Use Cost Segregation To Your Advantage

Is Cost Segregation Right For You?

In our previous article entitled “Strategies to Minimize Tax Liability for Business Owners” we talked briefly about the advantages of using Cost Segregation to accelerate depreciation on certain portions of both residential, and commercial real property. In this article, we’ll take a look at how, and why it may work for you. Additionally, we will share what you need to do to take advantage of the potential benefits.

As a reminder, Cost Segregation is a means by which owners of property can break out certain aspects of a building, and treat them like personal property for depreciation purposes. This allows you to depreciate a portion of your commercial property over 5, 7, or 15 years, rather than the standard 39 for commercial, or 27.5 for residential.

While certain aspects, like landscaping are fairly simple to document and segregate, you’d miss out on a number of opportunities to take advantage of all available accelerated deductions if you didn’t dig a little deeper. That’s where hiring a construction engineer who is a cost segregation specialist can be well worth the investment.

When to Hire a Professional

A cost segregation specialist can differentiate between elements of the building which are defined as “dedicated, decorative, or removable” versus what’s considered “necessary and ordinary for operation and maintenance of the building”. Assets included in the building cost which may be treated as personal property for depreciation purposes may include:

  • Carpeting and flooring
  • Bathroom fixtures
  • Dedicated cooling systems for machinery
  • Electrical fixtures and lighting
  • Decorative finishes

If you spent more than $750,000 to purchase, or remodel a building since 1987; which for rental and other commercial property is easy to do, HKMP can help you engage a specialist to perform a detailed study to identify components in your building qualifying for cost segregation, and who will provide supporting documentation for your allocations. This can be extremely insightful if you acquired the property.

A cost-segregation specialist will analyze architectural drawings, mechanical and electrical plans, and other blueprints to break out those components eligible for treatment as personal property from those which are structural components of the building. As part of their analysis, they’ll also identify, and allocate things like architecture and engineering fees, and other indirect costs to each element.

Take Full Advantage of TCIA Changes

The Tax Cuts and Jobs Act of 2017 (TCIA) made it even more attractive to identify assets which qualify for Cost Segregation. TCIA increases bonus depreciation on qualifying assets from 50% to 100%. It also allows you to retroactively utilize cost segregation on previously owned properties acquired after September 27, 2017. Prior tax law only applied to new construction, and remodels.

Before 1996, retroactive savings on property added since 1987 had to be realized over 4 years. However, in 1996, the law changed. Thus allowing cost savings to be realized all at once, upon completion of the cost segregation report. Until TCIA was enacted, it only applied to new construction. Taking advantage of Cost Segregation now allows you to claim retroactive deductions for catch-up depreciation on older buildings acquired since September 27, 2017 which didn’t qualify for cost segregation prior to the enactment of TCIA. Additionally, you can claim all the savings in one tax year.

Weigh the Costs and Benefits

By utilizing your cost-segregation specialist’s report, HKMP can ensure you take advantage of every opportunity to reduce your tax liability by adjusting the timing on your depreciable assets.  Advantages include:

  • Increased cash flow in years when costs are higher
  • Revisiting properties purchased used which were previously ineligible for cost segregation
  • Identifying opportunities to take advantage of catch-up depreciation
  • Possible reduction to real estate taxes by shifting costs away from real property
  • Potential increase in deductions for sales and use tax
  • Documentation of your re-allocations in the event of IRS inquiries

Please keep in mind, when you’re re-allocating assets you’ve depreciated in prior years, you could create a liability for recaptured depreciation. This could trigger understatement penalties, especially if you’re overly aggressive in your use of cost segregation. Also, cost segregation reports do have a cost. Therefore, it’s a good idea to weigh the potential benefits before any study is done.

HKMP can help weigh the costs and benefits of reallocating assets identified in your cost segregation report. Allowing you to make informed and intelligent decisions, and reallocate costs for the best possible outcome.

Financial Benefits of Estate Planning

Estate Planning: Know Your Worth

Estate planning is an oft-overlooked, but no less important part of your overall financial plan. Although the primary goal is to protect your assets postmortem, there are also tax advantages you can use to minimize the amount of assets you use to pay taxes now, and in the future.

One of the most common misconceptions when it comes to estate planning, is it’s only necessary for large estates. Granted, unless the value of your estate exceeds $12.06 million for Federal purposes (though this is scheduled to revert back to $5.49  million in 2026), and $6.11 million for the State of New York, it’s exempt from estate taxes. But taxes are just the tip of the iceberg.

Make Sense of the Dollars and Cents

Knowing not only the components of your estate, but their values is crucial when you’re:

  • Drawing up a will, and allocating assets amongst your heirs
  • Determining how much life insurance to buy

First, you’ll want to make a list of all of your intangible assets, as these tend to be more valuable

  • Bank accounts (checking, savings, CD’s)
  • Brokerage accounts (stocks, bonds, mutual funds)
  • Life insurance policies
  • Retirement plans (IRA, 401(k), pension)
  • HSA’s
  • Ownership interest in any businesses

Second, you’ll want to make a list of your tangible assets: Homes, land, and real estate

  • Vehicles
  • Collectibles
  • Jewelry
  • Household goods including electronics, furniture, power tools, and equipment

You can either estimate the value of these items based on:

  • Recent appraisals or comps, or
  • How you expect your heirs to value them

HKMP is here to help. We can ensure tangible assets are valued accurately, taking current market trends and fluctuations into consideration.

Make sure you include a list of account numbers, contact numbers for the custodians, and the location of relevant documents for all intangible assets. You can utilize bank and brokerage statements, or current financial statements where applicable to determine their current value.

The Pluses and Minuses Matter

Third, create a list of your creditors, and the current amount of debt with each one, even if it’s zero. Like your intangible assets, these things tend to ebb and flow over time:

  • Loans
  • Mortgages
  • HELOCs
  • Credit cards

Again, list all account numbers, contact numbers for whoever holds the debt, and where the statements, contracts, credit cards, or check books are located.

Knowing the value of your estate can provide the information you need to purchase adequate life insurance sufficient to relieve your heirs of any debt attached to your assets, and ensures your will is as complete as possible.

Make Important Decisions Sooner Rather Than Later

This is also the time to make certain important decisions:

  • Assign an Estate Administrator
  • Give medical power of attorney to a trusted individual in the event you’re unable to speak for yourself
  • Assign durable financial power of attorney allowing someone to manage your financial affairs if you’re medically unable to do so. This can include paying bills and taxes, as well as allowing your designee to manage and access your assets.
  • Determine whether or not you want to create either a Revocable or Irrevocable Living Trust.
  • Identify your beneficiaries (or in some cases, identify exclusions)
  • Who gets what?
  • Who are your contingent beneficiaries?
  • Manage designees on accounts such as retirement, insurance, bank, and brokerage
  • Update as circumstances change

Give Your Estate Plan Regular Check-Ups

While there are many low-cost, DIY options available for both managing your estate, and drafting wills and trusts, it’s up to you to determine whether or not it’s in your best interests, and those of your heirs to incur the cost of an attorney and certified public accountant to ensure your assets and heirs are protected, and your wishes are properly documented. Factors affecting your decision may include:

  • The size of your estate
  • Whether your wishes and allocations are simple or complicated
  • If you have concerns for the care of minor children
  • The size, number, and complexity of business interests
  • If you have non-familial heirs

Above all, revisit your estate plan periodically. The one thing you can count on in life is change, and more often than not, changes impact your estate, not only in value, but in how you want it allocated, and whether you need to revise your will.

Certain changes should, by nature and impact, trigger a reassessment:

  • Change of circumstances (job change, marriage, divorce, economic fluctuations)
  • Change of beneficiaries (birth, death, marriage, divorce)
  • Changes in State or Federal laws

With upcoming changes in tax laws affecting estates, let HKMP give your Estate Plan a financial check-up to determine whether there’s a potential favorable, or unfavorable impact from new laws and limitations.

Rental Property and Qualified Business Income

Are You Maximizing Your QBI Deduction?

If you’ve invested in real property, you’re probably using every opportunity you can to offset the income with expenses, so you don’t eat up the property’s cash flow with taxes. But are you doing everything you can to minimize your liability? If you’re not taking advantage of the QBI (Qualified Business Income) deduction, not only are you missing out on an opportunity, but your tax bill is higher than it should be.

As an investor in rental property, you’re probably already aware of the usual, allowable deductions available to you such as:

  • Advertising
  • Telephone and Internet
  • Repairs and Maintenance
  • Utilities
  • Employees
  • Interest
  • Etc.

You might also be taking advantage of special depreciation options discussed in a recent article entitled “Strategies to Minimize Tax Liability for Business Owners” including:

  • Section 179
  • Bonus Depreciation
  • Cost Segregation

What the Tax Cut and Jobs Act (TCJA) Means to You

You can maximize your QBI deduction on property held for lease or rental by taking advantage of the 20% pass-through deduction available through section 199A, which was introduced as the TCJAof 2017? Section 199A allows owners of certain pass-through businesses to deduct part of their qualified business income from a qualified trade or business.

What this could mean to you is a deduction of up to 20% of qualified business income if your rental property is held by a qualified trade or business, and you meet certain thresholds. On September 24, 2019, Revenue Procedure 2019-38 added:

“…a safe harbor allowing certain interests in rental real estate, including interests in mixed-use property, to be treated as a trade or business for purposes of the qualified business income deduction under section 199A of the Internal Revenue Code (section 199A deduction).

Of course, you do have to meet certain requirements in order to qualify:

As such, the deduction isn’t available to:

  • C-Corps
  • Income earned as an employee providing services
  • On properties with triple-net leases

Not unlike many deductions, there are also income thresholds which as of 2021 were:

  • $329,800 for Married couples filing jointly
  • $164,900 for all others

and for 2022 will be:

  • $340,100 for Married couples filing jointly
  • $170,050 for all others

How the QBI Deduction Works

Calculation of the deduction involves 2 components:

  • QBI – 20% of QBI from a domestic business meeting the ownership criteria discussed above, subject to the following limitations:
    • 50% of W-2 wages paid to employees of the business.
    • Or 25% of wages paid to employees of the business plus 2.5% of unadjusted basis immediately after acquisition (UBIA) of qualified property held for trade or business

Like much of the IRS code, section 199A can be quite convoluted. There are limitations and qualifications which can be difficult to navigate successfully. Having someone like HKMP, with extensive knowledge and experience with the IRS tax code, can ensure you meet all necessary criteria, your deduction is calculated correctly, and you don’t miss out on every opportunity for potential tax savings.

Protect Your QBI Deduction. Cover All the Bases.

Qualifying for the safe harbor isn’t just about meeting requirements for a qualifying business or understanding the thresholds which limit the deduction. There are specific record-keeping requirements which must be met as well:

  • Maintain separate books and records reflecting income and expenses for each property
    • Owners of multiple properties can satisfy this requirement by preparing separate income and expense statements for each property before consolidating.
  • Investment enterprises in existence less than 4 years must have at least 250 hours of service performed by the taxpayer or others for:
    • Plumbing
    • Landscaping
    • Landlord-related duties such as
      • Repairs and maintenance
      • Rent collection
      • Application review
      • Time spent with tenants
  • Ensure a record of all services performed includes:
    • Hours
    • Description
    • Dates of service
    • Who performed the service

In addition, you must attach a statement to your tax return for every year you rely on the safe harbor.

Enlisting HKMP’s help can ensure you comply with all the safe harbor requirements, maximize your deduction, and avoid jeopardizing the deduction now, or in the future.

The Importance of an Annual Financial Review

If you’ve ever been through a financial audit, you know they are time consuming and exhausting. Not to mention expensive. What if you could reduce the possibility of needing audited financials? Fortunately, you can. The answer is an annual financial review. They are less time consuming, less costly, and take less time away from you and your staff’s day-to-day business.

As a business owner, you accepted an element of risk the day you decided to launch your business. Continually monitoring and managing that risk affects every decision you make; every relationship you form.

Though annual reviews can help reduce your need for an audit, there are times an audit may be unavoidable, such as:

  • Financing for business expansion
  • Compliance

If you’re talking to lenders or investors about funds for expansion, you can be certain they’ll want reasonable assurance you’re worth the risk.

Depending on the nature of your business, and the industry in which you operate, you may be required to provide regular, audited financial statements to a government regulator. When audited financials are required, the auditor’s opinion is the assurance needed to provide a high level of confidence your company’s financial statements and disclosures conform to generally accepted accounting principles (GAAP) in the United States of America are presented fairly, and are free from any pertinent misstatements. However, if none of this applies to you, you might want to opt for reviews rather than audits.

How is an Annual Financial Review Different from an Audit?

A review is an examination by a CPA, where the auditor evaluates financial data to provide moderate assurance that they are not aware of any material modifications that should be made to the accompanying financial statements in order for them to be in accordance with GAAP. Due to the limited scope, a review has significantly less impact on time spent by staff and management than an audit.

While an audit and a review differ in their scope, they both consist of a systematic examination of the inputs to the financial statements in order for the accountant to provide a report which will, hopefully, state that the financials are free of material misstatements, and are prepared in accordance with GAAP.

HKMP can help you determine if, and when your company requires an external review.

Choosing the Right People for the Job

Audits and reviews must be performed by an independent, outside CPA.

Not every CPA firm is qualified to perform an audit or review. When the time comes for you to invest in an audit, you’ll need a firm who is experienced in your industry and understands your business. Although it could be the same firm who performs other services for your company, they must be able to maintain a position of independence throughout the audit.

It’s also important you feel confident they have a solid reputation, qualifications, and staffing to perform the audit efficiently. You need to ensure you’re ready for the process to begin, and avoid unnecessary, and often costly delays.

HKMP has the knowledge, experience, and reputation to ensure both audits and reviews are performed professionally, and efficiently. As such, they can advise you as to which process best serves your needs.

Prep Tips to Simplify Your Business Taxes

Tax Preparedness

Whether you’re a seasoned pro, or it’s your first-time filing taxes for a business, there are commonalities in what your tax preparer will need to ensure your returns are complete and accurate. Using a checklist will not only save time, but will help your tax professional find all the deductions and credits to which you’re entitled, giving you the lowest possible tax bill. Who doesn’t want to simplify their business taxes and pay less?

First and foremost, you should already have some form of business accounting system in place, capable of tracking your transactions, and generating reports. If you’re just starting out and have a minimum number of transactions, you might be able to keep it simple, using a spreadsheet, or Quicken.

However, you’ll pay for the simplicity by having to migrate to something more robust as your business grows.  Options for sole proprietors, freelancers, and very small businesses include Fresh Books, and Wave, both of which are recommended by Investopedia, Nerd Wallet, and PC Magazine.

If you’re growing, and have, or intend to have payroll, you might prefer something that will grow with you. Top picks include Xero, Quickbooks Online, and Zoho. Prices, functionality, integration and available modules vary from one system to another. For best results, and to avoid the perils of migration sooner than necessary, let HKMP help you determine which system will suit your needs and your growth, and provide the best overall value.

Checklists Simplified

Once you’ve entered all transactions for the year into your chosen accounting system, you can prepare the following reports:

  • Income and Expense (aka P & L)
  • Balance Sheet
  • Statement of Cash Flows
  • Previous Year’s Tax Return

This will help your tax preparer determine where additional detail is needed. You can start by providing detail for the following areas:

  • Assets purchased, depreciated, or disposed of
  • Loans
  • Leases
  • Opening and closing inventory, if applicable
  • Stocks or bonds purchased or sold
  • Payroll reports

Much of this information will also be useful when  tax planning during Q4 of 2022.

Information about your loans may be a little trickier this year if you took advantage of the Paycheck Protection Program (PPP), or Economic Injury Disaster Loan Program (EIDL). Though they may be excluded from income, it’s important to report them accurately so you won’t pay unnecessary taxes on funds which helped keep your business afloat amidst the challenges imposed by COVID regulations.

Detail Made Easy

Other areas for which you might be asked to provide detail are:

  • Officers’ salaries (corporations)
  • Guaranteed payments to partners (partnerships)
  • Dividends received broken down by payer
  • Taxes and licenses
  • Professional fees
  • Interest
  • Charitable contributions

Most of the accounting programs mentioned can create schedules by payee which will satisfy your accountant’s needs. Make sure your detail includes the tax year for which your tax payments were made so any pre-payments are applied correctly.

Staying Tax Prep Ready

Tax preparation shouldn’t be something you ignore until it’s time to give your records to your tax accountant. There are a number of ways to stay ahead of the curve so your accountant can not only prepare your tax returns, but help you with tax planning before the year is over. Above all, they’ll help simplify your business tax information gathering process and the transmitting of required filings at tax time.

  • Adequate accounts for collection of costs and income (e.g. Officers’ Salaries and bonuses separate from Employees)
  • Maintain up-to-date schedules for:
  • Taxes and licenses
  • Depreciation
  • Stocks and bonds
  • Reconcile accounts at least quarterly, if not monthly

Keeping your books and records up to date will enable you to schedule a tax planning appointment during the fourth quarter. There are many opportunities to improve your tax position in both the current, and subsequent year. Don’t lose out on many tax saving strategies by failing to act before the end of the year.

Make HKMP your one-stop-shop for accounting, tax planning, and tax preparation.

Avoid Post-Divorce Tax Consequences

Chances are, your life plan did not include filing for divorce. When you said, “I do”, you believed wholeheartedly it was a promise you’d honor as long as you and your spouse were alive. Unfortunately, life happens, and people change. Some couples can weather the storms and evolve together. Others are not. What’s important now is to protect yourself and ensure your share of what you built together is kept as intact as possible. All while avoiding post-divorce tax consequences.

Whether your divorce is amicable, or contentious, you need to get all agreements and disclosures in writing. This is needed to protect yourself, and ensure you receive an equitable distribution of marital property. A Statement of Net Worth and determining your tax filing status until the divorce is final need to occur as soon as possible after the initial divorce filing.

Engaging your accountant to help you navigate the financial details will help you avoid confusion. Your accountant can help mitigate potential conflict over past and future tax liability, refunds, and personal versus marital property.

Ensure Property Distribution is Equitable

The Statement of Net Worth is a sworn statement outlining each person’s assets, liabilities, and income. It’s important to be both accurate, and entirely honest when completing this document. Falsified, or omitted information can be used against you if you and your spouse fail to reach an agreement on the distribution of marital property.

Absent an agreement, the court will decide how assets and liabilities are divided. Omissions or falsifications can result in a less favorable distribution for the person who signed an inaccurate, or incomplete Statement.

While New York is an equitable distribution State, there are still a few which follow community property rules. What this means to you is marital property will be distributed equitably rather than 50/50. Divorce.net offers a list of factors the court will consider when determining what constitutes an equitable distribution in the State of New York. Some of those factors are:

  • Yours and your spouse’s income and property when you married, and on the date you filed for divorce
  • Length of the marriage
  • Yours and your spouse’s age and health
  • Whether the custodial parent needs to live in the family home, and have use or ownership of its effects.
  • Tax consequences to each of you

Separate property is not subject to distribution, but it’s important to know what it is, and how to ensure your Statement of Net Worth reflects both distributable and non-distributable assets, and income.

The experts at HKMP can not only help protect your sole and separate assets, but ensure all marital income and assets are accurately reported before you sign the Statement of Net Worth.

avoid divorce tax consequences

Marital vs Separate Property

In the State of New York, marital property includes anything acquired during the marriage, regardless of who acquired it including:

  • Income earned during the marriage
  • Property purchased with said income
  • Property purchased while married
  • Each person’s retirement benefits earned while married
  • Appreciation of marital property while married

There are a few exceptions which allow property to be considered separate property including:

  • Property acquired before marriage
  • Property either spouse acquired from someone other than each other by gift or inheritance
  • Compensation for personal injuries
  • Property spelled out as personal property in a prenuptial agreement, or other written contract
  • Property acquired from the proceeds or appreciation of separate property insofar as the appreciation didn’t involve a contribution or effort by the other person

Allocation of a business owned prior to the marriage can bring its own set of challenges if it wasn’t addressed in a prenuptial agreement. Though value prior to the marriage is considered separate property, there are certain aspects which can be considered marital property, and subject to equitable distribution.

  • Marital funds transferred to the business
  • Labor contributed to the business by the non-owner spouse
  • Appreciation of the business during the marriage
  • Enhancements such as professional licenses, and education achieved during the marriage

Also, labor contributions by the owner-spouse will be considered when determining how to equitably distribute the business. As such, it’s important to ensure the business is valued accurately at both the beginning and end of the marriage, and that labor contributions by both spouses are valued appropriately.

Appreciation of the business may also be considered allocable. As some spouses may try to hide or deflate assets, especially in a closely held business, hiring a forensic accountant can help ensure all aspects of the marital portion of the business are included, and valued correctly.

Choose Your Tax Filing Status Wisely

Although it’s possible for an uncontested divorce to take as little as six months, it’s more likely yours will take a year or more from start to finish. As such you and your spouse must also agree on tax filing status until the divorce is final, in the event you are still legally married on December 31. You must both sign a document if you wish to submit your returns as Married, filing jointly. Otherwise, you must use the filing status:

  • Married filing separately, or
  • Head of Household

Your tax preparer is your best resource when determining which status will be in your best interests, as well as which spouse, if either, can file as Head of Household. Only when you file for legal separation instead of divorce, and it is approved by the court by December 31, can you file as Single instead of Married, filing separately.

If part of your settlement involves selling the family home, each person is entitled to deduct up to $250,000 for capital gains purposes. Timing of the sale can have a positive or negative impact on the exclusion. An informed decision will protect your share of the sale and help maximize your tax benefits.

HKMP can review your assets, liabilities, and income to help maximize your tax benefits. Thus enabling you to make the best decisions possible under challenging circumstances. Divorce is expensive, financially, and emotionally. The last thing you need to deal with are post-divorce tax consequences.

Helpful Tips to Minimize Personal Taxes

Yes, You Can Minimize Your Personal Taxes

Every year, people like you pay too much in taxes. In most cases, the reason is lack of knowledge. There are many opportunities to decrease your tax liability and minimize your personal taxes, but if you don’t know they exist, how can you use them to your advantage?

The place to start is by understanding which opportunities are available to you. Do your earnings come from an employer? Self-employment? Both? Is there something you love doing which could be turned into a side hustle, or even a full-time business? The choices you make affect the tax saving opportunities available to you.

Tax Saving Opportunities For Employees

As an employee, your employer might offer you the opportunity to contribute pre-tax dollars into a Flexible Spending Account (FSA), Health Savings Account (HSA), or 401(k) account. By doing so, you reduce the taxable income reported on your W-2, which translates into a lower Adjusted Gross Income (AGI). Your AGI is the starting point for calculating your taxes. The lower your AGI, the less taxes you must pay.

By contributing to an FSA, you get to use pre-tax dollars to pay certain medical and dental expenses not covered by your insurance. Expenses included are:

  • Deductibles
  • Co-pays
  • Prescriptions
  • Over-the-counter medications prescribed by your doctor
  • Certain medical equipment

You get to contribute up to $2,850 per employer in 2022 but there’s a catch. You have to use at least $2,250 no later than 2 1/2 months after the end of the year, but you are allowed to carry up to $570 over into the next year.

If you have a high-deductible, Marketplace health plan, you might prefer to contribute to an HSA plan, if your employer offers you the option. Because these plans mean higher out-of-pocket expenses, you’re allowed to set aside more pre-tax dollars. For 2022, you can contribute up to $3,650 for individual, and $7,300 for families. You even get to contribute an extra $1,000 if you’re 55 or older.

Unlike an FSA, HSA’s have no provision requiring you to use the funds by a certain date, or risk losing part of your contributions. Instead, any funds remaining at the end of the year can be rolled over indefinitely. However, you can only choose this option if you have a high-deductible health plan.

Maximize Your Retirement, Minimize Your Taxes

Whether you’re an employee, business owner, or self-employed, maximizing contributions to your retirement account can not only lower your taxes in the current year, but help you provide for your own future. As an employee, the most common, elective option is a 401(k) plan.

Essentially, you contribute part of your salary to the plan. Like an FSA or HSA, the dollars are pre-tax, and the taxable income reported on your W-2 excludes your contributions. Though contributing to a 401(k) plan doesn’t protect you from paying taxes indefinitely, it can postpone your liability until after you’ve retired, and taxable income is lower.

Not only are you saving for your own future, but you can defer taxes on up to $20,500 for a 401(k) plan, or $14,000 for a SIMPLE 401(k) plan. If you are over 50, you’re also allowed to make catch-up contributions, and defer an additional $6,500 to a 401(k) plan, or $3,000 to a SIMPLE 401(k) plan, but only if your employer’s plan allows catch-up contributions. Be aware these limits might be adjusted by the terms of the plan.

It’s important to understand the rules concerning excess contributions, especially if you contribute to plans with more than one employer. HKMP can review your contributions in case you need to take a distribution by the April 15th deadline, This can potentially minimize your personal taxes and/or avoid being double taxed.

Retirement Plan Options for the Self-Employed

According to this recent article, there are several options for self-employed individuals. The most common are:

  • Traditional IRA
  • Solo 401(k), aka one-participant 401(k)
  • SEP IRA

If you’re just starting your business, a Traditional IRA offers a couple of advantages;

  • Simple to set up
  • You can roll an employer’s 401(k) into it
  • Can be set up easily with an online brokerage

However, if your self-employment income is growing quickly, you might want to choose another option since your contributions are limited to $6,000, or $7,000 if you’re 50 or older.

Tax Advantages for Higher Limit Plans

If your business is established, and enjoys higher earnings, a solo 401(k) might be a better option because it’s higher limits allow you defer more otherwise taxable income. You’re eligible if you’re self-employed, or a business owner with no employees other than a spouse. You can contribute to the plan:

  • As an employee, up to $20,500, plus $6,000 catch-up contributions, if applicable, or 100% of your salary,  whichever is less
  • For an employer, up to 25% of compensation except:
    • A sole proprietor or single owner LLC, up to 25% of net self-employment income
    • Net self-employment income for purposes of this calculation is net profit less half your self-employment tax, and the plan contributions you made for yourself.

If you are also contributing to an employer’s 401(k) plan, be aware your contribution limits apply to all plans in which you participate. Make sure you review your contributions to all plans as you may be double-taxed on any excess contributions.

Keep it Simple With a SEP IRA

As a business owner, or self-employed individual with either no, or a few employees, you can choose a SEP IRA.  Some advantages of a SEP IRA versus a solo 401(k) are:

  • No IRS reporting requirements
  • Allows you to make contributions for your employees
  • You can deduct the lesser of your contributions or 25% of net self-employment earnings, or compensation subject to certain limitations discussed below
  • Can be opened with an online broker like you would a traditional IRA

Possible disadvantages include:

  • No catch up contributions
  • You must contribute an equal percentage of salary for each eligible employee including yourself

Both a solo 401(k) and a SEP IRA are subject to the same compensation limits used to calculate your contribution. For 2022, the limit is $305,000.

Let HKMP help you make an informed decision, so you choose the plan which best fits your needs, both now, and as your business continues to grow. Allowing you to minimize your personal taxes and use that money elsewhere.

Tax Considerations When Retiring In Another State

Moving to another state is a key part of many peoples’ retirement plans. However, not everyone takes in to account all of the tax considerations when retiring in another state.

Some couples want to enjoy better weather so they can participate in more outdoor activities, such as those living up north who decide to relocate to Florida or Arizona. Others want to be closer to family members who may live far away.

Some retirees decide to move to lower their tax burden. There are seven states where individual income is not subject to state tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. And New Hampshire and Tennessee only assess state taxes on dividends and interest.

Identify All Applicable Taxes

It might seem like a no-brainer to simply move to a state with no personal income tax. To ensure you make a good decision, you must consider all taxes that can potentially apply to a state resident. In addition to income taxes, these may include property taxes, sales taxes and estate taxes.

If you’re considering moving to a state that does not have personal income tax, look closely at what types of income are taxed. Some states don’t tax wages but do tax interest and dividends, as noted above. And some states offer tax breaks for pension income and retirement plan and Social Security distributions.

For example, distributions from 401(k)s, IRAs and pensions are exempt from state tax in Illinois, Mississippi and Pennsylvania. However pension, but not 401(k) or IRA, income, is exempt from state tax in Alabama and Hawaii.

Watch Out For State Estate Tax

The federal estate tax currently doesn’t apply to many people. For 2021, the federal estate tax exemption is $11.7 million (or $23.4 million for a married couple). But some states levy additional estate taxes with a much lower exemption. Some may also have an inheritance tax in addition to (or in lieu of) an estate tax.

Establish Domicile In Your New State

If you make a permanent move to a new state and want to escape taxes in the state you came from, it’s important to establish legal domicile in the new location. The definition of legal domicile varies from state to state. In general, your domicile is your fixed and permanent home location and the place where you plan to return, even after periods of residing elsewhere.

Each state has its own rules regarding domicile. You don’t want to wind up in a worst-case scenario: Two states could claim you owe state income taxes if you established domicile in the new state but didn’t successfully terminate domicile in the old one. Additionally, if you die without clearly establishing domicile in just one state, both the old and new states may claim that your estate owes state income taxes and any applicable state estate tax.

The more time that elapses after you move to a new state and the more steps you take to establish domicile in the new state, the harder it will be for your old state to claim that you’re still domiciled there for tax purposes. Some ways to help lock in domicile in a new state include:

  • Buy or lease a home in the new state and sell your home in the old state (or rent it out at market rates to an unrelated party).
  • Change your mailing address at the post office.
  • Change your address on passports, insurance policies, your will or living trust and other important documents.
  • Register to vote, get a driver’s license and register your vehicle in the new state.
  • Open and use bank accounts in the new state and close accounts in the old one.

Also, if an income tax return is required in the new state, file a resident return and file a nonresident return or no return (whichever is appropriate) in your old state. We can help with these returns.

Make an Informed Choice

Before deciding where you want to live in retirement, do your research and contact your tax professional. We can help you better understand the tax considerations when retiring in another state. This will allow you to avoid unpleasant tax surprises that could be very costly.

Sales and Use Tax For Online Sellers After the Wayfair Case

It has been nearly three years since the U.S. Supreme Court decision was handed down that changed sales and use tax rules for online sellers. Known as South Dakota v. Wayfair, Inc., or simply as the Wayfair case, the ruling removed the physical presence requirement for sales tax nexus.

As a result, states can now require businesses to collect sales tax on goods and services sold in the state even if the business has no physical presence in the state. The ruling primarily affects online businesses and companies that sell via mail or telephone order (sometimes referred to as MOTO businesses).

Surprisingly, many companies have yet to adapt to the ruling. Often companies have heard of Wayfair but haven’t done anything about it.

Here are some of the most common questions clients have about how they can keep up with their sales and use tax obligations.

How does a company know where to file sales and use tax?

To know if it has a filing responsibility, a company needs to understand state law and how it applies to the company’s activities in the state.

Wayfair expanded states’ ability to require out-of-state companies to collect the state’s sales tax. Now, states can require out-of-state companies to collect the state’s sales tax if the company has sufficient “economic presence” in the state.

The most common economic threshold for a sales tax requirement is $100,000 in sales or 200 transactions in a state. The traditional parameters, however, such as whether a company has an employee presence or physical locations in the state, still apply. Complicating the situation, each state has its own parameters for determining when sales and use tax needs to be collected.

How can companies be sure they’re calculating sales and use tax correctly?

Calculating sales and use tax requires an analysis of state law and an understanding of the state’s sourcing rules. Depending on the state, some transactions are taxed all the time while some are circumstantially exempt.

Typically, a state will source a sale to the jurisdiction where the good is sold or delivered. Identifying that particular jurisdiction, however, can be tricky. Most states have a tax rate lookup system that enables companies to search for the correct jurisdiction and rate. However, it can be daunting when a company has thousands of customers with different addresses. Complete accuracy would require a check of every single transaction.

Alternatively, a company can invest in sales tax automation software. Whether that software produces the correct result depends on whether the correct information was input at the start.

What are the greatest challenges for companies that want to handle sales and use tax compliance in-house?

These companies face three main challenges: personnel, cost and risk. Calculating sales tax in-house requires at least one individual who is more than just knowledgeable about sales taxes. Companies that invest in such a person risk that person moving on and taking their knowledge with them. Also, calculating sales tax isn’t really a full-time job. Returns are typically due around the 20th of the month, so there’s a lot of downtime for an inhouse sales tax expert.

In addition, compliance and research software costs may be associated with handling sales and use tax in-house. Finally, if the person handling sales tax doesn’t rise to the expert level, there’s increased risk that the decisions made will turn out to be incorrect. This may lead to taxes, penalties and interest upon audit.

What tools can companies use to help with sales and use tax compliance?

Software can help, but the more complicated the software, the more expensive it gets. Also, software needs to be set up correctly and checked often to ensure its accuracy. This requires an expert.

Another option is to outsource the function or employ a hybrid solution. For example, a company could work with a sales tax expert on a quarterly basis to make sure filings are occurring in the right states, tax is being charged when it should be, and tax is being calculated correctly and for the right jurisdiction.

Although sales tax is often the smallest item on the invoice, companies should take it seriously. States will be motivated to go after out-of-state companies that haven’t been filing when they should have.

Contact us if you’d like assistance getting a handle on your sales and use tax obligations.

Succession Planning Strategies: 5 Questions to Ask Before Selling Your Business

1. What Are Your Post-Business Ownership Plans?

How much thought have you given to what you’re going to do after you sell your business? Maybe you plan to retire and take it easy for a while. If so, you should work closely with a professional wealth advisor to develop a detailed retirement financial plan to help ensure that you have sufficient resources to support your desired retirement lifestyle.

Or maybe you want to start another company after you sell your existing business. In this case, you’ll want to make sure that the proceeds from the sale of your business are sufficient to launch your new venture.

2. To Whom Will You Sell The Business?

Business buyers usually fall into one of two broad categories: internal buyers or external buyers. An internal buyer may be your existing employees or management team. In this case, the business sale could be conducted via an employee stock ownership plan (ESOP) or management buyout (MBO). Or it could be family members if yours is a family-run business.

There are two main types of external buyers: financial buyers and strategic buyers. Financial buyers, such as private equity groups, look for companies with high growth potential. This way, in the future, they can sell your company at a profit to reap a return on their investment. Strategic buyers, meanwhile, seek businesses whose products or services complement their own, such as a competitor. This kind of merger can help the buyer gain market share by acquiring your customer base and consolidating operations.

3. How Can You Add Value To The Business Before Putting It On The Market?

The best way to boost the eventual sale price of your business is to focus on key business value drivers today. These are things you can do now to make your business more valuable in the eyes of buyers while reducing potential risks.

For example, are your corporate records, contracts and other legal documents all current and in good standing? Are your financial statements accurate and current and is your technology up to date? Have you developed a seasoned and experienced management team that’s prepared, and financially incentivized, to help ensure a smooth transition to new ownership? Most importantly, is there a realistic business growth plan in place that will enable buyers to realize positive ROI on their investment?

4. How Much Is Your Business Worth?

This is the proverbial $64,000 question. Many owners think they have a good idea of what their business is worth based on their gut instinct. But this value often isn’t realistic. Most owners have an emotional connection to their business and tend to over-value the sweat equity they’ve put into building it.

Buyers will look at your business from a purely numbers and analytical approach. The main thing they’re looking at is the quality of business earnings and how repeatable these earnings are in the future. It might make sense to engage a valuation professional to conduct a quality of earnings study to estimate the future cash flow potential of the business and come up with at least a rough business valuation.

5. Who Will Form Your Business Advisory Team?

Selling a business is a lengthy and complex process that requires high-level expertise. You should begin forming a business advisory team that includes the following:

  • An investment banking firm to market your business.
  • A valuation professional to help you gauge business value and determine the selling price.
  • An experienced M&A attorney.
  • A Tax advisor
  • who specializes in the sale of closely held businesses.

Even if you’re not planning to sell anytime soon, it’s still smart to go ahead and start the succession planning for your business now. This way, you’ll be ahead of the game when you’re ready to exit the business one day down the road.