Privately-Owned Businesses

Choosing the Best Accounting Method for Business Tax Purposes

Choosing the Best Accounting Method for Business Tax Purposes
Choosing the Best Accounting Method for Business Tax Purposes 850 500 smolinlupinco

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: 

  • Simplified inventory accounting,
  • An exemption from the uniform capitalization rules, and
  • An exemption from the business interest deduction limit.

What about other types of businesses?

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

  • S-corporations
  • Partnerships without C-corporation partners
  • Farming businesses
  • Certain personal service corporations

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.

Is Qualified Small Business Corporation Status Right for You

Is Qualified Small Business Corporation Status Right for You?
Is Qualified Small Business Corporation Status Right for You? 850 500 smolinlupinco

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:

  •  
  • Law
  • Engineering
  • Architecture
  • Accounting
  • Actuarial science 
  • Performing arts 
  • Consulting 
  • Athletics 
  • Financial services 
  • Brokerage services 
  • Banking
  • Insurance 
  • Leasing 
  • Financing 
  • Investing
  • Farming
  • Production or extraction of oil, natural gas, or other minerals for which percentage depletion deductions are allowed 
  • Operation of a motel, hotel, restaurant, or similar business 

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. 

Can too much cash be bad for business

Can Too Much Cash Be Bad For Business?
Can Too Much Cash Be Bad For Business? 850 500 smolinlupinco

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: 

  • Paying down debt to reduce the carrying cost of cash reserves
  • Investing in marketable securities like diversified stock-and-bond portfolios or mutual funds  
  • Repurchasing stock, especially if minority shareholders routinely challenge management decisions 
  • Acquiring a struggling competitor or its assets 

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. 

Navigating Tax Implications Restricted Stock Awards

Navigating the Tax Implications of Restricted Stock Awards
Navigating the Tax Implications of Restricted Stock Awards 850 500 smolinlupinco

Equity-oriented executive compensation can take many forms, but restricted stock awards are a popular option. In fact, many businesses offer them as an alternative to stock option awards in light of the fact that options can lose most or all of their value if the price of the underlying stock decreases. This is less of an issue with restricted stock. If the price declines, companies can issue additional restricted shares to balance the difference. 

If you’re in a position to receive a restricted stock award, it’s important to know what to expect in regard to your taxes. 

Restricted stock: How it works 

Typically, when a company grants an employee restricted stock, the shares are subject to certain limitations. The restricted shares are transferred to the employee, but the employee won’t actually own them until they become vested.

Oftentimes, you must continue working for the company for a particular length of time. If you leave the job before the designated date, you may be forced to forfeit the restricted shares. 

Tax rules for awards of restricted stock

Before the shares become vested, you won’t have taxable income from a restricted share award. In other words, there won’t be an immediate tax obligation associated with the shares.

Once the shares become vested, however, you’ll receive taxable compensation income equal to the difference between the value of the shares on the vesting date and the amount they paid for them (if anything).

Federal income tax for compensation is up to 37%, and you may also owe an additional 3.8% net investment income tax (NIIT). You could also owe state income tax on the income.

Appreciation occurring after the shares are vested will be treated as capital gain. If you hold the stock for a year or more after vesting date, you’ll be subject to a lower-taxed, long-term capital gain on that appreciation. For long-term capital gains, the current maximum federal tax rate is 20%, but you may also be subject to state income tax and the 3.8% NIIT. 

Section 83(b) election

You’ll also have the option to make a special Section 83(b) election, which gives you the option to be taxed at the time they receive the restricted stock award rather than when the shares vest. In this case, income will equal the difference between the amount that you paid for the shares (if anything) and the value of them.

This income will still be treated as compensation and subject to federal employment taxes, federal income tax, and state income tax. However, making a Section 83(b) election offers the benefit that further appreciation in the value of the stock will be treated as lower-taxed, long-term capital gain if the stock is held for over a year. It also provides a level of protection against higher tax rates that could be in place when the shares become vested. 

However, recognizing taxable income the year the restricted stock award is received does come at a risk. The election can be a financial disadvantage in the event that the shares are later forfeited or decline in value. If you do go on to forfeit the shares, you may be able to claim a capital loss for the amount paid for them (if anything).

To make a Section 83(b) election, you must notify the IRS either before the stock is transferred or within the following 30 days. 

Questions? Smolin can help. 

While the tax rules for restricted stock awards are fairly simple, deciding whether to make a Section 83(b) election is still a time-sensitive decision that has the potential to impact the true financial benefit of your award.

Before making the decision to opt for a Section 83(b) election, contact your accountant for more personalized guidance. 

New Per Diem Business Travel Rates Effective October 1st

New Per Diem Business Travel Rates Effective October 1st
New Per Diem Business Travel Rates Effective October 1st 850 500 smolinlupinco

Do traveling employees at your business find documenting expenses tedious? Are you equally frustrated at the energy and time needed to review business travel expenses? If so, relief is on its way. In Notice 2023-68, the IRS set forth special “per diem” rates, which became effective on October 1st.

These rates may be used to substantiate expenses for lodging, incidentals, and meals when traveling away from home. (Note: Employees in the transportation industry can use the transportation industry rate.)

How to use the “high-low” method

Rather than tracking actual business travel expenses, the high-low method provides a simplified alternative through fixed travel per diems. These amounts are provided by the IRS and vary by locality.  

For certain areas with higher costs of living, the IRS establishes an annual flat rate. Any location within the continental United States that the IRS does not list as a “high-cost” area should automatically be considered “low-cost” under the high-low method. 

Areas such as Boston and San Francisco, for example, may be considered high-cost, while less metropolitan areas could be considered low-cost. Some areas, like resort areas, could be considered high-cost only during certain times of the year.

For business travel, this method can be used in lieu of the specific per-diem rates for business destinations.

When employers provide lodging or pay for the hotel directly, employees may only receive a per diem reimbursement for meals and incidental expenses. For employees who don’t incur meal expenses for a calendar day (or partial day) of travel, there is also a $5 incidental-expenses-only rate. 

Recordkeeping simplified

Employees working for companies that use per diem rates don’t need to meet the typical recordkeeping rules required by the IRS. Generally, receipts aren’t required under the high-low per diem method.

However, employees are still responsible for substantiating the business purpose, place, and time of travel. Per diem reimbursements aren’t typically subject to payroll tax withholding or income tax withholding reported on an employee’s Form W-2. 

What to know about the FY2024 rates

For travel occurring after September 30, 2023, FY2024 rates apply. The high-cost area per diem increased by $12, and the low-cost area per diem increased by $10. 

High-cost area per diem in 2024

The 2024 rate for all high-cost areas within the continental United States is $309. This can be broken down as follows.

Lodging: $235
Meals and incidental expenses: $74

Low-cost area per diem in 2024

For all other areas within the continental United States, the per diem rate is $214 for travel occurring after September 30, 2023. This may be broken down as follows:

Lodging: $150
Meals and incidental expenses: $64

Special considerations

The rules and restrictions that apply to reporting business travel expenses are nuanced. 

As an example, companies using the high-low method for an employee must continue using the same method to reimburse expenses for travel within the continental United States throughout the calendar year. However, the company may reimburse the same employee for travel outside of the continental United States using any permissible method during that calendar year.

In the last three months of a calendar year, employers must continue to use the same method (high-low method or per diem) for an employee as they used during the first nine months of the calendar year. 

Also worth noting: per diem rates don’t apply to individuals who own at least 10% of the business. 

Questions? Smolin can help. 

Now is the time to review travel rates and consider switching to the high-low method in 2024. Reduce the time and frustration associated with traditional travel reimbursement benefits managers and traveling employees alike.

For more information, contact your accountant.

Determining Business Entity Tax-Favorable

Determining Which Business Entity is Most Tax-Favorable
Determining Which Business Entity is Most Tax-Favorable 850 500 smolinlupinco

Are you planning to start a business? Perhaps you have already and are now thinking about changing your business entity. In either circumstance, careful evaluation is needed to determine which business structure works best for you. From C-corporations to sole proprietorships, there are many issues to consider.

At present, individual federal income tax rates begin at 10% and range up to 37%. Meanwhile, corporate federal income tax is evaluated at a flat 21% rate. For some pass-through entity owners that are individuals (and some trusts and estates), the qualified business income (QBI) deduction may ease these differences in rates. 

Comparing corporate rates to individual rates

Unless Congress acts to extend it, the QBI deduction will end in 2026. By contrast, the 21% corporate rate isn’t scheduled to expire. It’s also worth considering that noncorporate taxpayers with modified adjusted gross incomes that exceed certain levels face an additional 3.8% tax on net investment income.

For some, opting to organize a business as a C-corporation rather than a pass-through entity could soften federal income tax impacts on the business’s income. Of course, the corporation will still pay interest on loans from shareholders, as well as reasonable compensation to those shareholders. Although that income will be taxed at higher individual rates, the corporation’s overall tax burden may be lowered in comparison to if the business was operated as a pass-through entity instead.

Other tax-related factors to take into consideration 

If most of the profits from the business will be distributed to the owners…

Structuring the business as a pass-through entity instead of a C-corporation may be preferable because shareholders will be taxed on dividend distributions from the corporation leading to double taxation.

Owners of a pass-through entity are only taxed once—at the personal level—on income from the business. Meanwhile, the true cost of double taxation must be evaluated based on projected income levels for both the owners and the business. 

If the value of the assets is likely to increase… 

Typically, conducting business as a pass-through entity can help owners avoid corporate tax in the event that assets are sold or the business is liquidated. When the corporation’s shares (rather than its assets) are sold, corporate tax may be avoided. 

However, the buyer may attempt to negotiate a lower price since the tax basis of appreciated business assets can’t be stepped up to reflect the purchase price. This can secure lower post-purchase depreciation and amortization deductions for the buyer.

If the business is a pass-through entity…

An owner’s basis in his or her interest in the entity is stepped up by the entity income that’s allocated to the owner. When his or her interests in the entity are sold, structuring the business as a pass-through entity could lead to less taxable gain for the owner.

If the business is expected to incur tax losses for a while…

Structuring the business as a pass-through entity may be favorable because it makes it possible to deduct the losses against other income.

On the other hand, it may be preferable for the business to operate as a C-corporation if you have insufficient other income or those losses aren’t usable. (For example, losses aren’t usable when they’re limited by passive loss rules.)

If the owner of a business is subject to the alternative minimum tax (AMT)…

AMT rates can range from 26%-28%. Since corporations aren’t subject to AMT, it may be preferable to organize the business as a C-corporation in this situation. 

Questions? Smolin can help.

As you can tell, there is much nuance involved in choosing a business entity. This article covers some general information, but we recommend consulting with a knowledgeable accountant before making your final decision.

For more details about the best way to structure your business, consult with Smolin.

Accounting M&As

Accounting for M&As
Accounting for M&As 850 500 smolinlupinco

Mergers and acquisitions (M&A) transactions significantly impact financial reporting, especially the balance sheet, which will look markedly different after the business combination. Keep reading for basic guidance on reporting business combinations under U.S. Generally Accepted Accounting Principles (GAAP).

Understanding the purchase price allocation process

Under GAAP, the buyer must allocate the purchase price to all acquired assets and liabilities based on their fair values. 

Estimate the purchase price

The purchase price allocation process begins by estimating a cash equivalent purchase price. Of course, this is simpler if the buyer pays 100% cash upfront. (The purchase price is already at a cash equivalent value.) If a seller accepts non-cash terms, however, the cash equivalent price is less clear. An example of this could be accepting stock in the newly formed entity or if an earnout is contingent on the acquired entity’s future performance. 

Identify assets and liabilities

Next, the buyer needs to identify all intangible and tangible assets and liabilities acquired in the merger. While the seller’s presale balance sheet is likely to report tangible assets and liabilities—like inventory, payables, and equipment—intangibles can be more difficult to nail down. They might only be reported if they were previously purchased by the seller. Since intangibles are generated in-house, they’re not often included on the seller’s balance sheet. 

Determining the fair value of acquired assets and liabilities

When a company acquires another company, the acquired assets and liabilities are added to its balance sheet at their fair value on the acquisition date. Any difference between the sum of these fair values and the purchase price is recorded as goodwill.

Generally, goodwill and other intangible assets with indefinite lives, such as brand names and in-process research and development, aren’t amortized under GAAP. Rather, goodwill must be tested for impairment on an annual basis. 

Testing for impairment

It’s also a good idea to test for impairment when certain triggering events—like the loss of a major customer or enactment of unfavorable government regulations—occur. If an impairment loss is reported by a borrower, this may signal that the business combination isn’t quite meeting management’s expectations. 

Straight-line amortization

As an alternative to testing for impairment, private companies may opt to amortize goodwill over 10 years straight-line. Even with this approach, though, the company will need to test for impairment when triggering events occur. 

Occasionally, a buyer negotiates a bargain purchase. In this circumstance, the fair value of the net assets exceeds the fair value of consideration transfer (the purchase price). Instead of recording negative goodwill, the buyer reports a gain from the purchase on their income statement. 

Questions? Smolin can help.

Accurately allocating your purchase price is crucial to minimize write-offs and restatements in subsequent periods. Contact Smolin from the start to ensure every detail of your M&A accounting is correct. We’ll help ensure your fair value estimates are supported by market data and reliable valuation techniques.

Adjustments Social Security Wage Base

Adjustments to Social Security Wage Base Ahead
Adjustments to Social Security Wage Base Ahead 850 500 smolinlupinco

In 2024, the Social Security wage base for employees and self-employed people will increase.

Employees and employers can expect the wage base for computing Social Security tax to rise to $168,600 next year—a significant jump from the wage base of $160,200 in 2023. 

Self-employment income and wages above this amount won’t be subject to Social Security tax.

The basics on the Social Security wage base increase

Employers pay two taxes under the Federal Insurance Contributions Act (FICA): Social Security tax (for Old Age, Survivors, and Disability Insurance) and Medicare tax (for Hospital Insurance).

The amount of compensation subject to the Social Security tax is capped at a maximum, but there is no maximum amount for the Medicare tax. 

In 2024, employers should expect a FICA tax rate of 7.65%. This includes 6.2% for Social Security, with the remaining 1.45% going to Medicare. 

What is changing in 2024

In 2024, employees will pay a total of:

  • 6.2% Social Security tax on the first $168,600 of wages (6.2% x $168,600 makes the maximum tax $10,453.20)
  • 1.45% Medicare tax on the first $200,000 of wages ($250,000 for joint returns, $125,000 for married taxpayers filing separate returns)
  • 2.35% Medicare tax (regular 1.45% Medicare tax plus 0.9% additional Medicare tax) on all wages in excess of $200,000 ($250,000 for joint returns, $125,000 for married taxpayers filing separate returns)

In 2024, self-employed people pay the following rates in self-employment tax:

  • 12.4% Social Security tax on the first $168,600 of self-employment income, for a maximum tax of $20,906.40 (12.4% x $168,600)
  • 2.90% Medicare tax on the first $200,000 of self-employment income ($250,000 of combined self-employment income on a joint return, $125,000 on a return of a married individual filing separately)
  • 3.8% (2.90% regular Medicare tax plus 0.9% additional Medicare tax) on all self-employment income in excess of $200,000 ($250,000 of combined self-employment income on a joint return, $125,000 for married taxpayers filing separate returns)

What to know if you have more than one employer

Many people worked more than one job to make ends meet in 2023. If your employees are among them, you might have questions. 

Employees with a second job will have taxes withheld from two different employers. They may not ask you to stop withholding Social Security tax once they reach the wage base threshold. Even when an individual’s combined withholding exceeds the maximum amount of Social Security taxes that can be imposed for the year, each employer must withhold Social Security taxes. 

For any excess withheld, the employee should see a credit on their tax return.

Questions? Smolin can help.

If you have questions about payroll tax filing or payments, contact the helpful team at Smolin. We’ll help ensure you stay in compliance while achieving the most favorable tax rate possible.

Listing home vacation rental tax impacts

Listing your home as a vacation rental? Here are the tax impacts to watch for
Listing your home as a vacation rental? Here are the tax impacts to watch for 850 500 smolinlupinco

Whether in the mountains or a waterfront community, many Americans dream of owning their perfect vacation home. If you already own a second house in a desirable area, you might consider renting it out for part of the year.

Before you post that listing, though, take a moment to learn about the tax implications. Taxes for these transactions can be complicated. They are determined based on how many days the home is rented, as well as a few other factors.

Vacation use by yourself and family members (even if you charge them rent) may impact that amount of taxes you pay. Use by nonrelatives will also affect your rate if market rent isn’t charged.

Tax rates for short-term rentals

Did you know that if you rent a property out for less than 15 days during the year, it’s not treated as “rental property” at all? For tax purposes, any rent you receive for this timeframe won’t be included in your income. This can lead to revenue and significant tax benefits in the right circumstances.

There is a drawback to this, though. You can only deduct property taxes and mortgage interest—not depreciation or operating costs. (Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.)

Tax rates for longer rentals

You must include rent received for property rented out more than 14 days in your income for tax purposes. In this scenario, you may deduct part of your depreciation and operating expenses (subject to certain rules). 

However, navigating the numbers can prove challenging. You must allocate which portion of certain expenses are incurred via personal use days vs. rental days, such as: 

  • Maintenance
  • Utilities
  • Depreciation allowance 
  • Taxes
  • Interest

Both the personal use portion of taxes and the personal use part of interest on your second home may be deducted separately. To be eligible, the personal use part of interest must exceed the greater of 14 days or 10% of the rental days. Depreciation on the personal use portion of time is not deductible. 

Losses may be deductible

If allocable deductions are lower than your rental income, you must report the deductions and the rent to determine the amount of rental income you should add to your other income. If expenses exceed the income, it may be possible to claim a rental loss.

The number of days you use the house for personal purposes is important here. If you used the home for more than the greater of 14 days or 10% of the rental days, you used it “too much” to claim your loss.

In this instance, you may still be able to wipe out the rental income using your deductions. However, you can’t create a loss. Deductions you can’t claim will be carried forward, and you may even be able to use them in future years. 

If you can only deduct rental expenses up to the amount of rental income you received, you must prioritize the following deductions:

  • Interest and taxes
  • Operating costs
  • Depreciation

Even if you “pass” the personal use test, you must still allocate your expenses between the personal and rental portions. In this case, though, rental deductions that exceed rental income may be claimed as a “passive” loss (and will be limited under passive loss rules.) 

Questions? Smolin can help.

Tax rules regarding vacation rental homes can be confusing. We only discuss the basic rules above, and additional rules may apply to you if you’re considered a small landlord or real estate professional.

That’s why it’s best to consult with a tax professional before planning your vacation home use. Contact the friendly tax experts at Smolin to learn more.

Running business spouse Tax issues

Running a business with your spouse? Watch out for these tax issues.
Running a business with your spouse? Watch out for these tax issues. 850 500 smolinlupinco

For many spouses who run a profitable, unincorporated small business together, filing taxes can be confusing.

Here are some of the most common challenges to look out for.

Classification: the partnership issue

In many cases, the federal government classifies unincorporated businesses owned by two spouses as a partnership. This means you’ll need to file an annual partnership return on Form 1065.

In order to allocate the partnership’s taxable income, deductions, and credits, you and your spouse must also both be issued separate Schedule K-1s.

Once that paperwork is covered, you should also expect to complete additional compliance-related tasks. 

Calculating self-employment (SE) tax 

The government collects Medicare and Social Security taxes from self-employed people via self-employment (SE) tax.

This year, you should expect to owe 12.4% for Social Security tax on the first $160,200 of your income, as well as an additional 2.9% Medicare tax.

Beyond that $160,200 ceiling, you won’t owe additional Social Security tax. But the 2.9% Medicare tax component continues before increasing to 3.8%—thanks to the 0.9% additional Medicare tax—if the combined net SE income of a married couple that files jointly exceeds $250,000.

You must include a Schedule SE with your joint Form 1040 to calculate SE tax on your share of the net SE income passed through to you by your spousal partnership. In addition, you’ll need to submit a Schedule SE for your spouse to calculate their share of net SE income.

All in all, this can result in a larger SE tax bill than you might expect.

For example, say you and your spouse each have a net SE income of $150,000 ($300,000 total) in 2023 from your profitable 50/50 partnership business. The SE tax on your joint tax return is a whopping $45,900 ($150,000 x 15.3% x 2). That’s on top of regular federal income tax.

Potential tax saving solutions

Option 1: Minimize SE tax in a community property state via an IRS-approved method

IRS Revenue Procedure 2002-69 allows you to treat an unincorporated spousal business in a community property state as a sole proprietorship operated by one of the spouses for tax purposes.

This allocates all of the net SE income to one spouse, so that only the first $160,200 of net SE income from your business will be subject to the 12.4% Social Security tax.

This can dramatically reduce your SE tax bill.

Option 2: Make your business into an S-Corp that pays you and your spouse modest salaries as shareholder-employees

If you don’t live in a community property state, you still have options. By converting your business to an S-Corporation, you can lessen the amount of Social Security and Medicare taxes you’ll owe.

Only the salaries paid to you and your spouse will be hit by the Social Security and Medicare tax, collectively called FICA tax. From there, you can pay out most or all remaining corporate cash flow to yourselves as FICA-tax-free cash distributions. 

Option 3: End your partnership and hire your spouse as an employee

For some couples, running the operation as a sole proprietorship operated by one spouse may make more sense than continuing with a spousal partnership.

In this scenario, you’d hire your spouse as an employee of the proprietorship with a modest cash salary and withhold 7.65% of that salary to cover their share of the Social Security and Medicare taxes. The proprietorship must also pay 7.65% as the employer’s half of the taxes.

As long as the employee-spouse’s salary is modest, the FICA tax will also be modest.

With this strategy, you file only one Schedule SE with your joint tax return (for the spouse treated as the proprietor). A maximum of $160,200 (for 2023) will be exposed to the 12.4% Social Security portion of the SE tax.

Questions? Smolin can help.

If you’re looking for tax-saving strategies for your small business, contact Smolin. We’ll help you determine how to minimize compliance headaches and high SE bills so you can get back to running your business with less tax-induced stress.

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