The decision relative to what basis of accounting you should select for tax purposes is an important one. The two primary methods available are the cash basis method or the accrual basis method. The core difference between these two methods of accounting pertains to when revenue and expenses are recognized. The cash basis method recognizes revenues when cash is received and expenses when they are paid out. The accrual basis method recognizes revenues in the period earned and expenses are recognized in the period incurred regardless of when cash is actually received or paid out.
Which Method is Ideal for My Business?
The answer to this question much depends on the industry you are in and often the timing of payments to vendors as opposed to collections from clients. The cash basis method tends to provide the most flexibility with respect to when profits are recognized as it is primarily driven by cash received and cash paid. Alternatively, if your company tends not to have significant receivables by nature of the industry, often the accrual basis of accounting can prove favorable. For example, restaurants utilizing the accrual method of accounting can be afforded the benefit of recording accruals and payables owed to vendors and receive tax benefits even though the expenses have not been paid.
When is the Accrual Method Required?
The overall cash method of accounting is available to S corporations, partnerships (that do not have a C corporation as a partner), and personal service corporations (PSCs). A PSC performs activities in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting; and substantially all the stock of the corporation is held by employees performing services for the corporation in connection with those activities.
IRC §448 expressly prohibits C corporations, partnerships which have a C corporation as a partner, and tax shelters from using the cash basis method. However, within a C Corporation context,the cash basis method is available if their average annual gross receipts for the prior three tax years are less than $5 million. For a group of C corporations that files a consolidated return, the gross receipts of all the corporations in the group are aggregated for the $5 million test.
Entities that produce, purchase, or sell merchandise in the ordinary course of business where inventory is an integral component of their business must use the accrual method for purchases and sales of merchandise. There are certain exceptions in which a qualifying sole proprietorship or qualifying small business taxpayer can use the cash method of accounting even if they produce, purchase, or sell merchandise.
To be a qualifying sole proprietorship, the following must be met:
- The average annual gross receipts for the past 3 taxable years is $1 Million or less
- The business is not a tax shelter
To be a qualifying small business taxpayer, the following must be met:
- Average annual gross receipts for past 3 taxable years is more than $1 million but not more than $10 million
- The principal business activity is an eligible business
Cash to Accrual Conversions
A taxpayer will choose a permitted method of accounting when filing their initial tax return. This method must be consistently applied from year to year. If a taxpayer desires to change his/her method of accounting he/she needs to obtain IRS approval via Form 3115. Depending on the industry, one method may be more advantageous than the other. For example, a software company that has annual subscriptions may benefit greatly by converting to the accrual basis as it can take advantages of deferred revenue for cash received but not yet earned.
A taxpayer that converts his/her methods of accounting will need to compute the cumulative difference between the present and proposed method of accounting. Generally the accounting areas of focus will be Accounts Receivable, Accounts Payable, Prepaid Expenses, and Accrued Expenses. The adjustment for change in accounting method is computed as of the beginning of the taxable year for which the method is being changed. If the adjustment results in a decrease to income then the taxpayer generally recognizes the adjustment in the year of change.
If the adjustment results in an increase to income, the taxpayer can recognize the adjustment over a four year period starting with the year of the change.
If you have any questions regarding your current accounting method or are considering a change, please do not hesitate to contact us.
Last year you may have made significant gifts to your children, grandchildren or other heirs as part of your estate planning strategy. Or perhaps you just wanted to provide loved ones with some helpful financial support. Regardless of the reason for making a gift, it’s important to know under what circumstances you’re required to file a gift tax return.
Some transfers require a return even if you don’t owe tax. And sometimes it’s desirable to file a return even if it isn’t required.
When filing is required
Generally, you’ll need to file a gift tax return for 2016 if, during the tax year, you made gifts:
- That exceeded the $14,000-per-recipient gift tax annual exclusion (other than to your U.S. citizen spouse),
- That exceeded the $148,000 annual exclusion for gifts to a noncitizen spouse,
- That you wish to split with your spouse to take advantage of your combined $28,000 annual exclusions,
- To a Section 529 college savings plan for your child, grandchild or other loved one and wish to accelerate up to five years’ worth of annual exclusions ($70,000) into 2016,
- Of future interests — such as remainder interests in a trust — regardless of the amount, or
- Of jointly held or community property.
When filing isn’t required
No return is required if your gifts for the year consist solely of annual exclusion gifts, present interest gifts to a U.S. citizen spouse, qualifying educational or medical expenses paid directly to a school or health care provider, and political or charitable contributions.
If you transferred hard-to-value property, such as artwork or interests in a family-owned business, consider filing a gift tax return even if you’re not required to. Adequate disclosure of the transfer in a return triggers the statute of limitations, generally preventing the IRS from challenging your valuation more than three years after you file.
Meeting the deadline
The gift tax return deadline is the same as the income tax filing deadline. For 2016 returns, it’s April 18, 2017 (or October 16 if you file for an extension). If you owe gift tax, the payment deadline is also April 18, regardless of whether you file for an extension.
Have questions about gift tax and the filing requirements? Contact us to learn more.
Sharing your wealth with a favorite charity can benefit those in need and reduce your taxable estate. In addition, your donations can ease your income tax liability. But you must meet IRS substantiation requirements. If you fail to do so, the IRS could deny the corresponding deductions you’re claiming. Let’s take a look at the requirements for different asset types.
Generally, you can substantiate gifts of less than $250 with a canceled check, written receipt or other reliable record (such as a credit card statement) that indicates the name of the charity and the amount and date of your gift.
If you donate more than $75 in exchange for goods or services other than intangible religious benefits (such as admission to religious ceremonies), the charity must provide you with a statement that 1) advises you that your deduction is limited to the amount by which your gift exceeds the value of those goods and services, and 2) provides a good-faith estimate of that value.
Gifts of $250 or more require a “contemporaneous” written acknowledgment from the charity that includes the amount and date of your gift and the estimated value of any goods or services you received or a statement that no goods or services were received. If goods or services received consisted entirely of intangible religious benefits, a statement to that effect must be included. An email will suffice.
To satisfy the contemporaneous requirement, you must have the acknowledgment in your possession before you file your income tax return. If you file later than the extended due date of your return, you must have received the acknowledgment by that extended due date.
If you make noncash gifts totaling more than $500 for the year, you must file Form 8283, “Noncash Charitable Contributions,” with your federal income tax return. And for gifts of property valued at more than $5,000 ($10,000 for closely held stock) you’ll need to obtain a “qualified appraisal” by a “qualified appraiser” and have the appraiser sign Sec. B, Part III, “Declaration of Appraiser.” If property is valued at more than $500,000, you’re required to attach a copy of the appraisal report to your return. No appraisal is required for publicly traded securities, regardless of value.
A qualified appraiser is a professional who meets certain education, experience and accreditation requirements. A qualified appraisal must 1) be prepared, signed and dated by a qualified appraiser other than the taxpayer or the recipient of the donation, 2) be conducted within 60 days of the gift, 3) provide certain information about the property, the appraiser and the valuation methods used, and 4) not involve fees based on a percentage of the appraised value or deduction amount.
Don’t leave it to chance
If you’ve made substantial charitable donations, their deductibility depends on compliance with IRS substantiation rules. Contact us to ensure you’ve properly substantiated your donations and can maximize your deductions on your 2016 income tax return.
Incentive stock options allow you to buy company stock in the future at a fixed price equal to or greater than the stock’s fair market value on the grant date. If the stock appreciates, you can buy shares at a price below what they’re then trading for. However, complex tax rules apply to this type of compensation.
Current tax treatment
ISOs must comply with many rules but receive tax-favored treatment:
- You owe no tax when ISOs are granted.
- You owe no regular income tax when you exercise ISOs, but there could be alternative minimum tax (AMT) consequences.
- If you sell the stock after holding the shares at least one year from the exercise date and two years from the grant date, you pay tax on the sale at your long-term capital gains rate. You also may owe the 3.8% net investment income tax (NIIT).
- If you sell the stock before long-term capital gains treatment applies, a “disqualifying disposition” occurs and any gain is taxed as compensation at ordinary-income rates.
So if you were granted ISOs in 2016, there likely isn’t any impact on your 2016 income tax return. But if in 2016 you exercised ISOs or you sold stock you’d acquired via exercising ISOs, then it could affect your 2016 tax liability. And it’s important to properly report the exercise or sale on your return to avoid potential interest and penalties for underpayment of tax.
Future exercises and stock sales
If you receive ISOs in 2017 or already hold ISOs that you haven’t yet exercised, plan carefully when to exercise them. Waiting to exercise ISOs until just before the expiration date (when the stock value may be the highest, assuming the stock is appreciating) may make sense. But exercising ISOs earlier can be advantageous in some situations.
Once you’ve exercised ISOs, the question is whether to immediately sell the shares received or to hold on to them long enough to garner long-term capital gains treatment. The latter strategy often is beneficial from a tax perspective, but there’s also market risk to consider. For example, it may be better to sell the stock in a disqualifying disposition and pay the higher ordinary-income rate if it would avoid AMT on potentially disappearing appreciation.
The timing of the sale of stock acquired via an exercise could also positively or negatively affect your liability for higher ordinary-income tax rates, the top long-term capital gains rate and the NIIT.
Keep in mind that the NIIT is part of the Affordable Care Act (ACA), and lawmakers in Washington are starting to take steps to repeal or replace the ACA. So the NIIT may not be a factor in the future. In addition, tax law changes are expected later this year that might include elimination of the AMT and could reduce ordinary and long-term capital gains rates for some taxpayers. When changes might go into effect and exactly what they’ll be is still uncertain.
If you’ve received ISOs, contact us. We can help you ensure you’re reporting everything properly on your 2016 return and evaluate the risks and crunch the numbers to determine the best strategy for you going forward.
The Internal Revenue Service has issued a warning to taxpayers, urging them to be wary of an influx of IRS imposter scams which use “robo-calls” and other new strategies to demand payments.
Recently there has been an increase in automated phone calls in which scam artists leave messages urging taxpayers to call back and resolve their “tax bill”. These fraudulent calls allege that they are the last alert before legal action is taken. Taxpayers may be threatened with arrest, deportation, or revocation of their driver’s license when they attempt to settle their fake bill with these imposters.
As part of the latest scam tactic, impostors are requesting payments on iTunes and other gift cards. The IRS warns taxpayers that any demand for payment through a gift card, prepaid debit card, or wire transfer is a telltale sign of fraudulence. Other indications of faux-IRS scamming include:
- Soliciting payment for a “Federal Student Tax”
- “Verifying” tax return information over the phone
- Acquiring W-2 information through human resource professionals
In addition, the IRS will never:
- Demand payment over the phone immediately
- Call about taxes owed without mailing a notice first
- Threaten to enlist police or other law-enforcement personnel to have you arrested
- Order you to pay taxes without giving you the chance to question or appeal the amount
- Request credit or debit card numbers over the pone
If you receive a suspicious call from somebody claiming to be an IRS agent asking for money, promptly hang up and do not disclose any information. You may also contact us with any concerns you have about such a phone call and we will be happy to assist.
The IRS is also warning taxpayers about email schemes. Taxpayers have been falling victim to phishing and malware emails that can pull information related to refunds, filing status, SSN, and other personal information.
The IRS generally does not contact taxpayers via email to request personal information. Other reported types of phishing has been through text message and social media channels. Common subject lines used in these phishing emails are:
- Variations of your tax refunds
- Updates on filing details
- Confirmation of personal information
- “Get my IP PIN”
- “Get my E-file PIN”
- “Order a transcript”
- “Complete your tax return information”
If you receive a suspicious email that you feel may be a scam relating to your taxes, feel free to forward to us and we can verify its authenticity.