Author: KraftCPAs

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

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

Midyear checkup

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

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

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

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

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

Potential shortcomings

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

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

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

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

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

Evaluating irregularities

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

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

© 2024 KraftCPAs PLLC

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

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

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

Vacant land

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

Gains from depreciation

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

Gains from depreciable QIP

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

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

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

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

Plenty to consider

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

© 2024 KraftCPAs PLLC

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

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

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

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

Illustrative example

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

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

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

Social Security disability benefits 

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

State rules differ

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

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

© 2024 KraftCPAs PLLC

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

Need for change

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

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

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

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

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

Scope of proposal

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

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

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

Applying the changes

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

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

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

© 2024 KraftCPAs PLLC

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

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

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

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

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

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

© 2024 KraftCPAs PLLC

Maintaining a healthy inventory of products to sell is always a balancing act, and it usually involves a lot of trial and error when your business is young. If you’re selling unique products that you’ve created yourself, it’s not so hard. You make one, you sell it, and your inventory is gone.

It gets trickier if you’re mass-producing the same item or buying items in bulk or wholesale. How many will you be able to sell? Your first estimates may be wildly off base. You take those early losses and try to make better buying decisions. You want to have enough products in stock that you don’t have to turn away sales, but you also don’t want to tie up a lot of money in excess inventory that isn’t moving.

As a business manager, you must learn on your own where that sweet spot is for every item you stock. It can take months or even years. QuickBooks Online can’t make those buying decisions for you, but it can warn you when you’re running low and when you have too much on hand that isn’t selling so well.

Here are several ways to improve that delicate balance.

Turn on the inventory tracking options

Click the gear icon in the upper right and scroll down to Sales on the Account and Settings page. In the Product and services section, make sure all of the options are set to On (we’ll get to price rules later). Be sure to click Done when you’re finished.

Detail matters on inventory product records

We’ve described the process of creating inventory item records before. You click the gear icon in the upper right corner and select Lists | Products and services. Click New in the upper right and Inventory in the panel that slides out from the right. You’re only required to complete three fields here: Name, Initial quantity on hand, and As of date. This allows you to include those item records in transactions. QuickBooks Online will subtract items when you sell them and keep your inventory level current.

The Reorder point field is very important. When the inventory level for that product drops to the number you specify, QuickBooks Online will let you know. In fact, when your cursor is on the QTY (quantity) field in an invoice, the three numbers pictured above will appear in a pop-out window (Quantity on PO automatically appears in the record based on your current purchase orders). Be sure you pay attention to this information when you’re selling products.

Set up flexible pricing

There may be times when you want to temporarily lower the price of a product or products because they’re just not selling. Maybe it’s a seasonal issue, and you expect that sales will pick up later. You can use QuickBooks Online’s Price rules. This tool allows you to discount certain products for a specified period.

Let’s say you’re overstocked on fountain pumps, and you want to discount them for a month to see if you can reduce your inventory level. Click the gear icon in the upper right again and select Lists | All lists | Price Rules. Click Create a rule and give it a Rule name. Price rules apply to all products and all customers by default. So, you’d leave Customer | All customers as is. Scroll down under Products and services and click Select individually. Under Price adjustment method, select Fixed amount. Choose Decrease by and 12, and in the next two fields, then No rounding. Enter the Start date and End date (optional).

Click +Add product or service, then click the down arrow in the field under Products in the lower half of the screen. Scroll down to Fountain Pump and select it. Your Adjusted Price should appear in that column. Click Apply rule, and then save it. This price will appear automatically when you create an invoice, though you can override it or delete it on the Price Rules page.

Use the site’s inventory reports

As you might imagine, QuickBooks Online offers excellent templates for inventory reports that you should be running on a regular basis. We talked about how the site alerts you to low stock levels when you’re creating invoices. But you should study the big picture on occasion. These reports are:

Inventory valuation summary. Transactions for each inventory item, and how they affect quantity on hand, value, and cost.

Inventory valuation detail. The quantity on hand, value, and average cost for each inventory item.

Physical inventory worksheet. Your inventory items, with space to enter your physical count so you can compare to the quantity on hand in QuickBooks Online. QuickBooks Online allows you to adjust inventory levels, but this should be done with great care.

You can also visit the Products & Services page, which displays a detailed profile of each item. If you’re low on stock or completely out, you’ll see that information at the top of the page.

We can’t advise you on the inventory levels you should be maintaining. Over time, this will become easier to gauge. But we’re here if you have questions about the mechanics of inventory management or any other element of QuickBooks Online.

© 2024 KraftCPAs PLLC

Divorce entails difficult personal issues, and taxes might not seem like a priority during that difficult process.

However, several concerns may need to be addressed to ensure that taxes are kept to a minimum and that important tax-related decisions are properly made. Here are six financial issues that, if left unaddressed, can make the divorce proceedings even more traumatic:

Personal residence sale: In general, if a couple sells their home in connection with a divorce or legal separation, they should be able to avoid tax on up to $500,000 of gain (if they’ve owned and used the home as their principal residence for two of the previous five years). If one former spouse continues to live in the home and the other moves out (but they both remain owners of the home), they may still be able to avoid gain on the future sale of the home (up to $250,000 each), but special language may have to be included in the divorce decree or separation agreement to protect this tax exclusion for the spouse who moves out.

If the couple doesn’t meet the two-year ownership and use tests, any gain from the sale may qualify for a reduced exclusion due to unforeseen circumstances.

Pension benefits: A spouse’s pension benefits are often part of a divorce property settlement. In these cases, the commonly preferred method to handle the benefits is to get a qualified domestic relations order (QDRO). This gives one former spouse the right to share in the pension benefits of the other and taxes the former spouse who receives the benefits. Without a QDRO, the former spouse who earned the benefits will still be taxed on them even though they’re paid out to the other former spouse.

Filing status: If you’re still married at the end of the year, but in the process of getting divorced, you’re still treated as married for tax purposes. A financial advisor can help you determine how to file your 2024 tax return — as married filing jointly or married filing separately. Some separated individuals may qualify for head of household status if they meet the requirements.

Alimony or support payments: For alimony under divorce or separation agreements that are executed after 2018, there’s no deduction for alimony and separation support payments for the former spouse making them. And the alimony payments aren’t included in the gross income of the former spouse receiving them. The rules are different for divorce or separation agreements executed before 2019. This was a change made in the Tax Cuts and Jobs Act. However, unlike some provisions of the law that are temporary, the repeal of alimony and support payment deduction is permanent.

Child support and child-related tax return filing: No matter when the divorce or separation instrument is executed, child support payments aren’t deductible by the paying former spouse (or taxable to the recipient). You and your ex-spouse will also need to determine who will claim your child or children on your tax returns to claim related tax breaks.

Business interests: If certain types of business interests are transferred in connection with divorce, care should be taken to make sure tax attributes aren’t forfeited. For example, interests in S corporations may result in suspended losses (losses that are carried into future years instead of being deducted in the year they’re incurred). When these interests change hands in a divorce, the suspended losses may be forfeited. If a partnership interest is transferred, a variety of more complex issues may arise involving partners’ shares of partnership debt, capital accounts, built-in gains on contributed property, and other complex issues.

A range of tax challenges

These are just some of the issues you may have to cope with if you’re getting a divorce. In addition, you may need to adjust your income tax withholding, and you should notify the IRS of any new address or name change. There are also estate planning considerations that an advisor can help resolve.

© 2024 KraftCPAs PLLC

 

Are you buying a business that will have one or more co-owners? Or do you already own one fitting that description? If so, consider installing a buy-sell agreement, which can be a big help in three ways:

• Transform your business ownership interest into a more liquid asset.
• Prevent unwanted ownership changes.
• Avoid hassles with the IRS.

Agreement basics

There are two basic types of buy-sell agreements: Cross-purchase agreements and redemption agreements (sometimes called liquidation agreements).

A cross-purchase agreement is a contract between you and the other co-owners. Under the agreement, a withdrawing co-owner’s ownership interest must be purchased by the remaining co-owners if a triggering event, such as a death or disability, occurs.

A redemption agreement is a contract between the business entity and its co-owners (including you). Under the agreement, a withdrawing co-owner’s ownership interest must be purchased by the entity if a triggering event occurs.

Triggering events

You and the other co-owners specify the triggering events you want to include in your agreement. You’ll certainly want to include obvious events like death, disability, and attainment of a stated retirement age. You can also include other events that you deem appropriate, such as divorce.

Valuation and payment terms

Make sure your buy-sell agreement stipulates an acceptable method for valuing the business ownership interests. Common valuation methods include using a fixed per-share price, an appraised fair market value figure, or a formula that sets the selling price as a multiple of earnings or cash flow.

Also ensure the agreement specifies how amounts will be paid out to withdrawing co-owners or their heirs under various triggering events.

Life insurance to fund the agreement

The death of a co-owner is perhaps the most common, and catastrophic, triggering event. You can use life insurance policies to form the financial backbone of your buy-sell agreement.

In the simplest case of a cross-purchase agreement between two co-owners, each co-owner purchases a life insurance policy on the other. If one co-owner dies, the surviving co-owner collects the insurance death benefit proceeds and uses them to buy out the deceased co-owner’s interest from the estate, surviving spouse or other heir(s). The insurance death benefit proceeds are free of any federal income tax, so long as the surviving co-owner is the original purchaser of the policy on the other co-owner.

However, a seemingly simple cross-purchase arrangement between more than two co-owners can get complicated, because each co-owner must buy life insurance policies on all the other co-owners. In this scenario, you may want to use a trust or partnership to buy and maintain one policy on each co-owner. Then, if a co-owner dies, the trust or partnership collects the death benefit proceeds tax-free and distributes the cash to the remaining co-owners. They then use the money to fund their buyout obligations under the cross-purchase agreement.

To fund a redemption buy-sell agreement, the business entity itself buys policies on the lives of all co-owners and then uses the death benefit proceeds buy out deceased co-owners.

Specify in your agreement that any buyout that isn’t funded with insurance death benefit proceeds will be paid out under a multi-year installment payment arrangement. This gives you (and any remaining co-owners) some breathing room to come up with the cash needed to fulfill your buyout obligation.

Create certainty for heirs

If you’re like many business co-owners, the value of your share of the business comprises a big percentage of your estate. Having a buy-sell agreement ensures that your ownership interest can be sold by your heir(s) under terms that you approved when you set it up. Also, the price set by a properly drafted agreement establishes the value of your ownership interest for federal estate tax purposes, thus avoiding possible IRS hassles.

As a co-owner of a valuable business, having a well-drafted buy-sell agreement in place is pretty much a no-brainer. It provides financial protection to you and your heir(s) as well as to your co-owners and their heirs. The agreement also can help ward off hassles with the IRS over estate taxes.

© 2024 KraftCPAs PLLC

With the estate tax exemption amount at $13.61 million for 2024, it would be tempting to brush off concerns over federal taxes. Before 2011, a much smaller exemption resulted in many people with more modest estates attempting to avoid it.

But since many estates won’t currently be subject to estate tax, it’s a good time to devote more planning to income tax saving for your heirs.

Keep in mind that the federal estate tax exclusion amount is scheduled to sunset at the end of 2025. Beginning on January 1, 2026, the amount is due to be reduced to $5 million, adjusted for inflation. Congress could act to extend the higher amount or institute a new amount.

For now, at least, here are strategies to consider based on the current exemption amount.

Using the annual exclusion 

One of the benefits of using the gift tax annual exclusion to make transfers during your lifetime is to save estate tax. This is because both the transferred assets and any post-transfer appreciation generated by those assets are removed from your (the donor’s) estate.

As mentioned, estate tax savings may not be an issue because of the large exemption amount. Further, making an annual exclusion transfer of appreciated property carries a potential income tax cost because the recipient receives your basis upon transfer. Thus, the recipient could face income tax, in the form of capital gains tax, on the sale of the gifted property in the future. If there’s no concern that an estate will be subject to estate tax, even if the gifted property grows in value, then you might want to base the decision to make a gift on other factors.

For example, gifts may be made to help a relative buy a home or start a business. But a donor shouldn’t gift appreciated property because of the capital gains that could be realized on a future sale by the recipient. If the appreciated property is held until the donor’s death, under current law, the heir will get a step-up in basis that will wipe out the capital gains tax on any pre-death appreciation in the property’s value.

Spouses now have more flexibility 

Years ago, spouses often undertook complicated strategies to equalize their estates so that each could take advantage of the estate tax exemption amount. In many cases, a two-trust plan was established to minimize estate tax. “Portability,” or the ability to apply the decedent’s unused exclusion amount to the surviving spouse’s transfers during life and at death, became effective for estates of decedents dying after 2010. As long as the election is made, portability allows the surviving spouse to apply the unused portion of a decedent’s applicable exclusion amount (the deceased spousal unused exclusion amount) as calculated in the year of the decedent’s death. The portability election gives married couples more flexibility in deciding how to use their exclusion amounts.

Valuation discounts

Be aware that it may no longer be worth pursuing some estate exclusion or valuation discount strategies to avoid inclusion of property in an estate. It may be better to have the property included in the estate or not qualify for valuation discounts so that the property receives a step-up in basis. For example, the special use valuation — the valuation of qualified real property used for farming or in a business, based on the property’s actual use rather than on its highest and best use — may not save enough, or any, estate tax to justify giving up the step-up in basis that would otherwise occur for the property.

© 2024 KraftCPAs PLLC

Selling property that’s used in your trade or business isn’t as simple as signing on the dotted line. In fact, there are many complex rules that can apply to the sale.

To use a common example, let’s assume that the property you want to sell is land or depreciable property used in your business, and has been held by you for more than a year.

Different rules can apply for property held primarily for sale to customers in the ordinary course of business, intellectual property, low-income housing, property that involves farming or livestock, and other types of property.

Basic rules

Under tax law, your gains and losses from sales of business property are netted against each other. The tax treatment is as follows:

1. If the netting of gains and losses results in a net gain, then long-term capital gain treatment results, subject to “recapture” rules discussed below. Long-term capital gain treatment is generally more favorable than ordinary income treatment.
2. If the netting of gains and losses results in a net loss, that loss is fully deductible against ordinary income. In other words, none of the rules that limit the deductibility of capital losses apply.

The availability of long-term capital gain treatment for business property net gain is limited by “recapture” rules. Under these rules, amounts are treated as ordinary income, rather than capital gain, because of previous ordinary loss or deduction treatment.

There’s a special recapture rule that applies only to business property. Under this rule, to the extent you’ve had a business property net loss within the previous five years, any business property net gain is treated as ordinary income instead of long-term capital gain.

Different types of property

Under the Internal Revenue Code, different provisions address different types of property. For example:

Section 1245 property. This consists of all depreciable personal property, whether tangible or intangible, and certain depreciable real property (usually real property that performs specific functions). If you sell Section 1245 property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset.

Section 1250 property. In general, this consists of buildings and their structural components. If you sell Section 1250 property that’s placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to depreciation recapture. However, for most noncorporate taxpayers, the gain attributable to depreciation deductions, to the extent it doesn’t exceed business property net gain, will (as reduced by the business property recapture rule above) be taxed at a rate of no more than 28.8% (25% plus the 3.8% net investment income tax) rather than the maximum 23.8% rate (20% plus the 3.8% net investment income tax) that generally applies to long-term capital gains of noncorporate taxpayers.

Other rules apply to, respectively, Section 1250 property that you placed in service before 1987 but after 1980 and Section 1250 property that you placed in service before 1981.

As you can see, even based on the simple assumptions described here, the tax treatment of the sale of business assets can be complex. Consult an advisor to work through potential sticking points before the sale.

© 2024 KraftCPAs PLLC

Creating a comprehensive and actionable succession plan is rarely easy for business owners, but there are ways to go about succession planning in a slow, methodical manner that can make it relatively easier. In fact, it may strengthen the plan you eventually devise.

Lay down a foundation

Among the best ways to begin building the framework of your succession plan is to determine what you’ve got. You know you own a business, but how much is it worth, and what are its primary value drivers?

To determine these things, you can engage a qualified valuation expert familiar with your industry. Even if retirement is years or decades away, a valuation can provide fascinating and useful insights about your company that may inspire key strategic moves.

In addition, clearly outline your projected date and goals for retirement. That is, do you intend to retire outright or gradually retire by moving to a part-time schedule? Some business owners step down but keep a seat on the board of directors. You can pave your own road, but make sure that your plan is clear and followed.

Be sure to consider all stakeholders when thinking about succession planning. Discuss the topic with, as appropriate and applicable, your spouse and family members — particularly those involved in the business — as well as fellow business owners and your leadership team. Give them an opportunity to provide input and listen carefully to what they say.

You’ll also need to choose the best method to transfer ownership of the company, whether through a sale, stock gift, buy-sell agreement, trust, or other option. It’s also wise to address retirement and estate planning — how will your succession plan help fund your retirement and provide for your family and/or heirs?

Evaluate your business plan

Another important step is reviewing and revising your business plan to incorporate an eventual ownership succession. A business plan is essentially a baseline for monitoring progress and keeping the company on track. The targets laid out in the plan should serve as performance goals, and regular reviews of the plan can help determine whether the business is meeting those goals.

The plan should also define the responsibilities of each executive and manager. Your company’s succession depends on the leadership team’s ability to understand and carry out the financial and marketing objectives of the business plan.

This includes setting up a program to identify potential successors who are willing and able to take over — whether they be family members, employees or third parties — and to develop their abilities and transfer knowledge to them. Training can include industry certification courses, leadership workshops, and business management classes, as well as day-to-day mentoring and job shadowing.

Form an outside team

Perhaps the most straightforward way to make succession planning easier is to form a team of qualified, objective outside advisors to guide you through the process. Your advisory team should include a CPA, attorney, and qualified valuation expert. Many contractors also meet with business consultants or brokers, insurance experts, and estate planning advisors.

These experts can help you fine-tune the many minute details of your succession plan. When the time comes for you to step down, they can guide you through the execution process to minimize the financial risks and tax consequences of, say, activating a buy-sell agreement you’ve established with other owners.

Dream it, build it

It’s important to note that succession plans aren’t only for future retirees. There may be other callings, business ventures or life circumstances that eventually motivate you to step down from the helm of your company. A solid succession plan, laid out well in advance, can help preserve the legacy of the business you’ve worked so hard to build.

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