Author: KraftCPAs

Does your business need to prepare financial statements that conform to U.S. Generally Accepted Accounting Principles (GAAP)? Or should you generate financial statements based on the same methods you use for federal income tax purposes?

Not knowing the key differences between these frameworks can potentially be costly for your business.

GAAP basics

GAAP is the most common financial reporting standard in the United States. It’s based on the principle of conservatism, which generally ensures proper matching of revenue and expenses with a reporting period. The principle also aims to prevent companies from overstating profits and asset values to mislead investors and lenders.

The Securities and Exchange Commission (SEC) requires public companies to follow GAAP. Many lenders expect private borrowers to follow suit because GAAP is familiar and consistent. Likewise, if owners plan to sell the company, prospective buyers may prefer to perform due diligence on GAAP financial statements — or they may be public companies that are required to follow GAAP.

Tax-basis framework

However, some private companies opt to report financial results using a special reporting framework. One common format is based on reporting for federal income tax purposes. Contrary to GAAP, tax laws generally tend to favor accelerated gross income recognition and won’t allow taxpayers to deduct expenses until the amounts are known and other deductibility requirements have been met. In general, a company’s taxable income when reported in accordance with the tax-basis framework tends to be higher than its pretax profits as reported with GAAP.

To determine whether to use the tax-basis framework, management needs to decide if outside parties are going to rely on the financial statements. Tax-basis reporting might be appropriate if a business is owned, operated, and financed by individuals who are closely involved in day-to-day operations and understand its financial position. However, investors and lenders generally prefer GAAP financials to help them compare a company’s financial performance to others in the same industry.

Key differences

When comparing GAAP and tax-basis statements, one difference is the terminology used on the income statement. Under GAAP, companies report revenue, expenses, and net income. Tax-basis entities report gross income, deductions, and taxable income, and they report nontaxable items as separate line items or as footnote disclosures.

Capitalization and depreciation of fixed assets is another noteworthy difference. Under GAAP, the cost of a fixed asset (less its salvage value) is capitalized and systematically depreciated over its useful life. Companies that use GAAP must assess whether useful lives and asset values remain meaningful over time and occasionally incur impairment losses if an asset’s market value falls below its book value. For tax purposes, fixed assets are depreciated under the Modified Accelerated Cost Recovery System (MACRS), which generally results in shorter lives than under GAAP. Salvage value isn’t subtracted for tax purposes, but Section 179 and bonus depreciation deductions are subtracted before computing MACRS deductions.

Other reporting differences exist for inventory, pensions, leases, and accounting for changes and errors. Tax laws also prohibit deducting the following items:

• Penalties and fines
• Start-up costs
• Accrued vacations (unless they’re taken within 2½ months after the end of the taxable year)

In addition, companies record allowances for bad debts, sales returns, inventory obsolescence, and asset impairment under GAAP. These allowances generally aren’t permitted under tax law. Instead, they’re deducted when transactions take place or conditions are met that make the amount fixed and determinable.

Get it right

The optimal financial reporting method depends on your company’s situation, and deciding on one can be difficult. A CPA can help compare the pros and cons of each method to help determine the best option.

© 2024 KraftCPAs PLLC

The April 15 tax filing deadline is closing in. Even so, and despite best intentions, some taxpayers won’t be ready to file. Whatever the reason, consider filing Form 4868 for an extension if you suspect that April 15 will be an impossible deadline.

An extension will give most taxpayers until October 15 to file and helps avoid “failure-to-file” penalties. However, it only provides extra time to file, not extra time to pay. Whatever tax is owed must still be sent by April 15, or penalties will apply — and they can be steep.

There’s one notable change in the filing deadline this year for residents of Davidson, Dickson, Montgomery, and Sumner counties. Because those areas were declared federal disaster areas following severe storms in early December 2023, taxpayers in those counties have until June 17, 2024, to file federal returns. Extensions apply to many other returns as well.

Two different penalties

Separate penalties apply for failing to pay and failing to file. The failure-to-pay penalty is 0.5% for each month (or part of a month) the payment is late. For example, if payment is due April 15 and is made May 25, the penalty is 1% (0.5% times 2 months or partial months). The maximum penalty is 25%.

The failure-to-pay penalty is based on the amount shown as due on the return (less amounts paid through withholding or estimated payments), even if the actual tax bill turns out to be higher. On the other hand, if the actual tax bill turns out to be less, the penalty is based on the lower amount.

The failure-to-file penalty runs at the more severe rate of 5% per month (or partial month) of lateness to a maximum 25%. If a Form 4868 extension is obtained, then the filing is late only if the extended due date is missed. However, keep in mind that a filing extension doesn’t change the responsibility for payment.

If the 0.5% failure-to-pay penalty and the failure-to-file penalty both apply, the failure-to-file penalty drops to 4.5% per month (or part), so the combined penalty is 5%. The maximum combined penalty for the first five months is 25%. Thereafter, the failure-to-pay penalty can continue at 0.5% per month for 45 more months (an additional 22.5%). Thus, the combined penalties can eventually reach as much as 47.5%.

The failure-to-file penalty is also more severe because it’s based on the amount required to be shown on the return, not just the amount shown as due. (Credit is given for amounts paid through withholding or estimated payments. If no amount is owed, there’s no penalty for late filing.) For example, if a return is filed three months late showing $5,000 owed (after payment credits), the combined penalties would be 15%, which equals $750. If the actual liability is later determined to be an additional $1,000, the failure-to-file penalty (4.5% × 3 = 13.5%) would also apply to this amount for an additional $135 in penalties.

A minimum failure-to-file penalty also applies if a return is filed more than 60 days late. This minimum penalty is the lesser of $485 (for returns due after December 31, 2023) or the amount of tax required to be shown on the return.

Exemption in certain cases 

Both penalties may be excused by the IRS if lateness is due to “reasonable cause” such as death or serious illness in the immediate family.

Interest is assessed at a fluctuating rate set by the federal government apart from and in addition to the above penalties. Also, in particularly abusive situations involving a fraudulent failure to file, the late filing penalty can jump to 15% per month, but with a 75% maximum.

© 2024 KraftCPAs PLLC

If you have a tax-favored retirement account, including a traditional IRA, you’ll become exposed to the federal income tax required minimum distribution (RMD) rules after reaching a certain age. If you inherit a tax-favored retirement account, including a traditional or Roth IRA, these rules will also apply.

Specifically, you’ll be required to:

Take annual withdrawals from the accounts and pay the resulting income tax

and/or reduce the balance in your inherited Roth IRA sooner than you might like

Here’s a look at the current rules after recent tax-law changes.

RMD basics

The RMD rules require affected individuals to take annual withdrawals from tax-favored accounts. Except for RMDs that meet the definition of tax-free Roth IRA distributions, RMDs will generally trigger a federal income tax bill (and, in some states, a state tax bill).

Under a favorable exception, the original account owner of a Roth IRA is exempt from the RMD rules during his or her lifetime. But if you inherit a Roth IRA, the RMD rules for inherited IRAs come into play.

A later starting age

The SECURE 2.0 law was enacted in 2022. Previously, you generally had to start taking RMDs for the calendar year during which you turned age 72. However, you could decide to take your initial RMD until April 1 of the year after the year you turned 72.

SECURE 2.0 raised the starting age for RMDs to 73 for account owners who turn age 72 in 2023 to 2032. So, if you attained age 72 in 2023, you’ll reach age 73 in 2024, and your initial RMD will be for calendar 2024. You must take that initial RMD by April 1, 2025, or face a penalty for failure to follow the RMD rules. The tax-smart strategy is to take your initial RMD, which will be for calendar year 2024, before the end of 2024 instead of in 2025 (by the April 1, 2025, absolute deadline). Then, take your second RMD, which will be for calendar year 2025, by Dec. 31, 2025. That way, you avoid having to take two RMDs in 2025 with the resulting double tax hit in that year.

A reduced penalty

If you don’t withdraw at least the RMD amount for the year, the IRS can assess an expensive penalty on the shortfall. Before SECURE 2.0, if you failed to take your RMD for the calendar year in question, the IRS could impose a 50% penalty on the shortfall. SECURE 2.0 reduced the penalty from 50% to 25%, or 10% if you withdraw the shortfall within a “correction window.”

Controversial 10-year liquidation rule

A change included in the original SECURE Act (which became law in 2019) requires most non-spouse IRA and retirement plan account beneficiaries to empty inherited accounts within 10 years after the account owner’s death. If they don’t, they face the penalty for failure to comply with the RMD rules.

According to IRS proposed regulations issued in 2022, beneficiaries who are subject to the original SECURE Act’s 10-year account liquidation rule must take annual RMDs, calculated in the usual fashion — with the resulting income tax. Then, the inherited account must be emptied at the end of the 10-year period. According to this interpretation, you can’t simply wait 10 years and then drain the inherited account.

The IRS position on having to take annual RMDs during the 10-year period is debatable. Therefore, in Notice 2023-54, the IRS stated that the penalty for failure to follow the RMD rules wouldn’t be assessed against beneficiaries who are subject to the 10-year rule who didn’t take RMDs in 2023. It also stated that IRS intends to issue new final RMD regulations that won’t take effect until sometime in 2024 at the earliest.

© 2024 KraftCPAs PLLC

Assessing internal controls is just one step in the external audit process, but it’s a big step toward avoiding risks and setbacks down the road. By understanding an auditor’s approach to assessing internal controls, a business or organization can be better prepared for audit inquiries and additional procedures performed during fieldwork.

Guided by COSO framework

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) Internal Control: Integrated Framework outlines five components of internal controls that are required by Sarbanes-Oxley Act’s Section 404:

Control environment. A set of standards, processes, and structures is needed to provide the basis for carrying out internal controls across the organization.

Risk assessment. This dynamic, iterative process identifies stumbling blocks to the achievement of the company’s strategic objectives and forms the basis for determining how risks will be managed.

Control activities. Policies and procedures are necessary to help ensure that management’s directives to mitigate risks to the achievement of objectives are carried out.

Information and communication. Relevant and quality information supports the internal control process. Management should continually gather and share this information with people inside and outside company.

Monitoring. Management should routinely evaluate whether each of the five components of internal controls is present and functioning.

The COSO framework isn’t just for public companies that must comply with the Sarbanes-Oxley Act. It applies to all entities that follow U.S. Generally Accepted Accounting Principles (GAAP) standards.

The audit inquiry

During fieldwork, auditors will ask questions about your company’s internal controls. Under auditing standards set by the American Institute of Certified Public Accountants (AICPA), auditors must have a thorough understanding of a client’s information system, including the related business processes and communication relevant to financial reporting. They also need to distinguish between business processes and control activities.

Business processes are activities that accomplish three things:

• Develop, purchase, produce, sell and distribute products and services
• Ensure compliance with laws and regulations
• Record information, including accounting and financial reporting information

In contrast, control activities are “steps put in place by the entity to ensure that the financial transactions are correctly recorded and reported.” Auditors are expected to obtain an understanding of only those control activities that are considered relevant to the audit. There are no standard approaches when it comes to understanding business processes and control activities. The requirements vary from audit to audit.

Auditors often use detailed internal control questionnaires to perform a comprehensive assessment of the internal control environment. The content of these questionnaires is usually customized for a particular industry or business, although most include general questions about the company’s mission, control environment, and compliance situation. There also may be sections dedicated to mission-critical or fraud-prone elements of the company’s operations. Examples include accounts receivable, inventory, intellectual property, related-party transactions, and payroll.

Additional audit procedures

Each year, auditors must evaluate the design of the financial reporting controls that are related to the audit and determine if they’ve been properly implemented. This requires more than just inquiring with company personnel. Auditors must use additional procedures — such as observations, inspection, or tracing transactions through the information system — to obtain an understanding of controls relevant to the audit. The appropriate procedures are based on the auditor’s professional judgment.

For existing clients, auditors may leverage information from their previous experience with the entity and the results from audit procedures performed in previous reporting periods. In doing so, auditors evaluate whether changes affecting the control environment have occurred since the previous audit that may affect that information’s relevance to the current audit.

Eye on risk factors

Auditors are specifically expected to understand controls that address significant risks. These controls are identified and assessed for risks of material misstatement that require special consideration. Examples include control activities that:

• Are relevant to the risk of fraud
• Relate to nonrecurring, unusual transactions, or adjustments

Control activities that are relevant to a given audit may vary, depending on the client’s size, complexity, and nature of operations. Auditors consider such issues as materiality, risk, other components of the internal controls, and legal and regulatory requirements. Again, what’s relevant is a matter of the auditor’s professional judgment.

Changes are inevitable

Internal and external risk factors change over time. Upon completion of the year-end financial statements, you should brainstorm ways to update and strengthen your controls with an eye on the changing risk environment. Your review should cover the following three basic controls:

Physical restrictions. Employees should have access only to those assets necessary to perform their jobs. Locks and alarms are examples of ways to protect valuable tangible assets, including petty cash, inventory, and equipment. But intangible assets — such as customer lists, lease agreements, patents, and financial data — also require protection with controls including passwords, access logs, and appropriate legal paperwork.

Account reconciliation. Management should confirm and analyze account balances on a regular basis. To illustrate, proactive organizations reconcile bank statements and count inventory on a regular basis. Waiting until year end to complete these basic procedures can be a sign of weak oversight.

Job descriptions. Another basic control is maintaining detailed, up-to-date job descriptions. This exercise can help you better understand how financial job duties interact with one another. It can also highlight possible conflicts of interest that could lead to improper recordkeeping. Your policies should call for job segregation, job duplication, and mandatory vacations.

Team effort

Effective internal controls are critical to accurate financial reporting. It’s important to work closely with your external audit team to ensure your organization has a solid system of controls in place to help prevent, detect and correct financial misstatements due to errors and fraud.

© 2024 KraftCPAs PLLC

QuickBooks Online can tell you where your money comes from and where it’s going in very detailed, customizable reports. These reports can help you determine, for example, whether you should continue to sell a specific product or whether customers are paying their invoices late.

Sometimes, though, you may want to group all the income and costs that comprise a specific job. The site’s Project tools can tally all of that automatically. You can determine whether your project-related income, product and service costs, worker costs, and other expenses warrant taking on certain jobs in the future.

If you’re using QuickBooks Online Plus or Advanced, you can use these tools to calculate the profitability of projects by assigning relevant sales, time, and expenses to them. Here’s how it works.

Getting set up

Before you start working with Projects in QuickBooks Online, make sure you have the feature turned on. Click the gear icon in the upper right and select Account and settings. Click Advanced in the toolbar and scroll down to Projects. If the button there isn’t green, click it, then click Save. Click Done in the lower right to return to the main screen.

Creating a project record

To get started, click Projects in the toolbar to open a comprehensive “homepage.” This will eventually display a list of projects you’ve created that you’ll be able to filter by Status, Customer, and Employee rate.  Click New project in the upper right. A panel slides out from the right where you’ll create a project record by selecting a Customer and entering a Project name. Optional fields here include State date and End Date, Status (defaults to In progress), and Notes.

Click Save when you’re done. Now your project name will appear directly under its customer’s name when you’re entering transactions.

Assigning transactions to projects

Now that you’ve created a Project record, you can start assigning income and costs to it. There are seven types of transactions that can be assigned to projects: Invoice, Receive payment, Expense, Estimate, Time, Bill, and Purchase order. Where you enter the project name depends on the form type.

When you’re spending money on a project that you will eventually bill a customer for, (expense, bill, purchase order), you’ll choose a Vendor at the top of the form as you document billable purchases. In the table below (where you enter the products and/or services that you’re buying), you’ll select your Customer/Project in a column there. Be sure there’s a checkmark in the Billable column.

TIP: On Bill and Expense forms, you’ll notice another column in front of Customer/Project labeled Markup %. You can add a percentage to your billables to charge the customer a little extra for your work in obtaining needed materials.

When you’re creating the other four types of transactions (invoices, receive payment, estimate, and time), you’ll find your project listed under the Customer name at the top.

Also importantly, when you’re assigning transactions to projects, make sure you select the actual project name, not just the customer’s name.

The project “home page”

Once you’ve created a project, you can get to its relevant “homepage” by clicking it in the list on the main Projects page. This is where you can track each project’s progress, including its real-time profitability.

At the top of this page, you’ll see a line graph that shows your current Income vs. Cost. And you’ll see a number representing your profit margin. There are also links that take you to reports for open and overdue invoices.

A button in the upper right opens links that take you to pages where you can enter project-related transactions. You don’t have to be on the Projects page to enter these transactions, though. You can enter them as you normally would on their own pages and assign them accordingly.

Project “homepages” also contain other types of information, such as:

Overview. A breakdown of income, costs, and profit

Transactions. A list of project transactions that you can filter by Type and Date

Time Activity. A list of billable work completed

Reports. Project profitability, time costs, and unbilled time and expenses

Attachments. A space for uploading documents

The mechanics of creating Projects in QuickBooks Online are not difficult, but the process requires precise recordkeeping. You want to make sure that you’re billing your customers for everything you’ve provided and done. Also, if everything is recorded accurately, you’ll be able to look at your profit margins and determine whether you need to make any pricing changes in the future.

© 2024 KraftCPAs PLLC

It’s often assumed that Social Security benefits are always free from federal income tax. Unfortunately, that’s not the case. In fact, depending on how much overall income you have, up to 85% of your benefits could be hit with federal income tax.

While the truth about the federal income tax bite on Social Security benefits may be tough to hear, it’s good to understand how the rules work.

Calculate provisional income

The amount of Social Security benefits that must be reported as taxable income on your tax return depends on your provisional income. To determine provisional income, start with your adjusted gross income (AGI), which is the number that appears on Page 1, Line 11 of Form 1040. Then, subtract your Social Security benefits to arrive at your adjusted AGI for this purpose.

Next, take that adjusted AGI number and add the following:

• 50% of Social Security benefits
• Any tax-free municipal bond interest income
• Any tax-free interest on U.S. Savings Bonds used to pay college expenses
• Any tax-free adoption assistance payments from your employer
• Any deduction for student loan interest
• Any tax-free foreign earned income and housing allowances, and certain tax-free income from Puerto Rico or U.S. possessions

The result is your provisional income.

Find your tax scenario

Once you know your provisional income, you can determine which of the following three scenarios applies to you.

Scenario 1: All benefits are tax-free

If your provisional income is $32,000 or less, and you file a joint return with your spouse, your Social Security benefits will be federal-income-tax-free. But you might owe state income tax.

If your provisional income is $25,000 or less, and you don’t file jointly, the general rule is that Social Security benefits are totally federal-income-tax-free. However, if you’re married and file separately from your spouse who lived with you at any time during the year, you must report up to 85% of your Social Security benefits as income unless your provisional income is zero or a negative number, which is unlikely.

Having federal-income-tax-free benefits is nice, but, as you can see, this favorable outcome is only allowed when provisional income is quite low.

Scenario 2: Up to 50% of your benefits are taxed

If your provisional income is between $32,001 and $44,000, and you file jointly with your spouse, up to 50% of your Social Security benefits must be reported as income on Form 1040.

If your provisional income is between $25,001 and $34,000, and you don’t file a joint return, up to 50% of your benefits must be reported as income.

Scenario 3: Up to 85% of your benefits are taxed

If your provisional income is above $44,000, and you file jointly with your spouse, you must report up to 85% of your Social Security benefits as income on Form 1040.

If your provisional income is above $34,000, and you don’t file a joint return, the general rule is that you must report up to 85% of your Social Security benefits as income.

But remember, you also must report up to 85% of your benefits if you’re married and file separately from your spouse who lived with you at any time during the year — unless your provisional income is zero or a negative number.

© 2024 KraftCPAs PLLC

The qualified business income (QBI) deduction is available to businesses through 2025. If you’re eligible, be sure to make the most of the deduction while it’s still on the books, because it can be a big tax-saver.

Deduction basics

The QBI deduction is written off at the owner level. It can be up to 20% of:

• QBI earned from a sole proprietorship or single-member LLC that’s treated as a sole proprietorship for tax purposes
• QBI from a pass-through entity, meaning a partnership, LLC that’s treated as a partnership for tax purposes or S corporation

How is QBI defined? It’s qualified income and gains from an eligible business, reduced by related deductions. QBI is reduced by:

• Deductible contributions to a self-employed retirement plan
• The deduction for 50% of self-employment tax
• The deduction for self-employed health insurance premiums.

Unfortunately, the QBI deduction doesn’t reduce net earnings for purposes of the self-employment tax, nor does it reduce investment income for purposes of the 3.8% net investment income tax (NIIT) imposed on higher-income individuals.

Limitations

At higher income levels, QBI deduction limitations come into play. For 2024, these begin to phase in when taxable income before any QBI deduction exceeds $191,950 ($383,900 for married joint filers). The limitations are fully phased in once taxable income exceeds $241,950 or $483,900, respectively.

If your income exceeds the applicable fully-phased-in number, your QBI deduction is limited to the greater of: 1) your share of 50% of W-2 wages paid to employees during the year and properly allocable to QBI, or 2) the sum of your share of 25% of such W-2 wages plus your share of 2.5% of the unadjusted basis immediately upon acquisition (UBIA) of qualified property.

The limitation based on qualified property is intended to benefit capital-intensive businesses such as hotels and manufacturing operations. Qualified property means depreciable tangible property, including real estate, that’s owned and used to produce QBI. The UBIA of qualified property generally equals its original cost when first used in the business.

Finally, your QBI deduction can’t exceed 20% of your taxable income calculated before any QBI deduction and before any net capital gain (net long-term capital gains more than net short-term capital losses plus qualified dividends).

Unfavorable rules for certain businesses 

For a specified service trade or business (SSTB), the QBI deduction begins to be phased out when your taxable income before any QBI deduction exceeds $191,950 ($383,900 for married joint filers). Phaseout is complete if taxable income exceeds $241,950 or $483,900, respectively. If your taxable income exceeds the applicable phaseout amount, you’re not allowed to claim any QBI deduction based on income from a SSTB.

Other factors

Other rules apply to this tax break. For example, you can elect to aggregate several businesses for purposes of the deduction. It may allow someone with taxable income high enough to be affected by the limitations described above to claim a bigger QBI deduction than if the businesses were considered separately.

There also may be an impact for claiming or forgoing certain deductions. For example, in 2024, you can potentially claim first-year Section 179 depreciation deductions of up to $1.22 million for eligible asset additions (subject to various limitations). For 2024, 60% first-year bonus depreciation is also available. However, first-year depreciation deductions reduce QBI and taxable income, which can reduce your QBI deduction. So, you may have to thread the needle with depreciation write-offs to get the best overall tax result.

© 2024 KraftCPAs PLLC

More than 100,000 small businesses in Tennessee will have one less tax bill starting this year.

As part of the newly passed Tennessee Works Tax Act, businesses with annual gross sales of less than $100,000 within a county or city are no longer liable for a business tax return. The change applies to tax periods ending on or before December 31, 2023. Eligible businesses have been sent letters with instructions on confirming their eligibility.

The new law doesn’t change rules regarding business licenses, which are still required. And for jurisdictions in which a business has total gross sales between $3,000 and $100,000, the business must maintain a minimal activity license from the local county or city.

Find more details on the legislation at the Tennessee Department of Revenue website.

© 2024 KraftCPAs PLLC

The U.S. Department of Labor’s test for determining whether a worker should be classified as an independent contractor or an employee for purposes of the federal Fair Labor Standards Act (FLSA) has been revised several times over the past decade. Now, the DOL is implementing a new final rule that rescinds the employer-friendly test starting March 11, 2024.

Role of the new final rule

Even though the DOL’s final rule isn’t necessarily controlling for courts weighing employment status issues, it’s likely to be considered persuasive authority. Moreover, it’ll guide DOL misclassification audits and enforcement actions.

Under the new rule, a business that is found to have misclassified employees as independent contractors may owe back pay – in addition to penalties – if employees weren’t paid minimum wage or overtime pay. It also could end up liable for withheld employee benefits and find itself subject to federal and state employment laws that apply based on the number of affected employees.

The rescinded test

The Trump administration’s test (known as the 2021 Independent Contractor Rule) focused primarily on whether, as an “economic reality,” workers are dependent on employers for work or are in business for themselves. It examined five factors, and while no single factor was controlling, two so-called “core factors” were deemed most relevant:

• The nature and degree of the employer’s control over the work
• The worker’s opportunity for profit and loss

If both factors suggested the same classification, it’s substantially likely that classification was proper.

The new test

The final new rule closely shadows the proposed rule published in October 2022. According to the DOL, it continues the notion that a worker isn’t an independent contractor if, as a matter of economic reality, the individual is economically dependent on the employer for work. The DOL says the rule aligns with both judicial precedent and its own interpretive guidance prior to 2021.

Specifically, the final rule enumerates six factors that will guide DOL analysis of whether a worker is an employee under the FLSA:

• The worker’s opportunity for profit or loss depending on managerial skill (the lack of such opportunity suggests employee status)
• Investments by the worker and the potential employer (if the worker makes similar types of investments as the employer, even on a smaller scale, it suggests independent contractor status)
• Degree of permanence of the work relationship (an indefinite, continuous or exclusive relationship suggests employee status)
• The employer’s nature and degree of control, whether exercised or just reserved (control over the performance of the work and the relationship’s economic aspects suggests employee status)
• Extent to which the work performed is an integral part of the employer’s business (if the work is critical, necessary, or central to the principal business, the worker is likely an employee)
• The worker’s skill and initiative (if the worker brings specialized skills and uses them in connection with business-like initiative, the worker is likely an independent contractor)

In contrast to the 2021 rule, all factors will be weighed — no single factor or set of factors will automatically determine a worker’s status.

The final new rule does make some modifications and clarifications to the proposed rule. For example, it explains that actions that an employer takes solely to comply with specific and applicable federal, state, tribal, or local laws or regulations don’t indicate “control” suggestive of employee status. But those that go beyond compliance and instead serve the employer’s own compliance methods, safety, quality control, or contractual or customer service standards may do so.

The final rule also recognizes that a lack of permanence in a work relationship can sometimes be due to operational characteristics unique or intrinsic to businesses or industries and the workers they employ. The relevant question is whether the lack of permanence is due to workers exercising their own independent business initiative, which indicates independent contractor status. On the other hand, the seasonal or temporary nature of work alone doesn’t necessarily indicate independent contractor classification.

The return, and clarification, of the factor related to whether the work is integral to the business also is notable. The 2021 rule includes a noncore factor that asks only whether the work was part of an integrated unit of production. The final new rule focuses on whether the business function the worker performs is an integral part of the business.

For tax purposes

In a series of Q&As, the DOL addressed the question: “Can an individual be an employee for FLSA purposes even if he or she is an independent contractor for tax purposes?” The answer is yes.

The DOL explained that the IRS applies its version of the common law control test to analyze if a worker is an employee or independent contractor for tax purposes. While the DOL considers many of the same factors as the IRS, it added that “the economic reality test for FLSA purposes is based on a specific definition of ‘employ’ in the FLSA, which provides that employers ‘employ’ workers if they ‘suffer or permit’ them to work.”

In court cases, this language has been interpreted to be broader than the common law control test. Therefore, some workers who may be classified as contractors for tax purposes may be employees for FLSA purposes because, as a matter of economic reality, they’re economically dependent on the employers for work.

Next steps

Not surprisingly, the DOL’s final new rule is already facing court challenges. Nonetheless, employers should review their work relationships with freelancers and other independent contractors and make any appropriate changes. Remember that states can have different tests, some of which are more stringent than the DOL’s final rule.

© 2024 KraftCPAs PLLC

The credit for increasing research activities, often referred to as the research and development (R&D) credit, is a valuable tax break available to certain eligible small businesses. Claiming the credit involves complex calculations, but the savings can make the effort worthwhile.

In addition to the credit itself, be aware that there are two additional features that are especially favorable to small businesses:

• Eligible small businesses ($50 million or less in gross receipts for the three prior tax years) may claim the credit against alternative minimum tax (AMT) liability.
• The credit can be used by certain smaller startup businesses against their Social Security payroll and Medicare tax liability.

Let’s look at the second feature. The Inflation Reduction Act (IRA) has doubled the amount of the payroll tax credit election for qualified businesses and made a change to the eligible types of payroll taxes it can be applied to, making it better than it was before the law changes kicked in.

Election basics

Subject to limits, your business can elect to apply all or some of any research tax credit that you earn against your payroll taxes instead of your income tax. This payroll tax election may influence you to undertake or increase your research activities. On the other hand, if you’re engaged in — or are planning to undertake — research activities without regard to tax consequences, you could receive some tax relief.

Many new businesses, even if they have some cash flow, or even net positive cash flow and/or a book profit, pay no income taxes and won’t for some time. Thus, there’s no amount against which business credits, including the research credit, can be applied. On the other hand, any wage-paying business, even a new one, has payroll tax liabilities. Therefore, the payroll tax election is an opportunity to get immediate use out of the research credits that you earn. Because every dollar of credit-eligible expenditure can result in as much as a 10-cent tax credit, that’s a big help in the start-up phase of a business — the time when help is most needed.

Eligible businesses

To qualify for the election a taxpayer must:

• Have gross receipts for the election year of less than $5 million, and
• Be no more than five years past the period for which it had no receipts (the start-up period).

In making these determinations, the only gross receipts that an individual taxpayer considers are from the individual’s businesses. An individual’s salary, investment income or other income aren’t considered. Also, note that an entity or individual can’t make the election for more than six years in a row.

Limits on the election

The research credit for which the taxpayer makes the payroll tax election can be applied against the employer portion of Social Security and Medicare. It can’t be used to lower the FICA taxes that an employer withholds and remits to the government on behalf of employees. Before a provision in the IRA became effective for 2023 and later years, taxpayers were only allowed to use the payroll tax offset against Social Security, not Medicare.

The amount of research credit for which the election can be made can’t annually exceed $500,000. Prior to the IRA, the maximum credit amount allowed to offset payroll tax before 2023 was only $250,000. Additionally, an individual or C corporation can make the election only for those research credits which, in the absence of an election, would have to be carried forward. In other words, a C corporation can’t make the election for the research credit to reduce current or past income tax liabilities.

These are just the basics of the payroll tax election. Keep in mind that identifying and substantiating expenses eligible for the research credit itself is a complex task.

© 2024 KraftCPAs PLLC

In the dynamic landscape of industrial business, mergers and acquisitions (M&A) are becoming increasingly important strategic tools. But there are critical tax considerations that industrial businesses need to be aware of when embarking on M&A activities, including potential impacts of macroeconomic conditions such as inflation and interest rates on deal-making, as well as key tax issues ranging from cost segregation and bonus depreciation, to global minimum tax and superfund excise tax.

Read the full article here.

When launching a small business, it’s common for entrepreneurs to start out as sole proprietors. And as with any business classification, a sole proprietorship includes its own unique set of tax issues and considerations.

Here’s what to know if you’re considering that option.

You may qualify for the pass-through deduction. To the extent your business generates qualified business income, you’re eligible to claim the 20% pass-through deduction, subject to limitations. The deduction is taken “below the line,” meaning it reduces taxable income, rather than being taken “above the line” against your gross income. However, you can take the deduction even if you don’t itemize deductions and instead claim the standard deduction. This deduction is only available through 2025, unless Congress acts to extend it.

You report income and expenses on Schedule C of Form 1040. The net income will be taxable to you regardless of whether you withdraw cash from the business. Your business expenses are deductible against gross income and not as itemized deductions. If you have losses, they’ll generally be deductible against your other income, subject to special rules related to hobby losses, passive activity losses, and losses from activities in which you weren’t “at risk.”

You must pay self-employment taxes. For 2024, you pay self-employment tax (Social Security and Medicare) at a 15.3% rate on your net earnings from self-employment up to $168,600, and Medicare tax at a 2.9% rate on the excess. An additional 0.9% Medicare tax (for a total of 3.8%) is imposed on self-employment income more than $250,000 for joint returns, $125,000 for married taxpayers filing separate returns, and $200,000 in all other cases. Self-employment tax is imposed in addition to income tax, but you can deduct half of your self-employment tax as an adjustment to income.

You generally must make quarterly estimated tax payments. For 2024, deadlines are April 15, June 17, September 16, and January 15, 2025.

You can deduct 100% of your health insurance costs as a business expense. This means your deduction for medical care insurance won’t be subject to the rule that limits medical expense deductions.

You may be able to deduct home office expenses. If you work from a home office, perform management or administrative tasks there, or store product samples or inventory at home, you may be entitled to deduct an allocable part of certain expenses, including mortgage interest or rent, insurance, utilities, repairs, maintenance, and depreciation. You may also be able to deduct travel expenses from a home office to another work location.

You should keep complete records of your income and expenses. Specifically, you should carefully record your expenses to claim all the tax breaks to which you’re entitled. Certain expenses, such as automobile, travel, meals, and home office expenses, require extra attention because they’re subject to special recordkeeping rules or deductibility limits.

You have more responsibilities if you hire employees. For example, you need to get a taxpayer identification number and withhold and pay over payroll taxes.

You should consider establishing a qualified retirement plan. Amounts contributed to it are deductible at the time of the contributions and aren’t taken into income until they’re withdrawn. You might consider a SEP plan, which requires minimal paperwork. A SIMPLE plan is also available to sole proprietors and offers tax advantages with fewer restrictions and administrative requirements. If you don’t establish a retirement plan, you may still be able to contribute to an IRA.

© 2024 KraftCPAs PLLC