TAX+BUSINESS ALERT
News for your business and your life. | Hawkins Ash CPAs
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In this Edition
May 4, 2021
Know the Ins and Outs of "Reasonable Compensation" for a Corporate Business Owner
PODCAST: Child Deduction Credit
Claiming the Business Energy Credit for Using Alternative Energy
Bolster Wealth Management With Trusts
3 Things to Know After Filing Your Tax Return
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Know the Ins and Outs of "Reasonable Compensation" for a Corporate Business Owner |
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Owners of incorporated businesses know that there’s a tax advantage to taking money out of a C corporation as compensation rather than as dividends.
The Reason
A corporation can deduct the salaries and bonuses that it pays executives, but not dividend payments. Thus, if funds are paid as dividends, they’re taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is only taxed once — to the employee who receives it. However, there are limits to how much money you can take out of the corporation this way. Under tax law, compensation can be deducted only to the extent that it’s reasonable. Any unreasonable portion isn’t deductible and, if paid to a shareholder, may be taxed as if it were a dividend. Keep in mind that the IRS is generally more interested in unreasonable compensation payments made to someone “related” to a corporation, such as a shareholder-employee or a member of a shareholder’s family.
Determining Reasonable Compensation
There’s no easy way to determine what’s reasonable. In an audit, the IRS examines the amount that similar companies would pay for comparable services under similar circumstances. Factors that are taken into account include the employee’s duties and the amount of time spent on those duties, as well as the employee’s skills, expertise and compensation history. Other factors that may be reviewed are the complexities of the business and its gross and net income. There are some steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation.
For example, you can:
- Keep compensation in line with what similar businesses are paying their executives (and keep whatever evidence you can get of what others are paying to support what you pay). In the minutes of your corporation’s board of directors, contemporaneously document the reasons for compensation paid. For example, if compensation is being increased in the current year to make up for earlier years in which it was low, be sure that the minutes reflect this. (Ideally, the minutes for the earlier years should reflect that the compensation paid then was at a reduced rate.)
- Cite any executive compensation or industry studies that back up your compensation amounts. Avoid paying compensation in direct proportion to the stock owned by the corporation’s shareholders. This looks too much like a disguised dividend and will probably be treated as such by IRS. If the business is profitable, pay at least some dividends. This avoids giving the impression that the corporation is trying to pay out all of its profits as compensation.
You can avoid problems and challenges by planning ahead. If you have questions or concerns about your situation, contact us.
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Author: Randy Juedes, CPA
Direct: 715.748.1346
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PODCAST
Child Deduction Credit
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With the American Rescue Plan that was signed into law in March included a provision that we talked about a month or so ago. This provision increases the child tax credit and changes the way that it is paid out. |
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Claiming the Business Energy Credit for Using Alternative Energy |
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Are you wondering whether alternative energy technologies can help you manage energy costs in your business? If so, there’s a valuable federal income tax benefit (the business energy credit) that applies to the acquisition of many types of alternative energy property. The credit is intended primarily for business users of alternative energy (other energy tax breaks apply if you use alternative energy in your home or produce energy for sale).
Eligible Property
The business energy credit equals 30% of the basis of the following: Equipment, the construction of which begins before 2024, that uses solar energy to generate electricity for heating and cooling structures, for hot water, or heat used in industrial or commercial processes (except for swimming pools).
- If construction began in 2020, the credit rate is 26%, reduced to 22% for construction beginning in calendar year 2023; and, unless the property is placed in service before 2026, the credit rate is 10%. Equipment, the construction of which begins before 2024, using solar energy to illuminate a structure’s inside using fiber-optic distributed sunlight.
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If construction began in 2020, the credit rate is 26%, reduced to 22% for construction beginning in 2023; and, unless the property is placed in service before 2026, the credit rate is 0%. Certain fuel-cell property the construction of which begins before 2024.
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If construction began in 2020, the credit rate is 26%, reduced to 22% for construction beginning in 2023; and, unless the property is placed in service before 2026, the credit rate is 0%. Certain small wind energy property the construction of which begins before 2024.
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If construction began in 2020, the credit rate is 26%, reduced to 22% for construction beginning in 2023; and, unless the property is placed in service before 2026, the credit rate is 0%. Certain waste energy property, the construction of which begins before January 1, 2024.
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If construction began in 2020, the credit rate is 26%, reduced to 22% for construction beginning in 2023; and, unless the property is placed in service before 2026, the credit rate is 0%. Certain offshore wind facilities with construction beginning before 2026.
There’s no phase-out of this property. The credit equals 10% of the basis of the following:
- Certain equipment used to produce, distribute, or use energy derived from a geothermal deposit.
- Certain cogeneration property with construction beginning before 2024.
- Certain microturbine property with construction beginning before 2024.
- Certain equipment, with construction beginning before 2024, that uses the ground or groundwater to heat or cool a structure.
Pluses and Minuses
However, there are several restrictions. For example, the credit isn’t available for property acquired with certain non-recourse financing. Additionally, if the credit is allowable for property, the “basis” is reduced by 50% of the allowable credit. On the other hand, a favorable aspect is that, for the same property, the credit can sometimes be used in combination with other benefits — for example, federal income tax expensing, state tax credits or utility rebates.
There are business considerations unrelated to the tax and non-tax benefits that may influence your decision to use alternative energy. And even if you choose to use it, you might do so without owning the equipment, which would mean forgoing the business energy credit. As you can see, there are many issues to consider. We can help you address these alternative energy considerations.
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Contact: Amanda Farley, CPA
Phone: 920.337.4554
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Bolster Wealth Management With Trusts |
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Trusts can be a useful tool for affluent individuals and families when it comes to wealth management, protection and growth. But there are a wide variety to choose from, so it’s important to clearly understand the benefits and limits of a trust before choosing any one type.
What’s a Trust?
A trust is a legal document that dictates how an individual’s assets will be managed for another person’s (or other people’s) benefit(s). There are usually three parties to a trust: the grantor who creates the trust, the beneficiary (or beneficiaries) who’ll benefit from the trust and the trustee(s) who’ll manage the assets according to the trust’s terms and in the beneficiary’s best interests.
All trusts fall into one of two broad categories: living trusts and testamentary trusts. Living trusts are set up during an individual’s lifetime to transfer property to the trust. Testamentary trusts are established as part of an individual’s will and take effect after he or she dies.
Living trusts can be further categorized as revocable and irrevocable. With a revocable trust, the grantor retains control of the trust’s assets and can revoke or change its terms at any time. With an irrevocable trust, the grantor no longer owns the assets and, thus, can’t make changes to the trust without the beneficiary’s consent.
How Can One Protect You?
Individuals looking to manage their wealth in a patient and prudent manner can achieve various financial and estate planning goals from a trust, depending on its type. For example, many affluent individuals, professionals and business owners use a Delaware statutory trust to protect their assets from a loss resulting from a legal judgment, such as malpractice or personal injury liability. A Delaware trust also can be used instead of a prenuptial agreement by a spouse to preserve his or her assets in case of a divorce.
When establishing a Delaware trust, you transfer the assets you want to protect to an irrevocable trust — these assets can include cash, business ownership interests, real estate, and securities like stocks and bonds. These assets generally will be protected from future creditors. Although you must give up some control of the assets when you place them in the trust, you can retain some powers, such as the right to direct the investment of trust assets and to receive income and principal distributions from the trust.
Who Can Help?
There are many other trust types to consider. The rules for establishing and maintaining any trust can be complex, so please contact our firm for guidance.
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Contact: Matt Cantlon, CPA
Phone: 507.252.6672
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3 Things to Know After Filing Your Tax Return |
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Most people feel a sense of relief after filing their tax returns. But even if you’ve successfully filed your 2020 return with the IRS, there may still be some issues to bear in mind.
Here are three important things to know:
1. You can check on your refund.
The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Get Your Refund Status.” You’ll need your Social Security number, filing status and the exact refund amount.
2. You can file an amended return if you forgot to report something.
In general, you can file an amended tax return and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later. So, if you filed your 2020 tax return on April 15, 2021, you would typically have until April 15, 2024, to file an amended return.
However, there are a few opportunities when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.
3. You can throw out some tax records.
You should keep tax records related to your return for as long as the IRS can audit your return or assess additional taxes. The statute of limitations is generally three years after you file your return.
That means you can probably dispose of most tax-related records for the 2017 tax year and earlier years. (If you filed an extension for your 2017 return, hold on to your records until at least three years from when you filed the extended return.) However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.
You’ll need to hang on to certain tax-related records longer. For example, keep actual tax returns indefinitely so you can prove to the IRS that you filed legitimately. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)
Keep records associated with retirement accounts until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset, plus at least three years after you sell it and report the sale on your tax return. (You can keep these records for six years if you want to be extra safe.)
Always Available
Contact us if you have further questions about your refund, filing an amended return or record retention. We’re here all year!
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Contact: Judy Haven, CPA
Phone: 262.243.9610
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More Resources from CPA-HQ |
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PODCAST: Vacation Home Rental
In the old days, rental of your personal residence was mainly done for properties on a nice lake, a warm climate, or a resort area. Now with Airbnb, people everywhere are renting out their homes. These rentals can last hours, days or weeks.
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Be Prepared for Taxes on Social Security Benefits
Whether you’ve filed your 2020 tax return or soon will, you probably don’t want any surprises. One thing that takes many older people off-guard is getting taxed on their Social Security benefits.
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Business Highlights in the New American Rescue Plan Act
President Biden signed the $1.9 trillion American Rescue Plan Act (ARPA) on March 11. While the new law is best known for the provisions providing relief to individuals, there are also several tax breaks and financial benefits for businesses. Here are some of the tax highlights of the ARPA.
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