Wander CPA

Taxes – they’re about as enjoyable as a trip to the dentist, right? But what if I told you there’s a clever loophole that can help you legally dodge the dreaded $10,000 annual cap on state and local taxes (SALT)? Enter PTET – the State Pass-Through Entity Tax, your ticket to cutting through the tax clutter. Understanding the SALT Tax Before we dive into the wizardry of PTET, let’s demystify the SALT tax. For those who itemize deductions, it’s possible to deduct certain state and local taxes from your tax bill. However, thanks to the Tax Cuts and Jobs Act (TCJA) of 2018, this deduction was capped at a measly $10,000 per year. This cap covers various taxes like state real property taxes, state income or sales taxes, and personal property taxes. The catch? This cap is set to stick around until 2025 unless Congress decides to make it a permanent fixture. The SALT cap doesn’t just leave taxpayers groaning; local governments are estimated to be missing out on a whopping $24.4 billion due to this limit. But fear not, PTET is here to help. Meet PTET: The Heroic Tax Bypass Picture this: you’re a business owner, and you’re churning out profits through your partnership, limited partnership, S-corporation, or multi-member LLC. You’re watching your tax bill grow, inching closer to that $10K SALT cap. But wait, there’s a plot twist – PTET. Pass-Through Entity Taxes work like this: instead of you paying those state income taxes from your personal tax return, your business entity (PTE) swoops in and covers the bill. This isn’t just a charitable move; the PTE then nabs a federal business expense deduction for those state income tax payments. And the cherry on top? This deduction isn’t subject to the $10K SALT cap. Neat, right? PTET in Action: An Enchanting Example Let’s step into the shoes of ABC, LLC, a two-member LLC raking in $400K in net income. Both members are grappling with hefty California property taxes exceeding $10K. What’s their play? Option 1: No PTE Tax They let the $200K each pass through and each pays 9.3% CA income tax, chalking up $18,600 each. But here’s the bummer – this isn’t deductible on their federal income tax returns because of the SALT cap from property tax. If their federal tax rate is 24%, they’re looking at a total of $48K. Option 2: The PTET Magic Now, if both LLC members hop on the PTET bandwagon, the LLC forks over a 9.3% PTE tax to the California Franchise, amounting to $37,200 of the $400K net income. This payment turns into a deductible federal business expense, lowering the net income to $362,800. Each member reports $181,400 on their individual Federal K1’s, leading to a tax bill of $43,536 (at a 24% federal tax rate). But wait, there’s more! On their California income tax returns, they each report $200K of net income from ABC partnership LLC, adding the $18,600 share of PTE tax paid by the partnership. They take a tax credit of $18,600 against their individual California income tax, effectively eliminating the need for extra CA income tax payment. Bye-bye $4,464 in federal taxes. And remember the Section 199A QBI deduction? That gets reduced by $7,440 for each partner, resulting in a reduced overall benefit of $4,464 – $893. Why Bother When SALT Limit’s Not Around? You might wonder if PTET is still worth the excitement when there’s no SALT limit. But guess what? It’s still a good deal. Reducing your income on your Federal K1 also means you’re cutting down the SE tax you’ll have to pay. And the IRS? They’re cool with it, as confirmed in their 2020 Notice. Just keep in mind that PTET doesn’t tackle property taxes or state income taxes on personal wages. This is all about state income taxes on your PTE’s income, which would otherwise make a pit stop on your personal tax return. Final Word So, there you have it – PTET, the ingenious way to outsmart the SALT cap and keep more of your hard-earned money in your pocket. Just remember, while tax magic can save you a bundle, consulting a tax professional is your magic wand for navigating the tax labyrinth. Sources: Bradford Tax Institute Tax Foundation

In 1984, when Section 7702 was enacted, Insurance carriers were required to provide at least 4% guaranteed interest rate of return. This could be net of reasonable carrier expenses. Since the reduction of interest rates (Moody’s AA corporate Bond Yield went from 12% in the 80’s to 2-3%), Section 7702 required from 4% to 2%. So for the same death benefit, carriers could now charge a higher premium. In order for an insurance policy’s cash value to have preferential tax treatment it must pass the “cash accumulation test” or “guideline premium test” which are defined by the IRS. We will focus on the former. This “Cash Accumulation Test” is met if the cash surrender value does not exceed the single premium that would have to be paid at such time to fund the policy’s death benefit at life expectancy, based on the minimum guaranteed interest rate in Section 7702. The “Cash Surrender Value” is the actual amount of money you will receive if you choose to terminate a permanent life insurance policy before its maturity date, or before you die. This is different from the insurance policy’s “cash value” which is the total sum compiled in your policy’s cash account. Could section 7702 interest rates go up? Yes, but these rates are contractual to each policy at issuance, so policies already in effect should not be negatively impacted. Typically, life insurance provides a federal income tax-free death benefit for your loved ones. It life insurance can also help by providing supplemental income that is usually income tax-free. In some policies, the death benefit option increases if the cash value does. This may be a requirement for the policy to qualify as “Life Insurance”. Tax-free benefits while still alive could be for the following: If your policy lapses, or it is surrendered, you will need to pay tax on gains made. Any outstanding loan will be deducted from the payout of course. Loans from life-insurance policy: If you would like to discuss this or other tax strategies with a CPA or other Tax expert, please reach out to us via phone at 310-894-3211 or email info@wandercpa.com

Know the $75 Rule for Business Expenses The $75 rule applies to certain business expenses where you do not need a receipt. But we emphasize that this rule does not apply to all tax deductions. Many taxpayers mistakenly apply the $75 rule to all their tax deductions, which can result in a significant loss of deductions and penalties. We encourage you to know the $75 rule and its limitations to avoid potential negative consequences. IRS Reg. Section 1.274-5(c)(2)(iii) contains the $75 rule, and Notice 95-50 provides a clear explanation of what it applies to. The rule applies to business travel expenses, vehicle expenses, and gifts that cost less than $75. But remember that the $25 limit on deductions for business gifts applies, meaning the practical limit is $25. It’s worth noting that your bank and credit card statements do not provide sufficient proof of expenses for tax purposes. You need to have both the receipt (proof of what you purchased) and the canceled check or credit card statement (proof of payment) to substantiate the expenditure. While the $75 rule may allow you to avoid having a receipt for some expenses, it is crucial to document all your expenses properly. To document a $60 meal consumed during deductible business travel with or without a receipt, for example, you need to prove the amount spent, the date of the meal, and the name and location of the restaurant. While you don’t need a receipt for the $60 travel meal, your documentation life is easy with a receipt. We encourage you to keep all your receipts for tax purposes, as they often take less time to keep track of and are better evidence in the event of an IRS audit. Wander CPA, Accountant, Tax Advisor Wander CPA, Michael wander If I Hire My Kids, Can I Give Them Tax-Free Education Benefits? If your children work in your business, consider giving them education fringe benefits. Doing this right creates You can accomplish this without a Section 127 plan when your child needs the education to do the job for your business or to comply with a law or regulation. In general, you can’t treat undergraduate degree programs as work-related education. If you pay for such programs outside of a Section 127 plan, you must treat the payments as taxable income to the child-employee. But certain individual courses within a program may be evaluated separately, and certain courses, such as accounting courses for an employee-child with an accounting job, may qualify for tax-free working condition fringe benefit payments. On the other hand, MBA programs can qualify as work-related education if they maintain or improve the employee’s skills for his or her current profession or business. In addition to the possibilities listed above, if your child is age 21 or older, the Section 127 plan can offer up to $5,250 in tax-free education benefits. Wander CPA, Accountant, Tax Advisor Wander CPA, Michael wander Business Gym for Your Employees, and Maybe You Too To be tax-deductible, your gym or other athletic facilities must be primarily for the benefit of your employees—other than employees who are officers, shareholders, or other individuals who own a 10 percent or greater interest in the business, or other highly compensated employees. For the 10 percent ownership test, the law treats employees as owning any interest owned by their brothers and sisters, spouses, ancestors (such as parents and grandparents), and lineal descendants (such as children and grandchildren). The highly compensated group consists of employees who earned more than $150,000 for the preceding year. The gym or other athletic facility must benefit the rank-and-file employee group more than the owner and highly compensated employee group. Think of this primary-benefit test as a 51-49 test. This means that the rank-and-file employees and their families must use the facility on more days than the owner and highly compensated group do. To see if you pass the 51-49 test, look only at days of use of the facility. Example. Rank-and-file employees and their families use the gym 235 days during the year and you, the business owner and your family, use it 137 days. The gym passes the 51-49 test. It’s tax-free to the users and deductible to the business as an employee recreational facility. Wander CPA, Accountant, Tax Advisor Wander CPA, Michael wander Take Advantage of the Once-in-a-Lifetime IRA-to-HSA Rollover Health Savings Accounts (HSAs) are designed for use alongside high-deductible health plans, assisting you in covering your medical expenses. They can also function as an incredible retirement account due to their triple tax benefit: And after age 65, you can use the monies for non-medical purposes, the same as you can with a traditional IRA, and pay taxes at ordinary income rates but without penalties. We recommend that you fully fund your HSA each year until you enroll in Medicare and that you ideally minimize distributions. By doing so, even if you start at age 50, you could accumulate $200,000 or more by the time you reach age 65. To assist in funding your HSA, there is a special, lesser-known rule: you can roll over funds from your IRA to your HSA once in your lifetime through a qualified HSA funding distribution. The rollover amount is limited to your HSA contribution limit for the year. In 2023, this amounts to $3,850 for individual coverage and $7,750 for family coverage. If you are over age 55, you can add a $1,000 catch-up contribution. The rollover amount doesn’t count as income, isn’t deductible, and reduces the amount you can contribute to your HSA for the year. The big benefit is that you turn this otherwise taxable money into tax-free money when you use it for medical expenses.

Holding Real Property in a Corporation: Good or Bad Idea? As the real estate market has cooled off in many parts of the country, investing in property may seem wise in the long run. But taxes can be a significant concern. Owning real estate in a C corporation may not be wise when considering taxes because it puts you at risk of being double-taxed. This means that if you sell the property and make a profit, the gain may be subject to taxation twice—once at the corporate level and again at the shareholder level when the corporation pays out profits to shareholders as dividends. The Tax Cuts and Jobs Act reduced the double taxation threat, but with our current federal debt, you face the risk that lawmakers will hike the corporate tax rates and possibly also tax dividends at higher ordinary income rates. To avoid this threat, I usually recommend using a single-member LLC or revocable trust to hold real property. A disregarded single-member LLC delivers super-simple tax treatment combined with corporation-like liability protection, while a revocable trust can avoid probate and save time and money. If you are a co-owner of real property, it is advisable to set up a multi-member LLC to hold the property. The partnership taxation rules that multi-member LLCs follow have several advantages, including pass-through taxation. In conclusion, holding real property in a C corporation can expose you to the risk of double taxation, and I don’t recommend it. Instead, consider a single-member LLC, revocable trust, or multi-member LLC, depending on your situation. Wander CPA, Accountant, Tax Advisor Wander CPA, Michael wander Helicopter View of 2023 Meals and Entertainment As you may already know, there have been some major changes to the business meal deduction for 2023 and beyond. The deduction for business meals has been reduced to 50 percent, a significant change from the previous 100 percent deduction for business meals in and from restaurants, which was applicable only for the years 2021 and 2022. To help you better understand the current situation, see the table below: Wander CPA, Accountant, Tax Advisor Wander CPA, Michael wander Are You a Regular Investor or a Tax-Favored Securities Trader? As we navigate the recent volatility in the stock market, you may want to think about the possible favorable federal income tax treatment the tax code gives to a securities trader. Suppose you can qualify as a securities trader for federal income tax purposes. In that case, you deduct your trading-related expenses on Schedule C of Form 1040 and make the taxpayer-friendly mark-to-market election, which is not available to garden-variety investors. The mark-to-market election has two important federal income tax advantages: But there is a price to pay for these tax advantages. As a trader who has made the mark-to-market election, you must pretend to sell your entire trading portfolio at market on the last trading day of the year, which may have little or no tax impact if you have little or nothing in your trading portfolio at year-end. Your trading activities must constitute a business for you to qualify as a securities trader, and you must meet both of the following requirements: If you are a calendar-year taxpayer, the deadline to make the mark-to-market election for your 2023 tax year is April 18, 2023 (that’s right around the corner). You make the election by including a statement with your 2022 Form 1040 filed by that date or with a Form 4868 extension request for your 2022 return filed by that date. Wander CPA, Accountant, Tax Advisor Wander CPA, Michael wander Avoid This Family-Member S Corporation Health Insurance Mistake There are two important issues related to health insurance deductions for S corporations. First, if you own more than 2 percent of an S corporation, there are three steps you need to follow to claim a deduction for health insurance: Second, this three-step procedure applies to your spouse, children, grandchildren, great-grandchildren, parents, grandparents, and great-grandparents if they work for your S corporation and the corporation covers them with health insurance. The three rules apply to the relatives listed above who work in the S corporation, even if they don’t own any stock directly. For health insurance purposes, the tax code attributes your stock ownership to them and deems that they own what you own. It’s crucial to get this right, as failing to do so could result in a lost health insurance deduction for your family members and zero deductions or the S corporation. If you or your S corporation did not handle this correctly in the past, you need to amend the returns to ensure that you create and protect the proper tax deductions.

2023 Health Insurance for S Corporation Owners: An Update Here’s an update on the latest developments in 2023 health insurance for S corporation owners. As a more-than-2-percent S corporation owner, you are entitled to some good news when it comes to your health insurance. To ensure that your health insurance deductions are in order, and to avoid the $100-a-day penalties for violating the rules of the Affordable Care Act (ACA), you should take the following steps: For rank-and-file employees, the S corporation does not have to provide health insurance benefits, but if it does, it must use an acceptable ACA plan, such as (among others) the qualified small employer health reimbursement arrangement (QSEHRA) or the individual coverage HRA (ICHRA). The S corporation can reimburse more-than-2-percent owners for individually purchased insurance without any penalties, but if it reimburses rank-and-file employees without using the QSEHRA or ICHRA, it faces the $100-a-day penalty per employee. If you are looking to provide health benefits to employees through the S corporation, there are many tax-advantaged options available. If the S corporation provides group health insurance to all employees, including the shareholder-employee, the same rules apply. Wander CPA, Accountant, Tax Advisor Wander CPA, Michael wander SECURE 2.0 Act Creates New Tax Strategies for RMDs As you are likely aware, if you have an IRA or other tax-deferred retirement account, you must start taking required minimum distributions (RMDs) once you reach a certain age. The SECURE 2.0 Act raises the age at which RMDs must first be taken, from age 72 to age 75, over the next 10 years. Specifically, the RMD age will be 73 for those born between 1951 and 1959 and 75 for those born in 1960 or later. The purpose of RMDs is to ensure that you use the funds in your retirement accounts while you are still alive, rather than using those accounts as an estate planning device to pass money to your heirs tax-free. The amount you are required to withdraw as an RMD depends on your age and the balance of your retirement account as of December 31 of the previous year. RMDs are required for traditional IRAs; SEP-IRAs; SIMPLE IRAs; solo 401(k) plans; and all employer-sponsored tax-deferred retirement plans, including 401(k) plans, 403(b) plans, profit-sharing plans, and 457(b) plans. Your first RMD must be taken by April 1 of the year following the year you reach the age of RMD. For example, if you turn 73 in 2024, you have until April 1, 2025, to take your first taxable RMD. And then, including in 2025 and every year thereafter, you must take an annual RMD on or before December 31. It’s important to note that taking two RMDs in one year could increase your tax bracket and even your Medicare premiums. If you are faced with this situation, it’s best to take the first RMD in the year you reach the age of RMD. In the past, the IRS imposed an “excess accumulation” penalty tax of 50 percent if you failed to take your full RMD by the deadline. But starting in 2023, the SECURE 2.0 Act reduces the penalty to 25 percent. If you correct the shortfall within the “correction window,” you can reduce the penalty to 10 percent. The correction window begins on January 1 of the year following the RMD shortfall and ends on the earlier of If the shortfall was due to reasonable error and you took reasonable steps to remedy it, you may request a penalty waiver by filing IRS Form 5329 and a letter explaining the reasonable error. Before filing the waiver request, you should make a catch-up distribution from your retirement accounts to make up for the RMD shortfall. Wander CPA, Accountant, Tax Advisor Wander CPA, Michael wander Plan Your Passive Activity Losses for Tax-Deduction Relevance In 1986, lawmakers drove a stake through the heart of your rental property tax deductions. That stake, called the passive-loss rules, causes myriad complications that now, 37 years later, are still commonly misunderstood. The Trap In 1986, lawmakers made you shovel your taxable activities into three basic tax buckets. Looking at the buckets from a business perspective, you find the following: This letter explains three escapes from the passive-loss trap so that you can realize the tax benefits from your rental losses. Escape 1: Get Out of Jail Free Lawmakers allow taxpayers with a modified adjusted gross income of $100,000 or less to deduct up to $25,000 of rental property losses. Once your income goes above $100,000, the get-out-of-jail-free loss deduction drops by 50 cents on the dollar and disappears altogether at $150,000 of modified adjusted gross income. Escape 2: Changes in Operations If you, or you and your spouse, have modified adjusted gross income that exceeds the threshold, you need a different plan to obtain immediate benefit from your rental property tax losses. To begin, let’s review how the tax-benefit dollars get trapped in the first place. As you may remember, to benefit from your rental property tax loss, you must either Example. Say the taxable income on your Form 1040 is $200,000 and you have one rental property. Say further that rental has produced a tax loss of $10,000 a year for the past six years, none of which you have been able to deduct because you have no other passive income and you do not qualify as a tax-law-defined real estate professional. So here you sit: $60,000 in tax deductions trapped in the passive-loss bucket—not available for deduction against the income from the other buckets. Not Lost, Just Waiting This is sad, no doubt, but there’s some good news even in this bucket as you now see it. The $60,000 is not going to drown, disappear, or lose its tax-deduction attributes in some other way. That $60,000 simply waits in the bucket for you to give it an escape route. Here are four possibilities for the escape route: Escape 3: Total Release The $60,000 that’s trapped in the passive-loss bucket is like

When Cancellation of Debt (COD) Income Can Be Tax-Free You may have noticed that the IRS is in a bad way. Sometimes debts can pile up beyond a borrower’s ability to repay, especially if we are heading into a recession. But lenders are sometimes willing to cancel (forgive) debts that are owed by financially challenged borrowers. While a debt cancellation can help a beleaguered borrower survive, it can also trigger negative tax consequences. Or it can be a tax-free event. Wander CPA, Accountant, Tax Advisor Wander CPA, Michael wander General Rule: COD Income Is Taxable When a lender forgives part or all of your debt, it results in so-called cancellation of debt (COD) income. The general federal income tax rule is that COD income counts as gross income that you must report on your federal income tax return for the year the debt cancellation occurs. Fortunately, there are a number of exceptions to the general rule that COD income is taxable. You can find the exceptions in Section 108 of our beloved Internal Revenue Code, and they are generally mandatory rather than elective. The two common exceptions are: The cost of being allowed to exclude COD income from taxation under the bankruptcy or insolvency exception is a reduction of the borrower’s so-called tax attributes. You generally reduce these tax attributes (future tax benefits) by one dollar for each dollar of excluded COD income. But you reduce tax credits by one dollar for every three dollars of excluded COD income. You reduce these attributes only after calculating your taxable income for the year the debt cancellation occurs, and you reduce them in the following order: As mentioned above, any tax attribute reductions are deemed to occur after calculating the borrower’s federal taxable income and federal income tax liability for the year of the debt cancellation. This taxpayer-friendly rule allows the borrower to take full advantage of any tax attributes available for the year of the debt cancellation before those attributes are reduced. Wander CPA, Accountant, Tax Advisor Wander CPA, Michael wander Principal Residence Mortgage Debt Exception A temporary exception created years ago and then repeatedly extended by Congress applies to COD income from qualifying cancellations of home mortgage debts that occur through 2025. Under the current rules for this exception, the borrower can have up to $750,000 of federal-income-tax-free COD income—or $375,000 if the borrower uses married-filing-separately status—from the cancellation of qualified principal residence indebtedness. That means debt that was used to acquire, build, or improve the borrower’s principal residence and that is secured by that residence. Wander CPA, Accountant, Tax Advisor Wander CPA, Michael wander Is Airbnb Rental Income Subject to Self-Employment Tax? Do you owe self-employment tax on Airbnb rental income? That’s a good question. In Chief Counsel Advice (CCA) 202151005, the IRS opined on this issue. But before we get to what the IRS said, understand that the CCA’s conclusions cannot be cited as precedent or authority by others, such as you or your tax professional. Even so, we always consider what the CCA says as semi-useful information, so here’s some analysis that goes beyond what the IRS came up with. The Exact Question To be specific, the CCA asks whether net income from renting out living quarters is excluded from self-employment income under Section 1402(a)(1) when you’re not classified as a real estate dealer. If excluded under IRC Section 1402(a)(1), you don’t owe self-employment tax on your net rental income. Needless to say, that’s the outcome you want to see, and I’m here to help. The taxpayer addressed in this CCA was an individual who owned and rented out a furnished beachfront vacation property via an online rental marketplace (such as Airbnb or VRBO). The taxpayer provided kitchen items, linens, daily maid service, Wi-Fi, access to the beach, recreational equipment, and prepaid vouchers for rideshare services between the rental property and a nearby business district. The CCA’s Conclusions According to the CCA, when you’re not a real estate dealer, net rental income from renting out living quarters is considered rental from real estate and is therefore excluded from self-employment income—as long as you don’t provide services to rental occupants. The self-employment income exclusion for net rental income collected by a non-dealer is a statutory provision. The statute itself doesn’t say anything about providing services. But IRS regulations state that providing services to renters can potentially cause you to lose the exclusion from self-employment income. According to the CCA, you must include the net rental income in calculating your net self-employment income—which could cause you to owe the dreaded self-employment tax (ugh!)—if you provide services to renters and the services are not clearly required to maintain the living quarters in a condition for occupancy andare so substantial that compensation for the services constitutes a material portion of the rent. So, according to the CCA, determining whether providing services to renters will trigger exposure to the self-employment tax is the big issue for folks who rent out living quarters. The CCA’s anti-taxpayer conclusion rests on the giant assumption that the services provided by the taxpayer were above and beyond what was required. But were they? Probably not! The Customarily Issue According to IRS regulations, services are generally considered above and beyond the norm only if they exceed the services that are customarily provided to renters of living quarters. Therefore, services that simply maintain a vacation rental property in a condition that is customary for rental occupancy should not be considered above and beyond and therefore should not trigger exposure to the self-employment tax. In assessing whether services provided to renters are above and beyond what’s customary, circumstances obviously matter. In the real world of vacation rentals in expensive resort areas, renters customarily expect and receive lots of services that might be considered above and beyond in other circumstances. For instance, in resort areas, renters customarily expect and receive cable service; Wi-Fi access; periodic housekeeping services, including changing bedding and towels; repair of failed appliances; replacement of burned-out lightbulbs;