Five-Point Meal Expense Test

business-dining_LI-532x266 Five-Point Meal Expense Test
Photo: Rawpixel

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.

Year-End Business Tax Planning

qtq80-qxXJDS-1024x751 Year-End Business Tax Planning

Under the TCJA, equipment expensing permitted by Section 179 of the tax code was expanded. In 2018, your business can take a first-year deduction of up to $1 million worth of equipment purchases. You might buy, say, $400,000 worth of equipment and deduct $400,000 from your company’s profits this year. Without the Section 179 tax break, that $400,000 tax deduction would be spread over multiple years.

New and used equipment that is bought or leased can qualify for first-year expensing. The equipment must be placed in service by December 31 to earn a 2018 deduction. For this purpose, the date you pay for the equipment doesn’t matter.

Section 179 is meant to benefit smaller companies, not giant corporations. Therefore, this tax break phases out, dollar for dollar, at $2.5 million of outlays in 2018.

Example 1: ABC Corp. buys $2.8 million of equipment in 2018. That’s $300,000 over the $2.5 million limit for expensing this year. Consequently, ABC’s Section 179 deduction is reduced by $300,000, from the $1 million ceiling, to $700,000. After taking a $700,000 deduction under Section 179, the remaining $2.1 million of ABC’s equipment purchases must be depreciated under other tax code rules.

Bonus Depreciation

The TCJA also expanded the use of “bonus” depreciation: first-year deductions for equipment expenditures that don’t qualify for Section 179 expensing. Prior law allowed for 50% bonus depreciation, but that has been increased to 100% deductions in the year of acquisition.

Certain equipment is excluded from bonus depreciation, but most of the items you use in your business probably will qualify. Indeed, bonus depreciation now applies to some used equipment, as well, whereas only new equipment qualified in the past. Again, exceptions apply, but 100% tax deductions probably will be available for items that have not been used by your company in the past and have not been acquired from a related party.

Acting by year-end may lock in substantial depreciation deductions for this year. You even may be able to use bonus depreciation deductions that exceed business income to reduce your personal income tax bill for 2018.

Sport-Utility Vehicles

For more than a decade, large passenger autos defined as sport-utility vehicles have faced a $25,000 cap in regard to Section 179 expensing.

Example 2: Jerry Miller bought an SUV for $60,000 in 2017 and used it 100% for business. Jerry was entitled to a $25,000 deduction under Section 179. The remaining $35,000 qualified for 50% bonus depreciation, so Jerry’s 2017 deduction was $42,500. The other $17,500 had to be depreciated over a longer time.

The new law appears to improve the tax treatment of SUVs.

Example 3: Suppose Jerry Miller’s partner, Nancy Owens, buys a $70,000 SUV in 2018 and uses it solely for business. She’ll still face a $25,000 limit on Section 179 expensing, but the other $45,000 can qualify for 100% bonus depreciation in 2018, generating a full $70,000 deduction for this year.

Certain conditions will affect the amount of the deduction, including the extent of business use. For any vehicle that you use fully or partially for business, keep a careful log to support any tax benefits you claim.

Changing Times

For business owners, this first year-end tax planning opportunity under the TCJA of 2017 may be a time to reconsider how the company is structured. Broadly, your choice is between operating as a regular C corporation or as a flow-through entity, such as an S corporation or a limited liability company.

The new tax law lowered the corporate income tax, which has been set at a relatively attractive flat 21% rate. However, C corporations still impose two levels of tax: the corporate income tax plus personal tax paid by company owners. Dividends are not tax deductible, so business owners effectively pay double tax on dividends received.

Flow-through entities may qualify for a newly enacted 20% deduction on qualified business income (QBI).

Example 4: Carol Lawson owns 100% of CL Inc., which is an S corporation engaged in manufacturing. In 2018, she expects her company to pass through about $100,000 of income to her. Thanks to a 20% ($20,000) QBI deduction, only $80,000 of that $100,000 will count as income on Carol’s personal tax return.

The QBI deduction tilts the scale towards choosing a pass-through entity. However, a successful small company might pass through large amounts of money to owners, and there are rules that limit the amount of QBI for certain high-income taxpayers. Also note that even a 20% QBI deduction for someone in the top 37% personal income tax bracket would effectively leave that income taxed at 29.6% (80% of 37%), higher than the corporate income tax rate.

Don’t go it alone. Give us a call.

Our staff can review your specific situation and help you compare the tax treatment you’d face with different business entities. In some cases, a small business that distributes most or all of its income to shareholders as dividends may do well to avoid the double taxation that C corporations generate. Reach out to us to help you with your business year-end taxes.

Life Insurance for More Than Just Cash Flow

life-insurance_LI-532x266 Life Insurance for More Than Just Cash Flow
Photo: Stock

 

Many people think of life insurance as a product for family protection. The life of one or two breadwinners is insured; in case of an untimely death, the insurance payout can help with raising children and maintaining the current lifestyle.

Once the children are able to live independently and a surviving spouse is financially secure, insurance coverage may be dropped. Such a strategy uses life insurance as a hedge against the risk of lost income when that cash flow is vital.

This type of planning is often necessary. That said, life insurance may serve other purposes, including some that are not readily apparent.

Final Expenses

When someone dies, funeral and burial expenses can be daunting. In addition, the decedent’s debts might need to be paid off, perhaps including substantial end-of-life medical bills. Many insurers offer policies specifically for these and other post-death obligations, with death benefits commonly ranging from $10,000 to $50,000.

The beneficiary, typically a surviving spouse or child, can receive a cash inflow in a relatively short time. Generally, this payout won’t be subject to income tax. The result might be less stress for beneficiaries during a difficult time and a reduced need to make immediate financial decisions in order to raise funds.

Investment Support

This year’s stock market volatility has worried some investors, who may be tempted to turn to safer holdings, which have little or no long-term growth potential. Prudent use of life insurance might help to allay such fears.

Example 1: Jill Miller has $600,000 in her investment portfolio, where she has a sizable allocation to stocks. She is concerned that an economic downturn could drop her portfolio value to $500,000, $400,000, or less. Therefore, Jill buys a $250,000 policy on her life.

Now Jill knows that her children, the policy beneficiaries, will receive that $250,000 at her death, income-tax-free, in addition to any other assets she’ll pass down. This gives her the confidence to continue holding stocks, which might deliver substantial gains for Jill and her children.

Balancing Acts

Life insurance also can help to treat heirs equally, if that is someone’s intention, but circumstances create challenges.

Example 2: Charles Phillips, a widower, owns a successful business in which his older daughter Diane has become a key executive. Charles would like to leave the company to Diane, but that would exclude his younger daughter Eve, who has other interests.

Therefore, Charles buys a large insurance policy on his life, payable to Eve. This assured death benefit for Eve will help Charles structure his estate plan so that both of his daughters will be treated fairly. There is a potential downside to consider if Charles is wealthy enough to have an estate that is subject to the federal estate tax ($11.18 million in 2018). In this case, a large insurance policy will swell his gross estate, leading to a greater estate tax liability.

Life insurance may be especially helpful when one or both spouses has children from a previous marriage.

Example 3: Jim Devlin’s estate plan calls for most of his assets to be left in trust for his second wife, Robin. At Robin’s death, the trust assets will pass to Jim’s children from his first marriage. Robin is younger than Jim, so it could be many years before his children receive a meaningful inheritance.

Again, life insurance can provide an answer. If Jim insures his life and names his children as beneficiaries, his children may get an ample amount without having a long wait.

Proceed Carefully

The life insurance marketplace ranges from straightforward term policies to so-called permanent policies (forms of variable, universal, or whole life) that have investment accounts with cash value. In some cases, policyholders can tap the cash value for tax-free funds while they’re alive.

Our team can help explain the tax aspects of a policy you’re considering, but you should exercise caution when evaluating any possible purchase of life insurance. Give us a call to find out what you’ll be paying and what you’ll be receiving in return.

Additional Resources

Disclaimer: This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.

Work: Educational Fringe Benefits Are Still Possible

graduate-woman_LI-532x266 Work: Educational Fringe Benefits Are Still Possible
Photo: Esther Tuttle

As reported previously, the Tax Cuts and Jobs Act of 2017 dramatically reduced taxpayers’ ability to itemize deductions. Among the tax deduction opportunities that have vanished, from 2018–2025, are miscellaneous itemized deductions that exceed two percent of the taxpayer’s gross income. Such deductions included unreimbursed employee business expenses.

Drilling down, those no-longer-deductible employee expenses included education outlays that were related to someone’s work at your company.

Example 1: Heidi Larson is a supervisor at ABC Corp., where she is responsible for a small group of workers. Heidi is paying for online courses that will ultimately lead to an MBA and help her in her current job. Under prior law, Heidi may have been able to deduct her costs for the MBA program, but that’s not the case now.

Filling the Gap

Many people will be in Heidi’s situation, unable to offset the cost of paying for education that will bolster their careers. In this environment, your small business can provide valuable education-related assistance. Offering help in this area may allow your company to attract and retain high-quality workers, in addition to improving your employees’ on-the-job performance.

In 2018, the IRS released an updated Employer’s Tax Guide to Fringe Benefits, which reflects the new tax law. This guide mentions some ways that employers can offer education benefits that receive favorable tax treatment.

Educational Assistance Programs

An educational assistance program (EAP) must be a written plan created specifically to benefit your company’s employees. Under such a plan, you can exclude from taxable compensation up to $5,250 of educational assistance provided to each covered employee per year.

Example 2: Suppose that DEF Corp. has an EAP. Ken Matthews, a supervisor there, is taking courses in a local MBA program. DEF provides $5,000 to help Ken pay for his courses this year. DEF can deduct its $5,000 outlay, whereas Ken does not report that $5,000 as taxable income. It makes no difference whether DEF pays the bills directly or reimburses Ken for his outlay.

Some formality is required when setting up an EAP and certain requirements must be met. The plan can’t favor highly compensated employees or company owners, for example, and it can’t offer cash to employees instead of educational assistance. Our office can help you create an EAP that complies with IRS requirements.

Working-Condition Fringe Benefit 

The benefits in this category don’t require a formal plan, there is no limit on the amount of educational assistance involved, and no explicit limit on highly compensated employees or owners. However, there are rules that must be followed to earn tax breaks.

The education must be required, by the company or by law, in order for the employee to maintain his or her present position, salary, or status at the firm, and the learning must have a valid business purpose for the employer. If those conditions can’t be met, tax breaks still may be available if the education helps to maintain or improves job-related skills.

Regardless of the previous paragraph, tax benefits will be denied if the education is needed to meet the minimum educational requirements of the employee’s current job or if the course will qualify the employee for a new trade or business.

Example 3: Nora Pearson, a supervisor at GHI Corp., is going to law school at night. Even if learning the law will help Nora do her job better, company funding for her courses won’t qualify for favorable taxation because the education could enable Nora to become an attorney, a new trade for her. Any assistance from GHI will be treated as taxable compensation.

Note that it is possible to have an EAP and provide over $5,250 to an eligible employee. Assuming that all conditions are met, assistance over $5,250 might be deductible for the employer and excluded from the employee’s taxable compensation as a working-condition fringe benefit.

If you have questions about the tax implications of adding an EAP program to your company, give us a call. We’ll help walk you through the process.

Additional Resources

Forever G.I. Bill Extends Benefits to Family Members

Veterans-Day_LI Forever G.I. Bill Extends Benefits to Family Members
Photo: Unsplash

When you think of the G.I. Bill, you probably recall reading about a program designed to help military veterans receive college educations after they left the armed forces following World War II. Somewhat less known is that the G.I. Bill has endured, in various forms, until present times.

Last year, the Harry W. Colmery Veterans Education Assistance Act of 2017 became law, named for the American Legion member who wrote the initial G.I. Bill. The latest version is known as the “Forever G.I. Bill” because there is no time limit on receiving benefits for military personnel. Furthermore, education benefits may be transferred to spouses and children.

Who Qualifies

The new G.I. Bill applies to service members with at least 90 days of aggregate active duty service after September 10, 2001. In addition, at least one other condition must be met. A person must be:

  • Still on active duty,
  • Honorably discharged, or
  • Discharged with a service-connected disability after at least 30 days of service.

Thus, the new G.I. Bill can be used for college classes, including post-graduate study, or for various types of career training. An extensive approved list ranges from entrepreneurship training to flight training to vocational or technical training.

The current program provides up to 36 months of education benefits, equivalent to four years at a standard college. (A 45-month limit for educational benefits may apply for individuals who first enrolled before August 1, 2018.) For the 2018-2019 academic year, the benefits cover all tuition and fee payments for an in-state student at a public college or university; for private (or even some foreign) institutions, benefits cover costs up to $23,671.94. Many schools across the country participate in a Yellow Ribbon program that provides even greater benefits. The U.S. Department of Veterans Affairs matches contributions from the educational institutions.

In addition to those amounts, G.I. Bill recipients also may receive a housing allowance plus a stipend for books and supplies. Benefit amounts may differ for education that does not occur at an institution for higher learning, such as online learning.

Generally, someone must have served at least 36 months to get full benefits; those with less time in service may receive partial benefits. The time that a reservist was ordered to active duty counts towards eligibility. All post-9/11 Purple Heart recipients are fully eligible, regardless of length of service.

Previously, there was a 15-year time limit for use of these benefits. Under the new law, as long as someone’s release from active duty was after 2012, the time limit has been removed.

Transferring Benefits

One of the most interesting aspects of today’s G.I. Bill is the ability to transfer benefits to a spouse or a child.

Example: Tanya Walker has a college degree and no interest in further education after she leaves the military. She can transfer her unused G.I. Bill benefits to her husband Dave, but Dave also has no interest in continuing any classwork. Therefore, Tanya transfers her benefits to their son Ernie and their daughter Fiona.

Tanya must transfer her benefits before she leaves the military. Once she has been discharged, a transfer isn’t possible. If Tanya has used any benefits under the G.I. Bill, only the unused amount can be transferred.

A few more hurdles must be cleared. Applicants must have been in the military for at least 6 years when requesting the transfer and agree to serve another 4 years on active duty or in selected reserves. Alternatively, an individual must have been in the military for at least 10 years and agree to serve as long as allowed, by policy or by law. Special rules apply to anyone who was eligible for retirement on August 1, 2012.

When a transfer of benefits goes to the spouse, the recipient must use them in full within 15 years after the veteran leaves active duty. When a transfer goes to children, they can’t use the G.I. Bill benefits until they graduate from high school, get an equivalency certificate, or reach age 18. Once a child reaches age 26, he or she can no longer use the transferred benefits.

In this example, Ernie and Fiona may divide the transferred G.I. Bill benefits after they graduate high school. The benefits must be fully used before both children reach age 26.