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Getting Around in the Land of OZ

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Businessman standing in the mountains watching the distanceThe 2017 Tax Cut and Jobs Act created Opportunity Zones. These special economic zones give investors and business-owners a chance to do some good in a depressed area, make some money, and obtain some significant tax benefits. That is a pretty powerful combination.

For this reason, OZ investments have a significant edge over traditional 1031 exchanges. If owners exchange one investment property for another, they may reap some capital gains tax breaks. But 1031 exchanges only apply to real property, OZ investments apply to any capital asset. Additionally, 1031 tax breaks usually only apply when the owner dies.

However, unlike 1031 exchanges, which are rather straightforward, there are a number of intricate rules concerning OZ investment tax breaks. A certified tax coach has the tools you need to maximize these benefits.

The Basics of Opportunity Zone Investments

There are more than 8,500 opportunity zones throughout all fifty states and Puerto Rico. Most, but not all, of them are in the South and Mountain West. The IRS will certify an area as an Opportunity Zone if:

  • The state or territorial government nominates it, and
  • The area has a 20 percent or higher poverty level, or
  • Median household income is at least 20 percent lower than the nearby areas.

In practical terms, these numbers mean that Opportunity Zones are usually not hopelessly depressed areas. Many times, they are downtown neighborhoods that need a redevelopment jump-start. Other times, they are places where suburban sprawl is approaching, but has not quite arrived yet.

Types of Investment Opportunities

In general, either people or companies can invest in Qualified Opportunity Funds. A QOF directs invested funds into the Opportunity Zone. This setup decreases investor risk and helps ensure that more money goes to the Zone itself. In fact, in most cases, at least 50 percent of the QOF’s revenue must come from the OZ, and at least 90 percent of investors’ money must go into the Zone.

Some QOFs are direct funds. These entities operate businesses inside the OZ. Some vice or sin businesses, like massage parlors and liquor stores, are not eligible for OZ status. Other QOFs are indirect investment funds. The investor buys an equity interest in the QOF, which then reinvests this money into an Opportunity Zone business. According to complex IRS rules, at least 63 percent of all indirect investments must go to Qualified Opportunity Zone Business Property. That’s a good thing if, as is often the case, the QOF is a diverse, multistate entity. Some additional safe harbor provisions give indirect investors even more flexibility.

Tax Benefits

As mentioned, OZ tax benefits generally involve capital gains tax breaks. The three major ones are:

  • Deferral: Investors need not pay capital gains tax on any Opportunity Zone investment property until 2027 or until they sell or exchange any portion of the investment.
  • Exclusion: Lawmakers want to encourage long-term investment in these areas. So, investors who keep their money in the OZ for at least five years may exclude 10 percent of their capital gains tax. That exclusion increases to 15 percent after seven years.
  • Basis: This tax break is probably the big one. If investors hold the capital asset for more than ten years, the IRS calculates basis on the date of sale as opposed to the date of purchase. So, the investor basically pays no capital gains tax on the property’s increased value.

State tax rules may or may not be the same. So, it may be necessary to track the investments separately to maximize tax benefits.

To learn more about this tax break, and others like it, contact a certified tax coach near you.

Contact us today by calling 801-553-1120 or request your free consultation online now. As a thank you for scheduling your consultation, we’ll provide a free tax planning book, The Great Tax Escape.

Pursuing the right path: Which business entity is right for you?

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Businessmen handshakeCritical Choices: How the Business Entity You Select Impacts Your Taxes

Entrepreneurs have a long list of special opportunities to save on taxes. However, your eligibility for some tax breaks depends on the decisions you make as you are planning and launching your business. One of the most critical choices is which business entity you will operate under. The Amazon Best Selling book, The Great Tax Escape, walks you through each of your options, spelling out the benefits and drawbacks of the most common business structures.

Business Entity Basics

It’s no surprise that you must pay taxes on any income your business generates, but you might not realize that the same income can be taxed differently depending on how your business is organized. While some types of businesses are considered separate taxpayers from their owners, others require that you include your business income on your personal tax returns.

Your tax rates aren’t the only thing impacted by your choice of business entity. The structure you select affects whether you are personally responsible for business debts and whether you can be held personally liable if the business is sued. When your business exists as a separate entity, the business itself can apply for credit, and these types businesses can continue to operate when you decide to move on or retire.

These are a few of the most common options:

Sole Proprietorships and Partnerships

When you are starting out and working alone, it is easy to operate as a sole proprietorship. Essentially, you and your business are one and the same for tax and legal purposes. Simply register your business name with the state, and you are ready to launch. You can still have employees as a sole proprietor, but you own the entire company.

The simplicity of this structure makes it quite popular, but it isn’t always the best choice for entrepreneurs. Business income is treated the same way as other personal income for tax purposes, and you assume full liability for all business debts and legal issues. That puts your personal assets at risk.

Though there is slightly more paperwork involved, a partnership is quite similar to a sole proprietorship. Taxes and legal liability are the responsibility of all partners, and partners can be sued individually or collectively for the actions of one business owner.

Limited Liability Companies (LLC)

It is common to see the initials LLC after many small and medium-sized business names, and there is a good reason for that. LLCs offer business owners many of the protections that larger corporations enjoy, without the complexity and cost associated with incorporation. With LLCs, business owners are considered separate from the business itself for the purpose of taxation and legal liability. This can lead to significant tax savings, and it protects personal assets from business-related debts and lawsuits.

Of course, setting up an LLC is more complicated that operating as a sole proprietor, so some entrepreneurs choose to hold off on this step until the business begins to be profitable. Your choice of business entity can dramatically impact your bottom line tax bill, and it will affect your long-term level of risk as the organization grows. To learn more about your options for structuring your business, contact us today by calling 801-553-1120 or request your free consultation online now. As a thank you for scheduling your consultation, we’ll provide a free tax planning book, The Great Tax Escape.

The 199A Real Estate Rental Safe Harbor Provision and You

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realtor holding keysThis addition to the Internal Revenue Code allows taxpayers to deduct 20 percent of any Qualified Business Income they receive during a tax year. But the exact definition of QBI had long been uncertain. IRC Section 162 states that a trade or business “generally includes any activity carried on for the production of income from selling goods or performing services.”

That’s not a very helpful definition, especially in the real estate ownership context. IRS Notice 2019-07 substantially clarified the picture. It establishes a safe harbor for real estate rental income. If such money meets the 2019-07 test, it is automatically QBI. However, the safe harbor provisions are still rather subjective, and there are some limitations.

Certified tax coaches may provide the information you need in these situations. These professionals help navigate the Tax Code’s complex provisions.

Specific Requirements

Instead of the income itself, or the property itself, the real estate safe harbor provision focuses on the landowner’s activities. If the owner spends at least 250 hours a year on rental activity, any income from that property is QBI and eligible for the 20 percent deduction. Rental activity includes things like:

  • Making the property available for rent or lease
  • Advertising the opening
  • Verifying rental application information
  • Negotiating lease terms
  • Executing completed leases
  • Collecting rent
  • Managing the property
  • Supervising employees or contractors

The owner can delegate these functions to partners, employees, or independent contractors. So, if the owner hires a part-time maintenance worker who spends Saturday mornings fixing sprinkler heads, servicing tenant appliances, and so on, those 200 hours count toward the 250-hour minimum.

Property procurement, improvement, and investment activities specifically do not count as rental activities. Time spent commuting to and from the property does not count toward the 250-hour minimum either.

There are also some exclusions. Owner-occupied property, even if it was only for one day in the year, never qualifies for the 199A income deduction. Triple net lease property (the tenant pays rent, utilities, taxes, and insurance) never qualified either.

Practical Considerations

For the most part, multi-unit property usually qualifies for the safe harbor allowance. It does not matter if the property is residential or commercial. It also does not matter if the owner intends to sell the property or move into it at a later date.

Single-unit property probably will not qualify. It’s very difficult to meet the hourly requirement in these situations. 250 hours is over six weeks of full-time work. Additionally, the aforementioned residency and lease restrictions often apply.

Contact a certified tax coach near you to learn more about the QBI deduction.

Seriously? Sweat Equity is Not Deductible?

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man thinkingThe labors of love you pour into your business may have a fair market value on the street, but how do you accurately translate your net worth?

Is it $100 an hour or does it range in the thousands? For the CEOs of some publically traded companies that number is often tens of thousands an hour.

But you won’t be able to calculate the value of your efforts until you have been paid.

What About Charity Donation?

Okay, we know, you’re worth every penny, but when you donate time to charity or you’re looking to deduct the cost of your time spent, it can cause confusion at tax time. For entrepreneurs who assume their sweat equity is deductable this can result in shock and disappointment.

The Startup Phase

Starting a new business is an exciting time for an entrepreneur. Ideas are taking shape and heart-held dreams are becoming tangible realities. But unless they’re backed by a substantial nest egg or loan, most businesses need time to produce enough cash flow to compensate the owner for development time.

Many business owners spend hours establishing their businesses before they even open the front door (virtual or otherwise). Ensuring their company’s viability doesn’t often happen overnight. Market testing and calculating pricing take time.

What’s the legal answer to this question?

Well, perhaps it can be found in a recently decided court case. The issue? Whether or not a taxpayer can deduct the value of sweat equity, i.e. services for which he/she is unpaid.

In short, a sole proprietorship reported a loss in his business providing services at no charge. The amount was substantial: $29,500. The taxpayer used this loss as a deduction against his income of $234,000 earned that year (2014). While he had not spent any actual money out of pocket, he argued that research was needed to succeed in his business; yes, sweat equity.

The court ruled against the taxpayer in this case because in order to take a deduction, one must pay or otherwise incur an expense to be eligible to deduct it. The labor itself is not within the meaning of Code Section 162.

Donating Time to Charity

What about taxpayers or business owners who donate their time to a charitable cause? We’ve already determined their time has value. Certainly, the court must allow for this type of deduction, right?

Well, no, not this one. Donations of services are not deductible charitable contributions. However, if business owners or taxpayers donate the value of their work in cash so the organization can hire someone else to do the work, it then becomes a tax-deductible donation.

Donated labor is not deductible even to nonprofits because in the normal earning cycle of a business, the net value of the services donated is zero.

For example, consider service on a nonprofit board. If you charge for the work, you would earn according to your pay scale. However, in donating your services you are not paid.

Now, there’s a way around it.

If the organization pays you for your service and you then donate it, you would be reporting it as income. You would owe and pay taxes on the money earned and then be able to deduct your cash donation. By not receiving the income, you avoid reporting the fees in additional revenue for the year, and you’ll also forego the charitable deduction. Either way, the result is the same.

While your personal valuation of sweat equity you put into your business may result in Fortune 500 positioning, it won’t help you reduce your tax bill.

Certified Tax Coach, we can assist you. Contact us today by calling 801-553-1120 or request your free consultation online now. As a thank you for scheduling your consultation, we’ll provide a free tax planning book, The Great Tax Escape.

Finding the Right Accountant to Successfully Guide You Through the Tax Maze

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accountant talking with clientsChoosing an Accountant Who Puts Your Goals First

There is an endless supply of do-it-yourself tax preparation tools and websites, and the sheer volume of options can lead you to believe the process of filing your returns is simple.

However, a DIY approach only works if you are satisfied with paying more than necessary. Tax preparation software handles all of the basics, importing income and considering common tax deductions. Unfortunately, when it comes to careful application of less-common tax-reduction techniques, these programs simply can’t compete with a skilled tax professional.

The Amazon Best Selling book, The Great Tax Escape, walks you through the process of choosing an accountant. Specifically, you will learn what to look for – and what to avoid – if you want a tax specialist who will help you keep your tax bill low.

Five Reasons to Hire a Highly-Qualified Accountant

As you know from your experience in business settings, companies that focus on their core mission are more successful. Devoting internal resources to creating excellent products and services, while outsourcing peripheral functions like IT and HR, makes it possible to innovate and deliver best-in-class solutions.

Focusing on your core mission is just as critical when it comes to tax preparation. The time you would spend trying to track down tax information is better applied elsewhere, and you are likely to pay more in the end anyway. These are five ways your accountant will free up resources for you to use in ways that will further your personal mission:

  • The tax code is constantly changing, and deductions that were available last year may not be appropriate today. Conversely, expenses you couldn’t deduct in previous returns may now be permitted. A skilled accountant stays on top of these changes and applies them to your situation, so you don’t have to complete extensive research.
  • Much of the tax code is spelled out and clarified based on specific cases. Unless you are following industry developments day in and day out, you are likely to miss all but the most significant decisions. Your accountant has years of experience with filing returns, and continuing education is required in every state. You can be sure that these professionals understand what works – and what doesn’t.
  • Experience also helps when it comes to developing your long-term tax savings strategy. Accountants have watched businesses grow and change, and they know how to get results. Their expertise in complex decisions like choosing a business entity or whether to consider cost segregation can be invaluable.
  • Different types of income are taxed at varying rates, and do-it-yourself filers often assume there is nothing that can be done to change their circumstances. Talented accountants know better. With the help of a skilled professional, it may be possible to move income from high-tax categories to low-tax categories, which can mean significant savings. .
  • Finally, timing is always important in the financial world, and that holds true when it comes to your tax strategy. Accountants have a deep understanding of the economy’s ebb and flow, and they notice patterns that have played out over the course of their careers. They use this experience to advise on when and how to apply tax strategies for maximum savings.

Learn more about why and how to choose the right accountant for all of your tax preparation needs. Contact us today by calling 801-553-1120 or request your free consultation online now. As a thank you for scheduling your consultation, we’ll provide a free tax planning book, The Great Tax Escape.

Are Entertainment Deductions History?

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Sorenson & Company - Certified Tax CoachIt’s no secret that many a sale has been closed over a three-martini lunch. Client entertainment is a given in most industries and most salespeople carry a company credit card for just such transactions.

It’s also no secret that more than a little commingling goes on between personal entertainment expenditures and those that qualify as business expenditures. That is no longer an issue; at least for now. Here’s why….

Under the new tax reform, the veil separating business expenses and pleasure has come crashing down with the elimination of entertainment deductions.

Not good news for business owners who counted on this deduction to defray tax bills at the end of the year. Even the limited deduction of 50% is no longer valid for dinners or cocktails with prospective clients or service providers and similar entertainment expenses.

What could be worse?

Well, how about this: sales related entertaining such as:

  • Sporting events—nixed,
  • Boating and Golfing—nixed.
  • Theater and other shows, box seats at stadiums—yes, those too.

What Does This Mean for Tax Planners?

Will they still be able to work their magic? Their expertise as tax planners is founded in creative workarounds and alternatives. The old saying, when one door closes, another opens applies in the tax world too.

What are The Options?

Well, there’s always Internal Revenue Code Section 274(e).

Despite reforming entertainment-related expenses, this will allow some expenses to be deducted, albeit under different circumstances.

For instance, if you pay for the use of club seating or a private box at a stadium, using this as compensation for your employees will still allow this expense to be deductible.

You need to meet two criteria to make this shift:

  • Ensure your employees attend these events.
  • Include the value of each event as taxable wages.

The “downside” for your team is additional tax that will be subject to withholding and is includable on their form W-2.

The “upside” is it will ensure you can still deduct the expense.

Are Business Meetings Still Covered?

Brace yourself for the GOOD NEWS … YES!

As always, events and entertainment expenses related to business meetings including board of directors and employee meetings continue to be deductible. Deductible expenses continue to include meals and beverages, subject to the 50% limitation, facility rental, décor, supplies, and ancillary costs.

Is There Any Other Way to Deduct Entertainment Expenses?

Again, yes. You can still provide entertainment to the public, your clients, or prospective customers by issuing an information tax statement to the recipient. The most common form to use would be the form 1099-Misc. The recipient will need to include it as income and it will be taxable, but your business will still benefit from the deduction.

Let’s get more creative.

You might consider charging for the event or experience. Sure the income will be taxable, but the cost of the activity will become deductible, transforming your expense from after tax to pre-tax dollars.

The new tax reform brings big changes but your tax planner will still be able to work with you and provide valuable advice. To find out more about how to navigate the tax laws both new and old, be sure to work with someone who is certified in tax planning. We’ll help you find the new ways to open doors to a lower tax bill!

Contact us today by calling 801-553-1120 or request your free consultation online now. As a thank you for scheduling your consultation, we’ll provide a free tax planning book, The Great Tax Escape.