Author: KraftCPAs

Business travel expenses can be time-consuming to track and equally frustrating to review and approve. A new IRS option is designed to help.

In Notice 2023-68, the IRS announced special per diem rates for fiscal year 2024 that became effective October 1, 2023. Taxpayers can use these rates to substantiate the amount of expenses for lodging, meals, and incidentals when traveling away from home. Taxpayers in the transportation industry can use a special transportation industry rate.

Basics of the method

A simplified alternative to tracking actual business travel expenses is to use the “high-low” per diem method, which provides fixed travel per diems. The amounts provided by the IRS vary from locality to locality.

Under the high-low method, the IRS establishes an annual flat rate for certain areas with higher costs of living. All locations within the continental United States that aren’t listed as “high cost” are automatically considered “low cost.” The high-low method may be used in lieu of the specific per diem rates for business destinations. Examples of high-cost areas include Boston and San Francisco. Other locations, such as resort areas, are considered high cost during only part of the year.

Under some circumstances — for example, if an employer provides lodging or pays the hotel directly — employees may receive a per diem reimbursement only for their meals and incidental expenses. There’s also a $5 incidental-expenses-only rate for employees who don’t pay or incur meal expenses for a calendar day (or partial day) of travel.

Reduced recordkeeping

If your company uses per diem rates, employees don’t have to meet the usual recordkeeping rules required by the IRS. Receipts of expenses generally aren’t required under the per diem method. But employees still must substantiate the time, place, and business purpose of the travel. Per diem reimbursements generally aren’t subject to income or payroll tax withholding or reported on an employee’s Form W-2.

The FY2024 rates

For travel after September 30, 2023, the per diem rate for all high-cost areas within the continental United States is $309. This consists of $235 for lodging and $74 for meals and incidental expenses. For all other areas within the continental United States, the per diem rate is $214 for travel after September 30, 2023 ($150 for lodging and $64 for meals and incidental expenses). Compared to the FY2023 per diems, the high-cost area per diem increased $12, and the low-cost area per diem increased $10.

Remember that this method is subject to a variety of rules and restrictions. For example, companies that use the high-low method for an employee must continue using it for all reimbursement of business travel expenses within the continental U.S. during the calendar year. However, the company may use any permissible method to reimburse that employee for any travel outside the continental U.S.

For travel during the last three months of a calendar year, employers must continue to use the same method (per diem or high-low method) for an employee as they used during the first nine months of the calendar year. Also, note that per diem rates can’t be paid to individuals who own 10% or more of the business.

If your employees are traveling, it may be a good time to review the rates and consider switching to the high-low method. It can reduce the time and frustration associated with traditional travel reimbursement.

© 2023 KraftCPAs PLLC

If your employer offers a 401(k) plan and you don’t contribute, you might be missing out on the deal of a lifetime. These plans help employees accumulate a retirement nest egg on a tax-advantaged basis with very few drawbacks.

With a 401(k) plan, you can opt to set aside a certain amount of your wages in a qualified retirement plan. By setting that money aside, you’ll reduce your gross income and defer tax on the amount until the cash (adjusted by earnings) is distributed to you in the future. It will either be distributed from the plan or from an IRA or other plan that you roll your proceeds into after leaving your job.

Tax benefits

Your wages or other compensation will be reduced by the pre-tax contributions that you make, which will save you current income taxes. But the amounts will still be subject to Social Security and Medicare taxes. If your employer’s plan allows, you may instead make all, or some, contributions on an after-tax basis. These are Roth 401(k) contributions. With Roth 401(k) contributions, the amounts will be subject to current income taxation, but if you leave these funds in the plan for a required time, distributions (including earnings) will be tax-free.

Your elective contributions — either pre-tax or after-tax — are subject to annual IRS limits. In 2023, the maximum amount permitted is $22,500. When you reach age 50, if your employer’s plan allows, you can make additional “catch-up” contributions. In 2023, that additional amount is up to $7,500. If you’re 50 or older, the total that you can contribute to all 401(k) plans in 2023 is $30,000. Total employer contributions, including your elective deferrals (but not catch-up contributions), can’t exceed 100% of compensation or, for 2023, $66,000, whichever is less.

In a typical plan, you’re permitted to invest the amount of your contributions (and any employer matching or other contributions) among available investment options that your employer has selected. Periodically review your plan investment performance to determine that each investment remains appropriate for your retirement planning goals and your risk specifications.

Taking withdrawals

Another important characteristic of these plans is the limitation on withdrawals while you’re employed. Amounts in the plan attributable to elective contributions aren’t available to you before one of the following events:

• Retirement (or other separation from service)
• Reaching age 59½
• Disability
• Plan termination
• Hardship

Eligibility rules for a hardship withdrawal are strict. A hardship distribution must be necessary to help deal with an immediate and heavy financial need.

As an alternative to taking a hardship or other plan withdrawal while employed, your employer’s plan may allow you to receive a loan, which you pay back to your account with interest.

Matching contributions

Employers may opt to match 401(k) contributions up to a certain amount. Although matching is not required, surveys show that most employers offer some type of match. If your employer matches contributions, you should be sure to contribute enough to receive the full amount. Otherwise, you’ll lose out on free money.

© 2023 KraftCPAs PLLC

If you have a parent entering a nursing home, taxes are probably the last thing on your mind. But you should know that several tax breaks may be available to help offset some of the costs.

Medical expense deductions

The costs of qualified long-term care (LTC), such as nursing home care, may be deductible as medical expenses to the extent they, along with other qualified expenses, exceed 7.5% of adjusted gross income (AGI). But keep in mind that the medical expense deduction is an itemized deduction. And itemizing deductions saves taxes only if total itemized deductions exceed the applicable standard deduction.

Amounts paid to a nursing home are deductible as medical expenses if a person is staying at the facility principally for medical care rather than custodial care. Also, for those individuals, only the portion of the fee that’s allocable to actual medical care qualifies as a deductible expense.

If the individual is chronically ill, all qualified LTC services are deductible. Qualified LTC services are those required by a chronically ill individual and administered by a licensed healthcare practitioner. They include diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, as well as maintenance or personal-care services.

For someone to qualify as chronically ill, a physician or other licensed health care practitioner must certify him or her as unable to perform at least two activities of daily living (ADLs) for at least 90 days due to a loss of functional capacity or severe cognitive impairment. ADLs include eating, transferring, bathing, dressing, toileting, and continence.

Qualifying as a dependent

If your parent qualifies as your dependent, you can add medical expenses you incur for him or her to your own medical expenses when calculating your medical expense deduction. (A KraftCPAs advisor can help with this determination.)

If you aren’t married and you meet the dependency tests for your parent, you may qualify for head-of-household filing status, which has a higher standard deduction and lower tax rates than filing as single. You may be eligible to use this status even if the parent for whom you claim an exemption doesn’t live with you.

Selling your parent’s home

In many cases, a move to a nursing home also means selling the parent’s home. Fortunately, up to $250,000 of gain from the sale of a principal residence may be tax-free. To qualify for the $250,000 exclusion, the seller must generally have owned the home for at least two years out of the five years before the sale.

Also, the seller must have used the home as a principal residence for at least two of the five years before the sale. However, there’s an exception to the two-of-five-year use test for a seller who becomes physically or mentally unable to care for him- or herself during the five-year period.

LTC insurance

Perhaps your parent is still in good health but is paying for LTC insurance (or you’re paying LTC insurance premiums for yourself). If so, be aware that premiums paid for a qualified LTC insurance contract are deductible as medical expenses (subject to limits) to the extent that they, when combined with other medical expenses, exceed the 7.5%-of-AGI threshold. Such a contract doesn’t provide payment for costs covered by Medicare, is guaranteed renewable, and doesn’t have a cash surrender value.

The amount of qualified LTC premiums that can be included as medical expenses is based on the age of the insured individual. For example, for 2023 the limit on deductible premiums is $4,770 for those 61 to 70 years old and $5,960 for those over 70.

© 2023 KraftCPAs PLLC

A significant number of U.S. businesses will face extensive new reporting requirements starting January 1, 2024.

Under the Corporate Transparency Act (CTA), enacted in 2021, many companies will be required to provide information related to their “beneficial owners” — the individuals who ultimately own or control the company — to the Financial Crimes Enforcement Network (FinCEN). Failure to do so can result in civil or criminal penalties or both.

The CTA is intended to reduce exposure to serious crimes, including terrorist financing, money laundering, and other nefarious activities. But it could also open the door to the inspection of family offices, investment angels, and other private individuals who have generally been shielded from scrutiny in the past. A business characterized as a “reporting company” has either 30 days or one year to comply with the new rules.

Key definitions

The CTA rules generally apply to both domestic and foreign privately held reporting companies. For these purposes, a reporting company includes any corporation, limited liability company, or other legal entity created through documents filed with the appropriate state authorities. A foreign entity includes any private entity formed in a foreign country that’s properly registered to conduct business in a U.S. state.

The complete list of entities that are exempt from the reporting rules is lengthy, ranging from government units to nonprofit organizations to insurance companies and more. Notably, an exemption was created for any “large operating company” that employs more than 20 employees on a full-time basis, has more than $5 million in gross receipts or sales (not including receipts and sales from foreign sources), and physically operates in the U.S. However, many of these companies already must meet other reporting requirements providing comparable information.

If an entity initially qualifies for the large operating company exemption but subsequently falls short, it must then file a beneficial owner report. On the other hand, an entity that might not currently qualify can update its status with FinCEN and obtain an exemption.

Under the CTA, a nonexempt entity must provide identifying information about its beneficial owners. A beneficial owner is defined as someone who directly or indirectly exercises substantial control over a reporting company or owns or controls at least 25% of its ownership interests.

An individual has substantial control of a reporting company if he or she:

• Is a senior officer of the company
• Has authority over the senior officers or a majority of the board of a company
• Has substantial influence over the company’s important decisions, and
• Has any other type of substantial control over the company

This generally includes individuals who are directly related to ownership interests in the company, but indirect control may also result in classification as a beneficial owner.

The CTA requires reporting companies to provide identifying information about their company applicants. A company applicant is defined as someone who is either:

• Responsible for filing the documents that created the entity (for a foreign entity, this is the person who directly files the document that first registers the foreign reporting company to conduct business in a state), or
• Primarily responsible for directing or controlling filing of the relevant formation or registration document by another.

This rule often encompasses legal personnel acting in a business capacity.

Who isn’t a beneficial owner?

The following individuals aren’t treated as beneficial owners of a reporting company under the CTA:

• Someone acting as a nominee, intermediary, custodian or agent on behalf of a beneficial owner
• An employee of the reporting company who has substantial control over the entity’s economic benefits due to their employment status (but only if the individual isn’t a senior officer of the entity)
• An individual whose only interest in a reporting company is a future interest through a right of inheritance
• Any creditor of the reporting company (unless the creditor exercises substantial control or has a 25% ownership interest in the reporting company)
• A minor child

However, for minor children, the reporting company must report information about the child’s parent or legal guardian.

Other important issues

The reporting requirements are extensive. Specifically, the report to FinCEN must include the following information:

• The legal name of the entity (or any trade or doing-business-as name)
• The address of the entity
• The jurisdiction where the entity was formed
• The entity’s Taxpayer Identification Number
• The name, address, date of birth, unique identifying number information of the beneficial owners (such as a U.S. passport or state driver’s license number), and an image of the document that contains the identifying number

Reporting companies have either 30 days or one year from the effective date (January 1, 2024) to comply with the reporting requirements. Beneficial ownership information won’t be accepted by FinCEN until the effective date.

The determination of whether a reporting company has 30 days or one year to comply depends on its date of formation. Reporting companies created or registered prior to January 1, 2024, have one year to comply with the CTA by filing initial reports. Those created or registered on or after January 1, 2024, will have 30 days upon receipt of their creation or registration documents to file the initial reports.

After the initial filing, reporting companies then have 30 days to file an updated report after any change with respect to information previously reported. In addition, reporting companies must correct inaccurate information in previously filed reports within 30 days after the date the reporting company becomes aware of the error.

Reports filed with FinCEN aren’t available to the public. However, certain government agencies will have access to the information, including those involved in national security, intelligence, and law enforcement, as well as the IRS and U.S. Treasury Department.

An omission or fraudulent report could result in civil fines of $500 a day for as long as the reports are missing or remain inaccurate. Failure to comply may also trigger criminal penalties of a $10,000 fine or even jail time of two years.

Next steps

If you determine that your business must meet these obligations, collect the required information, update, and refine internal policies for accurately reporting the data, and establish a system for monitoring the reporting processes. For additional guidance, contact a KraftCPAs advisor.

© 2023 KraftCPAs PLLC

The dynamics of charitable giving are changing rapidly in the United States, and they bring important implications for nonprofits and their fundraising strategies. While overall giving has been boosted by larger donations and higher-income donors, smaller donations and contributions from lower-income donors have been on a consistent decline. This dichotomy has led to a pressing need for nonprofits to understand and adapt to the giving trends of more affluent donors. In a recent study by Bank of America and the Indiana University Lilly Family School of Philanthropy, the giving patterns of affluent households were examined, revealing some critical observations that could shape the future of philanthropy.

The study highlights the shifting preferences of younger donors, the decline in giving to religious organizations, and the importance of aligning mission and values in attracting donations. As the donor base evolves, nonprofits are forced to reassess their strategies and adapt to the changing landscape.

Read the full article …

If your business sells products, you already know the importance of tracking numbers. Keeping your stock at the right levels means that you shouldn’t run out of items, and you also won’t have a lot of money tied up in products that aren’t selling. It’s a delicate balance. 

Even though you probably have a sense of what’s hot and what’s not just from fulfilling orders, you shouldn’t have to rely on guesses. You need real numbers so that you know when to reorder and when to discount — and discontinue — items that aren’t selling.  

A popular solution to inventory problems is QuickBooks, which:

• allows you to create records for the products you sell
• keeps a real-time running tally of your item levels and alerts you when they’re running low
• generates specialized reports so you can get a detailed snapshot of your inventory at any time

Getting started 

Before you begin setting up an inventory system, make sure QuickBooks is ready. Open the Edit menu and select Preferences, then Items & Inventory. If you’re the software administrator, you can access the options that appear when you click the Company Preferences tab. 

Click the box in front of Inventory and purchase orders are active if it’s not already checked. If your version of QuickBooks supports sales order and purchase orders, select the options you want for the next two lines. Select When the quantity I want to sell exceeds Quantity Available in case you have items that are committed to assembles, for example. When you’re done, click OK. 

Building product records 

Even if you don’t have a lot of inventory, it’s a good idea to create a record for each item you sell so you always know where you stand. You don’t want to have to count or hunt for a unique product every time you fulfill an order. If you come up short and can’t complete a sale, you may lose that customer to a competitor who can. 

Open the Lists menu and select Item List. Once you’ve created records, they’ll appear in this table. Click the down arrow next to the Item field in the lower left corner and select New. In the upper left corner of the window that opens, select Inventory Part for the Type so QuickBooks knows to track it. 

Here’s one scenario: Let’s say you’re buying bracelets in volume from a wholesaler and reselling them. If you’re assembling a product that requires multiple parts, that requires more detailed records. But the process doesn’t have to be complicated.

Enter an Item Name/Number. The next two fields are optional. Now, enter the Purchase Information and Sales Information, starting with descriptions for transactions. Then, how much did you pay for them, and at what price will you sell them? The default COGS Account should be fine, and you can select a Preferred Vendor if you’d like. Be sure to select a Tax Code (if you need to collect sales tax and aren’t yet prepared, we can walk you through the process). The Income Account should be Retail Sales for this example. 

The fields under Inventory Information are important. The default Asset Account should be correct. Enter the minimum Reorder Point and the number of this item you currently have On Hand. QuickBooks will calculate the Total Value of your stock. When you’re finished, click OK.  

Built-in safeguards 

How does QuickBooks keep you from selling inventory items you don’t have? That’s easy. It’s unlikely, but let’s say someone really likes those multicolor beaded bracelets you’re selling and thinks he or she could sell them for more and make a bigger profit. They want to order 120 of them.  

There are two ways QuickBooks warns you about the potential issue. The first is a simple pop-up dialogue box that alerts you about insufficient supply. Second, if you get an unusually large order, you can consult QuickBooks’ Inventory Stock Status by Item report to get a real-time count (Reports | Inventory).  

More inventory tracking power

QuickBooks does a good job of tracking inventory items. It’s up to you, though, to keep an eye of how everything is selling and determine your future purchasing habits. Other reports may be able to help you here, like Sales by Item Detail.

© 2023 KraftCPAs PLLC

The wage base for computing Social Security tax will increase to $168,600 for 2024 — up from $160,200 this year — based on a recent decision by the Social Security Administration.

Wages and self-employment income above that threshold aren’t subject to Social Security tax.

Basic details

The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees, and self-employed workers — one for Old Age, Survivors, and Disability Insurance (commonly known as the Social Security tax) and the other for Hospital Insurance (known as the Medicare tax).

There’s a maximum amount of compensation subject to the Social Security tax, but no maximum for Medicare tax. For 2024, the FICA tax rate for employers will be 7.65% — 6.2% for Social Security, and 1.45% for Medicare (the same as in 2023).

Changes in the new year

For 2024, this is how much an employee will pay:

• 6.2% Social Security tax on the first $168,600 of wages (6.2% x $168,600 makes the maximum tax $10,453.20)
• 1.45% Medicare tax on the first $200,000 of wages ($250,000 for joint returns, $125,000 for married taxpayers filing separate returns)
• 2.35% Medicare tax (regular 1.45% Medicare tax, plus 0.9% additional Medicare tax) on all wages more than $200,000 ($250,000 for joint returns, $125,000 for married taxpayers filing separate returns)

For 2024, the self-employment tax imposed on self-employed people will be:

• 12.4% Social Security tax on the first $168,600 of self-employment income, for a maximum tax of $20,906.40 (12.4% x $168,600)
• 2.90% Medicare tax on the first $200,000 of self-employment income ($250,000 of combined self-employment income on a joint return, $125,000 on a return of a married individual filing separately)
• 3.8% (2.90% regular Medicare tax plus 0.9% additional Medicare tax) on all self-employment income more than $200,000 ($250,000 of combined self-employment income on a joint return, $125,000 for married taxpayers filing separate returns)

Employees with multiple employers

If you’re a business owner, there might be questions about an employee who works for your business but also has a second job. That employee would have taxes withheld from two different employers. Can the employee ask you to stop withholding Social Security tax once he or she reaches the wage base threshold? The answer is no. Each employer must withhold Social Security taxes from the individual’s wages, even if the combined withholding exceeds the maximum amount that can be imposed for the year. In that event, the employee will get a credit on his or her tax return for any excess withheld.

© 2023 KraftCPAs PLLC

Labor shortages, wage inflation, and the changing expectations of workers are the new normal challenges faced by employers. In response, many organizations are reevaluating their benefits package to attract and retain talent. What some may overlook are the tax implications associated with these benefits.

Taxes are a significant part of the cost of labor, and understanding the tax implications of employee benefits is crucial for managing liabilities and ensuring compliance with regulations. Additionally, it can help organizations strengthen the return on their investments in talent. Here are five scenarios that might apply to your organization and whether it’s time for a thorough review of your benefits plan.

Read the full article …

New guidance from the Financial Accounting Standards Board (FASB) will provide investors and other allocators of capital with more decision-useful information in a joint venture’s separate financial statements.

Accounting Standards Update (ASU) 2023-05, Business Combinations — Joint Venture Formations (Subtopic 805-60): Recognition and Initial Measurement, also aims to reduce diversity in practice in this area of financial reporting. Here’s what you should know.

Definition of a joint venture

Under existing U.S. Generally Accepted Accounting Principles (GAAP), there are no rules for the initial recognition and measurement of contributions to a joint venture. This has created accounting differences among entities, confusing those who use the financial reporting information to make investment decisions.
The updated guidance applies to the formation of entities that meet the definition of a joint venture. According to the FASB Accounting Standards Codification Master Glossary, a joint venture is “an entity owned and operated by a small group of businesses (the joint venturers) as a separate and specific business or project for the mutual benefit of the members of the group.”

The purpose of a joint venture may include:
• To share risks and rewards in developing a new market, product, or technology
• To combine complementary technological knowledge
• To pool resources in developing production or other facilities

Each joint venturer may participate, directly or indirectly, in the overall management of the joint venture. Ownership of joint ventures seldom changes, and their equity interests usually aren’t traded publicly. Joint ventures aren’t limited to corporate entities; in fact, governmental entities may be joint venturers.

Fair value measurement

The updated guidance will require that a joint venture, upon formation, account for contributions as though the joint venture were the acquirer of a business within the scope of Accounting Standards Codification (ASC) Subtopic 805-10, Business Combinations — Overall. The acquirer of a business is required to recognize and measure the identifiable assets acquired and liabilities assumed at fair value (with certain exceptions), under Subtopic 805-20, Business Combinations — Identifiable Assets and Liabilities, and Any Noncontrolling Interest.

The updated guidance also describes the formation date as the point when an entity initially meets the definition of a joint venture. In addition, the guidance addresses how a joint venture should account for certain contingent payments to one or more of the joint venturers that are determined to be part of the formation. In this context, the joint venture as a whole represents the fair value of 100% of the joint venture’s equity upon formation.

Finally, the guidance states that any contingent payments due to the joint venturers that are deemed to be part of the formation and classified within assets and liabilities should follow the guidance in Subtopic 805-20 for initial measurement, recognition, and subsequent measurement, rather than Subtopic 805-30 for contingent consideration. The recognition and initial measurement of contingent payments won’t affect the total goodwill recognized in a joint venture.

The FASB members agreed that references to a measurement period that already exist in Subtopic 805-20, such as for assets and liabilities arising from contingencies, will be applied by a newly formed joint venture as though the measurement period begins and ends on the formation date.

A joint venture also must provide relevant disclosures to help stakeholders better understand the nature and financial effect of the joint venture formation in the period when it’s formed. These disclosures are different from the disclosure requirements for business combinations.

The updated guidance goes into effect for all joint ventures with a formation date on or after January 1, 2025. Early adoption is permitted. In addition, joint ventures formed before the effective date of the updated guidance may elect to apply the amendments retrospectively if sufficient information is available.

Expanded disclosures on income taxes

The FASB has also finalized rules on income tax disclosures. It unanimously affirmed the significant aspects of Proposed Accounting Standards Update (ASU) No. 2023-ED100, Income Taxes (Topic 740) Improvements to Income Tax Disclosures. The changes aim to improve disclosure rules around the rate reconciliation table and cash taxes that companies pay in the United States and foreign jurisdictions.

Under the updated guidance, companies will need to provide a breakout of amounts paid for taxes between federal, state, and foreign taxing jurisdictions, rather than a lump sum amount. However, companies won’t be required to provide country-by-country disclosures.

Public companies will be required to report under the new guidance for fiscal years beginning after December 15, 2024. The standard goes into effect one year later for privately held companies. Early adoption is allowed.

© 2023 KraftCPAs PLLC

If you’ve ever tried to look up a business deduction in the Internal Revenue Code, you probably didn’t find it.

That’s because most business deductions aren’t actually listed. For example, federal tax law doesn’t explicitly state that you can deduct office supplies and certain other expenses. Some expenses are detailed in the tax code, but the general rule is contained in the first sentence of Section 162, which states you can write off “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

Basic definitions

In general, an expense is ordinary if it’s considered common or customary in the particular trade or business. For example, insurance premiums to protect a store would be an ordinary business expense in the retail industry.

A necessary expense is defined as one that’s helpful or appropriate. For example, let’s say a car dealership purchases an automated external defibrillator. It may not be necessary for the operation of the business, but it might be helpful and appropriate if an employee or customer suffers cardiac arrest.

It’s possible for an ordinary expense to be unnecessary — but to be deductible, an expense must be ordinary and necessary.

In addition, a deductible amount must be reasonable in relation to the benefit expected. For example, if you’re attempting to land a $3,000 deal, a $65 lunch with a potential client should be OK with the IRS. (Keep in mind that the Tax Cuts and Jobs Act eliminated most deductions for entertainment expenses but retained the 50% deduction for business meals.)

Examples to consider

Not surprisingly, the IRS and courts don’t always agree with taxpayers about what qualifies as ordinary and necessary expenditures. Here are three 2023 cases to illustrate some of the issues:

1. A married couple owned an engineering firm. For two tax years, they claimed depreciation of $76,264 on three vehicles, but they didn’t provide required details including each vehicle’s ownership, cost, and useful life. They claimed $34,197 in mileage deductions and provided receipts and mileage logs, but the U.S. Tax Court found they didn’t show any related business purposes. The court also found the mileage claimed included commuting costs, which can’t be written off. The court disallowed these deductions and assessed taxes and penalties. (TC Memo 2023-39)
2. The Tax Court ruled that a married couple wasn’t entitled to business tax deductions because the husband’s consulting company failed to show that it was engaged in a trade or business. In fact, invoices produced by the consulting company predated its incorporation. And the court ruled that even if the expenses were legitimate, they weren’t properly substantiated. (TC Memo 2023-80)
3. A physician specializing in gene therapy had multiple legal issues and deducted legal expenses of $360,295 for two years on joint Schedule C business tax returns. The Tax Court found that most of the legal fees were to defend the husband against personal conduct issues. The court denied the deduction for personal legal expenses but allowed a deduction for $13,000 for business-related legal expenses. (TC Memo 2023-42)

Proceed with caution

The deductibility of some expenses is clear. But for other expenses, it can get more complicated. Generally, if an expense seems like it’s not normal in your industry — or if it could be considered fun, personal, or extravagant in nature — you should proceed with caution. And keep careful records to substantiate the expenses you’re deducting.

© 2023 KraftCPAs PLLC

Accurate estimates are at the heart of every construction company’s financial success. They provide your team with a foundation to create project budgets, control costs, manage cash flow, and ensure profitability.

In a perfect world, initial estimates would match actual costs at the end of every job — with no hint of cost overruns or profit fade. But that hardly ever happens. Fortunately, there are ways you can tighten up your estimates so they’re as close as possible to final job costs. Here are 10 to consider:

1. Leverage software and digital tools. Be sure you’re using carefully chosen, up-to-date and construction-specific accounting software and digital tools to ensure accuracy and efficiency when gathering cost-related data. The right software can help automate calculations and processes, double-check accuracy, allocate and track costs more precisely to projects, and generate reports and other necessary documentation.

2. Use job costing to find the true costs. Job costing is a construction accounting method that itemizes costs to create more accurate estimates and bids, as well as simplify tax planning and filing. It essentially assigns price tags to individual jobsite tasks or activities based on the resources they consume — typically, equipment hours, labor hours and materials. The sum of those three expense categories is the true cost of each task/activity. The price tags then serve as line items in estimates that can be easily added or deleted as job scope changes. Essentially, job costing enables you to start at the task/activity level and estimate from the bottom up.

3. Don’t overlook overhead and indirect costs. These represent your construction company’s potentially hidden costs. If they aren’t baked into your estimates, your overall financial position may be compromised. Overhead costs generally include rent/mortgage, office equipment, supplies, utilities, insurance, and salaries.

But contractors must also grapple with indirect costs. These are costs that you incur for more than one job, such as workers’ compensation insurance, and that are indirectly related to on-site construction, such as field cell phone charges.

4. Avoid unpleasant surprises with cash reserves. When creating an estimate, consider reserving at least 5% of the project budget as a contingency for unforeseen costs, such as delays attributable to bad weather or poor site conditions. Regularly assess such risks and their potential financial impact, adjusting estimates accordingly.

5. Periodically review profit margin and markup percentage. Your construction company’s net profit is the amount of sales revenue left over after you’ve paid all hard and soft costs — that is, job costs, indirect costs, and overhead. One simple formula to determine net profit margin is:

Net Income ÷ Revenue x 100

Although there’s no industry standard, a rule of thumb says a construction business’s net profit margin objective should be at least 8%, if not more. Once you establish a desired profit margin goal, you can set a markup percentage to achieve that goal. Generally, markups should be recalculated at least once a year and reviewed quarterly.

6. Track project costs in real time. Monitoring construction costs throughout a project can help your team detect errors, rising prices, labor rate changes or other cost fluctuations. Project managers should work regularly with the accounting team to compare estimated costs to actual costs so they can make timely decisions to course-correct when costs start to creep up.

7. Monitor market conditions. Inflation, rising interest rates, supply chain issues, labor shortages, regulatory changes, weather events and public health crises — these are just a few of the variables that can influence your estimates. In short, follow the news carefully. Also, regularly refer to local industry standards and benchmarks to ensure your estimates are realistic and competitive.

8. Work closely with suppliers. Review the costs of materials on published vendor price lists, price quotes and subcontractor bids to track which items are rising and which are falling. Build cooperative relationships with suppliers that include using them as a resource when determining materials costs and spotting potential price changes.

9. Perform regular historical job-cost comparisons. After each project is completed, perform a detailed comparison of actual costs to estimated costs to identify trends that may inform future estimates. But don’t stop there! Comparing a cross-section of similarly sized jobs over a three-to-five-year period will allow for a broader understanding of your construction company’s estimating capabilities and where improvements may be needed.

10. Ask for help. To achieve sustained success in today’s tough competitive environment, construction businesses need to operate in a state of continuous improvement when it comes to their estimating processes and accounting practices. Reach out to a member of our construction industry team to start the conversation.

© 2023 KraftCPAs PLLC

The 3.8% net investment income tax (NIIT) is an additional tax that applies to some higher-income taxpayers on top of capital gains tax or ordinary income tax. However, there are strategies that can help minimize the financial hit of the NIIT.

Are you subject to the NIIT?

You’re potentially liable for the NIIT if your modified adjusted gross income (MAGI) exceeds $200,000 (or $250,000 for joint filers and qualifying widows or widowers, and $125,000 for married taxpayers filing separately). Generally, MAGI is the same as adjusted gross income. However, it may be higher if you have foreign earned income and certain foreign investments.

The NIIT is calculated by multiplying 3.8% by the lesser of:

• Net investment income (NII)
• The amount by which MAGI exceeds the applicable threshold

For example, if you’re single with $250,000 in MAGI and $75,000 in NII, your MAGI will exceed the $200,000 threshold for singles by $50,000, which is less than your NII. So, your NIIT will be 3.8% × $50,000, which equals $1,900.

But if your MAGI instead is $300,000, your NIIT will be 3.8% × $75,000, which equals $2,850. This is because your $75,000 NII is less than the $100,000 amount by which your MAGI will exceed the $200,000 threshold.

NII generally includes net income from taxable interest, dividends, capital gains, rents, royalties, and passive business activities. Several types of income are excluded from NII, such as wages, most non-passive business income, retirement plan distributions and Social Security benefits. Also excluded are alimony and nontaxable gain on the sale of a personal residence.

Planning strategies

Given the way the NIIT is calculated, you can reduce or defer the tax by reducing either your MAGI or your NII. Consider:

• Deferring income to next year
• Maximizing contributions to IRAs and qualified retirement plans
• Reducing your capital gains by selling investments at a loss
• Investing in tax-exempt municipal bonds or in growth stocks that pay little or no dividends

You also might be able to transfer — either directly or in trust — assets that generate investment income to lower-income family members who aren’t subject to the NIIT. With this strategy, though, be careful not to inadvertently trigger NIIT because of the transfer. For example, trusts have a dramatically lower income threshold level at which NIIT applies.

If you own rental real estate, talk to a KraftCPAs advisor about how you can avoid NIIT and obtain other tax benefits by qualifying as a materially participating real estate professional.

If you hold interests in pass-through entities — such as partnerships, limited liability companies, and S corporations — it’s important to consider the interplay between the NIIT and other taxes. For instance, it may be possible to avoid the NIIT by increasing your level of participation to convert a pass-through investment from passive to non-passive. But in some cases, doing so may also trigger self-employment or payroll taxes, so it’s important to weigh the NIIT savings against the potential SE or payroll tax costs.

Handle with care

There are many potential strategies for reducing or deferring NIIT, but it’s important to consult with your tax advisor before you implement them. Tax reduction is an important objective, so long as it doesn’t come at the expense of prudent investment decision-making.

© 2023 KraftCPAs PLLC