Month: April 2021

President Biden’s proposals for individual taxpayers were outlined in an April 28 address to Congress and in an 18-page fact sheet released by the White House. The “American Families Plan” contains tax breaks for low- and middle-income taxpayers and tax increases on those “making over $400,000 per year.”

Here’s a summary of some of the proposals.

Extended tax breaks

Extend the Child Tax Credit (CTC) increases in the American Rescue Plan Act (ARPA) through 2025 and make the credit permanently fully refundable. The ARPA made several changes to the CTC for 2021. For example, it expanded the credit for eligible taxpayers from $2,000 to $3,000 per child ages six and above, and $3,600 per child under age six. It also made 17-year-olds eligible to be qualifying children for the first time and made the credit fully refundable. It also provides for monthly advance payments of the credit that will be paid from July through December 2021.

The American Families Plan would make permanent the full refundability of the CTC, while extending the other expansions of it through 2025. “The credit would also be delivered regularly,” the fact sheet states, meaning that monthly payments would continue to families rather than waiting until tax season to claim the credit.

Permanently increase the Child and Dependent Care Credit. The ARPA increased the amount of the credit for many taxpayers and made it refundable. The American Families Plan would make these changes permanent.

Extend expanded Affordable Care Act tax credits for premiums. The ARPA expanded the premium credit that’s available to many people enrolled in an exchange-purchased qualified health plan, which in effect, lowers plan premiums for them. This expansion applies to 2021 and 2022. The American Families Plan would make the premium reductions permanent.

Make the Earned Income Tax Credit (EITC) expansion for childless workers permanent. The ARPA made changes that roughly tripled the EITC for childless workers for 2021. The American Families Plan would make the changes permanent.

Tax increases

Increase the top tax rate to 39.6%. The proposed plan would restore the top tax bracket to what it was before the 2017 Tax Cuts and Jobs Act, returning it to 39.6% from 37%. This would apply to taxpayers in the top 1%.

Increase the capital gains tax for “households making over $1 million.” They would pay the same 39.6% rate on all income, rather than the current maximum 20% tax rate on long-term capital gains. (Short term capital gains from investments held less than one year currently are taxed at the top individual tax rate of 37%.)

Reduce the “step-up in basis” at death for some taxpayers. The proposed plan would end the practice of stepping up the basis for gains in excess of $1 million ($2.5 million per couple when combined with existing real estate exemptions) at death and would tax the gains if the property isn’t donated to charity. The fact sheet states that this “will be designed with protections so that family-owned businesses and farms will not have to pay taxes when given to heirs who continue to run the business.”

Revise the taxation of carried interest. The proposed plan would close the carried interest loophole so that hedge fund partners will pay ordinary income rates on their income.

Cut back the rule for like-kind exchanges. President Biden would like to eliminate the Section 1031 like-kind exchange rule with respect to gains greater than $500,000 on real estate exchanges.

Make the excess business loss rules permanent. Under the tax code, for noncorporate taxpayers in tax years beginning after December 31, 2020, and before January 1, 2026, any “excess business loss” of a taxpayer for the tax year is disallowed. The American Families Plan would make this rule permanent.

Close loopholes in the 3.8% net investment income tax. Certain unearned income of high-income individuals, estates and trusts is subject to a surtax of 3.8%. The fact sheet states that the application of this provision is “inconsistent across taxpayers due to holes in the law” and proposes to “apply the taxes consistently to those making over $400,000.”

A challenging road ahead

These are only some of the proposals in the American Families Plan. Keep in mind that for any of these proposals to become reality, President Biden’s plan would have to be approved by Congress and that will be challenging. No matter what lies ahead, we can help you implement planning strategies to keep your tax bill as low as possible.

© 2021

Owners of incorporated businesses know that there’s a tax advantage to taking money out of a C corporation as compensation rather than as dividends. The reason: A corporation can deduct the salaries and bonuses that it pays executives, but not dividend payments. Thus, if funds are paid as dividends, they’re taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is only taxed once — to the employee who receives it.

However, there are limits to how much money you can take out of the corporation this way. Under tax law, compensation can be deducted only to the extent that it’s reasonable. Any unreasonable portion isn’t deductible and, if paid to a shareholder, may be taxed as if it were a dividend. Keep in mind that the IRS is generally more interested in unreasonable compensation payments made to someone “related” to a corporation, such as a shareholder-employee or a member of a shareholder’s family.

Determining reasonable compensation

There’s no easy way to determine what’s reasonable. In an audit, the IRS examines the amount that similar companies would pay for comparable services under similar circumstances. Factors that are taken into account include the employee’s duties and the amount of time spent on those duties, as well as the employee’s skills, expertise and compensation history. Other factors that may be reviewed are the complexities of the business and its gross and net income.

There are some steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation. For example, you can:

• Keep compensation in line with what similar businesses are paying their executives (and keep whatever evidence you can get of what others are paying to support what you pay). 
• In the minutes of your corporation’s board of directors, contemporaneously document the reasons for compensation paid. For example, if compensation is being increased in the current year to make up for earlier years in which it was low, be sure that the minutes reflect this. (Ideally, the minutes for the earlier years should reflect that the compensation paid then was at a reduced rate.) Cite any executive compensation or industry studies that back up your compensation amounts. 
• Avoid paying compensation in direct proportion to the stock owned by the corporation’s shareholders. This looks too much like a disguised dividend and will probably be treated as such by IRS.
• If the business is profitable, pay at least some dividends. This avoids giving the impression that the corporation is trying to pay out all of its profits as compensation.

You can avoid problems and challenges by planning ahead. If you have questions or concerns about your situation, contact us.

© 2021

Are you thinking about setting up a retirement plan for yourself and your employees, but you’re worried about the financial commitment and administrative burdens involved in providing a traditional pension plan? Two options to consider are a “simplified employee pension” (SEP) or a “savings incentive match plan for employees” (SIMPLE).

SEPs are intended as an alternative to “qualified” retirement plans, particularly for small businesses. The relative ease of administration and the discretion that you, as the employer, are permitted in deciding whether or not to make annual contributions, are features that are appealing.

Uncomplicated paperwork

If you don’t already have a qualified retirement plan, you can set up a SEP simply by using the IRS model SEP, Form 5305-SEP. By adopting and implementing this model SEP, which doesn’t have to be filed with the IRS, you’ll have satisfied the SEP requirements. This means that as the employer, you’ll get a current income tax deduction for contributions you make on behalf of your employees. Your employees won’t be taxed when the contributions are made but will be taxed later when distributions are made, usually at retirement. Depending on your needs, an individually-designed SEP — instead of the model SEP — may be appropriate for you.

When you set up a SEP for yourself and your employees, you’ll make deductible contributions to each employee’s IRA, called a SEP-IRA, which must be IRS-approved. The maximum amount of deductible contributions that you can make to an employee’s SEP-IRA, and that he or she can exclude from income, is the lesser of: 25% of compensation and $58,000 for 2021. The deduction for your contributions to employees’ SEP-IRAs isn’t limited by the deduction ceiling applicable to an individual’s own contribution to a regular IRA. Your employees control their individual IRAs and IRA investments, the earnings on which are tax-free.

There are other requirements you’ll have to meet to be eligible to set up a SEP. Essentially, all regular employees must elect to participate in the program, and contributions can’t discriminate in favor of the highly compensated employees. But these requirements are minor compared to the bookkeeping and other administrative burdens connected with traditional qualified pension and profit-sharing plans.

The detailed records that traditional plans must maintain to comply with the complex nondiscrimination regulations aren’t required for SEPs. And employers aren’t required to file annual reports with IRS, which, for a pension plan, could require the services of an actuary. The required recordkeeping can be done by a trustee of the SEP-IRAs — usually a bank or mutual fund. 

SIMPLE Plans

Another option for a business with 100 or fewer employees is a “savings incentive match plan for employees” (SIMPLE). Under these plans, a “SIMPLE IRA” is established for each eligible employee, with the employer making matching contributions based on contributions elected by participating employees under a qualified salary reduction arrangement. The SIMPLE plan is also subject to much less stringent requirements than traditional qualified retirement plans. Or, an employer can adopt a “simple” 401(k) plan, with similar features to a SIMPLE plan, and automatic passage of the otherwise complex nondiscrimination test for 401(k) plans.

For 2021, SIMPLE deferrals are up to $13,500 plus an additional $3,000 catch-up contributions for employees age 50 and older.

Contact us for more information or to discuss any other aspect of your retirement planning.

© 2021

As a business owner, you should be aware that you can save family income and payroll taxes by putting your child on the payroll.

Here are some considerations. 

Shifting business earnings

You can turn some of your high-taxed income into tax-free or low-taxed income by shifting some business earnings to a child as wages for services performed. In order for your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child’s salary must be reasonable.

For example, suppose you’re a sole proprietor in the 37% tax bracket. You hire your 16-year-old son to help with office work full-time in the summer and part-time in the fall. He earns $10,000 during the year (and doesn’t have other earnings). You can save $3,700 (37% of $10,000) in income taxes at no tax cost to your son, who can use his $12,550 standard deduction for 2021 to shelter his earnings.

Family taxes are cut even if your son’s earnings exceed his standard deduction. That’s because the unsheltered earnings will be taxed to him beginning at a 10% rate, instead of being taxed at your higher rate.

Income tax withholding

Your business likely will have to withhold federal income taxes on your child’s wages. Usually, an employee can claim exempt status if he or she had no federal income tax liability for last year and expects to have none this year.

However, exemption from withholding can’t be claimed if: 1) the employee’s income exceeds $1,100 for 2021 (and includes more than $350 of unearned income), and 2) the employee can be claimed as a dependent on someone else’s return.

Keep in mind that your child probably will get a refund for part or all of the withheld tax when filing a return for the year.

Social Security tax savings  

If your business isn’t incorporated, you can also save some Social Security tax by shifting some of your earnings to your child. That’s because services performed by a child under age 18 while employed by a parent isn’t considered employment for FICA tax purposes.

A similar but more liberal exemption applies for FUTA (unemployment) tax, which exempts earnings paid to a child under age 21 employed by a parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting only of his or her parents.

Note: There’s no FICA or FUTA exemption for employing a child if your business is incorporated or is a partnership that includes non-parent partners. However, there’s no extra cost to your business if you’re paying a child for work you’d pay someone else to do.

Retirement benefits

Your business also may be able to provide your child with retirement savings, depending on your plan and how it defines qualifying employees. For example, if you have a SEP plan, a contribution can be made for the child up to 25% of his or her earnings (not to exceed $58,000 for 2021).

Contact us if you have any questions about these rules in your situation. Keep in mind that some of the rules about employing children may change from year to year and may require your income-shifting strategies to change too.

© 2021