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How to determine if you need to worry about estate taxes

Among the taxes that are being considered for repeal as part of tax reform legislation is the estate tax. This tax applies to transfers of wealth at death, hence why it’s commonly referred to as the “death tax.” Its sibling, the gift tax — also being considered for repeal — applies to transfers during life. Yet most taxpayers won’t face these taxes even if the taxes remain in place.

Exclusions and exemptions

For 2017, the lifetime gift and estate tax exemption is $5.49 million per taxpayer. (The exemption is annually indexed for inflation.) If your estate doesn’t exceed your available exemption at your death, then no federal estate tax will be due.

Any gift tax exemption you use during life does reduce the amount of estate tax exemption available at your death. But every gift you make won’t use up part of your lifetime exemption. For example:

Gifts to your U.S. citizen spouse are tax-free under the marital deduction. (So are transfers at death — that is, bequests.)
Gifts and bequests to qualified charities aren’t subject to gift and estate taxes.
Payments of another person’s health care or tuition expenses aren’t subject to gift tax if paid directly to the provider.
Each year you can make gifts up to the annual exclusion amount ($14,000 per recipient for 2017) tax-free without using up any of your lifetime exemption.

What’s your estate tax exposure?

Here’s a simplified way to project your estate tax exposure. Take the value of your estate, net of any debts. Also subtract any assets that will pass to charity on your death.

Then, if you’re married and your spouse is a U.S. citizen, subtract any assets you’ll pass to him or her. (But keep in mind that there could be estate tax exposure on your surviving spouse’s death, depending on the size of his or her estate.) The net number represents your taxable estate.

You can then apply the exemption amount you expect to have available at death. Remember, any gift tax exemption amount you use during your life must be subtracted. But if your spouse predeceases you, then his or her unused estate tax exemption, if any, may be added to yours (provided the applicable requirements are met).

If your taxable estate is equal to or less than your available estate tax exemption, no federal estate tax will be due at your death. But if your taxable estate exceeds this amount, the excess will be subject to federal estate tax.

Be aware that many states impose estate tax at a lower threshold than the federal government does. So you could have state estate tax exposure even if you don’t need to worry about federal estate tax.

If you’re not sure whether you’re at risk for the estate tax or if you’d like to learn about gift and estate planning strategies to reduce your potential liability, please contact us. We also can keep you up to date on any estate tax law changes.

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Put your audit in reverse to save sales and use tax

It’s a safe bet that state tax authorities will let you know if you haven’t paid enough sales and use taxes, but what are the odds that you’ll be notified if you’ve paid too much? The chances are slim — so slim that many businesses use reverse audits to find overpayments so they can seek refunds.

Take all of your exemptions

In most states, businesses are exempt from sales tax on equipment used in manufacturing or recycling, and many states don’t require them to pay taxes on the utilities and chemicals used in these processes, either. In some states, custom software, computers and peripherals are exempt if they’re used for research and development projects.

This is just a sampling of sales and use tax exemptions that might be available. Unless you’re diligent about claiming exemptions, you may be missing out on some to which you’re entitled.

Many businesses have sales and use tax compliance systems to guard against paying too much, but if you haven’t reviewed yours recently, it may not be functioning properly. Employee turnover, business expansion or downsizing, and simple mistakes all can take their toll.

Look back and broadly

The audit should extend across your business, going back as far as the statute of limitations on state tax reviews. If your state auditors can review all records for the four years preceding the audit, for example, your reverse audit should encompass the same timeframe.

What types of payments should be reviewed? You may have made overpayments on components of manufactured products as well as on the equipment you use to make the products. Other areas where overpayments may occur, depending on state laws, include:

Pollution control equipment and supplies,
Safety equipment,
Warehouse equipment,
Software licenses,
Maintenance fees,
Protective clothing, and
Service transactions.

When considering whether you may have overpaid taxes in these and other areas, a clear understanding of your operations is key. If, for example, you want to ensure you’re receiving maximum benefit from industrial processing exemptions, you must know where your manufacturing process begins and ends.

Save now and later

Reverse audits can be time consuming and complicated, but a little pain can bring significant gain. Use your reverse audit not only to reap tax refund rewards now but also to update your compliance systems to help ensure you don’t overpay taxes in the future.

Rules and regulations surrounding state sales and use tax refunds are complicated. We can help you understand them and ensure your refund claims are properly prepared before you submit them.

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Will Congress revive expired tax breaks?

Most of the talk about possible tax legislation this year has focused on either wide-sweeping tax reform or taxes that are part of the Affordable Care Act. But there are a few other potential tax developments for individuals to keep an eye on.

Back in December of 2015, Congress passed the PATH Act, which made a multitude of tax breaks permanent. However, there were a few valuable breaks for individuals that it extended only through 2016. The question now is whether Congress will extend them for 2017.

An education break

One break the PATH Act extended through 2016 was the above-the-line deduction for qualified tuition and related expenses for higher education. The deduction was capped at $4,000 for taxpayers whose adjusted gross income (AGI) didn’t exceed $65,000 ($130,000 for joint filers) or, for those beyond those amounts, $2,000 for taxpayers whose AGI didn’t exceed $80,000 ($160,000 for joint filers).

You couldn’t take the American Opportunity credit, its cousin the Lifetime Learning credit and the tuition deduction in the same year for the same student. If you were eligible for all three breaks, the American Opportunity credit would typically be the most valuable in terms of tax savings.

But in some situations, the AGI reduction from the tuition deduction might prove more beneficial than taking the Lifetime Learning credit. For example, a lower AGI might help avoid having other tax breaks reduced or eliminated due to AGI-based phaseouts.

Mortgage-related tax breaks

Under the PATH Act, through 2016 you could treat qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction. The deduction phased out for taxpayers with AGI of $100,000 to $110,000.

The PATH Act likewise extended through 2016 the exclusion from gross income for mortgage loan forgiveness. It also modified the exclusion to apply to mortgage forgiveness that occurs in 2017 as long as it’s granted pursuant to a written agreement entered into in 2016. So even if this break isn’t extended, you might still be able to benefit from it on your 2017 income tax return.

Act now

Please check back with us for the latest information. In the meantime, keep in mind that, if you qualify and you haven’t filed your 2016 income tax return yet, you can take advantage of these breaks on thattax return. The deadline for individual extended returns is October 16, 2017.

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Material participation key to deducting LLC and LLP losses

If your business is a limited liability company (LLC) or a limited liability partnership (LLP), you know that these structures offer liability protection and flexibility as well as tax advantages. But they once also had a significant tax disadvantage: The IRS used to treat all LLC and LLP owners as limited partners for purposes of the passive activity loss (PAL) rules, which can result in negative tax consequences. Fortunately, these days LLC and LLP owners can be treated as general partners, which means they can meet any one of seven “material participation” tests to avoid passive treatment.

The PAL rules

The PAL rules prohibit taxpayers from offsetting losses from passive business activities (such as limited partnerships or rental properties) against nonpassive income (such as wages, interest, dividends and capital gains). Disallowed losses may be carried forward to future years and deducted from passive income or recovered when the passive business interest is sold.

There are two types of passive activities: 1) trade or business activities in which you don’t materially participate during the year, and 2) rental activities, even if you do materially participate (unless you qualify as a “real estate professional” for federal tax purposes).

The 7 tests

Material participation in this context means participation on a “regular, continuous and substantial” basis. Unless you’re a limited partner, you’re deemed to materially participate in a business activity if you meet just one of seven tests:

You participate in the activity at least 500 hours during the year.
Your participation constitutes substantially all of the participation for the year by anyone, including nonowners.
You participate more than 100 hours and as much or more than any other person.
The activity is a “significant participation activity” — that is, you participate more than 100 hours — but you participate less than one or more other people yet your participation in all of your significant participation activities for the year totals more than 500 hours.
You materially participated in the activity for any five of the preceding 10 tax years.
The activity is a personal service activity in which you materially participated in any three previous tax years.
Regardless of the number of hours, based on all the facts and circumstances, you participate in the activity on a regular, continuous and substantial basis.

The rules are more restrictive for limited partners, who can establish material participation only by satisfying tests 1, 5 or 6.

In many cases, meeting one of the material participation tests will require diligently tracking every hour spent on your activities associated with that business. Questions about the material participation tests? Contact us.

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A refresher on the ACA’s tax penalty on individuals without health insurance

Now that Affordable Care Act (ACA) repeal and replacement efforts appear to have collapsed, at least for the time being, it’s a good time for a refresher on the tax penalty the ACA imposes on individuals who fail to have “minimum essential” health insurance coverage for any month of the year. This requirement is commonly called the “individual mandate.”

Penalty exemptions

Before we review how the penalty is calculated, let’s take a quick look at exceptions to the penalty. Taxpayers may be exempt if they fit into one of these categories for 2017:

Their household income is below the federal income tax return filing threshold.
They lack access to affordable minimum essential coverage.
They suffered a hardship in obtaining coverage.
They have only a short-term coverage gap.
They qualify for an exception on religious grounds or have coverage through a health care sharing ministry.
They’re not a U.S. citizen or national.
They’re incarcerated.
They’re a member of a Native American tribe.

Calculating the tax

So how much can the penalty cost? That’s a tricky question. If you owe the penalty, the tentativeamount equals the greater of the following two prongs:

The applicable percentage of your household income above the applicable federal income tax return filing threshold, or
The applicable dollar amount times the number of uninsured individuals in your household, limited to 300% of the applicable dollar amount.

In terms of the percentage-of-income prong of the penalty, the applicable percentage of income is 2.5% for 2017.

In terms of the dollar-amount prong of the penalty, the applicable dollar amount for each uninsured household member is $695 for 2017. For a household member who’s under age 18, the applicable dollar amounts are cut by 50%, to $347.50. The maximum penalty under this prong for 2017 is $2,085 (300% of $695).

The final penalty amount per person can’t exceed the national average cost of “bronze coverage” (the cheapest category of ACA-compliant coverage) for your household. The important thing to know is that a high-income person or household could owe more than 300% of the applicable dollar amount but not more than the cost of bronze coverage.

If you have minimum essential coverage for only part of the year, the final penalty is calculated on a monthly basis using prorated annual figures.

Also be aware that the extent to which the penalty will continue to be enforced isn’t certain. The IRS has been accepting 2016 tax returns even if a taxpayer hasn’t completed the line indicating health coverage status. That said, the ACA is still the law, so compliance is highly recommended. For more information about this and other ACA-imposed taxes, contact us.

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