Tax-favored Ways to Build up a College Fund

If you’re a parent with a college-bound child, you may be concerned about being able to fund future tuition and other higher education costs. You want to take maximum advantage of tax benefits to minimize your expenses. Here are some possible options.

Savings bonds

Series EE U.S. savings bonds offer two tax-saving opportunities for eligible families when used to finance college:

You don’t have to report the interest on the bonds for federal tax purposes until the bonds are cashed in, and
Interest on “qualified” Series EE (and Series I) bonds may be exempt from federal tax if the bond proceeds are used for qualified education expenses.

To qualify for the tax exemption for college use, you must purchase the bonds in your name (not the child’s) or jointly with your spouse. The proceeds must be used for tuition, fees and certain other expenses — not room and board. If only part of the proceeds is used for qualified expenses, only that part of the interest is exempt.

The exemption is phased out if your adjusted gross income (AGI) exceeds certain amounts.

529 plans

A qualified tuition program (also known as a 529 plan) allows you to buy tuition credits for a child or make contributions to an account set up to meet a child’s future higher education expenses. Qualified tuition programs are established by state governments or private education institutions.

Contributions aren’t deductible. The contributions are treated as taxable gifts to the child, but they’re eligible for the annual gift tax exclusion ($15,000 for 2021). A donor who contributes more than the annual exclusion limit for the year can elect to treat the gift as if it were spread out over a five-year period.

The earnings on the contributions accumulate tax-free until college costs are paid from the funds. Distributions from 529 plans are tax-free to the extent the funds are used to pay “qualified higher education expenses.” Distributions of earnings that aren’t used for qualified expenses will be subject to income tax plus a 10% penalty tax.

Coverdell education savings accounts (ESAs)

You can establish a Coverdell ESA and make contributions of up to $2,000 annually for each child under age 18.

The right to make contributions begins to phase out once your AGI is over a certain amount. If the income limitation is a problem, a child can contribute to his or her own account.

Although the contributions aren’t deductible, income in the account isn’t taxed, and distributions are tax-free if used on qualified education expenses. If the child doesn’t attend college, the money must be withdrawn when he or she turns 30, and any earnings will be subject to tax and penalty. But unused funds can be transferred tax-free to a Coverdell ESA of another member of the child’s family who hasn’t reached age 30. (Some ESA requirements don’t apply to individuals with special needs.)

Plan ahead

These are just some of the tax-favored ways to build up a college fund for your children. Once your child is in college, you may qualify for tax breaks such as the American Opportunity Tax Credit or the Lifetime Learning Credit. Contact us if you’d like to discuss any of the options.

Here are some of the key tax-related deadlines affecting businesses and other employers during the third quarter of 2021. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

Monday, August 2

Employers report income tax withholding and FICA taxes for second quarter 2021 (Form 941) and pay any tax due.
Employers file a 2020 calendar-year retirement plan report (Form 5500 or Form 5500-EZ) or request an extension.

Tuesday, August 10

Employers report income tax withholding and FICA taxes for second quarter 2021 (Form 941), if you deposited all associated taxes that were due in full and on time.

Wednesday, September 15

Individuals pay the third installment of 2021 estimated taxes, if not paying income tax through withholding (Form 1040-ES).
If a calendar-year corporation, pay the third installment of 2021 estimated income taxes.
If a calendar-year S corporation or partnership that filed an automatic extension:
- File a 2020 income tax return (Form 1120S, Form 1065 or Form 1065-B) and pay any tax, interest and penalties due.
- Make contributions for 2020 to certain employer-sponsored retirement plans.

Episode 12: Single Audits for Government Entities

Welcome to Everyday Business, Yeo & Yeo’s podcast. We’ve had the privilege of advising Michigan businesses for more than 95 years, and we want to share our knowledge with you.

Covering tax, accounting, technology, financial and advisory topics relevant to you and your business, Yeo & Yeo’s podcast is hosted by industry and subject matter professionals, where we go beyond the beans.

On episode 12 of Everyday Business, host Alan Panter, principal and member of Yeo & Yeo’s Government Services Group, is joined by Jamie Rivette, principal and leader of the Government Services Group.

Listen in as Alan and Jamie discuss single audits for government entities in the first of our two-part podcast series focusing on auditing and accounting for government entities.

What is a Single Audit, and how do I determine if one is required? How should the federal dollars be reported in the financial statements? (1:20)
Who is responsible for preparing the SEFA? (3:42)
Which grants should be included in the SEFA and which should not? (4:08)
What else do I need to prepare? (4:53)
Which items will the auditor want to test in the SEFA? (6:30)
Which programs will the auditors select for testing? (8:20)
Who sets compliance requirements, and how will I know which areas will be tested? (10:00)
What else should I pay attention to? (11:20)

Thank you for tuning in to Yeo & Yeo’s Everyday Business Podcast. Yeo & Yeo’s podcast can be heard on Apple Podcasts, PodBean and, of course, our website. Please subscribe, rate and review.

For more business insights, visit our Resource Center and subscribe to our eNewsletters.

Listen to our second episode in this two-part series: Episode 13: Michigan Uniform Chart of Accounts for Local Government

DISCLAIMER
The information provided in this podcast is believed to be valid and accurate on the date it was first published. The views, information, or opinions expressed during the podcast reflect the views of the speakers. This podcast does not constitute tax, accounting, legal or other business advice or an advisor-client relationship. Before making any decision or taking action, consult with a professional regarding your specific circumstances.

In today’s unprecedented market conditions, it can be challenging to predict metrics that underlie your company’s accounting estimates. Examples of key “unknowns” include how much longer certain pandemic issues will continue, how federal stimulus spending will affect the economy over the long run, and the extent to which tax laws and environment regulations may change under the Biden administration.

Your predictions on these matters could, in turn, have a material impact on your company’s financial statements. Inaccurate predictions could lead to restatements or write-offs in future periods.

Relying on estimates

Accounting estimates may be based on subjective or objective information (or both) and involve some level of measurement uncertainty. Some estimates may be easily determinable, but many are inherently subjective or complex. Examples of accounting estimates include allowances for doubtful accounts, work-in-progress inventory and uncertain tax positions.

Fair value measurements are another type of accounting estimate. Under U.S. Generally Accepted Accounting Principles (GAAP), a fair value measurement represents “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Fair value is the basis for recording assets and liabilities in a business combination and measuring impairment of long-lived assets, goodwill and other intangible assets.

Auditing estimates

Accounting estimates involve a high degree of subjectivity and judgment and may be susceptible to misstatement. Therefore, they require more auditor focus.

Auditing standards generally provide three approaches for substantively testing accounting estimates and fair value measurements. During fieldwork, the auditor selects one or a combination of these approaches:

1.Testing management’s process. Auditors evaluate the reasonableness and consistency of management’s assumptions, as well as test whether the underlying data is complete, accurate and relevant.

2.Developing an independent estimate. Using management’s assumptions (or alternative assumptions), auditors come up with estimates to compare to what’s reported on the internally prepared financial statements.

3.Reviewing subsequent events or transactions. The reasonableness of estimates can be gauged by looking at events or transactions that happen after the balance sheet date but before the date of the auditor’s report.

Eye on estimates

Expect your auditors to give extra attention to your accounting estimates this year. For example, they may ask more in-depth questions or perform additional testing procedures. Some items may require a different measurement technique than you’ve used in the past. Before audit season begins, contact us for help making estimates, based on market research and the use of specialists, that will withstand scrutiny.

If you’re getting ready to retire, you’ll soon experience changes in your lifestyle and income sources that may have numerous tax implications.

Here’s a brief rundown of four tax and financial issues you may deal with when you retire:

Taking required minimum distributions. This is the minimum amount you must withdraw from your retirement accounts. You generally must start taking withdrawals from your IRA, SEP, SIMPLE and other retirement plan accounts when you reach age 72 (70½ before January 1, 2020). Roth IRAs don’t require withdrawals until after the death of the owner.

You can withdraw more than the minimum required amount. Your withdrawals will be included in your taxable income except for any part that was taxed before or that can be received tax-free (such as qualified distributions from Roth accounts).

Selling your principal residence. Many retirees want to downsize to smaller homes. If you’re one of them and you have a gain from the sale of your principal residence, you may be able to exclude up to $250,000 of that gain from your income. If you file a joint return, you may be able to exclude up to $500,000.

To claim the exclusion, you must meet certain requirements. During a five-year period ending on the date of the sale, you must have owned the home and lived in it as your main home for at least two years.

If you’re thinking of selling your home, make sure you’ve identified all items that should be included in its basis, which can save you tax.

Engaging in new work activities. After retirement, many people continue to work as consultants or start new businesses. Here are some tax-related questions to ask:

Should the business be a sole proprietorship, S corporation, C corporation, partnership or limited liability company?
Are you familiar with how to elect to amortize start-up expenditures and make payroll tax deposits?
What expenses can you deduct and can you claim home office deductions?
How should you finance the business?

Taking Social Security benefits. If you continue to work, it may have an impact on your Social Security benefits. If you retire before reaching full Social Security retirement age (65 years of age for people born before 1938, rising to 67 years of age for people born after 1959) and the sum of your wages plus self-employment income is over the Social Security annual exempt amount ($18,960 for 2021), you must give back $1 of Social Security benefits for each $2 of excess earnings.

If you reach full retirement age this year, your benefits will be reduced $1 for every $3 you earn over a different annual limit ($50,520 in 2021) until the month you reach full retirement age. Then, your earnings will no longer affect the amount of your monthly benefits, no matter how much you earn.

Speaking of Social Security, you may have to pay federal (and possibly state) tax on your benefits. Depending on how much income you have from other sources, you may have to report up to 85% of your benefits as income on your tax return and pay the resulting federal income tax.

Many decisions

As you can see, tax planning is still important after you retire. We can help maximize the tax breaks you’re entitled to so you can keep more of your hard-earned money.

If you’re claiming deductions for business meals or auto expenses, expect the IRS to closely review them. In some cases, taxpayers have incomplete documentation or try to create records months (or years) later. In doing so, they fail to meet the strict substantiation requirements set forth under tax law. Tax auditors are adept at rooting out inconsistencies, omissions and errors in taxpayers’ records, as illustrated by one recent U.S. Tax Court case.

Facts of the case

In the case, the taxpayer ran a notary and paralegal business. She deducted business meals and vehicle expenses that she allegedly incurred in connection with her business.

The deductions were denied by the IRS and the court. Tax law “establishes higher substantiation requirements” for these and certain other expenses, the court noted. No deduction is generally allowed “unless the taxpayer substantiates the amount, time and place, business purpose, and business relationship to the taxpayer of the person receiving the benefit” for each expense with adequate records or sufficient evidence.

The taxpayer in this case didn’t provide adequate records or other sufficient evidence to prove the business purpose of her meal expenses. She gave vague testimony that she deducted expenses for meals where she “talked strategies” with people who “wanted her to do some work.” The court found this was insufficient to show the connection between the meals and her business.

When it came to the taxpayer’s vehicle expense deductions, she failed to offer credible evidence showing where she drove her vehicle, the purpose of each trip and her business relationship to the places visited. She also conceded that she used her car for both business and personal activities. (TC Memo 2021-50)

Best practices for business expenses

This case is an example of why it’s critical to maintain meticulous records to support business expenses for meals and vehicle deductions. Here’s a list of “DOs and DON’Ts” to help meet the strict IRS and tax law substantiation requirements for these items:

DO keep detailed, accurate records. For each expense, record the amount, the time and place, the business purpose, and the business relationship of any person to whom you provided a meal. If you have employees who you reimburse for meals and auto expenses, make sure they’re complying with all the rules.

DON’T reconstruct expense logs at year end or wait until you receive a notice from the IRS. Take a moment to record the details in a log or diary or on a receipt at the time of the event or soon after. Require employees to submit monthly expense reports.

DO respect the fine line between personal and business expenses. Be careful about combining business and pleasure. Your business checking account shouldn’t be used for personal expenses.

DON’T be surprised if the IRS asks you to prove your deductions. Meal and auto expenses are a magnet for attention. Be prepared for a challenge.

With organization and guidance from us, your tax records can stand up to scrutiny from the IRS. There may be ways to substantiate your deductions that you haven’t thought of, and there may be a way to estimate certain deductions (“the Cohan rule”), if your records are lost due to a fire, theft, flood or other disaster.

Working capital equals the difference between current assets and current liabilities. Organizations need a certain amount of working capital to run their operations smoothly. The optimal (or “target”) amount of working capital depends on the nature of operations and the industry. Inefficient working capital management can hinder growth and performance.

Benchmarks

The term “liquidity” refers to how quickly an item can be converted to cash. In general, receivables are considered more liquid than inventory. Working capital is often evaluated using the following liquidity metrics:

Current ratio. This is computed by dividing current assets by current liabilities. A current ratio of at least 1.0 means that the company has enough current assets on hand to cover liabilities that are due within 12 months.

Quick (or acid-test) ratio. This is a more conservative liquidity benchmark. It typically excludes prepaid assets and inventory from the calculation.

An alternative perspective on working capital is to compare it to total assets and annual revenues. From this angle, working capital becomes a measure of operating efficiency. Excessive amounts of cash tied up in working capital detract from other spending options, such as expanding to new markets, buying equipment and paying down debt.

Best practices

High liquidity generally equates with low financial risk. However, you can have too much of a good thing. If working capital is trending upward from year to year — or it’s significantly higher than your competitors — it may be time to take proactive measures to speed up cash inflows and delay cash outflows.

Lean operations require taking a closer look at each component of working capital and implementing these best practices:

1. Put cash to good use. Excessive cash balances encourage management to become complacent about working capital. If your organization has plenty of money in its checkbook, you might be less hungry to collect receivables and less disciplined when ordering inventory.

2. Expedite collections. Organizations that sell on credit effectively finance their customers’ operations. Stale receivables — typically any balance over 45 or 60 days outstanding, depending on the industry — are a red flag of inefficient working capital management.

Getting a handle on receivables starts by evaluating which items should be written off as bad debts. Then viable balances need to be “talked in the door” as soon as possible. Enhanced collections efforts might include early bird discounts, electronic invoices and collections-based sales compensation programs.

3. Carry less inventory. Inventory represents a huge investment for manufacturers, distributors, retailers and contractors. It’s also difficult to track and value. Enhanced forecasting and data sharing with suppliers can reduce the need for safety stock and result in smarter ordering practices. Computerized technology — such as barcodes, radio frequency identification and enterprise resource planning tools — also improve inventory tracking and ordering practices.

4. Postpone payments. Credit terms should be extended as long as possible — without losing out on early bird discounts. If you can stretch your organization’s average days in payables from, say, 45 to 60 days, it trains vendors and suppliers to accept the new terms, particularly if you’re a predictable, reliable payor.

Prioritize working capital

Some organizations are so focused on the income statement, including revenue and profits, that they lose sight of the strategic significance of the balance sheet — especially working capital accounts. We can benchmark your organization’s liquidity and asset efficiency over time and against competitors. If necessary, we also can help implement strategies to improve your performance, without exposing you to unnecessary risk.

For many business owners, putting together a succession plan may seem like an overwhelming task. It might even seem unnecessary for those who are relatively young and have no intention of giving up ownership anytime soon.

But if the past year or so have taught us anything, it’s that anything can happen. Owners who’ve built up considerable “sweat equity” in their companies shouldn’t risk liquidation or seeing the business end up in someone else’s hands only because there’s no succession plan in place.

Variations on a theme

To help you get your arms around the concept of succession planning, you can look at it from three different perspectives:

1. The long view. If you have many years to work with, use this gift of time to identify one or more talented individuals who share your values and have the aptitude to successfully run the company. This is especially important for keeping a family-owned business in the family.

As soon as you’ve identified a successor, and he or she is ready, you can begin mentoring the incoming leader to competently run the company and preserve your legacy. Meanwhile, you can carefully identify how to best fund your retirement and structure your estate plan.

2. An imminent horizon. Many business owners wake up one day and realize that they’re almost ready to retire, or move on to another professional endeavor, but they’ve spent little or no time putting together a succession plan. In such a case, you may still be able to choose and train a successor. However, you’ll likely also want to explore alternatives such as selling the company to a competitor or other buyer. Sometimes even liquidation is the optimal move financially.

In any case, the objective here is less about maintaining the strategic direction of the company and more about ensuring you receive an equitable payout for your ownership share. If you’re a co-owner, a buy-sell agreement is highly advisable. It’s also critical to set a firm departure date and work with a qualified team of advisors.

3. A sudden emergency. The COVID-19 pandemic has brought renewed attention to emergency succession planning. True to its name, this approach emphasizes enabling the business to maintain operations immediately after an unforeseen event causes the owner’s death or disability.

If your company doesn’t yet have an emergency succession plan, you should probably create one before you move on to a longer-term plan. Name someone who can take on a credible leadership role if you become seriously ill or injured. Formulate a plan for communicating and delegating duties during a crisis. Make sure everyone knows about the emergency succession plan and how it will affect day-to-day operations, if executed.

Create the future

As with any important task, the more time you give yourself to create a succession plan, the fewer mistakes or oversights you’re likely to make. Our firm can help you create or refine a plan that suits your financial needs, personal wishes and vision for the future of your company.

High-income taxpayers face a 3.8% net investment income tax (NIIT) that’s imposed in addition to regular income tax. Fortunately, there are some steps you may be able to take to reduce its impact.

The NIIT applies to you only if modified adjusted gross income (MAGI) exceeds:

$250,000 for married taxpayers filing jointly and surviving spouses,
$125,000 for married taxpayers filing separately,
$200,000 for unmarried taxpayers and heads of household.

The amount subject to the tax is the lesser of your net investment income or the amount by which your MAGI exceeds the threshold ($250,000, $200,000, or $125,000) that applies to you.

Net investment income includes interest, dividend, annuity, royalty, and rental income, unless those items were derived in the ordinary course of an active trade or business. In addition, other gross income from a trade or business that’s a passive activity is subject to the NIIT, as is income from a business trading in financial instruments or commodities.

There are many types of income that are exempt from the NIIT. For example, tax-exempt interest and the excluded gain from the sale of your main home aren’t subject to the tax. Distributions from qualified retirement plans aren’t subject to the NIIT. Wages and self-employment income also aren’t subject to the NIIT, though they may be subject to a different Medicare surtax.

It’s important to remember the NIIT applies only if you have net investment income and your MAGI exceeds the applicable thresholds above. But by following strategies, you may be able to minimize net investment income.

Investment choices

If your income is high enough to trigger the NIIT, shifting some income investments to tax-exempt bonds could result in less exposure to the tax. Tax-exempt bonds lower your MAGI and avoid the NIIT.

Dividend-paying stocks are taxed more heavily as a result of the NIIT. The maximum income tax rate on qualified dividends is 20%, but the rate becomes 23.8% with the NIIT.

As a result, you may want to consider rebalancing your investment portfolio to emphasize growth stocks over dividend-paying stocks. While the capital gain from these investments will be included in net investment income, there are two potential benefits: 1) the tax will be deferred because the capital gain won’t be subject to the NIIT until the stock is sold and 2) capital gains can be offset by capital losses, which isn’t the case with dividends.

Qualified plans

Because distributions from qualified retirement plans are exempt from the NIIT, upper-income taxpayers with some control over their situations (such as small business owners) might want to make greater use of qualified plans.

These are only a couple of strategies you may be able to employ. You also may be able to make moves related to charitable donations, passive activities and rental income that may allow you to minimize the NIIT. If you’re subject to the tax, you should include it in your tax planning. Consult with us for tax-planning strategies.

If you’re a business owner and you hire your children this summer, you can obtain tax breaks and other nontax benefits. The kids can gain on-the-job experience, spend time with you, save for college and learn how to manage money. And you may be able to:

Shift your high-taxed income into tax-free or low-taxed income,
Realize payroll tax savings (depending on the child’s age and how your business is organized), and
Enable retirement plan contributions for the children.

A legitimate job

If you hire your child, you get a business tax deduction for employee wage expenses. In turn, the deduction reduces your federal income tax bill, your self-employment tax bill (if applicable), and your state income tax bill (if applicable). However, in order for your business to deduct the wages as a business expense, the work performed by the child must be legitimate and the child’s salary must be reasonable.

For example, let’s say you operate as a sole proprietor and you’re in the 37% tax bracket. You hire your 16-year-old daughter to help with office work on a full-time basis during the summer and part-time into the fall. Your daughter earns $10,000 during 2021 and doesn’t have any other earnings.

You save $3,700 (37% of $10,000) in income taxes at no tax cost to your daughter, who can use her 2021 $12,550 standard deduction to completely shelter her earnings.

Your family’s taxes are cut even if your daughter’s earnings exceed her standard deduction. Why? The unsheltered earnings will be taxed to the daughter beginning at a rate of 10%, instead of being taxed at your higher rate.

How payroll taxes might be saved

If your business isn’t incorporated, your child’s wages are exempt from Social Security, Medicare and FUTA taxes if certain conditions are met. Your child must be under age 18 for this to apply (or under age 21 in the case of the FUTA tax exemption). Contact us for how this works.

Be aware that there’s no FICA or FUTA exemption for employing a child if your business is incorporated or a partnership that includes nonparent partners. And payments for the services of your child are subject to income tax withholding, regardless of age, no matter what type of entity you operate.

Begin saving for retirement

Your business also may be able to provide your child with retirement benefits, depending on the type of plan you have and how it defines qualifying employees. And because your child has earnings from his or her job, he can contribute to a traditional IRA or Roth IRA and begin to build a nest egg. For the 2021 tax year, a working child can contribute the lesser of his or her earned income, or $6,000, to an IRA or a Roth.

Keep accurate records

As you can see, hiring your child can be a tax-smart idea. Be sure to keep the same records as you would for other employees to substantiate the hours worked and duties performed (such as timesheets and job descriptions). Issue your child a Form W-2. Contact us if you have questions about how these rules apply to your situation.

Eligible parents will soon begin receiving payments from the federal government. The IRS announced that the 2021 advance child tax credit (CTC) payments, which were created in the American Rescue Plan Act (ARPA), will begin being made on July 15, 2021.

How have child tax credits changed?

The ARPA temporarily expanded and made CTCs refundable for 2021. The law increased the maximum CTC — for 2021 only — to $3,600 for each qualifying child under age 6 and to $3,000 per child for children ages 6 to 17, provided their parents’ income is below a certain threshold.

Advance payments will receive up to $300 monthly for each child under 6, and up to $250 monthly for each child 6 and older. The increased credit amount will be reduced or phased out, for households with modified adjusted gross income above the following thresholds:

$150,000 for married taxpayers filing jointly and qualifying widows and widowers;
$112,500 for heads of household; and
$75,000 for other taxpayers.

Under prior law, the maximum annual CTC for 2018 through 2025 was $2,000 per qualifying child but the income thresholds were higher and some of the qualification rules were different.

Important: If your income is too high to receive the increased advance CTC payments, you may still qualify to claim the $2,000 CTC on your tax return for 2021.

What is a qualifying child?

For 2021, a “qualifying child” with respect to a taxpayer is defined as one who is under age 18 and who the taxpayer can claim as a dependent. That means a child related to the taxpayer who, generally, lived with the taxpayer for at least six months during the year. The child also must be a U.S. citizen or national or a U.S. resident.

How and when will advance payments be sent out?

Under the ARPA, the IRS is required to establish a program to make periodic advance payments which in total equal 50% of IRS’s estimate of the eligible taxpayer’s 2021 CTCs, during the period July 2021 through December 2021. The payments will begin on July 15, 2021. After that, they’ll be made on the 15th of each month unless the 15th falls on a weekend or holiday. Parents will receive the monthly payments through direct deposit, paper check or debit card.

Who will benefit from these payments and do they have to do anything to receive them?

According to the IRS, about 39 million households covering 88% of children in the U.S. “are slated to begin receiving monthly payments without any further action required.” Contact us if you have questions about the child tax credit.

The IRS recently released guidance providing the 2022 inflation-adjusted amounts for Health Savings Accounts (HSAs).

Fundamentals of HSAs

An HSA is a trust created or organized exclusively for the purpose of paying the “qualified medical expenses” of an “account beneficiary.” An HSA can only be established for the benefit of an “eligible individual” who is covered under a “high deductible health plan.” In addition, a participant can’t be enrolled in Medicare or have other health coverage (exceptions include dental, vision, long-term care, accident and specific disease insurance).

A high deductible health plan (HDHP) is generally a plan with an annual deductible that isn’t less than $1,000 for self-only coverage and $2,000 for family coverage. In addition, the sum of the annual deductible and other annual out-of-pocket expenses required to be paid under the plan for covered benefits (but not for premiums) can’t exceed $5,000 for self-only coverage, and $10,000 for family coverage.

Within specified dollar limits, an above-the-line tax deduction is allowed for an individual’s contribution to an HSA. This annual contribution limitation and the annual deductible and out-of-pocket expenses under the tax code are adjusted annually for inflation.

Inflation adjustments for next year

In Revenue Procedure 2021-25, the IRS released the 2022 inflation-adjusted figures for contributions to HSAs, which are as follows:

Annual contribution limitation. For calendar year 2022, the annual contribution limitation for an individual with self-only coverage under a HDHP will be $3,650. For an individual with family coverage, the amount will be $7,300. This is up from $3,600 and $7,200, respectively, for 2021.

High deductible health plan defined. For calendar year 2022, an HDHP will be a health plan with an annual deductible that isn’t less than $1,400 for self-only coverage or $2,800 for family coverage (these amounts are unchanged from 2021). In addition, annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) won’t be able to exceed $7,050 for self-only coverage or $14,100 for family coverage (up from $7,000 and $14,000, respectively, for 2021).

Many advantages

There are a variety of benefits to HSAs. Contributions to the accounts are made on a pre-tax basis. The money can accumulate tax free year after year and be can be withdrawn tax free to pay for a variety of medical expenses such as doctor visits, prescriptions, chiropractic care and premiums for long-term care insurance. In addition, an HSA is “portable.” It stays with an account holder if he or she changes employers or leaves the workforce. If you have questions about HSAs at your business, contact your employee benefits and tax advisors.

Strategic investments — such as expanding a plant, purchasing a major piece of equipment or introducing a new product line — can add long-term value. But management shouldn’t base these decisions on gut instinct. A comprehensive, formal analysis can help minimize the guesswork and maximize your return on investment.

Forecasting cash flows

Financial forecasts typically start with the most recent income statement. Then assumptions are made about 1) how much revenue (or cost savings) will the project generate, and 2) what incremental expenses will the project incur. In some cases, a project may create special tax savings (for example, first-year bonus depreciation or Section 179 deductions) that may need to be factored into the decision.

Strategic investments will also affect your company’s balance sheet and statements of cash flows. For example, they may require additional working capital and fixed assets. Preparing comprehensive financial forecasts helps management evaluate how much cash the project will need each period and whether internal resources will be sufficient to finance it. Some projects will require the company to tap into the company’s line of credit — or require additional loans or capital contributions.

Comparing investment alternatives

Company resources are limited. So, once cash flows have been forecasted, it’s time to analyze the results and prioritize competing investment alternatives. For example, you might have $50,000 to invest in either a new machine or IT upgrades. Which alternative is better from a financial perspective?

Three financial tools that are used to evaluate such decisions include:

1. Accounting payback period. This tells you how long it will take for a project to recoup its initial investment and start generating positive net cash flow — without considering the time value of money. For example, suppose a new machine that costs $48,000 is expected to generate $12,000 of incremental cash flow annually. Its accounting payback period would be four years ($48,000 divided by $12,000).

2. Net present value (NPV). This is a tool that discounts each period’s forecasted cash flow into its present value. The sum of the present values for all the periods equals the project’s NPV. If NPV is greater than zero, the project will generate positive cash flow and it’s worth considering. If not, the project may not be worthwhile. Typically, management uses the company’s cost of capital — or possibly a rate based on the risk of the investment — to discount forecasted cash flow.

3. Internal rate of return (IRR). This tool estimates a project’s expected return on investment. This is the point at which a project’s NPV equals zero. Management typically has a preset hurdle rate that a project must exceed to be considered. For example, if management sets its hurdle rate at 13%, any project with an IRR below 13% will be on the chopping block.

These financial tools may sometimes conflict with one another. So, it’s important to consider qualitative factors, too. For example, IT upgrades might also protect against cyberattacks and reputational harm, which may be difficult to quantify in financial forecasts.

Need help?

Contact us to evaluate the quantitative and qualitative effects of strategic investment alternatives. We can help determine what’s right for your situation.

The Internal Revenue Service (IRS) has provided guidance on tax breaks under the American Rescue Plan Act of 2021 for continuation health coverage under COBRA while also updating Form 7200 for advance payment of employer credits due to COVID-19.

IRS Notice 2021-31 guides employers, plan administrators, and health insurers regarding the new credit available to them for providing continuation health coverage to certain individuals under COBRA.

The American Rescue Plan provides a temporary 100% reduction in the premium that individuals would have to pay when they elect COBRA continuation health coverage following a reduction in hours or involuntary termination of employment. The new law provides a corresponding tax credit for the entities that maintain group health plans, such as employers, multiemployer plans, and insurers. The 100% reduction in the premium and the credit are also available concerning continuation coverage provided for those events under comparable state laws.

Notice 2021-31 provides information regarding the credit calculation, the eligibility of individuals, the premium assistance period, and other information vital to employers, plan administrators, and insurers to understand the credit.

COBRA provides certain former employees, retirees, spouses, former spouses, and dependent children the right to temporary continuation of health coverage at group rates. COBRA generally covers health plans maintained by private-sector employers with 20 or more full and part-time employees. It also covers employee organizations or federal, state, or local governments. State mini-COBRA laws often provide similar benefits for insured small employers not subject to federal COBRA.

Employers, even those with insured coverage, will have to cover the cost of the premium and request a rebate from the federal government. The IRS has also released Form 7200 and its instructions, which provide additional details on how to request the rebate. The IRS will continue to update information related to health plans on IRS.gov. Find more information about Form 7200 here:

Contact us with questions about COBRA coverage and completing Form 7200.

If your business is organized as a sole proprietorship or as a wholly-owned limited liability company (LLC), you’re subject to both income tax and self-employment tax. There may be a way to cut your tax bill by conducting business as an S corporation.

Fundamentals of self-employment tax

The self-employment tax is imposed on 92.35% of self-employment income at a 12.4% rate for Social Security up to a certain maximum ($142,800 for 2021) and at a 2.9% rate for Medicare. No maximum tax limit applies to the Medicare tax. An additional 0.9% Medicare tax is imposed on income exceeding $250,000 for married couples ($125,000 for married persons filing separately) and $200,000 in all other cases.

What if you conduct your business as a partnership in which you’re a general partner? In that case, in addition to income tax, you’re subject to the self-employment tax on your distributive share of the partnership’s income. On the other hand, if you conduct your business as an S corporation, you’ll be subject to income tax, but not self-employment tax, on your share of the S corporation’s income.

An S corporation isn’t subject to tax at the corporate level. Instead, the corporation’s items of income, gain, loss and deduction are passed through to the shareholders. However, the income passed through to the shareholder isn’t treated as self-employment income. Thus, by using an S corporation, you may be able to avoid self-employment income tax.

Keep your salary “reasonable”

Be aware that the IRS requires that the S corporation pay you reasonable compensation for your services to the business. The compensation is treated as wages subject to employment tax (split evenly between the company and the employee), which is equivalent to the self-employment tax. If the S corporation doesn’t pay you reasonable compensation for your services, the IRS may treat a portion of the S corporation’s distributions to you as wages and impose Social Security and Medicare taxes on the amount it considers wages.

There’s no simple formula regarding what’s considered reasonable compensation. Presumably, reasonable compensation is the amount that unrelated employers would pay for comparable services under similar circumstances. There are many factors that should be taken into account in making this determination.

Converting from a C corporation

There may be complications if you convert a C corporation to an S corporation. A “built-in gains tax” may apply when you dispose of appreciated assets held by the C corporation at the time of the conversion. However, there may be ways to minimize its impact.

Many factors to consider

Contact us if you’d like to discuss the factors involved in conducting your business as an S corporation, and how much the business should pay you as compensation.

Even after your 2020 tax return has been successfully filed with the IRS, you may still have some questions about the return. Here are brief answers to three questions that we’re frequently asked at this time of year.

Are you wondering when you will receive your refund?

The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Get Your Refund Status.” You’ll need your Social Security number, filing status and the exact refund amount.

Which tax records can you throw away now?

At a minimum, keep tax records related to your return for as long as the IRS can audit your return or assess additional taxes. In general, the statute of limitations is three years after you file your return. So you can generally get rid of most records related to tax returns for 2017 and earlier years. (If you filed an extension for your 2017 return, hold on to your records until at least three years from when you filed the extended return.)

However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.

You should hang on to certain tax-related records longer. For example, keep the actual tax returns indefinitely, so you can prove to the IRS that you filed legitimate returns. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)

When it comes to retirement accounts, keep records associated with them until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset, plus at least three years after you sell it and report the sale on your tax return. (You can keep these records for six years if you want to be extra safe.)

If you overlooked claiming a tax break, can you still collect a refund for it?

In general, you can file an amended tax return and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later.

However, there are a few opportunities when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.

Year-round tax help

Contact us if you have questions about retaining tax records, receiving your refund or filing an amended return. We’re not just here at tax filing time. We’re available all year long.

WASHINGTON – The Internal Revenue Service and the U.S. Department of the Treasury announced today that the first monthly payment of the expanded and newly-advanceable Child Tax Credit (CTC) from the American Rescue Plan will be made on July 15. Roughly 39 million households—covering 88% of children in the United States—are slated to begin receiving monthly payments without any further action required.

IRS and Treasury also announced the increased CTC payments will be made on the 15^th of each month unless the 15^th falls on a weekend or holiday. Families who receive the credit by direct deposit can plan their budgets around receipt of the benefit. Eligible families will receive a payment of up to $300 per month for each child under age 6 and up to $250 per month for each child age 6 and above.

The American Rescue Plan increased the maximum Child Tax Credit in 2021 to $3,600 for children under the age of 6 and to $3,000 per child for children between ages 6 and 17. The American Rescue Plan is projected to lift more than five million children out of poverty this year, cutting child poverty by more than half.

Households covering more than 65 million children will receive the monthly CTC payments through direct deposit, paper check, or debit cards, and IRS and Treasury are committed to maximizing the use of direct deposit to ensure fast and secure delivery. While most taxpayers will not be required to take any action to receive their payments, Treasury and the IRS will continue outreach efforts with partner organizations over the coming months to make more families aware of their eligibility.

Today’s announcement represents the latest collaboration between the IRS and Bureau of the Fiscal Service—and between Treasury and the White House American Rescue Plan Implementation Team—to ensure help quickly reaches Americans in need as they recover from the COVID-19 pandemic. Since March 12, the IRS has also distributed approximately 165 million Economic Impact Payments with a value of approximately $388 billion as a part of the American Rescue Plan.

Additional information for taxpayers on how they can access the Child Tax Credit will be available soon on at IRS.gov/childtaxcredit2021.

In recent years, the accounting rules for certain balance sheet items have transitioned from historical cost to “fair value.” Examples of assets that may currently be reported at fair value are asset retirement obligations, derivatives and intangible assets acquired in a business combination. Though fair value may better align your company’s financial statements with today’s market values, estimating fair value may require subjective judgment.

GAAP definition

Under U.S. Generally Accepted Accounting Principles (GAAP), fair value is “the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.” Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures, explains how companies should estimate the fair value of assets and liabilities by using available, quantifiable market-based data.

Topic 820 provides the following three-tier valuation hierarchy for valuation inputs:

Quoted prices in active markets for identical assets or liabilities,
Information based on publicly quoted prices, including older prices from inactive markets and prices of comparable stocks, and
Nonpublic information and management’s estimates.

Fair value measurements, especially those based on the third level of inputs, may involve a high degree of subjectivity, making them susceptible to misstatement. Therefore, these estimates usually require more auditor focus.

Auditing estimates

Auditing standards generally require auditors to select one or a combination of the following approaches to substantively test fair value measurements:

Test management’s process. Auditors evaluate the reasonableness and consistency of management’s assumptions, as well as test whether the underlying data is complete, accurate and relevant.

Develop an independent estimate. Using management’s assumptions (or alternate assumptions), auditors come up with an estimate to compare to what’s reported on the internally prepared financial statements.

Review subsequent events or transactions. The reasonableness of fair value estimates can be gauged by looking at events or transactions that happen after the balance sheet date but before the date of the auditor’s report.

Outside input

Measuring fair value is outside the comfort zone of most in-house accounting personnel. Fortunately, an outside valuation expert can provide objective, market-based evidence to support the fair value of assets and liabilities. Contact us for more information.

“Sales tax” is a phrase that fills many nonprofits with dread, especially when they try to determine whether or not to collect or remit it. The rules last changed in 2018. However, in December 2020, the Michigan Department of Treasury issued Revenue Administrative Bulletin (RAB) 2020-25, without any fanfare, which “clarifies” some things that may change how nonprofits operate.

Exemption for the first $10,000 of sales

Fundraising sales tend to be the biggest sales tax question in the nonprofit world. In Michigan, 501(c)(3), (4), and (19) have some leeway with fundraising sales. Those entities with total sales at retail of $25,000 or less can claim exemption from sales tax on the first $10,000 of sales. The exemption does not apply if the nonprofit already specifically collected the sales tax; all sales tax collected must be remitted. But if the nonprofit was going to do algebra to determine what amount of the gross price was sales tax versus sales price, they do not need to remit taxes on the first $10,000 as long as they keep total sales at retail below $25,000. Once $25,000 is met, all retail sales are taxable (subject to standard sales tax rules).

New developments – who carries the risk?

This RAB goes on to explain several nuances that may be different from how things have operated in the past. The RAB gives several examples where a nonprofit (a school in the example, but it could be any 501(c)(3), or (4)) purchases goods from a for-profit to sell for fundraising purposes. Whether or not these sales are considered sales at retail for the nonprofit or the for-profit is dependent on the entity bearing the risk. If the nonprofit simply takes orders on the front end (through the nonprofit itself or volunteers, including students) and then uses the orders to purchase the fundraising items from the for-profit, the nonprofit has no risk. In that case, the for-profit is the one making the sale because the for-profit is fulfilling the orders. Yes, the school pays the for-profit, but there is no risk to the nonprofit since they only ordered what they had sold. The for-profit must collect and remit the sales tax on the transaction; the nonprofit does not remit sales tax on the transaction.

If instead the nonprofit purchases the goods first, and after purchasing the goods enlists volunteers to sell them, now the nonprofit bears the risk that they may not sell all the items. The sale at retail is the nonprofit’s sale at retail; thus, the amounts are subject to sales tax collection and remittance by the nonprofit but could meet the nonprofit exemption described above. Similarly, suppose a nonprofit school operates their cafeteria themselves. In that case, meals sold to students are not taxable, but if the nonprofit outsources to a for-profit (who really makes the sales to the students), they are taxable.

What is not subject to exemption?

What is not subject to the exemption on the first $10,000 of sales at retail? If a 501(c)(19) sells tangible personal property that is not for the purpose of raising funds for the benefit of an active duty service member or a veteran, that is a taxable transaction for sales tax. However, fundraising by the 501(c)(19) that is for the benefit of the active duty or veterans would be subject to the exemption using the same rules as a 501(c)(3) or (4). In addition, non-fundraising retail sales (such as a gift shop at a nonprofit) are all taxable.

The RAB goes on to explain the tax base for retail sales as well. Just because the nonprofit paid sales tax on a purchase they made from the vendor does not cover their requirement for the nonprofit to charge sales tax on the sale. For example, if a nonprofit pays $10 for a t-shirt and sells it at $15, the nonprofit should not pay any sales tax when purchasing the t-shirt for $10 and should claim a resale exemption. Then the nonprofit would charge the final customer sales tax on the $15. If the nonprofit mistakenly paid tax on the $10 shirt, they still must remit on the $15 of sales and then request a refund on the $10 shirt.

Prepared food at events

Many fundraising events have prepared food. In determining the amount of sales tax required to be remitted, the nonprofit first must determine if the food is part of the fundraising event (not an optional payment and not separately stated) or if it is a separate deliverable (such as a cash bar that is optional to purchase.) If it is a separate deliverable, the nonprofit must remit sales tax on the sales and not simply pay sales tax when purchasing the food from the vendor. If the food is part of the fundraising event, there are two options. If they pay fair value to a vendor for the food, they can pay sales tax to the vendor and have the sales tax requirements complete; this only applies to prepared food sales at fundraising events. Otherwise, the taxable amount is the total fundraising event fee, unless the client can substantiate a lower fair value of the food (in which case the food’s fair value is the taxable amount). Note that in no case do they look at the cost of the food, but rather the fair value. If the event has a $25 admission fee and provides dinner with a fair value of $20, but the food was donated, $20 of the $25 is still subject to sales tax (the fair value).

Auctions and raffles

Auctions and raffles are other areas that can be confusing. If the entity is a 501(c)(3) or (4), then the taxable amount of the auction item is the lesser of the fair value or the proceeds received. However, other entities, including 501(c)(19) entities, must pay sales tax on the proceeds received, regardless of the fair value. The RAB also indicates raffle proceeds are not subject to sales tax, but if the nonprofit purchases a good to be raffled, the nonprofit owes use tax on that purchase. Donated items for the raffle have no use tax requirement (although for the auction, they have a sales tax requirement).

Sales tax license

Generally, nonprofit organizations making retail sales are required to obtain a sales tax license, even if they expect to meet the exemption. The RAB clarifies that a nonprofit entity that makes retail sales at two or fewer events in a calendar year does not have to obtain a sales tax license or register for use tax. Instead, the nonprofit may report and remit tax on Form 3421 Sales Tax Return for Special Events or Form 5089 Concessionaire’s Sales Tax Return.

Conclusion

Nonprofit sales tax has always been – and will always be – complex in the State of Michigan. However, this new RAB changes certain areas, especially fundraisers where the nonprofit does not have the risk, and prepared food sales where the nonprofit sells the food separately. Make sure your nonprofit is calculating sales tax correctly.

For more information, refer to the Treasury’s Revenue Administrative Bulletin 2020-25, Sales and Use Tax Treatment of Nonprofit Entities. Contact your Yeo & Yeo professional if you need assistance.

Management must formally adopt a budget to adhere to the law.

The legislative body must pass a budget for the general fund and each special revenue fund to comply with the Uniform Budget Manual issued by the Michigan Department of Treasury.

Treasury requires that specific requirements be reflected in local governments’ budgets. Although this may sound like a daunting task, adopting and monitoring the budget helps guide decision-making, all while meeting requirements set by the State. In this article, you will find how a budget can help your government and which approach may be best according to your needs.

Budgetary requirements of a local government

State the total mills to be levied and the purpose for each millage levied (truth in budgeting act).
Include amounts appropriated for expenditures and amounts to meet liabilities for the ensuing fiscal year in each fund.
Include estimated revenues by source in each fund for the ensuing fiscal year.
Be consistent with the Uniform Chart of Accounts issued by the State Treasurer (or by the Michigan Department of Education for school districts, intermediate school districts and public school academies).
The budgeted expenditures, including an accrued deficit, shall not exceed budgeted revenues, including available surplus and the proceeds from bonds or other obligations issued under the Fiscal Stabilization Act (Act 80 of 1981 MCL 141.1001).

The budget is sometimes viewed as tedious work when really it is management’s greatest tool.

The budget serves several vital functions for the government, such as a planning, control and communication, and it can also be a motivational tool.

More detailed benefits of proper budgeting procedures include:

A means of opening your eyes to the ongoing and future needs of the government
A control over frivolous spending and waste of government resources
A means to identify and project shortfalls in revenues
A tool to assist leadership in making sound decisions

Budget-to-actual activities should be shared with the finance or other committees regularly, and management must always have the most recent board-approved budget reflected in their financial reporting system. If the correct budget is not reflected in the financial reporting system, how can finance appropriately monitor activities within the budget? This can result in a deficiency in internal controls and noncompliance.

Which budgeting methodology is best for your local government?

Line item budget – identifies expenditures into groupings such as salaries, professional services, insurance, postage, etc. Preparation is simple, but this method makes it difficult to determine if goals are achieved or if programs are adequately funded.
Program budget – identifies expenditures by program accompanied by a narrative description of the services to be provided. Each program budget must detail line item amounts. Slightly more complex in nature, program budgets allow for the program itself to be evaluated.
Program performance budget – identifies the relationship between the dollars spent and units of service performed to determine a cost per unit. This approach is useful in measuring the success of a program but is typically avoided as difficulties arise in allocating unit costs appropriately. Like all the other budget approaches, line-item allocations of costs are necessary.
Management by objectives budget – identifies the specific programs or objectives to be accomplished during the budget year. This approach will allow management to establish target dates and costs for specific objectives and provide a means for the legislative body to measure the performance of the various departments and the management structure.
Zero-based budget – a method in which each department administrator must justify every dollar of their respective budget during each budget cycle.

When correctly approving and adhering to a sound budget, expect deviations from the respective budget. The budget is a benchmarking tool and will rarely equate to actual outcomes of the government’s ongoing activities. However, the legislative body must amend the budget as soon as a deviation is apparent to comply with Treasury guidelines. The budget should be dynamic and represent the financial needs and projections of the government at any point in time and should be amended not only at fiscal year-end.

Contact your Yeo & Yeo professional if you need assistance with your government entity’s budget process.