Estate Planning? Don’t Forget the Generation-Skipping Transfer (GST) Tax

Would you like to include grandchildren, great grandchildren, or nonrelatives who are significantly younger than you in your estate plan? If so, you’ve got more to consider than gift and estate taxes. The generation-skipping transfer (GST) tax may also apply.

GST Tax Basics

One of the harshest taxes in the Internal Revenue Code, the GST tax is a flat 40% tax on asset transfers that “skip persons”. For example, the tax may apply if you plan to leave assets to grandchildren or other family members who are more than one generation below you. (For non-family members, the tax applies when the heir in question is more than 37 ½ years younger than you.)   

Because this tax is calculated in addition to estate and gift taxes, it can significantly impact the amount of wealth you’re able to leave to future generations. 

GST Tax Exemption Under the Tax Cuts and Jobs Act

A generous GST tax exemption may fortunately offer some relief. For persons dying after December 31, 2017 and before January 1, 2026, the Tax Cuts and Jobs act adjusts the GST tax exemption amount to an inflation-adjusted $10 million. That totals $13.61 million for 2024.

Unless congress takes action before this time frame ends, the exemption will shrink back to an inflation-adjusted $5 million starting on January 1, 2026.

Of course, taking advantage of this exemption requires careful planning.

For an exemption to apply in some cases, it’s necessary to allocate the exemption to particular assets on a timely filed gift tax return. This is called an affirmative election.

In some cases, the exemption may be allocated automatically unless you opt out. If you prefer to allocate your exemption elsewhere, this can lead to unwanted results.

Reviewing each transfer for potential GST tax liability is a great way to avoid costly mistakes and ensure your exemption is allocated as advantageously as possible.

What transfers are taxable under the GST?

In addition to direct gifts that skip persons, GST tax applies to two types of trust-related transfers: 

  1. Taxable terminations

Trust assets pass to your grandchildren when your child dies and the trust terminates.

  1. Taxable distributions

Trust income or principal is distributed to a skip person.

Note: Gifts covered by the annual gift tax exclusion aren’t currently subject to the GST tax. 

Protections offered by automatic allocation rules

While the automatic allocation rules can be unfavorable if you prefer to allocate your exemption elsewhere, they’re ultimately intended to protect you against unintentional loss of GST tax exemptions.

For instance, your unused GST tax exemption may be automatically applied to a gift to a grandchild or other “skip person” that exceeds the annual gift tax exclusion ﹘without the need to make an allocation on a gift tax return. 

The rules’ impact on “GST trusts” are complex. In general, a trust is considered a GST trust if it will likely benefit skip persons or your grandchildren in the future.

In most cases, these automatic allocation rules work favorably and ensure your GST tax exemption is applied where it’s most needed. However, they can also lead to unintended﹘and potentially expensive﹘results in other cases.   

Questions? Smolin can help

For many people, the GST tax might not be top of mind right now. After all, the exemption amount is currently high enough that it doesn’t impact most families’ estate plans. 

However, the GST tax exemption rate is expected to decrease significantly after 2025 without action from congress. 

By choosing to contact your accountant to plan for this tax now, you can avoid unexpected costs and protect the wealth you want to leave to your younger relatives in the future. 

Stressed About Long-Term Care Expenses? Here’s What You Should Consider

Most people will need some form of long-term care (LTC) at some point in their lives, whether it’s a nursing home or assisted living facility stay.  But the cost of unanticipated long-term care is steep.

LTC expenses generally aren’t covered by traditional health insurance policies like Social Security or Medicare. A preemptive funding plan can help ensure your LTC doesn’t deplete your savings or assets.

Here are some of your options.

Self-funding

If your nest egg is large enough, paying for LTC expenses out-of-pocket may be possible. This approach avoids the high cost of LTC insurance premiums. In addition, if you’re fortunate enough to avoid the need for LTC, you’ll enjoy a savings windfall that you can use for yourself or your family. 

The risk here is that your LTC expenses will be significantly larger than what you anticipated, and it completely erodes your savings.

Any type of asset or investment can be used to self-fund LTC expenses, including:

Another option is to tap your home equity by selling your house, taking out a home equity loan or line of credit, or obtaining a reverse mortgage.

Both Roth IRAs and Health Savings Accounts (HSAs) are particularly effective for funding LTC expenses. Roth IRAs aren’t subject to minimum distribution requirements, so you can let the funds grow tax-free until they’re needed. 

HSAs, coupled with a high-deductible health insurance plan, allow you to invest pre-tax dollars that you can later use to pay for qualified unreimbursed medical expenses, including LTC. Unused funds may be carried over from year to year, which makes an HSA a powerful savings vehicle.

LTC insurance

LTC insurance policies—which are expensive—cover LTC services that traditional health insurance policies typically don’t cover. 

It can be a challenge to determine if LTC insurance is the best option for you. The right time for you to buy coverage depends on your health, family medical history, and other factors. 

The younger you are, the lower the premiums, but you’ll be paying for insurance coverage when you’re not likely to need it. Many people purchase these policies in their early to mid-60s. Keep in mind that once you reach your mid-70s, LTC coverage may no longer be available to you, or it may become prohibitively expensive.

Hybrid insurance

Hybrid policies combine LTC coverage with traditional life insurance. Often, these policies take the form of a permanent life insurance policy with an LTC rider that provides tax-free accelerated death benefits in the event of certain diagnoses or medical conditions.

Compared to stand-alone LTC policies, hybrid insurance provides less stringent underwriting requirements and guaranteed premiums that won’t increase over time. The downside, of course, is that the more you use LTC benefits, the fewer death benefits available to your heirs.

Potential tax breaks

If you buy LTC insurance, you may be able to deduct a portion of the premiums on your tax return.

If you have questions regarding LTC funding or the tax implications, please don’t hesitate to contact us.

Questions? Smolin can help. 

If you’re concerned about planning for long-term care, don’t put it off any longer. We’re here to help! Contact your Smolin accountant to learn more about your options for LTC expenses so you can rest easy.

Can the Research Credit Help Your Small Business Save On Payroll Taxes?

Often called the R&D credit, the research and development credit for increasing research activities offers a valuable tax break to many eligible small businesses. Could yours be one of them? 

In addition to the tax credit itself, the R&D credit offers two additional features of note for small businesses: 

This second feature, in particular, has been enhanced by the Inflation Reduction Act (IRA), which

1. Doubled the amount of payroll tax credit election for qualified businesses
2. Made a change to the eligible types of payroll taxes the credit can be applied to

Payroll election specifics

Limits to claiming the R&D credit do apply. Your business might elect to apply some or all of any research tax credit earned against payroll taxes rather than income tax, which may make increasing or undertaking new research activities more financially favorable.

However, if you’re already engaged in these activities, this election may offer some tax relief.

Even if they have a net positive cash flow or a book profit, many new businesses don’t pay income taxes and won’t for some time. For this reason, there’s no amount against which the research credit can be applied.

Any wage-paying business, however, does have payroll tax liabilities. This makes the payroll tax election an ideal way to make immediate use of the research credits you earn. This can be a big help in the initial phase of your business since every dollar of credit-eligible expenses holds the potential for up to 10 cents in tax credit. 

Which businesses are eligible? 

Taxpayers may only qualify for the payroll election IF:

To evaluate these factors, an individual taxpayer should only consider gross receipts from the individual’s businesses. Salary, investment income, and other types of earnings aren’t taken into account.

It’s also worth noting that individuals and entities aren’t permitted to make the payroll election for more than six years in a row. 

Limitations

Prior to an IRS provision that became effective in 2023, taxpayers were only allowed to use the credit to offset payroll tax against Social Security. However, the research credit may be now applied against the employer portion of Medicare and Social Security. That said, you won’t be able to use it to lower FICA taxes that are withheld on behalf of employees.

You also won’t be able to make the election for research credit in excess of $500,000. This is a significant uptick compared to the pre-2023 maximum credit of $250,000.

A C corporation or individual may only make the election for research credits that would have to be carried forward in the absence of an election—not to reduce past or current income tax liabilities. 

Questions? Smolin can help. 

We’ve only covered the basics of the payroll tax election here. It’s important to keep in mind that identifying and substantiating expenses eligible for the research credit—and claiming the credit—is a complicated process that involves extensive calculations.

Of course, we’re here to help! Contact your Smolin accountant to learn more about whether you can benefit from the research tax credit and the payroll tax election. 

How Do Cash Accounting and Accrual Accounting Differ?

Financial statements play a key role in maintaining the financial health of your business. Not only do year-end and interim statements help you make more informed business decisions, but they’re also often non-negotiable when working with investors, franchisors, and lenders.

So, which accounting method should you use to maintain these all-important financial records—cash or accrual?

Let’s take a look at the pros and cons of each method.

Cash basis accounting

Small businesses and sole proprietors often choose to use the cash-basis accounting method because it’s fairly straightforward. (Though, some other types of entities also use this method for tax-planning opportunities.)

With cash basis accounting, transactions are immediately recorded when cash changes hands. In other words, revenue is acknowledged when payment is received, and expenses are recorded when they’re paid.

The IRS places limitations on which types of businesses can use cash accounting for tax purposes. Larger, complex businesses can’t use it for federal income tax purposes. Eligible small businesses must be able to provide three prior tax years’ annual gross receipts, equal to or less than an inflation-adjusted threshold of $25 million. In 2024, the inflation-adjusted threshold is $30 million.

While it certainly has its pros, there are some drawbacks to cash-basis accounting. For starters, revenue earned isn’t necessarily matched with expenses incurred in a given accounting period. This can make it challenging to determine how well your business has performed against competitors over time and create unforeseen challenges with tracking accounts receivable and payable. 

 Accrual basis accounting

The United States. Generally Accepted Accounting Principles (GAAP) require accrual-basis accounting. As a result, a majority of large and mid-sized U.S. businesses use this method. 

Under this method, expenses are accounted for when they’re incurred, and revenue when it’s earned. Revenue and its related expenses are recorded in the same accounting period, which can help reduce significant fluctuations in profitability, at least on paper, over time. 

Revenue that hasn’t been received yet is tracked on the balance sheet as accounts receivable, as are expenses that aren’t paid yet. These are called accounts payable or accrued liabilities. 

With this in mind, complex-sounding line items might appear, like work-in-progress inventory, contingent liabilities, and prepaid assets.

As you can see, the accrual accounting method is a bit more complicated than cash accounting. However, it’s often preferred by stakeholders since it offers a real-time picture of your company’s financial health. In addition, accrual accounting supports informed decision-making and benchmarking results from period to period. It also makes it simpler to compare your profitability against other competitors.

For eligible businesses, accrual accounting also offers some tax benefits, like the ability to: 

There are downsides, too.

In the event that an accrual basis business reports taxable income prior to receiving cash payments, hardships can arise, especially if the business lacks sufficient cash reserves to address its tax obligations. Choosing the right method? Smolin can help!

Each accounting method has pros and cons worth considering. Contact your Smolin accountant to explore your options and evaluate whether your business might benefit from making a switch.

Choosing the Best Accounting Method for Business Tax Purposes

Businesses categorized as “small businesses” under the tax code are often eligible to use accrual or cash accounting for tax purposes. Certain businesses may be eligible to take a hybrid approach, as well. 

Prior to the implementation of the Tax Cuts and Jobs Act (TCJA), the criteria for defining a small business based on gross receipts ranged from $1 million to $10 million, depending on the business's structure, industry, and inventory-related factors.

By establishing a single gross receipts threshold, the TCJA simplified the small business definition. The Act also adjusts the threshold to $25 million for inflation, which allows more companies to take advantage of the benefits of small business status. 

In 2024, a business may be considered a small business if the average gross receipts for the three-year period ending prior to the 2024 tax year are $30 million or less. This number has risen from $29 million in 2023.

Small businesses may also benefit from: 

What about other types of businesses?

Even if their gross receipts are above the threshold, other businesses may be eligible for cash accounting, including: 

Regardless of size, tax shelters are ineligible for the cash method.

How accounting methods differ

Cash method 

The cash method provides significant tax advantages for most businesses, including a greater measure of control over the timing of income and deductions. They recognize income when it’s received and deduct expenses when they're paid. 

As year-end approaches, businesses using the cash method can defer income by delaying invoices until the next tax year or shift deductions into the current year by paying expenses sooner.

Additionally, the cash method offers cash flow advantages. Since income is taxed when received, it helps guarantee that a business possesses the necessary funds to settle its tax obligations.

Accrual method

On the other hand, businesses operating on an accrual basis recognize income upon earning it and deduct expenses as they are incurred, irrespective of the timing of cash receipts or payments. This reduces flexibility to time recognition of expenses or income for tax purposes. 

Still, this method may be preferable for some businesses. For example, when a company's accrued income consistently falls below its accrued expenses, employing the accrual method could potentially lead to a reduced tax liability.

The ability to deduct year-end bonuses paid within the first 2 ½ months of the next tax year and the option to defer taxes on certain advance payments is also advantageous. 

Switching accounting methods? Consult with your accountant

Your business may benefit by switching from the accrual method to the cash method or vice versa, but it’s crucial to account for the administrative costs involved in such a change.

For instance, if your business prepares financial statements in accordance with the U.S. Generally Accepted Accounting Principles, using the accrual method is required for financial reporting purposes. Using the cash method for tax purposes may still be possible, but you’ll need to maintain two sets of books, the administrative burden of which may or may not offset those advantages.

In some cases, you may also need IRS approval to change accounting methods for tax purposes. When in doubt, contact your Smolin accountant for more information.

What’s the Difference Between Filing Jointly or Separately as a Married Couple?

You know that you must choose a filing status when you file your tax return, but do you know what your choice really means?

Picking the right filing status matters because the status you select will influence your tax rates, eligibility for certain tax breaks, standard deduction, and correct tax calculation.

And there are plenty of filing statuses to choose from: 

Married individuals may wonder whether filing a joint or separate tax return will yield the lowest tax. That depends. 

If you and your spouse file a joint return, you are “jointly and severally” liable for the tax on your combined income. That means you’re both on the line for getting it right and settling up. You’ll also both be liable for any additional tax the IRS assesses, including interest and penalties.

In other words, the IRS can pursue either you or your spouse to collect the full amount you owe. 

“Innocent spouse” provisions may offer some relief, but they have limitations. For this reason, some people may still choose to file separately even if a joint return results in less tax overall. For example, a separated couple may not want to be legally responsible for each other’s tax obligations. Still, filing jointly usually offers the most tax savings, especially when the spouses have different income levels.

While combining two incomes may put you in a higher tax bracket, it’s important to recognize that filing separately doesn’t mean you go back to using the “single” rates that applied before you were married. Instead, each spouse must use “married filing separately” rates. These rates are less favorable than the single rates.

Still, there are situations where it’s possible to save tax by filing separately. For example, medical expenses are deductible only to the extent they exceed 7.5% of adjusted gross income (AGI). If a medical expense deduction is claimed on a spouse’s separate return, that spouse’s lower separate AGI, as compared to the higher joint AGI, can result in a larger total deduction.

Tax breaks only available on a joint return

Some tax breaks are only available to married couples on a joint return, including: 

If you or your spouse were covered by an employer retirement plan, you may not be able to deduct IRA contributions if you file separate returns. Nor will you be able to exclude adoption assistance payments or interest income from Series EE or Series I savings bonds used for higher education expenses.

Unless you and your spouse lived apart for the entire year, you won’t be able to take the tax credit designated for the elderly or the disabled, either. 

Social Security benefits

When married couples file separately, Social Security benefits may be taxed more.

Benefits are tax-free if your “provisional income” (AGI with certain modifications, plus half of your Social Security benefits) doesn’t exceed a “base amount.” The base amount is $32,000 on a joint return but zero on separate returns (or $25,000 if the spouses didn’t live together for the whole year).

Questions? Contact your accountant

Choosing a filing status impacts your state or local income tax bill, in addition to your federal tax bill. It’s important to evaluate the total taxes you might owe before making a final decision.

Considering these factors and deciding whether to file jointly or separately may not be as straightforward as you’d think. That’s where we come in. Contact your Smolin accountant for a fuller picture of the potential tax impacts of each option.

Is Qualified Small Business Corporation Status Right for You?

For many business owners, opting for a Qualified Small Business Corporation (QSBC) status is a tax-wise choice.

Potential to pay 0% federal income tax on QSBC stock sale gains

For the most part, typical C corporations and QSBCs are treated the same when it comes to tax and legal purposes, but there is a key difference. QSBC shareholders may be eligible to exclude 100% of their QSBC stock sale gains from federal income tax. This means that they could face an extremely favorable 0% federal income tax rate on stock sale profits.

However, there is a caveat. The business owner must meet several requirements listed in Section 1202 of the Internal Revenue Code. Plus, not all shares meet the tax-law description of QSBC stock. And while they’re unlikely to apply, there are limitations on the amount of QSBC stock sale gain a business owner can exclude in a single tax year. 

The date stock is acquired matters

QSBC shares that were acquired prior to September 28, 2010 aren’t eligible for the 100% federal income tax gain exclusion. 

Is incorporating your business worth it?

Owners of sole proprietorships, single-member LLCs treated as a sole proprietorship, partnerships, or multi-member LLCs treated as a partnership will need to incorporate their business and then issue shares to themselves in order to attain QSBC status in order to take advantage of tax savings. 

There are pros and cons of taking this step, and this isn’t a decision that should be made without the guidance of a knowledgeable accountant or business attorney. 

Additional considerations

Gains exclusion break eligibility

Only QSBC shares held by individuals, LLCs, partnerships, and S corporations are potentially eligible for the tax break—not shares owned by another C corporation. 

5 Year Holding period
QSBC shares must be held for five years or more in order to be eligible for the 100% stock sale gain exclusion. Shares that haven’t been issued yet won’t be eligible until 2029 or beyond. 

Share acquisition 

Generally, you must have acquired the shares upon original issuance by the corporation or by gift or inheritance. Furthermore, only shares acquired after August 10, 1993 are eligible.

Not all businesses are eligible

The QSBC in question must actively conduct a qualified business. Businesses where the principal asset is the reputation or skill of employee are NOT qualified, including those rendering services in the fields of:

Limitations on gross assets

Immediately after your shares are issued, the corporation’s gross assets can’t exceed $50. However, if your corporation grows over time and exceeds the $50 million threshold, it won’t lose its QSBC status for that reason.

Impact of the Tax Cuts and Jobs Act

Assuming no backtracking by Congress, 2017’s Tax Cuts and Jobs Act made a flat 21% corporate federal income tax rate permanent. This means that if you own shares in a profitable QSBC and decide to sell them once you’re eligible for the 100% gain exclusion break, the 21% corporate rate could be the only tax you owe.

Wondering whether your business could qualify? Smolin can help.

The 100% federal income tax stock sale gain exclusion break and the flat 21% corporate federal income tax rate are both strong incentives to operate as a QSBC, but before making your final decision, consult with us.

While we’ve summarized the most important eligibility rules here, additional rules do apply. 

Starting a Business as a Sole Proprietor? Here’s How It Could Impact Your Taxes

It’s not uncommon for entrepreneurs to launch small businesses as sole proprietors. However, it’s crucial to understand the potential tax impacts first.

Here are 9 things to consider. 

1. The pass-through deduction may apply

If your business generates qualified business income, you could be eligible to claim the 20% pass-through deduction. (Of course, limitations may apply.)

The significance of this deduction is that it’s taken “below the line”. It reduces taxable income, as opposed to being taken “above the line” against your gross income.

Even if you claim the standard deduction instead of itemizing deductions, you may be eligible to take the deduction. Unless Congress acts to extend the pass-through deduction, though, it will only be available through 2025. 

2. Expenses and income should be reported on Schedule C of Form 1040

Whether you withdraw cash from your business or not, its net income will be taxable to you. Business expenses are deductible against gross income, rather than as itemized deductions.

If your business experiences losses, they’ll be deductible against your other income. Special rules may apply in relation to passive activity losses, hobby losses, and losses from activities in which you weren’t “at risk”. 

2. Self-employment taxes apply

In 2024, sole proprietors must pay self-employment tax at a rate of 15.3% on net earnings from self-employment up to $160,600. You must also pay a Medicare tax of 2.9% on any earnings above that. If self-employment income is in excess of $250,000 for joint returns, $125,000 for married taxpayers filing separate returns, or $200,000 in other cases, a 0.9%
Medicare tax (for a total of 3.8%) will apply to the excess. 

Self-employment tax is charged in addition to income taxes. However, you may deduct half of your self-employment tax as an adjustment to income. 

4. You’ll need to make quarterly estimated tax payments

In 2024, quarterly estimated tax payments are due on April 15, June 17, September 16, and January 15. 

5. 100% of your health insurance costs may be deducted as a business expense

This means the rule that limits medical expense deductions won’t apply to your deduction for medical care insurance. 

6. Home office expenses may be deductible.

If you use a portion from your home to work, perform management or administrative tasks, or store product samples or inventory, you could be entitled to deduct part of certain expenses, such as: 

Travel expenses from a home office to another work location may also be deductible. 

7. Recordkeeping is essential

Keeping careful records of expenses is key to claiming all of the tax breaks to which you’re entitled. Special recordkeeping rules and deductibility limits may apply to expenses like travel, meals, home office, and automobile costs. 

8. Hiring employees leads to more responsibilities 

If you’d like to hire employees, you’ll need a taxpayer identification number and will need to withhold and pay over payroll taxes. 

9. Establishing a qualified retirement plan is worth considering

Amounts contributed to a qualified retirement plan will be deductible at the time of the contributions and won’t be taken into income until the money is withdrawn.

Many business owners prefer a SEP plan since it requires minimal paperwork. A SIMPLE plan may also be suitable because it offers tax advantages with fewer restrictions and administrative requirements. If neither of these options appeal to you, you may still be able to save using an IRA.

Questions? Smolin can help.

For more information about the tax aspects of various business structures or reporting and recordkeeping requirements for sole proprietorships, please contact your Smolin accountant. 

Can Too Much Cash Be Bad For Business?

Today’s marketplace can feel uncertain, so it’s no surprise that many businesses are stashing operating cash in their bank accounts. However, without imminent plans to deploy these reserves, do these excessive “rainy day funds” really offer efficient use of capital?

If you want to estimate reasonable cash reserves while maximizing your company’s return on long-term financial positions, try this approach. 

Why is it harmful to reserve extra cash? 

While maintaining a “cushion” can help with slowed business or unexpected maintenance needs, it’s important to acknowledge that cash has a carrying cost. The return your company earns on cash vs. the price you pay to obtain cash may be more significant than you realize. 

Carrying debts on your balance sheet for equipment loans, credit lines, and mortgages comes with interest that might be higher than the interest earned on your business checking account. After all, interest earnings on checking accounts are often little to none. Many generate returns of 2% or less.

The greater this spread, the higher the cost of carrying cash. 

What’s the ideal amount for a cash reserve?

While dividing current assets by current liabilities is helpful, there’s no magic ratio that’s appropriate for every business. A lender’s liquidity covenants can only provide an educated guess.

Still, it’s possible to analyze how your business’s liquidity metrics have evolved in previous months or years and compare those numbers to industry benchmarks. If you notice ratios well above industry norms—or substantial increases in liquidity—this could be a sign that capital is being inefficiently deployed. 

Looking forward may also prove helpful. Developing prospective financial reports for the next 12 to 18 months may help you evaluate whether your company’s cash reserves are too high.

For instance, you might use a monthly forecasted balance sheet to estimate expected seasonal ebbs and flows in the cash cycle. Projecting a truer picture of a worst-case scenario, using “what-if” assumptions, could also be helpful. When examining these scenarios, be sure to consider future cash flows, including debt maturities, working capital requirements, and capital expenditures.

Formal financial projections and forecasts provide a much better method for building up healthy cash reserves than relying on gut instinct alone. Over time, comparing actual performance to this data—and adjusting them, if necessary—will help you reach your ideal reserve.   

What to do with excess cash

Once you’ve determined your company’s ideal cash balance, it’s time to find a way to reinvest any cash surplus.

Some possible options include: 

When implemented with due diligence, these strategies are the key to growing your business in the long run—not just your checking account balance.  

Questions? Smolin can help

Need help creating formal financial forecasts and projections to devise sound cash management strategies? We’re here to help. Contact your Smolin accountant for personalized advice on the efficient use of your business capital and the ideal cash reserve needed to meet your business’s operating needs.