Taxes

As a result of rising interest rates and a slowing economy, last year’s merger and acquisition (M&A) activity decreased significantly. According to S&P Global Market Intelligence, the total value of M&A transactions in North America was down 41.4% in 2022 (compared to 2021). 

But in 2023, some analysts anticipate increased M&A activity in some industries. If you’re thinking about selling or buying a business, it’s important that you understand the tax implications. 

Two approaches to M&A transactions

According to current tax law, M&A transactions can be structured in one of two ways: 

1. Stock/ownership interest

If the target business operates as a C- or S-corporation, a partnership, or an LLC that’s treated as a partnership for tax purposes, a buyer can directly purchase the seller’s ownership interest. 

The option to buy a stock of a C-corporation may become more appealing with the current 21% corporate federal income tax rate, as the corporation will pay less tax while generating more post-tax income. Additionally, any built-in gains from appreciated corporate assets will be taxed at lower rates when sold. 

Ownership interests in S-corporations, partnerships, and LLCs have also become more appealing due to the current individual federal tax rates; the passed-through income from these entities is also taxed at a lower rate on a buyer’s personal tax return. However, it’s important to note that these individual rate cuts will expire at the end of 2025. 

2. Assets

Another option is to purchase the business assets, which may be ideal when a buyer only wants specific assets or product lines. If the target business is a sole proprietorship (or single-member LLC treated as a sole proprietorship for tax purposes), purchasing business assets is the only option. 

Choosing the right option

The right approach to M&A transactions depends largely on the goals of those involved. 

What buyers want

Buyers often prefer to purchase assets rather than ownership interests. This is because, generally, a buyer’s primary goal is to generate enough cash flow from an acquired business to be able to pay any acquisition debt while also providing an acceptable ROI. As a result, buyers tend to be concerned about limiting exposure to unknown liabilities and minimizing post-transaction taxes. 

A buyer can step up—or increase—the tax basis of purchased assets to reflect the purchase cost. When certain assets (such as receivables and inventory) are sold or converted into cash, a stepped-up basis lowers taxable gains. It can also increase depreciation and amortization deductions for qualified assets. 

What sellers want

Sellers generally prefer stock sales for both tax and non-tax reasons. One objective is to minimize a sale’s tax bill, often achieved by selling business ownership interests (corporate stock or partnership or LLC interests) instead of business assets. 

When a stock or other ownership interest is sold, liabilities typically transfer to the buyer. Additionally, any gain on sale is often treated as lower-taxed long-term capital gain—assuming ownership interest has been held longer than one year. 

Buying or selling a business? Contact a financial professional.

Buying or selling a business is a significant transaction with far-reaching impacts. If you’re considering an M&A transaction, it’s important to seek assistance from a professional before finalizing a deal—because after the transaction is complete, it may be too late to get the best tax results. 
That’s where Smolin comes in. Contact us to speak to a knowledgeable tax advisor.

During the height of the COVID-19 pandemic, the Employee Retention Credit (ERC) helped employees keep their staff members on payroll. While this tax credit is no longer available, eligible employers who have yet to claim it may be able to do so by filing amended payroll returns for 2020 and 2021. 

However, the IRS warns against third parties advising non-eligible employers to claim the ERC. 

ERC 101

The ERC is a refundable tax credit designed specifically for businesses that: 

• Continued to pay employees while being closed due to the COVID-19 pandemic, or 
• Had significant declines in gross receipts between March 13, 2020, and September 30, 2021 (or, for certain startup businesses, December 31, 2021) 

Eligible employers who did not claim the ERC on an original tax return may still be able to claim it on an amended return. 

Eligible businesses must have fully or partially suspended operations due to government orders limiting commerce, travel, or group meetings due to the pandemic during 2020 or the first three quarters of 2021. Those who qualified as a recovery startup business during the third or fourth quarters of 2021 may also be eligible. 

Note that for any quarter, eligible employers cannot claim the ERC on wages that were: 

• Reported as payroll costs in obtaining Paycheck Protection Program (PPP) loan forgiveness 
• Used to claim certain other tax credits 

The problem with third-party “ERC mills” 

Some third-party “ERC mills” are sending notices via email, postal mail, and voicemail—and even advertising on television—promising businesses that they can help them receive a refund, despite not knowing anything about the employers’ unique circumstances. 

When businesses respond, these third parties claim many improper write-offs relating to the tax credit, such as taxpayer eligibility and computation. These third parties often charge large fees, whether upfront or contingent on a refund, without informing taxpayers that wage deductions claimed on federal income tax returns must deduct the amount of the credit. 

Getting the facts straight

If a business filed an income tax return that deducted qualified wages prior to filing an employment tax return claiming the ERC, they should file an amended return correcting any overstated wage deductions. 

The IRS encourages businesses to be wary of advertisements and offerings that seem too good to be true. Regardless of the third parties involved, taxpayers are always held responsible for any information reported on their tax returns. By improperly claiming the ERC, you may be required to repay not only the credit, but also any penalty fees and interest.

Wondering if you can still claim the ERC? Contact a knowledgeable tax professional

If you’re an employer who didn’t previously claim the ERC and believe you may be eligible, Smolin’s tax advisors can help you determine how to proceed. Contact us today. 

Conveniently enough, one of the most effective ways to save on your estate taxes is also one of the simplest: when you use the annual gift tax exclusion, you can transfer assets to loved ones without any gift tax. 

While the current gift tax exclusion amount is $16,000 per recipient in 2022, that amount will increase by $1,000 in 2023. 

Making the most of your gifts

While it’s commonly misconceived that the onus of the federal gift tax is on the recipient of the gift, the reality is that these taxes are generally owed by the giver. That said, gifts can be structured so that they’re excluded from gift tax (and, if necessary, unified gift and estate tax). 

In 2022, you can gift each family member up to $16,000 without owing gift tax. In 2023, that amount will increase to $17,000. If you gift your children and grandchildren up to $16,000 before December 31, you can then gift them each an additional $17,000 beginning in January—significantly reducing your estate in a matter of months. 

This annual gift tax exclusion is available to each taxpayer. For those who are married and whose spouse consents to a joint gift, or “split gift,” the exclusion amount is effectively doubled. 

If you exceed the annual exclusion amount, you will need to file a gift tax return. Note that even if you give joint gifts with your spouse, you must each file individual gift tax returns. 

Lifetime gift tax exemption

As part of the unified gift and estate tax exemption, the lifetime gift tax exemption can shelter gifts above the annual exclusion amount from taxation. The current amount is $12.06 million, and that amount will increase to $12.92 million in 2023. 

That said, if you tap into your lifetime gift tax exemption, the exemption amount available for your estate will be eroded.

Gift tax exceptions 

Some gifts are exempt from gift tax, including gifts given: 

• From one spouse to another
• To a qualified charitable organization
• To a healthcare provider for medical expenses
• To an educational institution for tuition

These exemptions preserve both the full annual gift tax exclusion amount and the exemption amount, and won’t count against the annual gift tax exclusion. 

Plan your gifting strategy with us

Not sure how to get the most out of the annual gift tax exclusion for your estate planning? Contact us to work with a knowledgeable advisor and develop a powerful strategy that works for you. 

While investing in tax-free municipal bonds generally provides tax-free interest, you may still encounter tax consequences. Keep reading to learn more about the potential tax and other financial consequences of investing in tax-free bonds.

Purchasing tax-exempt bonds

There are no immediate tax consequences for purchasing a tax-exempt bond for its face amount, whether on the initial offering or in the market. If you buy a tax-exempt bond between interest payment dates, however, you will owe the seller any accrued interest since the most recent interest payment date. 

The amount of interest accrued is then treated as a capital investment and will be deducted as a return of capital from the following interest payment. 

Is interest included in income?

Generally speaking, interest received on a tax-free municipal bond will not be included in gross income—but it may be used for alternative minimum tax (AMT) purposes. Tax-free interest may be appealing, but it’s important to note that compared to an otherwise equal taxable investment, a municipal bond may pay a lower interest rate. What really matters is the after-tax yield. 

The after-tax yield for a tax-free bond is typically equivalent to the pre-tax yield. Alternatively, the after-tax yield for a taxable bond is determined by your interest amount after accounting for the increase in your tax liability due to annual interest payments—which is based on your effective tax bracket. 

Taxpayers in higher brackets tend to be more interested in tax-free bonds, since excluding interest from income offers a greater benefit. Taxpayers in lower brackets, however, may find that the tax benefit from excluding interest from income may not adequately make up for a lower interest rate.

While not taxable, municipal bond interest still shows on a tax return. This is because tax-exempt interest is taken into account when determining the amount of taxable Social Security benefits (and other tax breaks). 

Tax-exempt bond interest and the NIIT

Another tax advantage of tax-exempt bond interest is that it is exempt from the 3.8% net investment income tax (NIIT). 

This is imposed on the investment incomes of individuals whose adjusted gross income exceeds:

• $250,000 for joint filers
• $125,000 for married filing separate filers
• $200,000 for other taxpayers 

What about retirement accounts?

Because the income in your traditional IRA or 401(k) isn’t currently taxed, it generally isn’t logical to hold municipal bonds in those accounts. Once you start taking distributions, however, the entire amount withdrawn may be taxed. 

For those who want to invest retirement funds in fixed-income obligations, it’s typically a good idea to invest in higher-yielding taxable securities. 

Consult with a tax professional

Before investing in tax-free municipal bonds, it’s important to fully understand the tax implications—and those mentioned above are only some of the tax consequences. If you need assistance understanding and applying tax rules to your situation, contact us to work with a knowledgeable tax advisor.

© 2022

If you’re a high-income taxpayer, you may need to pay two extra taxes: a 3.8% net investment income tax (NIIT), and an additional 0.9% Medicare tax on wage and self-employment income. 

Keep reading to learn more about these taxes and what they might mean for you. 

3.8% NIIT

In addition to income taxes, the NIIT applies to your net investment income. This tax affects taxpayers with adjusted gross income (AGI) exceeding the following: 

• $250,000 for joint filers
• $200,000 for single taxpayers and heads of household
• $125,000 for married individuals filing separately 

If your AGI is above this threshold, the NIIT applies to the lesser of: 

• Your net investment income for the year, or
• The excess of your AGI over the threshold amount for the tax year 

What incomes are subject to the NIIT? 

Net investment incomes subject to the NIIT include interest, dividends, annuities, royalties, rents, property sale net gains, and passive business income. This does not include wage income and active trade or business income, or tax-exempt income tax such as bond interest. 

After considering your income needs and investments, you may want to consider switching some of those taxable investments over to tax-exempt bonds. 

How does the NIIT apply to home sales? 

If you sell your primary residence, you may be able to exclude up to $250,000—or $500,000 for joint filers—in your income tax, which will not be subject to the NIIT. If your gain exceeds that amount, however, it will be subject to tax. This also applies to gain from selling a vacation home or other secondary residence. 

Note that distributions from retirement plans such as pension plans and IRAs are not subject to the NIIT. However, if these distributions push your AGI above the threshold, they can cause other income types to be taxed. 

Additional 0.9% Medicare tax

In addition to the 1.45% Medicare tax that applies to all wage earners, some high wage earners are subject to an additional 0.9% Medicare tax. This applies to wages that exceed: 

• $250,000 for joint filers
• $125,000 for married individuals filing separately
• $200,000 for all others 

Note that this tax only applies to employees—not employers. 

The employer must begin withholding the additional 0.9% Medicare tax once their employee’s wages for the year reach $200,000. However, if the employee (or the employee’s spouse) has additional wage income from another job, this may prove insufficient. Instead, the employee may file a new W-4 with the employer to request extra income tax withholding. 

How does the extra Medicare tax affect self-employment income? 

In addition to the regular 2.9% self-employment Medicare tax, the additional 0.9% Medicare tax applies to self-employment income for the tax year that exceeds the same amounts as wage earners—note, however, that the $250,000, $125,000, and $200,000 thresholds are modified according to the self-employed taxpayer’s wage income. 

Work with our tax advisors

Income taxes can be complicated, especially when they vary from year to year. Is your income high enough that you owe these extra taxes? Contact us to discuss your taxes and their implications with a qualified tax professional.

© 2022