Category: Article

Falling interest rates have created renewed excitement in the real estate market, and potential homebuyers are once again exploring new home options.

If you’re in the process of buying a home, or you just bought one, you may have wondered if you can deduct mortgage points paid on your behalf by the seller. The answer is “yes” – but subject to significant limitations.

Basics of points

Points are upfront fees charged by a mortgage lender, expressed as a percentage of the loan principal. Points may be deductible if you itemize deductions and are usually the buyer’s obligation. However, a seller sometimes sweetens a deal by agreeing to pay the points on the buyer’s mortgage loan.

In most cases, points that a buyer pays are a deductible interest expense. And seller-paid points may also be deductible.

Suppose, for example, that you bought a home for $600,000. In connection with a $500,000 mortgage loan, your bank charged two points, or $10,000. The seller agreed to pay the points to close the sale.

You can deduct the $10,000 in the year of sale. The only disadvantage is that your tax basis is reduced to $590,000, which will mean more gain if — and when — you sell the home for more than that amount. But that may not happen until many years later, and the gain may not be taxable anyway. You may qualify for an exclusion of up to $250,000 ($500,000 for a married couple filing jointly) of gain on the sale of a principal residence.

Important limits

Some important limitations exist on the rule allowing a deduction for seller-paid points. The rule doesn’t apply to points that are:

• Allocated to the part of a mortgage above $750,000 ($375,000 for marrieds filing separately) for tax years 2018 through 2025 (above $1 million for tax years before 2018 and after 2025)
• On a loan used to improve (rather than buy) a home
• On a loan used to buy a vacation or second home, investment property or business property
• Paid on a refinancing, or home equity loan or line of credit

Tax aspects of the transaction

Consult a tax planning expert to determine whether the points in your home purchase are deductible, as well as to discuss other crucial tax aspects of your transaction.

© 2024 KraftCPAs PLLC

When drafting partnership and LLC operating agreements, various tax issues must be addressed. This is also true of multi-member LLCs that are treated as partnerships for tax purposes. Here are some critical issues to include in your agreement so your business remains in compliance with federal tax law.

Identify and describe guaranteed payments to partners

For income tax purposes, a guaranteed payment is one made by a partnership that’s: 1) to the partner acting in the capacity of a partner, 2) in exchange for services performed for the partnership or for the use of capital by the partnership, and 3) not dependent on partnership income.

Because special income tax rules apply to guaranteed payments, they should be identified and described in a partnership agreement. For instance:

• The partnership generally deducts guaranteed payments under its accounting method at the time they’re paid or accrued.
• If an individual partner receives a guaranteed payment, it’s treated as ordinary income — currently subject to a maximum income tax rate of 37%. The recipient partner must recognize a guaranteed payment as income in the partner’s tax year that includes the end of the partnership tax year in which the partnership deducted the payment. This is true even if the partner doesn’t receive the payment until after the end of his or her tax year.

Account for the tax basis from partnership liabilities

Under the partnership income taxation regime, a partner receives additional tax basis in his or her partnership interest from that partner’s share of the entity’s liabilities. This is a significant tax advantage because it allows a partner to deduct passed-through losses in excess of the partner’s actual investment in the partnership interest (subject to various income tax limitations such as the passive loss rules).

Different rules apply to recourse and nonrecourse liabilities to determine a partner’s share of the entity’s liabilities. Provisions in the partnership agreement can affect the classification of partnership liabilities as recourse or nonrecourse. It’s important to take this fact into account when drafting a partnership agreement.

Clarify how payments to retired partners are classified

Special income tax rules also apply to payments made in liquidation of a retired partner’s interest in a partnership. This includes any partner who exited the partnership for any reason.

In general, payments made in exchange for the retired partner’s share of partnership property are treated as ordinary partnership distributions. To the extent these payments exceed the partner’s tax basis in the partnership interest, the excess triggers taxable gain for the recipient partner.

All other payments made in liquidating a retired partner’s interest are either:

• Guaranteed payments if the amounts don’t depend on partnership income.
• Ordinary distributive shares of partnership income if the amounts do depend on partnership income. These payments are generally subject to self-employment tax.

The partnership agreement should clarify how payments to retired partners are classified so the proper tax rules can be applied by both the partnership and recipient retired partners.

Consider other partnership agreement provisions

Since your partnership may have multiple partners, multiple issues can come into play. You’ll need a carefully drafted partnership agreement to handle potential issues even if you don’t expect them to arise. For instance, you may want to include:

• A partnership interest buy-sell agreement to cover partner exits.
• A noncompete agreement.
• How the partnership will handle the divorce, bankruptcy, or death of a partner. For instance, will the partnership buy out an interest that’s acquired by a partner’s ex-spouse in a divorce proceeding or inherited after a partner’s death? If so, how will the buyout payments be calculated and when will they be paid?

Be sure tax issues are fully addressed when putting together a partnership deal to avoid potential IRS setbacks later.

© 2024 KraftCPAs PLLC

In June 2024, the IRS released final regulations addressing the prevailing wage and apprenticeship (PWA) requirements for increased clean energy tax deduction or credit amounts. These tax breaks were made available under the Inflation Reduction Act (IRA). Satisfying the requirements can quintuple the total amount of tax benefit potentially available.

To claim the enhanced tax treatment, however, both general contractors and subcontractors on eligible jobs must follow the PWA requirements. So construction business owners and their leadership teams should familiarize themselves with the new regulations if they intend to compete for qualifying projects.

General requirements

The IRA provides for a five-fold increase in the amount of certain clean energy incentives, including the:

• Investment tax credit
• Production tax credit
• Energy-efficient commercial buildings deduction
• Renewable energy production tax credit
• Renewable energy property investment tax credit

The incentives are triggered by the construction, alteration, or repair of certain clean energy facilities or properties, projects, or equipment.

To qualify, taxpayers generally must pay laborers and mechanics employed on such projects at or above the prevailing wage rates set by the U.S. Department of Labor (DOL). They also need to employ sufficient apprentices from a registered apprentice program. And, as mentioned, they must ensure that all contractors and subcontractors comply with the PWA requirements.

The IRA imposes substantial penalties for noncompliance.

Additional highlights

At more than 300 pages, the final regulations cover a lot of ground and include important revisions and clarifications.

For example, they state that the apprentice requirements apply only for the construction of an energy project — not to alteration or repair work after a facility is placed in service. The prevailing wage requirements don’t apply to routinely scheduled maintenance work that’s generally required to keep the energy project in its current condition so it can continue to be used. However, the requirements do apply to repair work.

The final regulations also include revisions on the timing for prevailing wage determinations. Under the final regulations, the determination should be made when the contract for construction is executed by the taxpayer and contractor. If there’s no contract, the determination is made when construction starts — activities that may previously have been treated as “preliminary activities” not subject to prevailing wage requirements could now be subject to them.

Supplemental wage determinations must be made no more than 90 days before a contract is executed between the taxpayer and contractor. They’re effective for 180 days from the date of issue. If the supplemental determination isn’t incorporated into the contract or the construction already underway within that time, a new supplemental wage determination must be requested.

In addition, revisions were made regarding the “good faith effort” exception to the apprenticeship requirements. To qualify, requests must be made electronically or by registered mail to a registered apprenticeship program in the applicable geographic area at least 45 days before the qualified apprentice is to begin work.

Requests are valid for 365 days, as opposed to 120 days under the proposed regulations. If no registered apprentice program operates in the area of the energy project, the exception will apply as long as the taxpayer contacts the DOL or state apprenticeship agency for assistance in finding qualified apprentices.

Records are crucial

It’s worth noting that the final regulations include extensive recordkeeping requirements and provide that the records for a given project can be maintained by the taxpayer, its contractor, or a third party. Although taxpayers are ultimately responsible for ensuring compliance with the documentation requirements, contractors should read up on them in case an owner expects the construction company involved to maintain records.

Also note that the final regulations generally apply to qualified facilities that began construction and were placed in service after June 25, 2024.

With such a hefty potential increase in tax benefits on the line, it’s not surprising that the IRS plans to keep a close eye out for noncompliance with the PWA requirements. The agency has described enforcing the requirements as a “top priority.”

© 2024 KraftCPAs PLLC

Appraisal professionals typically consider three approaches when valuing a business —cost, market, and income approaches — ultimately relying on one or two depending on the nature of the business and other factors.

So, it’s no wonder that financial statements are an important piece of the business valuation process, and having accurate and updated financial statements can provide valuable insight into the fair market value of the business.

Cost approach leverages the balance sheet

Under U.S. Generally Accepted Accounting Principles (GAAP), a company’s balance sheet reports its assets and liabilities generally based on the lower of historical cost or market values. This is a logical starting point for the cost (or asset) approach to valuing a business.

Under this technique, value is derived from the combined fair market value of the business’s net assets minus any liabilities. This approach is particularly useful when valuing holding companies, asset-intensive companies, and distressed entities that aren’t worth more than their net tangible value.

The cost approach includes the book value and adjusted net asset value methods. The former calculates value using the data in the company’s accounting records. Its flaws include the failure to account for unrecorded intangibles and its reliance on historical costs, rather than current market values. The adjusted net asset value method converts book values to fair market values and accounts for all intangibles and liabilities (recorded and unrecorded).

Market approach relies on the balance sheet and income statement

The market approach bases the value of a business on sales of comparable businesses or business interests. Under this approach, the valuator identifies recent, arm’s-length transactions involving similar public or private businesses and then develops pricing multiples typically based on items reported on the balance sheet or income statement.

A pricing multiple is developed by dividing the sales prices of comparable companies by an economic variable (for example, book value or pre-tax earnings). Then, the pricing multiple is applied to the same economic variable as reported on the subject company’s financial statements.

The two main methods that fall under the market approach are:

Guideline public company method. This technique considers the market prices of comparable (or “guideline”) public company stocks.

Guideline transaction (or merger and acquisition) method. Here, the expert calculates pricing multiples based on real-world transactions involving entire comparable companies or operating units that have been sold.

When applying these methods, valuators may need to adjust the subject company’s economic variables for certain items.

Income approach turns to the statement of cash flows

Under the income approach, future expected economic benefits (generally, net cash flows) are converted into a present value. Most business owners understand that profits don’t necessarily equate with net cash flows — and cash is king when valuing a business. Equity investors are less interested in profits reported on the income statement than they are in the amount and timing of net cash flow that’s available to recoup their investment after funding business operations, paying taxes, making necessary capital investments and servicing debt.

There are two main methods that fall under the income approach:

Capitalization of earnings method. Here, estimated future economic benefits from a single representative period are capitalized using an appropriate rate of return. This method is most appropriate for companies with stable earnings or cash flow.

Discounted cash flow method. Under this technique, the valuator accounts for projected cash flows over a discrete period (say, three or five years) and a terminal value at the end of the discrete period. All future cash flows (including the terminal value) are then discounted to present value using a discount rate instead of a capitalization rate.

When applying the income approach, a valuator will consider making appropriate adjustments to the subject company’s cash flows to reflect the economic benefits investors could expect to receive in the future.

Excess earnings method blends the cost and income approaches

The excess earnings method is a lesser-known valuation technique, but it still may be used in certain situations, particularly when valuing small professional practices. This method was originally developed to compensate distilleries and breweries for loss of business value during the Prohibition era. However, to date, there’s no reliable source of market data to support comparable returns on net assets or capitalization rates for excess earnings. So, valuators generally refrain from using it as a sole method of valuation, unless a particular court has shown a preference for this technique. In addition, IRS Revenue Ruling 68-609 suggests that the excess earnings method be used only if there are no other appropriate methods.

This method derives value from the sum of adjusted net assets from the balance sheet and capitalized “excess” earnings from the income statement. The second component represents the extra earnings that the company has achieved beyond the return that comparable businesses earn on a similar set of net assets.

Essentially, capitalized excess earnings are intended to estimate the value of the business’s goodwill. It’s usually calculated using a technique like the capitalization of earnings method — that is, excess earnings are divided by an appropriate capitalization rate.

Common financial statement adjustments

Historical financial results are a helpful starting point for valuing a business. However, valuators must consider making the following three categories of adjustments to reflect the economic benefits that a future investor could expect to receive.

Nonrecurring items. The first category of adjustments accounts for any unusual or nonrecurring items, such as revenue from a one-time project or legal expenses associated with a pending lawsuit. These items aren’t expected to continue in the future and thus have no effect on the price hypothetical buyers would pay for the business.

Discretionary spending. Fair market value is often based on the future economic benefits that a hypothetical prospective buyer could generate from the business’s operations. These adjustments are designed to bring a company’s expenses in line with industry norms. Discretionary costs that commonly require adjustment include owners’ compensation and related-party transactions. These adjustments are especially important when valuing a controlling interest in a business.

Accounting norms. Valuators evaluate the company’s accounting methods. Adjustments may be needed to align the business’s financial reporting practices with comparable companies that are used to benchmark performance, gauge risk and return, and calculate pricing multiples. Examples of accounting method differences include reporting for inventory, pension reserves, depreciation, income taxes and cost capitalization vs. expensing policies. Small businesses also may use cash- or tax-basis reporting, rather than conforming to U.S. Generally Accepted Accounting Principles.

After a valuator makes a preliminary estimate of a company’s value, he or she considers additional fine-tuning. Common last-minute adjustments may include nonoperating assets, contingent or unrecorded assets and liabilities, and excess working capital (compared with the company’s normal operating needs). In some situations, it also may be appropriate to take discounts for lack of control and marketability associated with a business interest.

© 2024 KraftCPAs PLLC

 

With just a little over three months left in 2024, now’s the time for small business owners to take steps that could help lower taxes this year and next year.

For starters, the strategy of deferring income and accelerating deductions to minimize taxes can be effective for most businesses, as is the approach of bunching deductible expenses into this year or next to maximize their tax value.

Do you expect to be in a higher tax bracket next year? If so, then opposite strategies may produce better results. For example, you could pull income into 2024 to be taxed at lower rates, and defer deductible expenses until 2025, when they can be claimed to offset higher-taxed income.

Here are other ideas that may help you save tax dollars – but you’ll have to act soon.

Estimated taxes

Make sure you make the last two estimated tax payments to avoid penalties. The third-quarter payment for 2024 is due on September 16, 2024, and the fourth-quarter payment is due on January 15, 2025.

QBI deduction

Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income (QBI). For 2024, if taxable income exceeds $383,900 for married couples filing jointly (half that amount for other taxpayers), the deduction may be limited based on whether the taxpayer is engaged in a service-type business such as law, health, or consulting, the amount of W-2 wages paid by the business, and/or the unadjusted basis of qualified property such as machinery and equipment held by the business. The limitations are phased in.

Taxpayers may be able to salvage some or all the QBI deduction or be subject to a smaller deduction phaseout by deferring income or accelerating deductions to keep income under the dollar thresholds. You also may be able increase the deduction by increasing W-2 wages before year end.

Cash vs. accrual accounting

More small businesses can use the cash (rather than the accrual) method of accounting for federal tax purposes than were allowed to do so in previous years. To qualify as a small business under current law, a taxpayer must – among other requirements – satisfy a gross receipts test. For 2024, it’s satisfied if, during the three prior tax years, average annual gross receipts don’t exceed $30 million. Cash method taxpayers may find it easier to defer income by holding off on billing until next year, paying bills early, or making certain prepayments.

Section 179 deduction

Consider making expenditures that qualify for the Section 179 expensing option. For 2024, the expensing limit is $1.22 million, and the investment ceiling limit is $3.05 million. Expensing is generally available for most depreciable property – other than buildings – including equipment, off-the-shelf computer software, interior improvements to a building, HVAC, and security systems.

The high-dollar ceilings mean that many small and midsize businesses will be able to currently deduct most or all their outlays for machinery and equipment. Also, the deduction isn’t prorated for the time an asset is in service during the year. Even if you place eligible property in service by the last days of 2024, you can claim a full deduction for the year.

Bonus depreciation

For 2024, businesses also can generally claim a 60% bonus first-year depreciation deduction for qualified improvement property and machinery and equipment bought new or used, if purchased and placed in service this year. As with the Sec. 179 deduction, the write-off is available even if qualifying assets are only in service for a few days in 2024.

Upcoming tax law changes

These are just a few year-end strategies that may help you save on taxes, but it’s important to stay informed about potential changes that could affect your business’s taxes. In the next couple years, tax laws will be changing. Many tax breaks, including the QBI deduction, are scheduled to expire at the end of 2025. Plus, the outcome of the presidential and congressional elections could result in new or repealed tax breaks.

© 2024 KraftCPAs PLLC

 

It might often feel like there’s a tax on every type of financial gain, but believe it or not, there are ways to collect money and (legally) avoid paying taxes. Here are some of the best opportunities to put money in your pocket without current federal income tax implications:

Roth IRAs offer tax-free income accumulation and withdrawals. Unlike withdrawals from traditional IRAs, qualified Roth IRA withdrawals are free from federal income tax. A qualified withdrawal is one that’s taken after you’ve reached age 59½ and had at least one Roth IRA open for over five years, or you are disabled or deceased. After your death, your heirs can take federal-income-tax-free qualified Roth IRA withdrawals, with proper planning.

A large amount of profit from a home sale is tax-free. In one of the best tax-saving deals, an unmarried seller of a principal residence can exclude (pay no federal income tax on) up to $250,000 of gain, and a married joint-filing couple can exclude up to $500,000. That can be a big tax-saver, but you generally must pass certain tests to qualify. For example, you must have owned the property for at least two years during the five-year period ending on the sale date. And you must have used the property as a principal residence for at least two years during the same five-year period. To be eligible for the larger $500,000 joint-filer exclusion, at least one spouse must pass the ownership test, and both spouses must pass the use test.

People with incomes below a certain amount can collect tax-free capital gains and dividends. The minimum federal income tax rate on long-term capital gains and qualified dividends is 0%. Surprisingly, you can have a decent income and still be within the 0% bracket for long-term gains and dividends — based on your taxable income. Single taxpayers can have up to $47,025 in taxable income in 2024 and be in the 0% bracket. For married couples filing jointly, you can have up to $94,050 in taxable income in 2024.

Gifts and inheritances receive tax-free treatment. If you receive a gift or inheritance, the amount generally isn’t taxable. However, if you’re given or inherit property that later produces income such as interest, dividends, or rent, the income is taxable to you. There also may be tax implications for an individual who gives a gift. In addition, if you inherit a capital gain asset like stock or mutual fund shares or real estate, the federal income tax basis of the asset is stepped up to its fair market value as of the date of your benefactor’s demise, or six months after that date if the estate executor so chooses. So, if you sell the inherited asset, you won’t owe any federal capital gains tax except on appreciation that occurs after the applicable date.

Some small business stock gains are tax-free. A qualified small business corporation (QSBC) is a special category of corporation. Its stock can potentially qualify for federal-income-tax-free treatment when you sell for a gain after holding it for over five years.

You can pocket tax-free income from college savings accounts. Section 529 college savings plan accounts allow earnings to accumulate free of any federal income tax. And when the account beneficiary (typically your child or grandchild) reaches college age, tax-free withdrawals can be taken to cover higher education expenses. Alternatively, you can contribute up to $2,000 annually to a Coverdell Education Savings Account (CESA) set up for a beneficiary who hasn’t reached age 18. CESA earnings are allowed to accumulate free from federal income tax. Then, tax-free withdrawals can be taken to pay for the beneficiary’s college tuition, fees, books, supplies, and room and board. The catch: Your right to make CESA contributions is phased out between modified adjusted gross incomes of $95,000 and $110,000, or between $190,000 and $220,000 if you’re a married joint filer.

Planning may lead to better results 

You may be able to collect federal-income-tax-free income and gains in several different ways, including some not addressed  here. For example, proceeds from a life insurance policy paid to you because of an insured person’s death generally aren’t taxable. Check with an advisor before making any significant transaction, because there may be options that result in tax-free income or gains that would otherwise be taxable.

© 2024 KraftCPAs PLLC

A Federal Trade Commission (FTC) rule that would ban most noncompete agreements with employees was scheduled to take effect on September 4.

Instead, after a recent U.S. District Court decision that nixed the rule, employers wait to see whether the ruling will be appealed or retired for good.

The FTC ban 

The FTC’s rule would have prohibited noncompetes nationwide. In addition, existing noncompetes for most workers would no longer be enforceable after it became effective. The rule was expected to affect 30 million workers.

The rule includes an exception for existing noncompete agreements with senior executives, defined as workers earning more than $151,164 annually who are in policy-making positions. Those positions include:

• A company president, chief executive officer, or equivalent
• Any other officer who has policy-making authority
• Any other person who has policy-making authority similar to an officer with such authority

Employers couldn’t enter new noncompetes with senior executives under the new rule.

Unlike an earlier proposed rule issued for public comment in January 2023, the final rule didn’t require employers to legally modify existing noncompetes by formally rescinding them. Instead, they were required only to provide notice to workers bound by an existing agreement — other than senior executives — that they wouldn’t enforce such agreements against the workers.

Legal challenges

On the day the FTC announced the new rule, a Texas tax services firm filed a lawsuit challenging the rule in the Northern District of Texas (Ryan, LLC v. Federal Trade Commission). The U.S. Chamber of Commerce and similar industry groups joined the suit in support of the plaintiff. Additional lawsuits were filed in the Eastern District of Pennsylvania (ATS Tree Services, LLC v. Federal Trade Commission) and the Middle District of Florida (Properties of the Villages, Inc. v. Federal Trade Commission).

The Ryan case was actually the last of the three cases to reach judgment. On August 20, 2024, the U.S. District Court for the Northern District of Texas held that the FTC exceeded its authority in implementing the rule and that the rule was arbitrary and capricious. It further held that the FTC cannot enforce the ban, a ruling that applies on a nationwide basis.

Earlier, in the ATS Tree Services case, the U.S. District Court for the Eastern District of Pennsylvania denied the plaintiff’s request for a preliminary injunction and stay of the rule’s effective date. It found the plaintiff didn’t establish that it was reasonably likely to succeed in its argument against the ban.

In the Properties of the Villages case, the U.S. District Court for the Middle District of Florida granted the plaintiff a preliminary injunction and stay. That plaintiff requested relief only for itself, so the ruling had no nationwide impact.

An FTC appeal would go before the conservative U.S. Court of Appeals for the Fifth Circuit, which has become a favorite destination for challenges to President Biden’s policies. Although the court often sides with the challengers, it’s frequently been reversed by the U.S. Supreme Court.

An appeal could face an uphill battle, though, considering a recent Supreme Court ruling that reversed the longstanding doctrine of “Chevron deference.” Under that precedent, courts gave deference to federal agencies’ interpretations of the laws they administer. According to the new ruling, however, it’s now up to courts to decide “whether the law means what the agency says.”

The bottom line

For now, the FTC’s noncompete ban remains in limbo and won’t take effect on September 4, 2024. But that doesn’t mean noncompetes are safe. For example, some private parties are using anti-trust laws to challenge such agreements. And an FTC spokesperson has indicated that the Ryan ruling won’t deter the agency “from addressing noncompetes through case-by-case enforcement actions.”

© 2024 KraftCPAs PLLC

How has your business performed so far this year? How is its financial health compared to six months ago?

If your company is privately held, you probably prepare financial statements just once a year – unlike public companies, which are required by the Securities and Exchange Commission to file financial reports quarterly. But more frequent reporting is sometimes a smart idea. Here’s a summary of the benefits of issuing interim financial reports on a monthly, quarterly or biannual basis, as well as certain drawbacks and limitations.

Midyear checkup

Financial statements present a company’s financial condition at one point in time. When companies report only year-end results, it leaves investors, lenders and other stakeholders in the dark until the next year. Sometimes, they may want more than one “snapshot” per year of your company’s financial well-being. This is especially true when a company’s financial performance has deteriorated over the last year or when the industry is experiencing a downturn or implementing new regulations.

Interim financial statements report how a company is doing year-to-date. For example, they may signal impending financial turmoil due to:

• The loss of a major customer
• Significant uncollectible accounts receivable
• Pilfered inventory

They also might confirm that a turnaround plan appears successful or that a start-up has finally achieved profits.

Management can benefit from interim reporting, too. Benchmarking interim reports against the same period from the prior year (or against budgeted figures) can help ensure your company meets its financial goals for the year. If your company is underperforming, it may call for corrective measures and/or updated financial forecasts.

Potential shortcomings

While interim reporting may provide some insight into a company’s ongoing performance, it’s important to understand the drawbacks and limitations of these reports. This can help minimize the risk of year-end surprises.

First, outside accounting firms rarely review or audit private companies’ interim statements because of the cost to do so. Absent external oversight, managers with bad news to report may be tempted to artificially inflate revenue and profits in interim reports.

Midyear numbers also may omit estimates for bad-debt write-offs, accrued expenses, prepaid items, management bonuses, or income taxes. And some companies save tedious bookkeeping procedures, such as physical inventory counts and updating depreciation schedules, until year-end. Instead, interim account balances often reflect last year’s amounts or may be based on historic gross margins.

When reviewing interim reports, outside stakeholders may ask questions to assess the quality of accounting personnel and the adequacy of year-to-date accounting procedures. Some even may inquire about journal entries made by external auditors to adjust last year’s preliminary numbers to the results. This provides insight into potential adjustments that would be needed to make the interim numbers conform to U.S. Generally Accepted Accounting Principles. Journal entries often recur annually, so a list of adjusting journal entries can help identify which accounts your controller or CFO has the best handle on.

In addition, interim reporting can sometimes be misleading for seasonal businesses. For example, if your business experiences operating peaks and troughs throughout the year, you can’t multiply quarterly profits by four to reliably predict year-end performance. For seasonal operations, it might make more sense to compare last year’s monthly (or quarterly) results to the current year-to-date numbers.

Evaluating irregularities

If interim statements reveal irregularities, stakeholders might ask your company to hire an accounting firm to conduct agreed-upon procedures. These procedures target high-risk account balances or those previously adjusted by auditors.

Agreed-upon procedures engagements may give your stakeholders greater confidence in your interim results. For instance, agreed-upon procedures reports can help identify sources for any irregularities, evaluate your company’s ability to service debt, and address concerns that management could be intentionally or unintentionally inflating the numbers.

© 2024 KraftCPAs PLLC

Real estate is a hot commodity in several parts of the United States – including Middle Tennessee – but don’t be caught off guard by potential tax liabilities that lurk behind the lucrative sale of your property.

Here’s a plausible scenario: Let’s say you own real estate that was held for more than one year and is sold for a taxable gain. Perhaps this gain comes from indirect ownership of real estate via a pass-through entity such as an LLC, partnership, or S corporation. You might assume you’ll pay Uncle Sam the standard 15% or 20% federal income tax rate that usually applies to long-term capital gains from assets held for more than one year.

However, that real estate gain could be taxed at higher rates due to depreciation deductions. Here’s a rundown of the most common federal income tax issues that might be involved in real estate gains.

Vacant land

The current maximum federal long-term capital gain tax rate for a sale of vacant land is 20%. The 20% rate only hits those with high incomes. Specifically, if you’re a single filer in 2024, the 20% rate kicks in when your taxable income, including any land sale gain and any other long-term capital gains, exceeds $518,900. For a married joint-filing couple, the 20% rate kicks in when taxable income exceeds $583,750. For a head of household, the 20% rate kicks when your taxable income exceeds $551,350. If your income is below the applicable threshold, you won’t owe more than 15% federal tax on a land sale gain. However, you may also owe the 3.8% net investment income tax (NIIT) on some or all of the gain.

Gains from depreciation

Gain attributable to real estate depreciation calculated using the applicable straight-line method is called “unrecaptured Section 1250 gain.” This category of gain generally is taxed at a flat 25% federal rate, unless the gain would be taxed at a lower rate if it was simply included in your taxable income with no special treatment. You may also owe the 3.8% NIIT on some or all of the unrecaptured Section 1250 gain.

Gains from depreciable QIP

Qualified improvement property (QIP) generally means any improvement to an interior portion of a nonresidential building that’s placed in service after the date the building is placed in service. However, QIP does not include expenditures for the enlargement of the building, elevators, escalators or the building’s internal structural framework.

You can claim first-year Section 179 deductions or first-year bonus depreciation for QIP. When you sell QIP for which first-year Section 179 deductions have been claimed, gain up to the amount of the Section 179 deductions will be high-taxed Section 1245 ordinary income recapture. In other words, the gain will be taxed at your regular rate rather than at lower long-term gain rates. You may also owe the 3.8% NIIT on some or all of the Section 1245 recapture gain.

What if you sell QIP for which first-year bonus depreciation has been claimed? In this case, gain up to the excess of the bonus depreciation deduction over depreciation calculated using the applicable straight-line method will be high-taxed Section 1250 ordinary income recapture. Once again, the gain will be taxed at your regular rate rather than at lower long-term gain rates, and you may also owe the 3.8% NIIT on some or all of the recapture gain.

If you opt for straight-line depreciation for real property, including QIP (in other words, you don’t claim first-year Section 179 or first-year bonus depreciation deductions), there won’t be any Section 1245 ordinary income recapture. There also won’t be any Section 1250 ordinary income recapture. Instead, you’ll only have unrecaptured Section 1250 gain from the depreciation, and that gain will be taxed at a federal rate of no more than 25%. However, you may also owe the 3.8% NIIT on all or part of the gain.

Plenty to consider

The federal income tax rules for gains from sales of real estate may be more complicated than you thought. Different tax rates can apply to different categories of gain. You may also owe the 3.8% NIIT, as well as income tax in some states.

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If you’re one of the many Americans who receive disability income, it’s vital to understand when and how that income is taxed. The answer: It depends on the type of disability benefit and your overall income.

For starters, determine who paid for the benefit. If the income is paid directly to you by your employer, it’s taxable to you just as your ordinary salary would be. Taxable benefits are also subject to federal income tax withholding. However, depending on the employer’s disability plan, in some cases they aren’t subject to Social Security tax.

Frequently, the payments aren’t made by an employer but by an insurance company under a policy providing disability coverage. In other cases, they’re made under an arrangement having the effect of accident or health insurance. In these cases, the tax treatment depends on who paid for the insurance coverage. If your employer paid for it, then the income is taxed to you just as if it was paid directly to you by the employer. On the other hand, if it’s a policy you paid for, the payments you receive under it aren’t taxable.

Even if your employer arranges for the coverage (likely in a policy made available to you at work), the benefits aren’t taxed to you if you (and not your employer) pay the premiums. For these purposes, if the premiums are paid by the employer but the amount paid is included as part of your taxable income from work, the premiums will be treated as paid by you. In these cases, the tax treatment of the benefits received depends on the tax treatment of the premiums paid.

Illustrative example

Let’s say your salary is $1,050 a week ($54,600 a year). Additionally, under a disability insurance arrangement made available to you by your employer, $15 a week ($780 annually) is paid on your behalf by your employer to an insurance company. You include $55,380 in income as your wages for the year ($54,600 paid to you plus $780 in disability insurance premiums). Under these circumstances, the insurance is treated as paid for by you. If you become disabled and receive benefits under the policy, the benefits aren’t taxable income to you.

Now assume that you include only $54,600 in income as your wages for the year because the amount paid for the insurance coverage qualifies as excludable under the rules for employer-provided health and accident plans. In this case, the insurance is treated as paid for by the employer. If you become disabled and receive benefits under the policy, the benefits are taxable income to you.

There are special rules if there is a permanent loss (or loss of the use) of a member or function of the body or a permanent disfigurement. In these cases, employer disability payments aren’t taxed if they aren’t computed based on amount of time lost from work.

Social Security disability benefits 

This discussion doesn’t cover the tax treatment of Social Security Disability Insurance (SSDI) benefits. They may be taxed to you under the rules that govern Social Security benefits. These rules make a portion of SSDI benefits taxable if your annual income exceeds $25,000 for individuals and $32,000 for married couples.

State rules differ

State rules vary on how, when, or if disability benefits are taxed. In Tennessee, disability benefits may be taxable depending on the type of benefit and how the premiums are paid.

When deciding how much disability coverage you need to protect yourself and your family, take the tax treatment into consideration. If you’re buying a private policy yourself, you only must replace your “after-tax” (take-home) income because your benefits won’t be taxed. On the other hand, if your employer is paying for the benefit, keep in mind that you’ll lose a percentage of it to taxes. If your current coverage is insufficient, you may want to supplement the employer benefit with a policy you take out on your own.

© 2024 KraftCPAs PLLC

New guidance proposed by the Financial Accounting Standards Board (FASB) would standardize the reporting for government grants on financial statements, potentially affecting a wide range of transactions for both public and private U.S. companies.

Need for change

COVID-related legislation and the Inflation Reduction Act spurred an increased in federal grants to assist struggling companies and encourage clean-energy projects. During the COVID pandemic, the FASB issued Accounting Standard Update No. 2021-10, Government Assistance (Topic 832): Disclosures by Business Entities About Government Assistance.

The 2021 rule requires grant recipients to disclose the following details:

• The nature of the grant transactions.
• The accounting policies used to account for the transactions.
• Line items on the balance sheet and income statement that are affected by the transactions. and the amounts applicable to each financial statement line item.
• Significant terms and conditions of the transactions, including commitments and contingencies.

However, the absence of more specific requirements has made it difficult for stakeholders to compare the underlying accounting of grants from one company to the next.

Many companies voluntarily disclose their grants using the guidance in International Accounting Standard 20, Accounting for Government Grants and Disclosure of Government Assistance. But there are no specific rules under U.S. Generally Accepted Accounting Principles (GAAP) related to the recognition, measurement, or presentation of these grants. So, the FASB added a project on government grants to its technical agenda in 2023.

Scope of proposal

The FASB voted on June 4, 2024, to issue proposed guidance related to this topic, based largely on the international rule. Key decisions made during the FASB meeting include:

• The proposal will cover both monetary assets (such as cash and forgivable loans) and physical assets (such as equipment and land) transferred from governments to businesses.
• Certain loans, government guarantees, and tax credits would be excluded from the guidance.
• Businesses would be required to disclose the fair value of grants of tangible nonmonetary assets in the periods in which grants are recognized.
• Grants related to income would be recognized on the income statement in the periods in which businesses incur any grant-related costs.
• When accounting for grants related to assets, businesses generally would have to disclose the amounts they received based on either the grant’s gross or net value. Those that report grants on a net basis wouldn’t be required to disclose the amount by which they reduced the value of the asset tied to the grant over time.
• For grants related to assets that are accounted for using a cost-accumulation approach, businesses wouldn’t be required to disclose the line items on their balance sheets and income statements that are affected by the grant and the amounts applicable to each financial statement line item in the current reporting period.
• The proposal’s disclosure requirements would apply only to annual reporting periods (not interim periods).

The update also will provide guidance on accounting for leftover grants after a business combination.

Applying the changes

If the proposal is approved, businesses will be allowed to elect to apply it either retrospectively or prospectively for grants that either aren’t completed as of the effective date or are entered into after the effective date.

Those that apply the changes retrospectively would be required to provide the disclosures in the period of adoption under Accounting Standards Codification Topic 250, Accounting Changes and Error Corrections. Those that elect to apply the changes prospectively would be required to disclose the nature of and reason for the change in accounting principle.

The proposal aims to bring greater consistency in reporting government grants. It’s expected to be issued by the end of 2024 with a 90-day public comment period.

© 2024 KraftCPAs PLLC

Businesses that benefited from faulty employee retention credit (ERC) claims will get another chance to correct their mistake and avoid costly repercussions.

The voluntary disclosure program (VDP) – initially introduced by the IRS in late 2023 and ended in March 2024 – is back to give businesses owners another chance to repay unearned ERC money. The IRS program’s newest run will end November 22, according to IRS Announcement 2024-30.

While the updated terms of the VDP aren’t as favorable this time around, they still could save businesses from future audits, interest, and fees. Businesses will be allowed to repay 85% of their ERC credits instead of the full amount. The first round of the VDP offered a 20% discount, and it resulted in more than 2,600 applications and about $1.09 billion in returned ERC money.

Under terms of the VDP, participating businesses will not be charged penalties or interest on credits repaid on time. However, missed payment deadlines could lead to an installment agreement that may include penalties.

The IRS said it will send letters to about 30,000 businesses whose ERC credits might have been received improperly, many of them the result of dubious marketing tactics by tax preparers and firms that misled businesses into filing claims that didn’t meet IRS requirements. Businesses that qualify for the program will be required to provide the name and contact information for the adviser or consultant who assisted them with the ERC claim.

The ERC was designed to help businesses during the COVID-19 pandemic and was available from early 2020 to late 2021.

© 2024 KraftCPAs PLLC