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Five-Point Meal Expense Test

Posted on by ORRPC
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The Tax Cuts and Jobs Act (TCJA) of 2017 generally disallowed all deductions for business entertainment, amusement, and recreation (see the May 2018 CPA Client Bulletin). However, the TCJA did not specifically turn thumbs up or down on the deductibility of business meal expenses.

Example: Jim Morgan, who owns a roof cleaning business, takes a prospect to lunch and pays the $60 bill. Under the old law, Jim could take a $30 (50%) tax deduction.

Is this still the case? In Notice 2018-76, issued in the second half of last year, the IRS clarified that such business meals generally remain 50% tax deductible. Proposed regulations will be published in the future, but business owners can rely on Notice 2018-76 in the interim.

Essentially, this notice confirms that anything that might be considered entertainment won’t be a deductible expense. The IRS’s list includes nightclubs, theaters, country clubs, sports events, and so on. Regular business meals, on the other hand, may still qualify for the 50% deduction.

Five Points

Drilling down, the IRS listed five tests that must be passed in order to support the deduction:

  1. The expense must be an ordinary and necessary expense, paid or incurred in carrying on a trade or business.
  2. The meal can’t be considered lavish or extravagant, considering the business context.
  3. The taxpayer (or an employee) must be present.
  4. The other party must be a current or potential business customer, client, consultant, or similar business contact.
  5. In the case of food and beverages provided during or at an entertainment activity, the food and beverages must be purchased separately from the entertainment, or the cost of the food and beverages must be stated separately from the cost of the entertainment on one or more bills, invoices, or receipts and must be priced reasonably.

Example: Carol Clark takes a client to a baseball game, where Carol buys hot dogs and drinks for herself and the client. The cost of the game tickets is not deductible. Carol can deduct 50% of the cost of the food and beverages as long as she can show that these outlays were separate from the ticket cost.

Note that the IRS uses the expression “food and beverages” in this notice. This may imply that the cost of taking a business contact out for coffee or alcoholic drinks may be 50% deductible, even if no meal was served.

It’s also worth noting that activities generally perceived to be entertainment may be deductible business expenses ― if you’re in an appropriate business. The IRS gives examples of a professional theater critic attending a play and a garment manufacturer conducting a fashion show for retailers.

Business expenses can get complicated. Our staff can let you know if some type of entertainment could be considered deductible advertising or public relations for your company. Give us a call.

Double IRA Season Is Here

Posted on by ORRPC
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Photo: Christin Hume

The start of each year might be considered “Double IRA” season. Until mid-April (the 15th, in 2019), you still can make contributions to an IRA for 2018, if you have funds you’d like to save for retirement. Most workers and their spouses may each contribute up to $5,500, or $6,500 for those who were 50 or older at the end of 2018.

If you have additional dollars to invest, you also can put them into an IRA for 2019, now that the year has begun. The sooner you put money into a 2019 IRA and choose investments, the sooner tax-advantaged buildup might begin.

Note that such IRA contributions are permitted even if you also participate in an employer’s retirement plan. The same is true if you participate in a SEP-IRA or SIMPLE IRA through your company or self-employment.

Three for the Money

Many workers can choose from among three types of IRAs.

Deductible IRAs. Whereas most workers and their spouses can contribute to regular (traditional) IRAs, only some people can deduct their contributions. A full deduction is available if you do not participate in an employer’s retirement plan; if you do participate, the deduction allowed depends on your income.

Example 1: Paula Adams, a single taxpayer who participates in a 401(k), must have had modified adjusted gross income (MAGI) of $63,000 or less in 2018 for a full deduction on her 2018 tax return. If her MAGI is greater than $63,000 but less than $73,000, a partial deduction is allowed.

Different MAGI numbers apply to married taxpayers filing joint returns, qualifying widows or widowers, and married taxpayers filing separate returns.

Contributions to traditional IRAs are not allowed after you reach age 70½.

 Roth IRAs. Contributions to Roth IRAs are never tax deductible. However, once you have had a Roth IRA account for five years and reach age 59½, all withdrawals ― including withdrawn investment earnings ― are untaxed.

There are no age limits for contributions to a Roth IRA. However, income limits apply.

Example 2: Rick Baker, a single taxpayer, must have had MAGI of $120,000 or less in 2018 for a full contribution to a Roth IRA for 2018. Rick can make a partial contribution if his MAGI is greater than $120,000 but less than $135,000, and no contribution if his MAGI is $135,000 or more.

Different MAGI numbers for Roth IRA contributions apply to married taxpayers filing joint returns, qualifying widows or widowers, and married taxpayers filing separate returns.

Nondeductible traditional IRAs. Some workers and workers’ spouses will not be able to deduct contributions to traditional IRAs or contribute to Roth IRAs because of their income.

Example 3: Carol Davis, a single taxpayer who participates in a 401(k), had MAGI of $220,000 in 2018. That puts her over the upper MAGI limits for traditional IRA deductions ($73,000) and Roth IRA contributions ($135,000), mentioned previously. However, as long as Carol was under age 70½ by the end of 2018, she can make a full nondeductible contribution to a traditional IRA. Any earnings within this IRA will not be taxed until money is withdrawn.

Once money is in a traditional IRA, it can be converted to a Roth IRA, in which future distributions may be untaxed. Roth IRA conversions have no income or age limits.

Tax Trap

Roth IRA conversions generate tax bills if pretax dollars are moving into an after-tax account. That may not be the case if only after-tax dollars are being converted.

Example 4: Suppose that Carol Davis from example 3 is 55 years old. She contributes $6,500 to a nondeductible traditional IRA for 2018. Carol has no pretax money in any other traditional, SEP, or SIMPLE IRA. If she converts that $6,500 to a Roth IRA, Carol will owe no tax. She will have made what’s known as a back-door Roth IRA contribution and will get around the income limits.

Behind the Back Door

  • Suppose a taxpayer with $26,000 of pretax money in a traditional IRA makes a $6,500 nondeductible contribution to a new traditional IRA.
  • That brings the IRA total to $32,500, of which $6,500 (20 percent) is after-tax money.
  • Then, a Roth IRA conversion of any amount will be 20 percent tax-free and 80 percent taxable, regardless of which IRA is used for the Roth conversion.
  • Such back-door Roth conversions may be most appealing to high-income taxpayers with little or no pretax money in traditional, SEP, or SIMPLE IRAs.

Additional Resources

If you need help with your financial plan, we can assist. In addition, below are some of our other financial planning tips you might like.

7 Ways to Prevent Financial Scams Directed At Elders

Posted on by ORRPC
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As tax season ramps up, so do the efforts of scam artists looking to steal people’s financial data and money. Such fraudulent activities often target older adults.

Whether you’re in this age bracket or worry about senior parents and other relatives, here are seven ways to prevent elder financial abuse:

  1. Keep both paper and online financial documents in a secure place. Monitor accounts and retain statements.
  2. Exercise caution when making financial decisions. If someone exerts pressure or promises unreasonably high or guaranteed returns, walk away.
  3. Write checks only to legitimate financial institutions, rather than to a person.
  4. Be alert for phony phone calls. The IRS doesn’t collect money this way. Another scam involves someone pretending to be a grandchild who’s in trouble and needs money. Don’t provide confidential information or send money until you can verify the caller’s identity.
  5. Beware of emails requesting personal data — even if they appear to be from a real financial institution. After all, shouldn’t your banker or financial professional already know these things? Ignore contact information provided in the email. Instead, contact the financial institution through a known telephone number.
  6. As much as possible, maintain a social network. Criminals target isolated people because often they’re less aware of scams and lack trusted confidants.
  7. Work only with qualified professionals, including accountants, bankers and attorneys.

Installment Sales: A Viable Option for Transferring Assets

Posted on by ORRPC
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Are you considering transferring real estate, a family business or other assets you expect to appreciate dramatically in the future? If so, an installment sale may be a viable option. Its benefits include the ability to freeze asset values for estate tax purposes and remove future appreciation from your taxable estate.

Giving Away vs. Selling

From an estate planning perspective, if you have a taxable estate it’s usually more advantageous to give property to your children than to sell it to them. By gifting the asset you’ll be depleting your estate and thereby reducing potential estate tax liability, whereas in a sale the proceeds generally will be included in your taxable estate.

But an installment sale may be desirable if you’ve already used up your $11.18 million (for 2018) lifetime gift tax exemption or if your cash flow needs preclude you from giving the property away outright. When you sell property at fair market value to your children or other loved ones rather than gifting it, you avoid gift taxes on the transfer and freeze the property’s value for estate tax purposes as of the sale date. All future appreciation benefits the buyer and won’t be included in your taxable estate.

Because the transaction is structured as a sale rather than a gift, your buyer must have the financial resources to buy the property. But by using an installment note, the buyer can make the payments over time. Ideally, the purchased property will generate enough income to fund these payments.

Advantages and Disadvantages

An advantage of an installment sale is that it gives you the flexibility to design a payment schedule that corresponds with the property’s cash flow, as well as with your and your buyer’s financial needs. You can arrange for the payments to increase or decrease over time, or even provide for interest-only payments with an end-of-term balloon payment of the principal.

One disadvantage of an installment sale over strategies that involve gifted property is that you’ll be subject to tax on any capital gains you recognize from the sale. Fortunately, you can spread this tax liability over the term of the installment note. As of this writing, the long-term capital gains rates are 0%, 15% or 20%, depending on the amount of your net long-term capital gains plus your ordinary income.

Also, you’ll have to charge interest on the note and pay ordinary income tax on the interest payments. IRS guidelines provide for a minimum rate of interest that must be paid on the note. On the bright side, any capital gains and ordinary income tax you pay further reduces the size of your taxable estate.

Simple Technique, Big Benefits

An installment sale is an approach worth exploring for business owners, real estate investors and others who have gathered high-value assets. It can help keep a family-owned business in the family or otherwise play an important role in your estate plan.

Bear in mind, however, that this simple technique isn’t right for everyone.

We can review your situation and help you determine whether an installment sale is a wise move for you. Contact us today, before transferring real estate.

How To: Trim the Inventory Fat

Posted on by ORRPC
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Inventory is expensive. Here are some ways to trim the fat from your inventory without compromising revenue and customer service.

Objective Inventory Counts

Effective inventory management starts with a physical inventory count. Accuracy is essential to know your cost of goods sold — and to identifying and remedying discrepancies between your physical count and perpetual inventory records. A CPA can introduce an element of objectivity to the counting process and help minimize errors.

The next step is to compare your inventory costs to those of other companies in your industry. Trade associations often publish benchmarks for:

  • Gross margin ([revenue – cost of sales] / revenue),
  • Net profit margin (net income/revenue), and
  • Days in inventory (annual revenue / average inventory × 365 days).

Your company should strive to meet — or beat — industry standards. For a retailer or wholesaler, inventory is simply purchased from the manufacturer. But the inventory account is more complicated for manufacturers and construction firms. It’s a function of raw materials, labor, and overhead costs.

The composition of your company’s cost of goods will guide you on where to cut. In a tight labor market, it’s hard to reduce labor costs. But it may be possible to renegotiate prices with suppliers.

And don’t forget the carrying costs of inventory, such as storage, insurance, obsolescence, and pilferage. You can also improve margins by negotiating a net lease for your warehouse, installing anti-theft devices or opting for less expensive insurance coverage.

Product Mix

To cut your days-in-inventory ratio, compute product-by-product margins. Stock more products with high margins and high demand — and less of everything else. Whenever possible, return excessive supplies of slow-moving materials or products to your suppliers.

Product mix should be sufficiently broad and in tune with consumer needs. Before cutting back on inventory, you might need to negotiate speedier delivery from suppliers or give suppliers access to your perpetual inventory system. These precautionary measures can help prevent lost sales due to lean inventory.

Reality Check

Often management is so focused on sales, HR issues and product innovation that they lose control over inventory.

Contact us for a reality check.

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