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How to handle year-end bonuses

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Rewarding employees at the end of the year can brighten up their holidays and set the stage for your company to enjoy a good start to 2019. Some forethought and careful communications can avoid problems.

A key first step is to check your company’s financial condition. Year-end bonuses can boost morale, but you shouldn’t pay out more than your company can afford. On the other hand, if your business is doing well, some holiday generosity might help it do even better.

Spread the word

 Once you have a budget for bonuses in mind, tell your employees what to expect. Let them know as soon as possible so they can plan accordingly.

Long-time employees probably will expect the type and size of bonus they have received in the past. If that’s not going to be the case, explain the reason for the shortfall. Consider replacing any lack of cash with extra time off, if that’s practical.

Among possible methods of calculating bonuses, giving a flat amount to all full-time workers might be the simplest approach. Another tactic is to give everyone a percentage of their salary; the percentage might escalate for people with management responsibility or special tasks. Performance-based bonuses, which can be sizable, may motivate key employees and could help to retain valued workers.

Tax treatment

 Cash bonuses are compensation for employees, so employment taxes apply. For income tax withholding, employers have some options about how to handle supplemental pay such as bonuses. Our office can help you choose the right method and properly comply with all the rules. If you use an outside payroll provider, that company should be notified in advance of your plans.

At many companies, cash bonuses might be a few hundred dollars per employee. Some firms, though, pay much larger bonuses as part of some workers’ compensation package. For ample bonuses, it may be advantageous to deduct them for 2018, but defer payment as late as March 15, 2019.

To qualify for this deduct-now-pay-later opportunity, your company must be on the accrual, rather than the cash, basis of accounting. You must spell out the recipients and the amounts involved, perhaps in corporate minutes, by year-end 2018. S corporation shareholders and over-50% C corporation shareholders don’t qualify for this tax benefit.

At some companies, a pool of money for bonuses can be deducted at year-end without an employee-by-employee allocation, yet payments can be delayed until mid-March. Several rules apply, such as maintaining the amount declared at year-end. Again, our office can guide your firm through the complexities.

Powers of attorney can be vital documents

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Most people realize the importance of a will to help direct the transfer of assets after death. During your lifetime, you also may want to have a power of attorney (POA) for convenience and asset protection.

The person who creates a POA is known as the principal. In the POA, an agent (known as the attorney-in-fact) is given the authority to act on the principal’s behalf. POAs come in different forms with different purposes.

General POA

A general or regular POA gives the agent the broad ability to act for the principal. This type might be useful when the principal will be unable to act on his or her own behalf for some reason. Someone in the military, for example, might name an agent to handle financial affairs during the principal’s overseas assignment.

Limited POA

As the name suggests, these special POAs are not open-ended. There could be a specified time period when you’re unable to act on your own behalf. Alternatively, a limited POA could be effective only for a designated purpose, such as signing a contract when you can’t be present.

Durable POA

Regular or limited POAs may become void if the principal loses mental competence. Unfortunately, that can be the time when a POA is needed most: when assets could be squandered because of poor decisions.

Therefore, a durable POA can be extremely valuable because it remains in effect if the principal becomes incompetent. The agent can make financial decisions, such as asset management and residential transactions. If a durable POA is not in place, the relatives of an individual deemed to be incompetent might have to go to court to request that a conservator be named, which can be a time-consuming and expensive process with an uncertain outcome.

Springing POA

Some people are not comfortable creating a POA while they are still competent, yet an individual who loses mental capability cannot legally create a POA. One solution is to use a springing POA, which takes effect only in certain circumstances, such as a doctor certifying that the principal cannot make financial decisions. Note that some states may not allow springing POAs, and some attorneys are skeptical about using them because the process of getting a physician’s timely certification might be challenging.

Health care POA

The POAs described previously empower an agent to make financial decisions. A health care POA is different because it names someone to make medical decisions if the patient cannot do so. The agent named on a financial POA could be someone trusted with money matters, whereas someone with other abilities and concerns could be appropriate for a health care POA.

Powerful thoughts

As indicated, the agent you name on any POA should be someone you trust absolutely with your wealth or your health. Married couples are best protected if both spouses have their own POAs.

In addition, you might have to check with the financial firms holding your assets before having a POA drafted. Some companies prefer to use their own forms, so a POA drafted by your attorney might not be readily accepted. Moreover, financial institutions might be reluctant to accept a very old POA, so periodic updating can be helpful.

When creating a POA, you should make it clear that the power applies to retirement accounts such as IRAs. Your agent should have the ability to execute rollovers and designate beneficiaries, for example. An attorney who is experienced in estate planning can help you obtain a POA with the power to help you and your loved ones, if necessary.

The new SALT deduction limits will affect home sales

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The Tax Cuts and Jobs Act (TCJA) of 2017 sharply raised the standard deduction and placed limits on itemized deductions. In particular, no more than $10,000 can be deducted in state and local tax (SALT) payments on a single or joint tax return.

As a result, most people will take the standard deduction now and get no tax benefit from their property tax payments. Even those who itemize may get little or no tax benefit from their property tax payments if they also have ample outlays for state and possibly local income tax. The bottom line is that property tax payments will be fully or mainly out-of-pocket expenses for most homeowners — and for many home buyers — with reduced federal tax savings as an offset.

When the TCJA was passed, some observers predicted that this effective cost increase would significantly bring down home prices.

Example: John and Mary Smithe pay $20,000 a year in property tax. They had been in a 28% tax bracket, giving them a $5,600 (28% of $20,000) federal tax saving, resulting in a net cost of $14,400. If this couple sells their home, the buyer could owe the full $20,000 a year in property tax. This might reduce the home’s appeal to buyers, who would offer lower bids than would have been offered in the past.

Broadly, such price declines have not happened. The U.S. House Price Index Report from the Federal House Finance Agency shows a 6.5% growth in prices from the second quarter of 2017 to the second quarter of 2018. Nevertheless, residential housing markets are very local, and it is likely that the new tax rules are affecting numerous transactions, especially in areas where property taxes are steep.

For sellers

If you are planning to sell a primary residence or second home, be aware that buyers probably will raise questions about the ongoing property tax they will incur. You should know the amount you’re paying now and the amounts you have paid in the past. If the growth rate has been modest, or if your home is taxed less than those in your neighborhood, tell your real estate agent. Then, your agent can use this fact as a selling point.

All homeowners, particularly those who plan a sale, should investigate the possibility of reducing their property tax bill. You should find out the procedure for obtaining a lower assessment in your community and see if you might qualify. Any reduction in annual tax obligation may be worth the effort, from increased cash flow today and a potentially higher selling price tomorrow.

For buyers

If you are planning to buy a house, know your tax situation. Will you be taking the standard deduction? Will your itemized SALT deductions be capped? You’ll know whether you’ll get any tax savings from deducting property tax, so you will know what to expect in after-tax costs from a home purchase. If those costs, which are likely to rise in the future, might strain your budget, you can drop your bid price or look for another place with lower property taxes.

The IRS 15% solution

 Taxpayers in high tax states may hope that state “workarounds” will effectively preserve SALT tax benefits and their housing prices. (See the CPA Client Bulletin, June 2018.) One tactic has been to create state-run charities to which taxpayers can contribute in return for a credit against state income tax. These contributions would get federal tax deductions, which generally have much higher caps, instead of deductions for state and local tax payments, with lower caps.

In response, the IRS issued proposed regulations on this subject on August 23, 2018. Here, the IRS said that a taxpayer’s charitable deduction will be reduced if the anticipated state tax credit exceeds 15% of the contribution. (See the Trusted advice box.) The message from the IRS is that the new SALT deduction rules will be enforced.

Explaining the proposed regulations

  • For example, suppose Ann Clark contributes $20,000 to a state sponsored health or education charity.
  • Ann expects to receive a $14,000 state income tax credit (70% of $20,000).
  • Ann’s state tax credit is greater than 15% of her contribution.
  • These IRS proposed regulations say that Ann’s charitable deduction will be reduced by $14,000, regardless of when she claims the tax credit.

High Earners Take Note – Roth IRA Strategies

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Have you been locked out of contributing to a Roth individual retirement account (IRA) by the tax law’s income limits? There may be a way you can get around those limits and invest in a Roth IRA.

Why Consider a Roth IRA?

Unlike a traditional IRA, a Roth IRA offers the potential for tax-free earnings. You’re not taxed on investment earnings while they remain in the account, and qualified Roth distributions are not included in taxable income. If you want, you can leave your Roth IRA intact for your beneficiaries since you won’t have to take required minimum distributions (RMDs) after age 70½.

The Problem

Their potential for tax-free growth makes Roth IRAs a powerful planning tool. However, high earners face contribution restrictions. No Roth IRA contribution is allowed if modified adjusted gross income (AGI) is more than $135,000 (unmarried filers) or $199,000 (married joint filers).

A Potential Solution

Even if you aren’t allowed to contribute to a Roth IRA directly, you still may convert a traditional IRA to a Roth IRA. No income limits apply to conversions. This opens up a planning possibility: Make nondeductible contributions to a traditional IRA and later convert it to a Roth IRA. Repeating this process over several years would allow you to build up the amount in your Roth IRA. You’d be taxed on the account earnings you convert, but the taxable amount may be small if you haven’t held the traditional IRA for long.

Caution: This strategy could backfire if you already have a large traditional IRA (from a plan rollover or regular contributions). Under complex rules, much more of each conversion amount would be subject to tax. See us for details.

Connect with our team today for all the latest and most current tax rules and regulations.

How Hiring Your Children can Save You Money at Tax Time

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If you are self-employed, hiring your children to work for you can provide spending money for them and tax savings for you. But make sure you follow the guidelines.

Pay Reasonable Wages

You can deduct “reasonable wages” paid to your children for legitimate work performed for your business. As long as your children are under age 18 and your business is unincorporated, you generally won’t have to pay Social Security or Medicare taxes on their pay.

Keep Good Records

Ask your child to fill out a time sheet or punch a time clock, and pay with a check rather than cash. Keep in mind that wages that are inconsistent with the job or the age of the child won’t pass muster with the IRS.

Report Their Earnings

Complete and file a Form W-2 at the end of the year showing how much you paid your child. Income that exceeds the standard deduction will be taxable.

For more help with individual or business taxes, connect with us today. Our team can help you with all your tax issues, large and small.

Tax Tips for Investors

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As an investor, you may be able to reduce your income-tax liability through year-end tax planning. Here are a few ideas to consider for your next year’s taxes.

Take Advantage of Capital Losses

Do you have capital losses from selling stock shares held in taxable accounts? Maybe you can use the losses to generate a tax benefit. Capital losses can be used to offset capital gains, eliminating tax on the gains. For these purposes, you have to separate long-term gains and losses (on assets held for more than one year) from short-term gains and losses (on assets held one year or less) and net them in a certain order.

Similarly, you may have a carryover loss from a prior tax year that you’ve been “saving up” and hoping to use at some point to offset a capital gain. Well, maybe the time has come. Consider selling carefully selected profitable securities to utilize your carryover loss. Again, how this will play out when the tax law’s netting rules are applied depends on whether the loss is short term or long term and the nature of your current gain.

What if you haven’t sold securities that are showing a paper loss but are thinking of doing so? You can put realized capital losses to work for you by using them to offset any capital gains from this year’s sales. If you have a capital loss with no offsetting gain, you can take up to $3,000 of the loss against your ordinary income. Any loss exceeding this amount can be carried over to subsequent tax years.

Be Careful with Mutual Fund Sales or Purchases

If you’ve been thinking about cashing in appreciated mutual fund holdings that you’ve held for longer than a year, consider completing your transaction prior to the fund’s ex-dividend date (typically in November or December). This will help qualify your entire gain as capital gain, as opposed to having a portion of it potentially identified as a distribution of ordinary income. Conversely, you may want to complete any mutual fund share purchases after the ex-dividend date. You will thus avoid having an immediate tax liability attributable to the dividend payment.

Donate Appreciated Stock to Charity

If you are charitably inclined, donating appreciated securities accomplishes two things: You will create an immediate income-tax deduction equal to the full value of the stock, and you will avoid realization of a capital gain on the sale of your position. Note that deductions for charitable contributions are subject to certain tax law limits.

To learn more about tax rules and regulations for investments, give us a call today. Our knowledgeable and trained staff is here to help.