Author: Jean Godin

Disaster Declarations

Natural phenomena such as floods, forest fires, hurricanes, tornadoes, and earthquakes pose unpredictable threats to life and property. When disaster strikes, the IRS has policies in place to attempt to ease the burden on affected taxpayers and businesses. But understanding your rights as a taxpayer would be a headache in the midst of an emergency. Read on to familiarize yourself ahead of the unthinkable with what disaster declarations do and don’t mean.

 

1. The IRS may only authorize relief for victims of disasters that have been recognized by the Federal Emergency Management Agency (FEMA).

The clearest way to qualify for disaster relief is to reside or have established a principal place of business in a qualifying area designated by FEMA. Taxpayers whose address of record is in an area qualifying for IRS disaster tax relief will automatically receive extra time from the IRS to file returns and pay taxes. For example, victims of the wildfires in Colorado earlier this year received an automatic extension of almost a month to May 16, 2022.

However, taxpayers who do not reside or do business in a disaster area may still qualify for relief if their tax records are stored in a designated disaster area. For example, if your tax preparer is located in a disaster area and unable to file or pay your taxes on your behalf, you qualify for relief. Similarly, a shareholder in an s-corporation or partnership qualifies for relief if they cannot obtain their tax records due to a designated disaster. But unlike those with an address of record in a disaster area, taxpayers who are affected by the storage of their records must request relief by calling the IRS’s Disaster Hotline at (866) 562-5227.

 

2. Taxpayers may deduct property losses that are not covered by insurance or other reimbursements.

For individuals, damaged or lost personal property can include homes, household items, and vehicles. However, losses on personal property are only deductible to the extent that they were not reimbursed by insurance. Taxpayers do not have to itemize their deductions to report these losses. Furthermore, taxpayers may choose whether to report the loss in the year that it occurred or on their prior-year return. Reporting the loss on the prior year is often more beneficial because it provides the funds from a refund more quickly.

Disaster loss rules are the same for renters and commercial property owners as they are for homeowners. For example, if a business loses a large piece of equipment with a tax basis of $100,000, and the insurance reimbursement was only $85,000, the tax deduction would be $15,000.

 

3. The Small Business Administration (SBA) offers financial help to business owners, not-for-profits, homeowners, and renters affected by disasters.

Help may include grants or low-interest loans. This influx of working capital is often enough for small businesses to weather the economic injury caused by a disaster.

Once again, the person or entity must be in a designated disaster area. In addition to FEMA, the President of the United States and the Secretary of Agriculture may make disaster declarations for purposes of SBA programs. The SBA website maintains a search feature for currently qualified disaster areas.

 

In Conclusion

According to the National Center for Environmental Information, Americans have experienced 310 natural disasters since 1980. The center estimates that the dollar value of damage from disasters has exceeded $1 billion (Consumer Price Index adjusted to 2021). Unfortunately, even taxpayers who never live through a disaster themselves likely know a friend or loved one impacted by the aftermath of a natural disaster. We hope that this brief overview of the special tax law provisions in place for victims of disasters provides some reassurance in the face of a crisis.

Self-Directed Retirement Accounts: Possibilities and Pitfalls

Accountants and financial advisors alike agree that investing in tax-advantaged retirement accounts like 401(k)s and IRAs are a great way to save for retirement. Many investors save money on taxes in the year they contribute to the account, and the contributions grow tax-free for decades until the account holder withdraws the funds. Other investors may choose to pay taxes by making an after-tax contribution today in exchange for future tax-free fund withdrawals by contributing to a ROTH account.

While the tax advantages make some retirement options attractive, many investors prefer to be more active in their investment decisions or prefer to invest in more volatile assets. Most brokerage firms limit retirement account investment options to publicly traded stocks, bonds, mutual funds, CDs, and ETFs. Thus, some individuals may find traditional retirement accounts limiting. That is where self-directed retirement accounts, especially the self-directed IRA, come in.

Self-directed IRAs offer two main advantages:

  1. Allows investments in alternative assets
  2. Gives the investor control over buy/sell decisions

All retirement accounts have restrictions such as contribution limits, early distributions, or required minimum distributions. However, self-directed IRAs carry much more complex compliance and reporting requirements that could cost owners substantially in the case of an accidental violation.

 

Self-Directed Possibility #1: Invest in Alternative Assets

Allowable alternative assets include:

  • Real estate
  • Precious metals
  • Cryptocurrency
  • Private businesses
  • Livestock
  • Oil and gas interests
  • Promissory notes

 

If an investor has a strong interest and expertise in a particular type of investment, self-directed IRAs provide flexibility without compromising on tax savings. Since these markets are much risker than stocks, bonds, and mutual funds, these investment options are only appropriate for investors ready for a considerable commitment of time and attention.

Potential pitfall: The IRS has specified that certain assets may not be purchased in self-directed retirement accounts such as life insurance and collectibles like art, antiques, stamps, rugs, and coins. Additionally, cash will need to be contributed to the self-directed IRA before assets are purchased. The self-directed IRA itself, not its owner, must purchase the asset directly.

 

Self-Directed Possibility #2: Control Buy/Sell Decisions

The first step in establishing a self-directed IRA is opening an account with a custodian that offers such accounts. Typically, the custodian will be a brokerage or investment firm. This custodian holds the IRA assets and executes the purchase or sale of investments on the investor’s behalf.

While the custodian cannot provide financial advice, they play an important role in administration and compliance. The custodian will file a Form 5498 every year for every IRA it oversees to report contributions and the fair market value of the account.

Investors who seek even more direct control over their retirement account may establish a “checkbook IRA.”

To form a checkbook IRA, a limited liability company (LLC) is established and owned by the IRA. A business checking account is linked to the IRA funds. The IRA owner manages the LLC and controls the transactions in the account. But while a checkbook IRA can eliminate some delays and fees associated with using a third-party custodian, it opens the investor to serious risks.

Potential pitfall: Engaging in self-dealing or prohibited transactions can cause your self-directed IRA to lose its tax-advantaged status, resulting in an unexpected tax bill.

The IRS rules for IRA investments are complex, and violations can occur accidentally. Examples of violations include:

  • Investing in prohibited assets
  • Selling property to your IRA
  • Borrowing money from your IRA
  • Using the IRA or property in the IRA as collateral for a personal loan
  • Using property in the account for personal use, such as vacationing at an investment property or renting an investment property to your ancestor or descendant
  • Receiving money produced by an IRA investment into your personal account

 

If you violate any of the IRS rules and therefore lose tax-advantaged status, all the money invested into the account will be treated as a taxable distribution.

Furthermore, owners of checkbook IRAs are responsible for the filing requirements that custodians typically handle.

Given the consequences of the potential pitfalls of investing in a self-directed retirement account, they are likely only beneficial to the most hands-on, risk-friendly investor.

 

Main Takeaway

While self-directed IRAs can be a powerful tool for opening unique investment opportunities, it is critical to work with a team that understands the risks and pitfalls. K&R Tax Accounting Services can assist you in the set-up and oversight of such accounts. If you are interesting in exploring whether a self-directed retirement account might be right for you, contact our office at 480-392-6801.

IRS Destroys 30 million Information Returns

In March of 2021, the IRS shocked taxpayers and tax preparers alike when an audit uncovered that the IRS office in Ogden, UT, had destroyed an estimated 30 million paper-filed information documents.

Yes, 30 MILLION.

 

What are the possible consequences of this mass destruction?

The IRS asserts that the data that was destroyed included only informational pages, like 1099s and W-2s. Officials insist that no actual tax return filings were destroyed. While neither K&R nor any other firm can verify that claim, we suspect that missing data will worsen the already overwhelming delays in processing returns.

For example, when a taxpayer’s return includes wages paid by an employer, the IRS has a system in place to compare the wages the taxpayer reports with the wages reported by the employer on the W-2. The missing data causes a mismatch that could trigger more notices sent by the IRS and longer delays in issuing refunds.

The IRS isn’t worried about the consequences: officials stated that the onus for providing proof of correct amounts rests on the taxpayer.

In the event of an IRS audit, how many average Americans could produce a 1099 from 3 years ago without major headaches?

 

Why did this happen?

The constraints of outdated technology. The IRS uses an imaging processing system to convert paper informational returns into a usable data format. However, the documents must be processed prior to the end of the year they were received in. Once the 2021 filing season began, documents received in 2020 could no longer be processed. Thus, the unprocessed documents were destroyed.

In an official statement, the IRS asserted that it intends to process all paper information returns received in 2021 and 2022. Only time will prove or disprove that promise. We do know that despite encouraging taxpayers to file electronically, the IRS continues to require paper filing of many documents including some amended tax returns.

 

What can your accounting firm do to protect you?

In times when taxpayers can’t rely on our government agencies, your accounting firm should protect you as a client by maintaining historical records with an emphasis on security.

Jessica, one of our staff members, recalls a very different experience as a customer at a big-name tax preparation service:

“When my first daughter was a toddler and my second was on the way, my spare moments were spent getting as much rest as possible. I didn’t have the energy the calculate the tax implications of selling my house in Texas! So, I made an appointment with another preparer for the first and only time.

I remember at the end of my appointment, the employee handed me a nice-looking folder with my documents and a printout of my tax return. . . that is the last time I remember seeing that folder. I’m sure that it’s in my house, tucked away somewhere.”

At K&R, we made the commitment several years ago to transition to a paperless office. We don’t handle original hard copies which could be damaged, lost, or stolen. Our clients have access to both their submissions and completed tax returns 24 hours a day through our online client portal.

As K&R clients face relocations, natural disasters, life changes, and even governmental misconduct, their tax information remains stored in one safe location.

The Best Time for Tax Planning: Today

Have you ever felt anxious going in to review your tax return? Have you ever been uncertain whether you were going to receive a refund or owe money to the IRS?

Too often, tax season brings unpleasant surprises like balances due and penalties. However, at K&R we believe that surprises at tax time are not only unpleasant but also unnecessary. By the time you reach the tax preparation stage, it is too late to implement many of the strategies that can save you money. When planning for taxes happens throughout the year, strategies for tax deferral and tax avoidance can be put into action.

Tax planning is especially effective for self-employed individuals or small business owners. Unlike W-2 employees, business owners have a much larger array of options for finding credits and deductions that make sense for the way you are already doing business. A tax advisor can help you strategically time expenditures that you already make like donations to charity or large purchases of equipment.

For many business owners, the last time that they evaluated the structure of their business was when it was formed. However, owners of LLCs have the flexibility to tell the IRS how they want to be taxed. Often, the default method is not the most beneficial for the taxpayer, especially as their income grows. For example, electing to be taxed as an s-corp can save business owners up to 15.3% in taxes annually, but the decision of if and when to make this election is different for every business. K&R performs analyses that consider projected income, profit margins, and other performance indicators to determine the most tax-efficient structure of your business.

Tax planning goes hand-in-hand with financial planning. The right professional services firm will consider both your short-term and long-term goals. Saving for retirement is a priority for almost everyone, but decisions such as investing in a traditional versus a ROTH retirement account can be overwhelming. Determining the most tax efficient option depends upon a variety of factors including your marginal tax bracket and the projected growth of your income. K&R employs an in-house financial advisor to ensure that your tax and financial planning are working in tandem.

As each new administration takes office in Washington, promises to improve federal tax law contribute to increasingly confusing rules and regulations. Most business owners do not have the time to devote to researching and implementing new tax strategies while also growing their businesses. The right financial services firm remains in front of these shifting opportunities. At K&R, we proactively reach out to clients that we think will be eligible for credits such as the Arizona Corporate Credit for school tuition organizations and the federal Employee Retention Credit.

EXPECT MORE than tax preparation from your accounting firm. Effective tax strategy must be timely and integrated with your financial goals. Your tax advisor should be as knowledgeable about tax strategy as they are about compliance.

Do you think K&R is the right advisor to help you save money on taxes? Call our office today at 480-392-6801 to set up your tax planning meeting.

Arizona Corporate Credits

Business owners in Arizona have a unique opportunity to offset their personal tax burden dollar for dollar by having their corporation make a charitable donation.  Specifically, s-corporations can donate up to the state income tax liability of the business owner for the given tax year.

 

Substantial Tax Savings

Unlike the Arizona individual credits, the Arizona business tax credit is eligible for a tax deduction on your federal business tax return. Your business will record the donation as a marketing expense, lowering your taxable income.

These credits require a minimum contribution of $5,000; however, this substantial investment carries even more potential for tax savings. Let’s consider the impact of even the minimum donation:

State                     $5,000 donation = $5,000 tax credit

Federal                 $5,000 donation x 24% marginal tax rate = $1,200 in tax savings

Total                      $6,200 in total tax savings

 

Applications and STOs

While the individual credit is available to every Arizona taxpayer, the corporate tax credit requires an application. Applications are open to c-corps, s-corps, and LLCs that are taxed as s-corps. Donations must be made to a School Tuition Organization (STO) certified by the Arizona Department of Revenue.

STOs award scholarships to underprivileged children so they can receive the education they deserve. Eligible students must meet a state defined low-income threshold. Donors can designate money to a particular school but not to a particular student.

 

Timing Considerations

Applications open July 1, but the state allocates a limited amount of funding to the credits on a first come, first served basis, so timing is critical.  Contributions must be made during the tax year for which the credit will be taken. If the application is approved, the business has 20 days to make the donation to the STO.

A new round of applications for this business credit opens to Arizona corporations on July 1, 2022. Remember that all donors MUST have prior approval by the state. K&R can connect you with a qualified STO and help with your application. To get started, call our office at 480-392-6801.

Understanding Qualified and Nonqualified Retirement Plans

The Employee Retirement Income Security Act (ERISA) protects employees by setting out minimum standards that retirement and health care plans must meet. Since the law’s inception in 1974, these requirements have evolved, but its core principles remain:

  • Responsibility of fiduciaries in managing plan funds.
  • Disclosure of information about the plan and its investments.
  • Right to participate by all employees who meet eligibility requirements.
  • Right to vesting of employer-provided assets over time.
  • Nondiscrimination in coverage between high-paid and lower-paid employees.
  • Protection of plan funds from creditors, bankruptcy proceedings, and civil lawsuits.

 

Plans that meet ERISA’s standards are referred to as “qualified plans.” Qualified plans include 401(k)s, defined-benefit plans, and profit-sharing plans.
These standards obviously make qualified plans attractive to employees, but they are attractive to employers as well. Qualified plans have tax-deferred contributions from the employee, and employers can deduct amounts they contribute to the plan. As employers offer more generous matching policies to more employees, they can attract talent to their team while lowing their tax burden.

Despite these benefits, however, qualified plans are not feasible for every employer. ERISA rules are complicated, and setting up qualified retirement plans can be prohibitively expensive.

Employers may also consider nonqualified plans that do not meet ERISA standards. From a tax perspective, however, nonqualified plans miss out on savings because they are funded with after-tax dollars and are not deductible to the employer.

There are alternatives that allow small businesses to avoid the black and white divide between qualified and nonqualified plans. For example, companies with 100 or fewer employees can set up SIMPLE IRAs. A SIMPLE IRA is covered by ERISA but doesn’t bear the same reporting and administrative burden as qualified plans like 401(k)s. At the same time, this plan offers tax savings because contributions by the employee are tax-deferred and contributions by the employer are tax-deductible.

Many more retirement plans are available than those that can fit in one blog post. When deciding what retirement options are right for your small business, talking with a trusted advisor is an important step. They can help you weigh the advantages and costs of the plans that are available. They can help you navigate how plans to grow your workforce beyond yourself and your family will influence your retirement offerings. If you would like K&R to plan alongside you, call our office at 480-392-6801 to schedule a consultation.