Many businesses provide education fringe benefits so their employees can improve their skills and gain additional knowledge. An employee can receive, on a tax-free basis, up to $5,250 each year from his or her employer for educational assistance under a “qualified educational assistance program.”
For this purpose, “education” means any form of instruction or training that improves or develops an individual’s capabilities. It doesn’t matter if it’s job-related or part of a degree program. This includes employer-provided education assistance for graduate-level courses, including those normally taken by an individual pursuing a program leading to a business, medical, law or other advanced academic or professional degree.
The educational assistance must be provided under a separate written plan that’s publicized to your employees, and must meet a number of conditions, including nondiscrimination requirements. In other words, it can’t discriminate in favor of highly compensated employees. In addition, not more than 5% of the amounts paid or incurred by the employer for educational assistance during the year may be provided for individuals who (including their spouses or dependents) who own 5% or more of the business.
No deduction or credit can be taken by the employee for any amount excluded from the employee’s income as an education assistance benefit.
If you pay more than $5,250 for educational benefits for an employee during the year, he or she must generally pay tax on the amount over $5,250. Your business should include the amount in income in the employee’s wages. However, in addition to, or instead of applying, the $5,250 exclusion, an employer can satisfy an employee’s educational expenses, on a nontaxable basis, if the educational assistance is job-related. To qualify as job-related, the educational assistance must:
“Job-related” employer educational assistance isn’t subject to a dollar limit. To be job-related, the education can’t qualify the employee to meet the minimum educational requirements for qualification in his or her employment or other trade or business.
Educational assistance meeting the above “job-related” rules is excludable from an employee’s income as a working condition fringe benefit.
In addition to education assistance, some employers offer student loan repayment assistance as a recruitment and retention tool. Recent COVID-19 relief laws may provide your employees with tax-free benefits. Contact us to learn more about setting up an education assistance or student loan repayment plan at your business.
Owners of incorporated businesses know that there’s a tax advantage to taking money out of a C corporation as compensation rather than as dividends. The reason: A corporation can deduct the salaries and bonuses that it pays executives, but not dividend payments. Thus, if funds are paid as dividends, they’re taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is only taxed once — to the employee who receives it.
However, there are limits to how much money you can take out of the corporation this way. Under tax law, compensation can be deducted only to the extent that it’s reasonable. Any unreasonable portion isn’t deductible and, if paid to a shareholder, may be taxed as if it were a dividend. Keep in mind that the IRS is generally more interested in unreasonable compensation payments made to someone “related” to a corporation, such as a shareholder-employee or a member of a shareholder’s family.
Determining reasonable compensation
There’s no easy way to determine what’s reasonable. In an audit, the IRS examines the amount that similar companies would pay for comparable services under similar circumstances. Factors that are taken into account include the employee’s duties and the amount of time spent on those duties, as well as the employee’s skills, expertise and compensation history. Other factors that may be reviewed are the complexities of the business and its gross and net income.
There are some steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation. For example, you can:
You can avoid problems and challenges by planning ahead. If you have questions or concerns about your situation, contact us.
As a business owner, you should be aware that you can save family income and payroll taxes by putting your child on the payroll.
Here are some considerations.
Shifting business earnings
You can turn some of your high-taxed income into tax-free or low-taxed income by shifting some business earnings to a child as wages for services performed. In order for your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child’s salary must be reasonable.
For example, suppose you’re a sole proprietor in the 37% tax bracket. You hire your 16-year-old son to help with office work full-time in the summer and part-time in the fall. He earns $10,000 during the year (and doesn’t have other earnings). You can save $3,700 (37% of $10,000) in income taxes at no tax cost to your son, who can use his $12,550 standard deduction for 2021 to shelter his earnings.
Family taxes are cut even if your son’s earnings exceed his standard deduction. That’s because the unsheltered earnings will be taxed to him beginning at a 10% rate, instead of being taxed at your higher rate.
Income tax withholding
Your business likely will have to withhold federal income taxes on your child’s wages. Usually, an employee can claim exempt status if he or she had no federal income tax liability for last year and expects to have none this year.
However, exemption from withholding can’t be claimed if: 1) the employee’s income exceeds $1,100 for 2021 (and includes more than $350 of unearned income), and 2) the employee can be claimed as a dependent on someone else’s return.
Keep in mind that your child probably will get a refund for part or all of the withheld tax when filing a return for the year.
Social Security tax savings
If your business isn’t incorporated, you can also save some Social Security tax by shifting some of your earnings to your child. That’s because services performed by a child under age 18 while employed by a parent isn’t considered employment for FICA tax purposes.
A similar but more liberal exemption applies for FUTA (unemployment) tax, which exempts earnings paid to a child under age 21 employed by a parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting only of his or her parents.
Note: There’s no FICA or FUTA exemption for employing a child if your business is incorporated or is a partnership that includes non-parent partners. However, there’s no extra cost to your business if you’re paying a child for work you’d pay someone else to do.
Your business also may be able to provide your child with retirement savings, depending on your plan and how it defines qualifying employees. For example, if you have a SEP plan, a contribution can be made for the child up to 25% of his or her earnings (not to exceed $58,000 for 2021).
Contact us if you have any questions about these rules in your situation. Keep in mind that some of the rules about employing children may change from year to year and may require your income-shifting strategies to change too.
The statement of cash flows essentially tells you about cash entering and leaving a business. It’s arguably the most misunderstood and underappreciated part of a company’s annual report. After all, a business that reports positive net income on its income statements sometimes doesn’t have enough cash in the bank to pay its bills. Reviewing the statement of cash flows can provide significant insight into a company’s financial health and long-term viability.
Under Generally Accepted Accounting Principles (GAAP), the statement of cash flows is typically organized into three sections:
1. Cash flows from operations. This section focuses on cash flows from selling products and services. It customarily starts with accrual-basis net income. Then it’s adjusted for items related to normal business operations, such as:
The end result is cash-basis net income. Companies that report several successive years of negative operating cash flows may be better off closing than continuing to incur losses.
2. Cash flows from investing activities. If a company buys or sells property, equipment or marketable securities, the transaction generally shows up here. This section reveals whether a company is reinvesting in its future operations — or divesting assets for emergency funds.
3. Cash flows from financing activities. This section shows cash flows from raising, borrowing and repaying capital. It highlights the company’s ability to obtain cash from lenders and investors, including:
Capital leases and noncash transactions are reported in a separate schedule at the bottom of the statement of cash flows or in a narrative footnote disclosure. For example, if a borrower purchases equipment directly using loan proceeds, the transaction would typically appear at the bottom of the statement, rather than as a cash outflow from investing activities and an inflow from financing activities.
In addition, U.S. companies that enter into foreign currency transactions customarily report the effect of exchange rate changes as a separate item in the reconciliation of beginning and ending balances of cash and cash equivalents.
For more information
The statement of cash flows provides valuable insight about your company’s financial health. But it may not always be clear how to classify transactions. We can help you get it right.
President Biden signed the $1.9 trillion American Rescue Plan Act (ARPA) on March 11. While the new law is best known for the provisions providing relief to individuals, there are also several tax breaks and financial benefits for businesses.
Here are some of the tax highlights of the ARPA.
The Employee Retention Credit (ERC). This valuable tax credit is extended from June 30 until December 31, 2021. The ARPA continues the ERC rate of credit at 70% for this extended period of time. It also continues to allow for up to $10,000 in qualified wages for any calendar quarter. Taking into account the Consolidated Appropriations Act extension and the ARPA extension, this means an employer can potentially have up to $40,000 in qualified wages per employee through 2021.
Employer-Provided Dependent Care Assistance. In general, an eligible employee’s gross income doesn’t include amounts paid or incurred by an employer for dependent care assistance provided to the employee under a qualified dependent care assistance program (DCAP).
Previously, the amount that could be excluded from an employee’s gross income under a DCAP during a tax year wasn’t more than $5,000 ($2,500 for married individuals filing separately), subject to certain limitations. However, any contribution made by an employer to a DCAP can’t exceed the employee’s earned income or, if married, the lesser of employee’s or spouse’s earned income.
Under the ARPA, for 2021 only, the exclusion for employer-provided dependent care assistance is increased from $5,000 to $10,500 (from $2,500 to $5,250 for married individuals filing separately).
This provision is effective for tax years beginning after December 31, 2020.
Paid Sick and Family Leave Credits. Changes under the ARPA apply to amounts paid with respect to calendar quarters beginning after March 31, 2021. Among other changes, the law extends the paid sick time and paid family leave credits under the Families First Coronavirus Response Act from March 31, 2021, through September 30, 2021. It also provides that paid sick and paid family leave credits may each be increased by the employer’s share of Social Security tax (6.2%) and employer’s share of Medicare tax (1.45%) on qualified leave wages.
Grants to restaurants. Under the ARPA, eligible restaurants, food trucks, and similar businesses that provide food and drinks may receive restaurant revitalization grants from the Small Business Administration. For tax purposes, amounts received as restaurant revitalization grants aren’t included in the gross income of the person who receives the money.
These are only some of the provisions in the ARPA. There are many others that may be beneficial to your business. Contact us for more information about your situation.
Many businesses have experienced severe cash flow problems during the COVID-19 pandemic. As a result, some may have delayed or missed loan payments. Instead of filing for bankruptcy in court, delinquent debtors may reach out to lenders about restructuring their loans.
Restructuring vs. Chapter 11
Out-of-court debt restructuring is a process by which a public or private company informally renegotiates outstanding debt obligations with its creditors. The resulting agreement is legally binding, and can enable the distressed company to reduce its debt, extend maturities, alter payment terms or consolidate loans.
Debt restructuring is a far less extreme and burdensome (not to mention less expensive) alternative to filing for Chapter 11 (reorganization) bankruptcy protection. And lenders often are more receptive to a restructuring than they are with taking their chances in bankruptcy court.
Types of restructuring
There are two basic types of out-of-court debt restructuring:
1. General. This type of negotiation buys the distressed company the time needed to regain its financial footing by extending loan maturities, lowering interest rates and consolidating debt. Creditors typically prefer a general restructuring because it means they’ll receive the full amount owed, even if it’s over a longer time period.
General restructuring suits companies facing a temporary crisis — such as the sudden loss of a large customer or the departure of a key management team member — but have overall financials that are still strong. Debt structure changes can be permanent or temporary. If they’re permanent, creditors are likely to push for higher equity stakes or increased loan payments as compensation.
2. Troubled. A troubled debt restructuring requires creditors to write off a portion of the distressed company’s outstanding debt and permanently accept those losses. Typically, the creditor and debtor reach a settlement in lieu of bankruptcy.
This solution is appropriate when a company simply can’t pay its current debts at current interest rates and the only alternative is bankruptcy. Creditors may receive some compensation, however, with increased equity shares in the business or, if it’s acquired, in the merged company.
During the COVID-19 pandemic, the Financial Accounting Standards Board has received many questions about how to apply the accounting guidance on debt restructurings. So, it recently published an educational staff paper to help financially distressed borrowers work through the details.
Thinking about debt restructuring?
We are on top of the latest developments in this nuanced accounting topic. Contact us to help report restructured loans in your company’s financial statements.
A number of tax-related limits that affect businesses are annually indexed for inflation, and many have increased for 2021. Some stayed the same due to low inflation. And the deduction for business meals has doubled for this year after a new law was enacted at the end of 2020. Here’s a rundown of those that may be important to you and your business.
Social Security tax
The amount of employees’ earnings that are subject to Social Security tax is capped for 2021 at $142,800 (up from $137,700 for 2020).
Deduction for eligible business-related food and beverage expenses provided by a restaurant: 100% (up from 50%)
Other employee benefits
These are only some of the tax limits that may affect your business and additional rules may apply. If you have questions, please contact us.
Does your business need a loan? Before contacting your bank, it’s important to gather all relevant financial information to prove your business is creditworthy. By anticipating information requests, you can expedite the application process and improve your chances of approval.
Lenders love GAAP
U.S. Generally Accepted Accounting Principles (GAAP) is a collection of specific accounting rules and principles that’s regularly updated by the Financial Accounting Standards Board. Lenders generally prefer GAAP financial statements over those prepared under special purpose frameworks, such as cash- or tax-basis financial statements, because GAAP financials tend to be more transparent and consistent from one business (or reporting period) to the next.
Businesses that follow GAAP use accrual-basis reporting. That is, they record sales as earned and expenses when incurred. Under GAAP, the balance sheet also includes receivables, payables, prepaid assets and accrued expenses. These accounts generally are created only when a business uses accrual accounting.
Dig deeper with financial benchmarks
During the loan application process, lenders may also compute various financial ratios and then compare them over time or against competitors. Common benchmarks used in the underwriting process include:
Beyond the numbers
Your lenders also may want to evaluate the operations of your business. This meeting provides opportunities to perform the following due diligence procedures:
Also be prepared to explain how you intend to use the loan proceeds for future business operations. For example, you might want to expand your facilities, hire more employees or buy equipment. Or maybe you want a cushion to fund occasional working capital shortfalls.
Ready, set, apply
Need help securing a commercial loan for your business? We can be a valuable resource during the application process.
The footnotes to your company’s financial statements give investors and lenders insight into account balances, accounting practices and potential risk factors — knowledge that’s vital to making well-informed business and investment decisions. Here are four important issues that you should cover in your footnote disclosures.
1. Unreported or contingent liabilities
A company’s balance sheet might not reflect all future obligations. Detailed footnotes may reveal, for example, a potentially damaging lawsuit, an IRS inquiry or an environmental claim.
Footnotes also spell out the details of loan terms, warranties, contingent liabilities and leases. Unscrupulous managers may attempt to downplay liabilities to avoid violating loan agreements or admitting financial problems to stakeholders.
2. Related-party transactions
Companies may employ friends and relatives — or give preferential treatment to, or receive it from, related parties. It’s important that footnotes disclose all related parties with whom the company and its management team conduct business.
For example, say, a dress boutique rents retail space from the owner’s uncle at below-market rents, saving roughly $120,000 each year. If the retailer doesn’t disclose that this favorable related-party deal exists, its lenders may mistakenly believe that the business is more profitable than it really is. When the owner’s uncle unexpectedly dies — and the owner’s cousin, who inherits the real estate, raises the rent — the retailer could fall on hard times and the stakeholders could be blindsided by the undisclosed related-party risk.
3. Accounting changes
Footnotes disclose the nature and justification for a change in accounting principle, as well as how that change affects the financial statements. Valid reasons exist to change an accounting method, such as a regulatory mandate. But dishonest managers also can use accounting changes in, say, depreciation or inventory reporting methods to manipulate financial results.
4. Significant events
Disclosures may forewarn stakeholders that a company recently lost a major customer or will be subject to stricter regulatory oversight in the coming year. Footnotes disclose significant events that could materially impact future earnings or impair business value. But dishonest managers may overlook or downplay significant events to preserve the company’s credit standing.
Too much, too little or just right?
In recent years, the Financial Accounting Standards Board has been eliminating and simplifying footnote disclosures. While disclosure “overload” can be burdensome, it’s important that companies don’t cut back too much. Transparency is key to effective corporate governance.
This year, the optional standard mileage rate used to calculate the deductible costs of operating an automobile for business decreased by one-and-one-half cents, to 56 cents per mile. As a result, you might claim a lower deduction for vehicle-related expenses for 2021 than you could for 2020 or 2019. This is the second year in a row that the cents-per-mile rate has decreased.
Deducting actual expenses vs. cents-per-mile
In general, businesses can deduct the actual expenses attributable to business use of vehicles. This includes gas, oil, tires, insurance, repairs, licenses and vehicle registration fees. In addition, you can claim a depreciation allowance for the vehicle. However, in many cases, certain limits apply to depreciation write-offs on vehicles that don’t apply to other types of business assets.
The cents-per-mile rate is useful if you don’t want to keep track of actual vehicle-related expenses. With this method, you don’t have to account for all your actual expenses. However, you still must record certain information, such as the mileage for each business trip, the date and the destination.
Using the cents-per-mile rate is also popular with businesses that reimburse employees for business use of their personal vehicles. These reimbursements can help attract and retain employees who drive their personal vehicles extensively for business purposes. Why? Under current law, employees can no longer deduct unreimbursed employee business expenses, such as business mileage, on their own income tax returns.
If you do use the cents-per-mile rate, be aware that you must comply with various rules. If you don’t comply, the reimbursements could be considered taxable wages to the employees.
The 2021 rate
Beginning on January 1, 2021, the standard mileage rate for the business use of a car (van, pickup or panel truck) is 56 cents per mile. It was 57.5 cents for 2020 and 58 cents for 2019.
The business cents-per-mile rate is adjusted annually. It’s based on an annual study commissioned by the IRS about the fixed and variable costs of operating a vehicle, such as gas, maintenance, repair and depreciation. The rate partly reflects the current price of gas, which is down from a year ago. According to AAA Gas Prices, the average nationwide price of a gallon of unleaded regular gas was $2.42 recently, compared with $2.49 a year ago. Occasionally, if there’s a substantial change in average gas prices, the IRS will change the cents-per-mile rate midyear.
When this method can’t be used
There are some situations when you can’t use the cents-per-mile rate. In some cases, it partly depends on how you’ve claimed deductions for the same vehicle in the past. In other cases, it depends on if the vehicle is new to your business this year or whether you want to take advantage of certain first-year depreciation tax breaks on it.
As you can see, there are many factors to consider in deciding whether to use the mileage rate to deduct vehicle expenses. We can help if you have questions about tracking and claiming such expenses in 2021 — or claiming them on your 2020 income tax return.