reviewed by the Court for the Wayfair decision. Some states have passed economic nexus standards that are already in effect or will take effect within the next year.

If you would like to evaluate the impact this new law may have on your business, please contact Bauman Associates today by calling (715) 834-2001.

Measuring Customer Profitability

BY Daniel Carlson

Your P&L statement may measure the overall profitability of your business, but it falls short in terms of measuring the profitability of individual customers or services. To continually improve performance, every company should understand the economic building blocks that drive their business and have a deep understanding of their customers. For a company to be valuable to its shareholders it must also be valuable to current and future customers. Knowing how to grow customers into more profitable customers is essential to creating value and remaining competitive.

As companies evolve from a product-centric focus to a customer-centric business model, it’s important to keep in mind that not all customers are profitable. In truth, some high-maintenance customers can even be unprofitable. The true cost to handle one unit or serve one customer is a living barometer of profitability and should, therefore, be examined carefully.

Many companies’ managerial accounting systems are unable to accurately report the information used to rationalize which types of customers to retain, grow or win back and which types of new customers to target.

Accurately translating revenue into profitability requires a costing method that measures the cost to serve each customer or the cost to perform each service. This type of method is an economic or cost model of the business; it differs from an accounting model, which focuses on GAAP standards or financial statements. An economic model should focus on costs (inputs), cost drivers (activities), and how they relate to products or services (outputs). This model may be conceptual in nature or a complex system, depending on the needs of your business.

A costing methodology should provide accurate and relevant cost information, which is not the same as exact or precise cost information. In fact, we believe it can be a mistake to go to great lengths to provide exact information and lose sight of the intent of the analysis. Relevant cost information considers the decision at hand and does not necessarily require an ongoing costing system. It can be a point-in-time analysis that correctly measures customer or product profitability to support a specific decision. Depending on the business situation, direct activity costing information may involve analysis of fully-absorbed costs, incremental costs, historical costs or estimated future costs.

The process of developing a costing model is as important as the methodology itself. Traditional activity-based costing models are often useless for decision support. Every company has unique issues, including their core business model, time and resource limitations and access to data. A successful costing method for most small to mid-sized businesses will rely heavily on the 80/20 rule in applying 20% of the appropriate concepts to realize 80% of the benefits.

Employing a costing model in your company may help you increase your profitability and provide additional guidance in your decision-making processes. The professionals in our firm can assist you in developing these models and analyzing the results. If you would like to discuss how to measure customer or product profitability in your business, please feel free to contact us.

Individual Year-End Tax Planning

BY Casper Haas

With Donald Trump in the White House and Republicans maintaining a majority in Congress, dramatic tax changes may be on the horizon. Most likely, many provisions will not go into effect until 2018 or later. However, it’s important to keep in mind that 2018 legislation can still impact 2017 tax planning.

During year-end planning for 2017, individuals will need to keep an eye on future legislative changes and be prepared to take prompt action, if necessary. Below you will find an overview of key tax provisions and tax minimizing strategies.

Alternative Minimum Tax

Alternative minimum tax (AMT) should be considered before you and/or your accountant begin to time income and deductions. AMT is a separate tax system that limits some deductions and disallows others, such as state and local income tax deductions, property tax deductions and other miscellaneous itemized deductions that are subject to the 2% of AGI. Deductions include investment advisory fees and non-reimbursable employee business expenses.

With proper planning, you may be able to avoid AMT, reduce its impact or even take advantage of its lower maximum rate. Speak with your tax professional on AMT projections for this year and next.

Timing Income and Expenses

Timing is everything when it comes to income and expenses. Smart timing will reduce your tax liability, while poor timing can unnecessarily increase it.

If you don’t expect to be subject to AMT in the current or following year, consider income deferment. Deferring income and increasing deductible expenses for the current year is typically a good idea because it will postpone tax. If you expect to be in a higher tax bracket, or if tax rates are expected to increase, the opposite approach rings true.

Whatever the reason for timing your income and deductions, here are some income items you may be able to control:

  • Bonuses
  • Consulting or other self-employment income
  • U.S. Treasury bill income
  • Retirement plan distributions (to the extent they won’t be subject to early withdrawal penalties)

Followed by potentially controllable expenses:

  • State and local income taxes
  • Property taxes
  • Mortgage interest
  • Margin interest
  • Charitable contributions

Charitable Donations

Good deeds in the form of cash or in-kind items can reap great tax benefits. Generally, you may deduct up to 50% of your adjusted gross income for qualified charitable contributions. Tax savings can also be achieved through noncash donations. By giving gently worn items to a local resale shop, you can deduct the fair market value of the donated items. Before making a large donation to the charity of your choosing, discuss options with your tax professional.

 Healthcare Breaks

If medical expenses were not paid through tax-advantaged accounts or were reimbursable by insurance and exceed 10% of your AGI, you can deduct the excess amount. Eligible expenses may include:

  • Health insurance premiums
  • Long-term care insurance premiums (limits apply)
  • Medical and dental services
  • Prescription drugs

You may be able to save tax by contributing to one of these accounts:

  • HSA – You can contribute pretax income to an employer-sponsored Health Savings Account — or make deductible contributions to a personal HSA. Contributions are $3,400 for self-only coverage and $6,750 for family coverage for 2017. As a bonus, if you’re age 55 or older, you may contribute an additional $1,000. Like an IRA, HSAs can bear interest or be invested, growing tax-deferred. Balances can be carried over from year to year, and withdrawals for qualified medical expenses are tax-free.
  • FSA – An employer-sponsored Flexible Spending Account can be used to redirect pretax income. The plan pays or reimburses you for qualified medical expenses, not to exceed $2,600 in 2017. The balance that remains at the end of the year you lose, unless your plan allows you to roll the balance over (up to $500).

Sales Tax Deduction

Taking an itemized deduction for state and local sales taxes instead of state and local income taxes can be valuable for taxpayers residing in states with no or low-income tax or who purchase a major item, such as a car or boat. Certain deductions are reduced by 3% of the AGI amount if your AGI surpasses the applicable threshold (not to exceed 80% of otherwise allowable deductions).

The thresholds for 2017 are $261,500 (single), $287,650 (head of household), $313,800 (married filing jointly) and $156,900 (married filing separately).

Self-Employment Taxes

As a self-employed taxpayer, you may benefit from other above-the-line deductions. You can deduct 100% of health insurance costs for yourself, your spouse and your dependents, up to your net self-employment income. You can also deduct retirement plan contributions and, if you’re eligible, an HSA.

Estimated Payments and Withholdings

You can become subject to penalties if you don’t pay enough tax through estimated tax payments and withholding. Here are some strategies to help avoid underpayment penalties:

  • Know the minimum payment rules
  • Use the annualized income installment method
  • Estimate your tax liability and increase withholdings

 If you have questions about these or other tax saving tips, please contact your accounting professional to schedule your year-end planning meeting.

New Option for Small Business Startups Claiming Research Credit

BY Justin Koppa

The IRS has issued guidance explaining how a new research credit option can help minimize the tax liability for eligible small businesses that incur qualifying research expenses throughout the year. According to Notice 2017-23, eligible businesses can take advantage of a new option which enables them to apply part or all of their research credit against their payroll tax liability. This is big news for taxpayers who previously could only take the research credit against their income tax liability.

This new option was available for the first time to any eligible small business filing its 2016 federal income tax return this last tax season. The new payroll tax credit is especially attractive to eligible startups that have little or no income tax liability. To qualify, a business must:

  • have gross receipts of less than $5 million and
  • could not have had gross receipts prior to 2012

An eligible small business with qualifying research expenses has the option to apply up to $250,000 of its research credit against its payroll tax liability. This option can be selected by completing Form 6765, Credit for Increasing Research Activities, and attaching it to a timely-filed business income tax return. Don’t worry if you failed to choose this option and still wish to do so. Under a special rule for the 2016 tax year, eligible small businesses can still make the election by filing an amended return by Dec. 31, 2017.

For more information, please contact one of our tax professionals today.

Don’t Overlook Your Tax Credit Eligibility

BY Robert Sorensen

Around this time of year, many organizations are re-evaluating their annual budgets to improve profit margins and consolidate spending. One aspect of this process often includes exploring new or revised tax credits that can help offset the amount of money owed to the federal and state governments. Unfortunately, many organizations fail to recognize every tax credit they are eligible to receive. This oversight can happen for several reasons, including:

  • obsolete technology,
  • inadequate processes and
  • difficulty keeping up with the complex tax credit landscape.

Whether you are an individual taxpayer or a small business owner, understanding your tax credit eligibility is important. The good news is that there are resources and processes designed to help you monitor and navigate the complex tax credit landscape. Utilizing such tools can help capture 2017 credits as well as retroactive 2016 tax credit opportunities.

Both the federal and state government administer tax credit programs, each having defined eligibility requirements and refund amounts. In some instances, county and city governments even offer localized tax credits to encourage specific activities. The most common business tax credits nationwide include:

  • Investment
  • Hiring and employment
  • Negotiated/discretionary
  • Transferable
  • Pre-certification
  • Training

Taking advantage of tax credits from 2016 and the upcoming year can help your organization reduce its tax liability, lower its tax rate and improve the bottom line. For businesses that operate in multiple states, it is essential to understand the variations between credits because businesses based in certain states may be eligible to retroactively claim specific tax credits. For instance, 2016 tax credits that focus on job creation and property investments are still available.

Is your organization taking advantage of both state and federal tax credits? Consult with one of our tax professionals to ensure you are receiving the maximum amount due to you.

AICPA Unveils Cybersecurity Risk Management

BY Nathan Kalepp

One only needs to skim the daily news to realize that hackers are getting better and cybersecurity is more important than ever. The most recent cyberattack was a strain of ransomware that spread itself across all workstations in a network, causing a global epidemic. It is estimated that this attack impacted more than 200,000 victims in at least 150 countries. Luckily, a programmer developed an internal “kill switch,” which disabled the malware from spreading any further. Regardless of whether your system was impacted by this outbreak or not, there are many lessons to be learned; principally, the need to reinforce fundamental security practices to prepare for the future.

Taking these recent outbreaks into consideration, it is evident that organizations need to make cybersecurity risk management a top priority. To help leaders in the accounting profession reach this goal, the American Institute of Certified Public Accountants (AICPA) has unveiled a cybersecurity risk management reporting framework that will help companies and auditors communicate cyber risk readiness to stakeholders. The framework is long overdue. Until now, a common language for companies to communicate about their cybersecurity risk management was non-existent. The AICPA’s new framework includes three main resources:

  1. Description criteria used by management to explain the organization’s cybersecurity risk management program in a consistent manner and for use by CPAs to report on management’s description.
  2. Control criteria used by CPAs providing advisory or attestation services to evaluate and report on the effectiveness of the controls within a client’s program.
  3. Attest Guide, Reporting on an Entity’s Cybersecurity Risk Management Program and Controls, will be used to assist CPAs engaged to examine and report on an entity’s cybersecurity risk management program.

Cyber threats are constantly evolving; and unfortunately, your cash and customer information are desirable targets. Providing assurance to your team and stakeholders requires intentionality and a plan. Having strong cybersecurity measures in place will help safeguard sensitive information, and the AICPA’s new reporting framework will help you better communicate your preparedness to key stakeholders. If you need any guidance in this area, please reach out to one of our professional staff.

Determining if Your Business Is Subject to State Taxes

BY Chad Ryder

Operating exclusively in one physical location may no longer be ideal for some businesses to remain profitable in an ever-changing landscape. To adapt, many businesses are moving towards virtual business models. As businesses expand their operations across state lines, it becomes increasingly important for states to collect taxes (income and sales tax being the most common).

As a result, many states are making necessary updates to tax laws. For instance, several states have implemented an “economic nexus” standard, which requires businesses to file a state tax return regardless of whether they have a physical presence there.

The AICPA defines economic nexus as the amount and degree of a taxpayer’s business activity that must be present in a state before the taxpayer becomes subject to the state’s taxing jurisdiction or taxing power. There are numerous business activities that can prompt a tax filing. We have listed the most common below. Consider which of these might apply to your business.

  • Presence of employees, even without sales
  • Execution of contracts
  • Others acting in an “agent” capacity
  • Employees who work remotely
  • Product delivery via a company-owned truck
  • Data stored on a server

While the economic nexus standard can be helpful in determining if your business is subject to state tax, there is inconsistency between states that define economic benefit differently. To provide additional guidance, some states have gone a step further to set a “bright-line rule.” The purpose of such a rule is to define a standard, leaving little or no room for interpretation.

To help determine if your business is required to file and pay state taxes:

  • Identify which states you have activity in
  • Research the state nexus rules for income and sales tax

If you have questions regarding your state tax return filing requirements, please contact one of our professionals today.

 

How the New Audit Rules Will Impact Estate Planning

BY John Satre

Future changes to partnership audit rules will impact estate planning. Typically, one would not assume these changes would impact estate planning but they do, considering many estates have LLCs taxed as partnerships to obtain valuation discounts. Entities taxed as partnerships will need to update their operating agreements so they:

  • reflect the new rules,
  • appoint a partnership representative and define their authority, and
  • determine whether to elect out of the unified audit rules.

Effective January 1, 2018 both existing and new partnerships will be subject to new partnership audit rules. The new rules allow for partnership level determination of deficiencies if the partnership is audited as the default regime. There are several potential problems to consider:

  • Current partners could be liable for past deficiencies if there were different partners during the year under audit.
  • Allocation issues may arise since the IRS will not undo errors; rather, they will assess the net increase against the partnership.
  • The deficiency will be assessed at the highest tax rate.

 

In addition, under the new rule, the tax matters partner (the partner that represents the partnership before the IRS in all tax matters) no longer exists. Under the new rule, the partnership representative does not even need to be a partner. A potential problem to consider:

  • Electing a representative should be a high priority as the IRS can select one if one is not appointed.

These potential problems may motivate partnerships to opt out, keeping determinations at the partner level. If so, the question will be whether trustees that own partnership interests on behalf of trusts will have the capability to opt out. Under the new audit rules, opting out is allowed only if:

  1. there are less than 100 K-1s and
  2. the partner of the pass-through entity reveals the identity of its members. This is so that the master partnership can confirm that the pass-through entity has 100 or fewer direct and indirect partners who are US individuals, C corporations or foreign entities that would be treated as C corporations if they were US entities.

At this time, it is uncertain whether partnerships that have trusts as owners will be able to opt out as the new code section does not address trusts or trustees.

 

What’s next?

Entities taxed as partnerships should ensure compliance by including portions of the new code in partnership and operating agreements. This will be especially important should a scenario arise where the partners do not return to amend the agreements.

Regarding existing partnerships, waiting to make modifications is best as the IRS will likely issue more regulations. For now, remain cautious regarding trusts as owners since it is uncertain whether they can opt out.

The professionals in our office can answer any questions you may have about the new audit rules. Call us today.

 

Three Implications to Consider Before Converting Your Business to an S Corp

BY Chad Ryder

Unincorporated, businesses are susceptible to high self-employment (SE) tax bills because of how they are taxed. One way around this is to convert your business to an S corporation. For many business owners, this is an appealing option. Before you make the switch, here is what you need to know.

The Basics: Certain income, such as sole proprietorship and partnership income, is subject to SE tax. Also subject to the SE tax are single-member limited liability companies (LLCs) and multimember LLCs. Effective 2017, the maximum federal SE tax rate of 15.3 percent applies to the first $127,200 of net SE income. That rate is inclusive of both the Social Security tax (12.4 percent) and the Medicare tax (2.9 percent).

The rate declines once SE income reaches $127,200 because the Social Security tax component is eliminated.  The Medicare tax will continue to accrue at the same rate of 2.9 percent. It will increase to 3.8 percent at higher income levels because of the additional Medicare tax (0.9 percent). As part of the Affordable Care Act, we anticipate the additional Medicare tax to disappear once the ACA is replaced.

For the purpose of this article, we make reference to the Social Security and Medicare taxes together as federal employment taxes.

How an S Corp can Lower SE Taxes: Converting your unincorporated business into an S corporation, can help lower your SE taxes. This is done by paying yourself a modest salary and then, distributing any remaining cash flow to shareholder-employees as federal-employment-tax-free distributions. This works in your favor because,

  • For compensation paid to an S corporation employee, the FICA tax rate is 7.65 percent on the first $127,200. That rate is inclusive of both the Social Security tax (6.2 percent) and the Medicare tax (1.45 percent).
  • Above $127,200, the rate drops to 1.45 percent because the Social Security tax component is eliminated. The Medicare tax component of 1.45 percent is indefinite.
  • S corporation employees are required to pay an additional Medicare Tax of 0.9 percent at higher wage levels. The funds to pay FICA tax are withheld from employee paychecks.

The employer is responsible for matching the amounts of Social Security tax and Medicare tax, paid directly to the U.S. Treasury. The combined FICA and employer rate for the Social Security tax is still the same as the SE tax rates you face as an individual, but the employer is now responsible for them.

Where the tax savings arise is on the cash distributions made to shareholder-employees because only wages are subject to federal employment taxes.

In terms of federal employment tax treatment, S corporations are in a better position compared to businesses that are conducted as sole proprietorships, partnerships or LLCs.
Your Considerations – Before you change your business structure, consider the following caveats.

  1. If you cannot prove your salary is reasonable, you are at a high risk of an IRS audit, back employment taxes, interest and penalties. To minimize the risk, collect evidence that proves someone hired externally to perform the same work would be paid the same salary.
  2. Modest salaries will reduce the maximum eligible contribution to your retirement accounts. One workaround would be to set up 401(k) plans, where modest salaries won’t prevent substantial contributions.
  3. Consider the added administrative tasks that are associated with operating as an S corporation. For example, S corporations are required to file a separate federal return. Also, there are state-law corporation requirements to abide by such as holding board of director’s meetings and keeping minutes.

Depending on the situation, converting your business to an S corporation can be a strategic move that reduces federal employment taxes. However, there are many legal implications to consider. The professionals in our office can answer the questions you may have. Call us today.

Income from Sole Proprietorship (LLC) $75,000
35% Tax Rate $26,250
15.3% Employer Matching Tax $11,475
Total Taxes: $37,725

 

Tax Savings on an S Corporation

Salary from S-Corporation: $40,000
Pass-through Income: $35,000
Total Income: $75,000
35% Tax Rate: $26,250
15.3% Employer Matching Tax $6,120
Total Taxes: $32,370

 

 Tax Savings:  $5,355