Reap Tax Rewards for Business Property
Section 179 provides immediate benefit
There is a unique tax break for business entities of all sizes contained in Section 179 of the Internal Revenue Code. Under this section, a business can elect to “expense,” or currently deduct, the cost of qualified property placed in service during the year, up to an annual maximum. It is near-instant tax gratification.
Although the maximum deduction has gradually increased over time, the Tax Cuts and Jobs Act (TCJA) of 2017 significantly sweetened the pot by doubling the amount from $500,000 to $1 million, subject to inflation indexing. Icing on the cake: Unlike many other changes in the TCJA, this provision is permanent.
Background: When your business acquires qualified property (e.g., equipment or machinery), it generally can recover the costs over time through depreciation deductions under the Modified Accelerated Cost Recovery System (MACRS). For instance, if your company buys computers for the business, it may be able to write off the cost over five years. Other types of business property have longer recovery periods.
With Section 179, you do not have to wait as long. This special provision enables you to claim a deduction of up to $1.16 million for the cost of property placed in service in 2023, up from $1.08 million in 2022. (The latter is the maximum you can claim on your 2022 return.) The property may be new or used.
Furthermore, the Section 179 election is available to most business taxpayers ranging from corporate giants to self-employed individuals. But there are two important rules that may limit deductions.
- Annual business income limit: The expensing deduction cannot exceed the net taxable income from all the businesses you actively operate. For this purpose, net income is figured without regard to expensing, the 50% deduction for self-employment tax and any net operating loss (NOL) carryforwards or carrybacks.
- Annual dollar cap: If the total cost of qualified property placed in service during the year exceeds an annual threshold, the maximum expensing allowance is reduced on a dollar-for-dollar basis. The TCJA raised the threshold from $1 million to $2.5 million. As with the maximum annual deduction, this threshold is indexed for inflation. For 2023, it is $2.89 million, up from $2.7 million in 2022.
Note that the property may also be eligible for first-year bonus depreciation if the Section 179 deduction is limited. For instance, bonus depreciation may be claimed for property with a cost recovery period of 20 years or less. But bonus depreciation is being gradually phased out over five years. It drops from 100% in 2022 to 80% in 2023. Finally, regular MACRS deductions may cover any remainder.
Other special rules may apply to specific types of business property. For example, deductions for vehicles may be limited by the so-called “luxury car” rules, although the TCJA recently enhanced these write-offs.
Reminder: Taxes are an important factor when you consider an acquisition of business property. Be aware of how the tax law limits may affect your Section 179 deductions. Your professional tax advisors can provide guidance.
Keying in on Home Sale Records
Maximize home sale exclusion
It has often been said the home sale exclusion is one of the “biggest and best” tax breaks on the books. But the exclusion may not completely shelter your taxable gain due to the upswing in housing prices in many parts of the country in recent years.
Fortunately, you can minimize any capital gains tax that is due, or even eliminate it entirely, if you have the proper records.
Background: If you have owned and used your home as your principal residence for at least two of the previous five years, you can elect to exclude from tax up to $250,000 of home sale gain if you are a single filer or $500,000 if you are joint filer. There is no limit on the number of times you can claim the exclusion.
The taxable amount for purposes of the exclusion is essentially the difference between the selling price and your adjusted basis in the home. For example, your basis may have been reduced to reflect rollovers from prior home sales. On the other hand, certain home improvements increase your basis, thereby reducing your taxable gain.
Simplified example: Say you bought your principal residence 15 years ago for $250,000. Now you’re planning to sell the home for $850,000, or $600,000 more than what you paid for it. You are married and file a joint return each year.
In the intervening years, you have added improvements costing a total of $200,000. So your basis for calculating taxable gain is $450,000 ($250,000 + $200,000). This reduces your taxable gain to $400,000 ($850,000 – $450,000). Result: The exclusion covers the entire taxable gain.
Any gain that is subject to tax is favorably-taxed long-term capital gain if you have owned the home longer than a year. The maximum long-term capital gain rate is 20%.
What types of expenses are treated as home improvements? As a general rule, a home improvement adds to your home’s value or prolongs its useful life. The list includes the following:
- Finishing a basement or attic;
- New plumbing, heating or air conditioning system;
- Adding a fireplace or new room;
- Outside improvements such as a patio, deck or swimming pool;
- Installing aluminum or vinyl siding or storm windows and doors; and
- New landscaping.
But note that the cost of repairs—such as expenses for painting, fixing gutters, plastering walls and replacing broken windows—cannot be added to your basis.
Also, you can reduce your sales price for tax calculation purposes by the amount of certain home selling expenses. This includes the following:
- Real estate broker’s commission;
- Appraisal fees;
- Attorney’s fees;
- Closing and settlement fees;
- Document preparation fees;
- Advertising expenses;
- Escrow fees;
- Mortgage satisfaction fees;
- Notary fees;
- Title search fees; and
- Transfer taxes charged by a city, county or state government.
Generally, these expenses are reflected in the closing statement you receive when you sell the home. All the grunt work is done for you.
Final words: Consult with your tax professional before you sell your home so you fully understand the tax consequences.
Don’t Ignore the Threat from Within
Protecting business from embezzlement
It is not enough for a small business owner to be concerned with hackers or other outsiders who may try to invade your computer system or vandalize your business premises. The potential threat of embezzlement from inside your company is just as a real. You may see it played out often in local news reports.
In fact, according to recent statistics, about 75% of employees have committed a theft, while 95% of companies have been victimized by embezzlement. So do not think that your business is immune.
How can you best protect your company? A good place is to start with a thorough examination of your bookkeeping procedures. Be sure to completely separate the accounts payable from the accounts receivable. Also, whether wages are paid by check or electronically, have at least two employees handle payroll—one to authorize payment and the other to disburse funds. If only one person is assigned both of these critical jobs, it may create an irresistible temptation to embezzle.
Furthermore, the owner of a small business should approve payments over a certain amount. Payments should be made with an original invoice, not a copy. Have all bank statements reconciled and audits performed periodically.
Even with these safeguards in place, there is no guarantee that you will not be victimized. What should you do if you find out an employee has embezzled from the company?
Following are several practical suggestions to follow:
- Consult with an attorney to find out the civil and criminal legal remedies that may be available to you. For instance, you might sue the employee to recover the embezzled money.
- Contact the authorities. Frequently, owners feel partly to blame for allowing the theft to take place, but hiding it does no good. In most cases, the employee will then move on to the next victim and you will be left holding the bag.
- Try to recover the funds. Reporting the crime does not mean you will be reimbursed in full. Before paying claims, insurance companies want solid proof of embezzlement, which is not always easy to provide. For example, when inventory is stolen, it is hard to show that the loss is actually theft and not an inventory mistake by an employee.
- Notify the IRS about the embezzlement. This becomes an added incentive for the employee to make restitution, since embezzled funds are considered to be taxable income. If you report the crime to the IRS, the employee will owe tax on the total amount stolen. This amount will be reduced to the extent that the employee makes restitution.
Be fully aware of the risks. Do what you can to discourage potential problems before they occur. Finally, keep your eyes and ears wide open at all times.
Three Ways to Leave Gifts to Charity
Tax-smart donations from an estate
Giving to a charity through your estate can create a lasting legacy, yet this concept is not limited to the “rich and famous.” There are several possible tax-wise ways to accomplish your goals. Consider these three basic techniques.
- Direct gifts: The easiest way to donate through an estate is to make an outright gift by will. Direct gifts do not provide any income tax benefits, but they reduce the size of your taxable estate. Upon death, the estate tax exemption can shelter from estate tax up to $10 million of assets bequeathed to non-spouse beneficiaries (indexed to $12.92 million for 2023). In addition, the estate of a surviving spouse may utilize any unused portion of the deceased spouse’s exemption. The direct gift technique gives your estate even more flexibility.
- Retirement plan assets: Donating assets in a retirement plan account is another relatively simple way to give to a charity. All you have to do is to designate the charitable recipient as a beneficiary on your plan documents. Because the charity is exempt from income and estate taxes, it receives the full value of the amount transferred. Keep other assets for your heirs.
- Split-interest gifts: The third technique is more complicated than the other two. With a split-interest gift, you open up a trust and fund it with a lifetime gift. As a result, you are entitled to a charitable deduction at the time of the transfer. This enables you to retain some rights to the assets. Nevertheless, you still reduce the size of your taxable estate and avoid potential capital gains tax on assets transferred to the trust. Here are a few variations on the theme.
- With a charitable remainder trust (CRT), you transfer assets to a trust and name an income beneficiary, such as yourself or your spouse, to receive either a fixed payment or percentage payment for the trust term (subject to certain limits). The beneficiary pays tax on the CRT amounts. When the trust expires, the assets go to a designated charity. As the donor, you are entitled to a tax deduction in the year of the transfer.
- A charitable lead trust (CLT) is the opposite of a CRT. In this case, the charity receives annual income while the remainder goes to your heirs at the end of the trust term. A CLT may be preferable to a CRT if you do not need current income. Again, the donor is entitled to a current tax deduction.
- A pooled income fund (PIF) is a trust maintained by a charity. In effect, it is like a CRT with the charity administering the trust. As with a CRT, the donor may receive annual income with the remainder going to charity. PIF contributions qualify for a current tax deduction.
Which technique, if any, is best for you? It depends on your personal circumstances. Be sure to talk matters over with your family before you make a determination.
IRS Issues New Mileage Rates
The IRS has announced the standard mileage rates that may be used in 2023 instead of deducting actual expenses. The new rates are as follows:
- For business driving, the rate is 65.5 cents per mile (up from 62.5 cents in the second half of 2022).
- For medical and moving expenses, the rate is 22 cents per mile (the same it was in 2022).
- For charitable travel, the rate is 14 cents per mile (the same as it was in 2022).
Note that you can add related tolls and parking fees to these flat IRS-approved rates.
Facts and Figures
Timely points of particular interest
Payroll Tax Break—Certain start-up companies are in line for a bigger payroll tax break in 2023. Under the Inflation Reduction Act (IRA), a business with less than 100 full-time employees can use up to $500,000 in research credits to offset payroll taxes instead of income tax. The IRA doubled the amount from $250,000 in 2022. This election is available to a business with annual gross receipts of $5 million or less that did not have income prior to the last five years.
No Kidding—The “kiddie tax” generally applies to investment income received by a child you support who is under age 19 or a full-time student under age 24. Essentially, the excess above an annual threshold is taxed at the top tax rate of the child’s parents. The threshold for 2022 returns is $2,300. It is increasing to $2,500 in 2023. Note: The kiddie tax does not apply to earned income like wages from a child’s summer job.