How to Handle Bad Debt and Taxes

When can you use bad debt to reduce business income?

How to Handle Bad Debt and Taxes Even when you take the customer to court and you still don’t get your money, there’s a way to make lemonade from this lemon of a customer.

If your business has already shown this amount as income for tax purposes, you may be able to reduce your business income by the amount of the bad debt. Look at bad debt as an uncollectible account—a receivable owed by a customer, client or patient that you are not able to collect.

Bad debt may be written off at the end of the year if it is determined that the debt is in fact uncollectible.

According to the IRS, bad debt includes:

  • Loans to clients and suppliers
  • Credit sales to customers
  • Business loan guarantees

How do you write off bad debt?

Your business uses the accrual accounting method, showing income when you have billed it, not when you collect it.

If your business operates on a cash accounting basis, you can’t deduct bad debt because you don’t record income until you’ve received the payment. If you don’t get the money, there’s no tax benefit to recording bad debt. You only record the sale when you receive the money from the customer.

Under accrual accounting, manually take the bad debt out of your sales records before you prepare your business tax return.

You must wait until the end of the year, just in case someone pays.

  • Prepare an accounts receivable aging report, which shows all the money owed to you by all your customers, how much is owed and how long the amount has been outstanding.
  • Total all bad debt for the year, listing all customers who have not paid during the year. Only make this determination at the end of the year and only if you’ve made every effort to collect the money owed to your business.
  • Include the bad debt total on your business tax return. If you file business taxes on Schedule C, you can deduct the amount of all bad debt. Each type of business tax return has a place to enter bad debt expenses.

It makes sense in any kind of business—no income recorded, no bad debt.

Collection efforts are important

A business bad debt often originates as a result of credit sales to customers for goods sold or services provided. The best documentation is likely to be a detailed record of collection efforts, indicating you made every effort a reasonable person would in order to collect a debt.

Take some solace by claiming a bad business debt deduction on your tax return. Not exactly a guarantee because you need to show that the debt is worthless, but it’s good to know there may be some relief.

We’ve got your back

The tax experts at KRS can help you with important accounting issues such as bad debt. Contact us today at 201.655.7411. And did you know that KRSCPAS.com is accessible from your mobile device and is loaded with tax guides, blogs, and other resources? Check it out today!

Estate and Gift Tax Update: No Clawback After Increased Transfer Limit Expires

Estate and Gift Tax Update: No Clawback After Increased Transfer Limit ExpiresThe Tax Cuts and Jobs Act of 2017 (“TCJA”) increased the lifetime estate and gift tax amount that may be transferred free from $5 million to $10 million per taxpayer, indexed for inflation.  This increased exemption applies to transfers made between January 1, 2018 and December 31, 2025.  On January 1, 2026, the lifetime exemption reverts to $5 million.

The IRS recently announced that the 2019 inflation adjusted exemption amount is $11.4 million, which allows a married couple to shield $22.8 million from transfer tax.

Because the increased tax exemption was temporary, there was uncertainty whether gifts exceeding $5 million made under these provisions would be clawed back into the estates of decedents dying after the 2025 expiration of the increased exemption amount.   In other words, if you made a $10 million gift in 2025 and died in 2027 when the exemption is $5 million, would your estate owe tax on the $5 million excess?

On November 25, 2018, the IRS answered this question with the issuance of proposed regulations, which indicate that gifts made before January 1, 2026, will not be clawed back to the estates of decedents dying after December 31, 2025.  The issuance of these proposed regulations strengthens a tremendous opportunity for the tax-free transfer of wealth, including ownership interests in closely held businesses.

Gifting closely held business interests

For those considering gifting closely held business interests, the process is more complicated than gifting assets such as marketable securities, the fair market value of which is readily determinable.  To gift a business ownership interest, a valuation of the business and the gifted interest must be performed by a qualified business appraiser.  Although 2025 is distant, those who wait until the last minute may encounter problems obtaining the required business valuation.  You may recall 2016, when the IRS proposed rules eliminating valuation discounts in estate and gift valuations.  There was a mad rush to get valuation reports completed, with limited capacity to complete this work.

We’ve got your back

If you have a large estate, this is a tremendous opportunity to save transfer taxes, which get to a 40% tax rate very quickly.  If your estate includes a closely held business, you would benefit by starting the process sooner rather than later. Once this opportunity is gone, it will be gone for good.  Contact your advisors today to get the process going.

Understanding IRC Code Section 1033

Understanding IRC Code Section 1033Unfortunately, 2018 has been another year of major disasters due to hurricanes, fires, and floods. As taxpayers turn to the process of restoring property, some may be considering whether a 1033 exchange is more relevant than a 1031 exchange.

This blog entry examines some of the key aspects of the 1033 exchange.

What is an IRC 1033 exchange?

A section 1033 exchange, named for Section 1033 of the Internal Revenue Code, applies when you lose property through a casualty, theft or condemnation and realize gain from the insurance or condemnation proceeds. If your accountant or tax advisor believes you will realize gain from the insurance or condemnation proceeds, you may be able to defer that gain using a 1033 exchange.

Compared to IRC 1031

Internal Revenue Code Section 1031, commonly referred to as a “like-kind exchange,” does not allow a taxpayer to hold or benefit from the proceeds during the exchange period. It also requires the replacement property be identified within 45 days and acquired within 180 days after the closing of the relinquished property. If a taxpayer is deferring gain in a 1033 exchange, he can hold the proceeds until the acquisition of the replacement property and an intermediary is not required.

Replacement property

Another difference between a 1031 and a 1033 exchange is the standard that is used to limit what you can buy as replacement property. In general, the standard is more restrictive under 1033 than the like-kind standard under IRC 1031. Section 1033 provides the replacement property must be “similar or related in service or use” to the property that was lost in the casualty or condemnation. It is important to note the Tax Cuts and Jobs Act of 2017 eliminated tax-deferred like-kind exchanges of personal property, but allows exchanges of business and investment real estate.

Time period

The time period allowed for the taxpayer to acquire the replacement property is much more liberal than Section 1031 exchanges. The period begins at the earlier of when the taxpayer first discovers the threat or imminence of condemnation proceedings or when the condemnation or other involuntary conversion occurs. The period ends either two or three years after the end of the tax year in which the conversion occurs. The time period is three years for real property held for business or investment and two years for all other property. If the taxpayer has lost property in a federally declared disaster area, Section 1033 gives the taxpayer a two year extension on the replacement period, granting a total of four years in which to replace the lost property.

Taxpayers having lost their property due to casualties or those facing condemnation should consult with their tax advisors to take advantage of the tax deferral afforded under Section 1033 if they wish to replace their lost property.

We’ve got your back

With Simon Filip, the Real Estate Tax Guy, on your side, you can focus on your real estate investments while he and his team take care of your accounting and taxes. Contact him at [email protected] or 201.655.7411 today.

 

Time to Gather All Your Papers for Taxes

Time to gather your paperwork for Tax TimeGet started organizing paperwork now to make tax time less stressful.

Most of the papers you need to document the income, interest and withheld taxes you report arrive in your mailbox in January, with investment-related 1099s often coming in February. Get ready for their arrival by creating print and online folders. It’s a good idea to create a paper and an email tax folder for messages relating directly to tax information.

Email announcements that documents are available online will land in your inbox. The postal service may deliver your W-2s in your physical mailbox — although some companies post them on a secure site for downloading. Mortgage providers, banks and other financial institutions often post important 1099 forms on your online account.

Paperless banking may have turned shoe boxes into receipt relics of the past, while your online statements often contain key backup records for such potential deductions as:

  • Charitable donations
  • Outlays for health care
  • Gambling winnings and losses
  • Property tax expenditures

Many of us ignore the line items on these statements until we start our annual tax-filing ritual. However you may save time by taking a few extra minutes each month to jot down tax-related information, like:

  • Expense title
  • Check numbers
  • Payee names
  • Dollar amounts
  • Dates

Create a spreadsheet dedicated to tax records. Throughout the year, consider downloading and printing online documents that will be available for only a limited time.

Keeping track of everything

Here are some of the documents you should have handy:

  • Documents related to life events — marriage, death of a spouse or divorce, deductible alimony payment records, adoption papers, and child custody agreements should all be saved.
  • Paperwork related to childbirth. You’ll want the newborn’s Social Security card, childcare receipts and details on college savings plans.
  • Home ownership information. Keep such paperwork as closing documents — it’s good to keep closing documents in case you paid real estate taxes or points when you closed that don’t appear on your year-end mortgage interest statement. Save annual mortgage statements.

Other documents to consider:

  • Last year’s taxes, both federal and state. These are handy as good refreshers of what you filed and documents you’ll need.
  • Retirement account contributions. Keep track of your contributions to a traditional IRA or a self-employed retirement account. Keep this information handy for tax time.
  • Education expenses. Documents help your deduction claim here.
  • State and local taxes. Save these documents so that they can be easily retrieved.

The value of a tax return doesn’t end on April 15. You’ll need to provide this document to get a mortgage, apply for student loans and check the status of your refund. Generally, the IRS can audit you for three years after a filing date, and in some cases, even longer. Hold on to your return copies and supporting documents just in case. The IRS can audit you years after you file, so be prepared.

We’ve got your back

KRSCPAS.com is accessible from your mobile device and is loaded with tax guides, blogs, and other resources to help you succeed. Check it out today!

The Importance of Working Capital for Staffing Companies

A snapshot of short-term liquidity

Working capital is a key financial concept for business owners when evaluating the overall health of operations. It reveals a snapshot of the company’s short-term liquidity position.

The working capital computation is relatively simple:

Current Assets – Current Liabilities = Working CapitalThe Importance of Working Capital for Staffing Companies

Current assets represent the most liquid items on the company’s balance sheet. They consist mostly of cash, accounts receivable, and inventory.

Current liabilities represent debts the company will need to satisfy within 12 months or less.

How much working capital do owners need?

A company should have sufficient working capital on hand to pay all its bills for a year. The amount of working capital informs owners if they have the necessary resources to expand internally or they will need to turn to banks or outside services to raise capital to reach sufficient working capital levels. Having a large positive working capital balance allows the company to grow using funds that were generated internally instead of being liable to outside investors or banks.

One of the main advantages of looking at the working capital position of a company is being able to foresee potential financial difficulties that might arise. If there is insufficient working capital the Company may need to secure financing to meet its current financial obligations. For staffing companies, having positive working capital is imperative for the business to succeed.

Staffing companies and working capital

Staffing companies also need to look into the business cycle of the company to fully understand the importance of working capital. The operating cycle analyzes the accounts receivable, inventory, and accounts payable cycles in terms of days. In other words, accounts receivable is analyzed by the average number of days it takes to collect an account. Accounts payable are analyzed by the average number of days it takes to pay a supplier invoice.

The main goal for staffing companies is to have a high accounts receivable turnover ratio, which is net credit sales divided by average accounts receivable. Divide 365 by your ratio and that will reflect the number of days, on average, to collect receivables. A higher ratio and lower number of days means the company is efficient in collecting receivables. A strong performance ratio for staffing companies range from 11.4 to 16.0, with the number of days to collect balances between 23-32 days.

If receivables are not being collected in a timely manner then the agency has to generate the cash to fund payroll, employee benefits, and payroll taxes not only for placements but for its own employees as well.

Working capital has a direct impact on cash flow in a staffing agency. Since cash flow is the name of the game for all business owners, a good understanding of working capital is imperative to make s business venture successful.

We’ve got your back

At KRS, our CPAs can help you review your staffing company’s working capital and put together a plan for improving your company’s financial situation. Give us a call at 201.655.7411 or email Sean at [email protected]

Understanding Family Business Dynamics

The Family Business – It’s Not Easy!

Managing a family business presents unique challenges not faced by businesses owned and operated by unrelated individuals.  If not addressed, family issues can divide the family and damage or destroy the business.  The larger the family, the more difficult it is to address the challenges. Ignoring the problems is Understanding Family Business Dynamicsnot a solution because they will not go away.

Statistics show that only 10 to 15 percent of family businesses make it to the third generation and only three to five percent make it to the fourth generation.

Typically, the business is started by the first generation and the founder’s children go to work in the business.  While the founder is alive and well, he or she takes the lion’s share of the compensation and profits and, most of the time, everyone appears to get along.  After the founder is gone, the second generation may continue to get along, but in many cases, it becomes a competition to see who can take the most and work the least. This puts a great deal of financial stress on the business because it now may have to support two, three or more families at the level that it previously supported one.

If the business does make it to the third generation, there are many more children involved and the problem grows exponentially, which almost always leads to its demise.

Compensating family members fairly

When it comes to family business, fair is not equal.  Although the business may be owned by many family members, the ones that actually work in the business must receive fair compensation for the jobs they do.  If one family member is the company’s top salesperson and her older brother is a part time worker, they should not receive equal compensation.  For a family business to succeed over multiple generations, there can be no entitlement.  The top performers can get a job anywhere; they do not have to stay in the family business.  If the performers leave, the entitled people are in trouble.

If after everyone receives fair compensation for their services, profits can be distributed to all owners, but only in an amount that will leave the business with enough cash to continue operations.  The business should never make the mistake of borrowing to make distributions.

To succeed in the end, business decisions must be right for the business and family decisions must be right for the family.  All of the children may not be interested in the business, or your youngest daughter may have more to contribute than your oldest son.  When it comes to the business, each family member should be evaluated based on what they bring to the table, not who their parents are or the order in which they were born.

We’ve got your back

At KRS CPAs, we know business is personal for you and your family. Learn more about our services for family-run businesses and contact me at 201.655.7411 or [email protected] to discuss your situation.

 

Deeper Dive into Single Member Limited Liability Companies

Deeper Dive into Single Member Limited Liability CompaniesEntity classification

LLCs with two or more members can be treated as a partnership or corporation for tax purposes. An LLC with one owner or single member limited liability company (SMLLC) can choose to be treated as a corporation or a “disregarded entity.”

The member of a SMLLC who wishes to be treated as corporation for tax purposes must file either Form 8832 to be treated as a ‘C’ Corporation or Form 2553 to elect classification as an ‘S’ Corporation. Where an individual does not file Forms 8832 or 2553 to elect to be treated as a corporation, the IRS will treat the LLC as a disregarded entity and it will be taxed as a sole proprietorship.

Tax treatment

By default, the IRS treats a SMLLC as a “disregarded entity.” This means the IRS will not look at a SMLLC as an entity separate from its sole member for the purpose of filing tax returns. Instead, similar to a sole proprietorship, the IRS will disregard the SMLLC and the member will report income and expenses and pay taxes for the business as part of his or her own personal tax return. Taxable income or loss generated by an operating business will be reported on Schedule C, while rental income will be reported on Schedule E. Since the ultimate responsibility for paying taxes on income generated by a SMLLC is passed through to the member, this way of taxing profits is called pass-through taxation.

Profits earned

As a disregarded entity, if the SMLLC has taxable profits for a given year, the sole member is required to pay taxes on that profit, regardless of whether the profits are actually distributed to the member. It is not relevant whether a member of a SMLLC leaves the profits in the business bank account or withdraws the money. Regardless, all income or loss are reported by the SMLLC owner for income taxation.

Example

Steve’s SMLLC, which owns rental real estate, earned $25,000 this year after expenses and depreciation. Steve decides that he doesn’t need the money and will leave the entire $25,000 in his business checking account to use next year. Steve will have to report and pay tax on the full $25,000.

SMLLC to partnership

There are instances when a SMLLC ceases to be a disregarded entity. One instance this is accomplished is through the addition of one or more new members to the limited liability company. The LLC’s tax reporting after an additional member is admitted no longer is reflected on Schedules C or E of the former sole member. The entity has become a multi-member limited liability company and must obtain an Employer Identification Number and file a partnership return.

We’ve got your back

With Simon Filip, the Real Estate Tax Guy, on your side, you can focus on your real estate investments while he and his team take care of your accounting and taxes. Contact him at [email protected] or 201.655.7411 today.

Understanding the Mortgage Interest Deduction after the Tax Cuts and Jobs Act

Understanding the Mortgage Interest Deduction after the Tax Cuts and Jobs ActThe TCJA modified the mortgage interest deduction for homeowners. Here’s what you need to know about the changes.

Home ownership has long been the American dream.  Mortgage loans have made it possible for the majority of American homeowners to afford buying a home. The government has encouraged home-ownership by offering tax breaks linked to mortgages, but recent changes in tax law changes how much a typical homeowner-taxpayer will benefit from the deductions. In 2018, the Tax Cuts and Jobs Act (TCJA) changed the rules on how much mortgage interest can be deducted from taxable income.

Mortgage limits

Mortgage interest was one of the biggest deductions that tax law allowed. Unlike interest in borrowing for personal expenses, mortgage interest on a taxpayer’s residence can be deducted as an itemized deduction.

TCJA modified the mortgage interest deduction in several ways. The change that garnered the most attention was the reduction in the amount of interest that you’re allowed to deduct. Going forward, taxpayers will only be able to deduct interest on up to $750,000 of mortgage debt, down from $1 million under prior law.

The old $1 million mortgage limit is grandfathered in for existing mortgages, but if a taxpayer obtains a new mortgage post-TCJA, they will be subject to the lower limit. Taxpayers obtaining new mortgages exceeding $750,000are still eligible for a mortgage deduction, however, it will only be on the portion of interest attributable to the first $750,000 borrowing.

Home equity debt

Under old law, taxpayers could deduct interest on up to $100,000 of home equity debt. This allowed taxpayers to do whatever they wanted with the money, including paying down other types of debt (credit card, student loan, auto loans, etc.) or spending on things unrelated to their residence while still able to deduct the interest.

Tax reform under TCJA partially took away the ability to deduct interest on home equity debt. The interest is still tax deductible if the loan is used to buy, build, or improve your home and doesn’t bring the total outstanding mortgage above the new $750,000 limit. If the home equity debt was used for other purposes, it is no longer deductible. Unlike other changes, existing home equity loans were not grandfathered in.

Refinancing

It is important for taxpayers to understand how refinancing an existing mortgage will work for income tax purposes. When a taxpayer takes a mortgage to buy or build a home, it counts as home acquisition debt and is capped at $750,000. A mortgage for other purposes is treated as a home equity debt and now receives no interest deduction. When a taxpayer refinances a mortgage they originally counted as home acquisition debt, the refinanced mortgage will also count as home acquisition debt as long as it is in the same amount. If there is excess borrowed in the refinancing, the extra portion of cash pulled out will be treated as home equity debt, so that portion of the interest you pay won’t be deductible unless it is used to improve the home.

Key takeaways

  1. Interest payments are deductible on mortgage debt up to $750,000 (formerly $1 million).
  2. Deduction for other home equity debt (HELOCs and second mortgages eliminated (formerly $100,000).

With Simon Filip, the Real Estate Tax Guy, on your side, you can focus on your real estate investments while he and his team take care of your accounting and taxes. Contact him at [email protected] or 201.655.7411 today.

Accounting Concerns for Legal Marijuana Business Operations

Accounting Concerns for Legal Marijuana Business OperationsAccounting for the growing cannabis industry is unique. Here’s why.

The goal of any accounting system is to ensure that accurate financial information is available timely to users. An appropriate system will include processes and procedures for collecting, recording and classifying data and will assist in preventing and detecting waste or, even worse, fraud.

So why is accounting for the growing cannabis industry so unique?

Management, investors and other financial statement users require the same accurate financial information as any other industry. However, in this growing industry, businesses must comply with strict state and federal regulations to avoid substantial penalties or even the risk of losing their business.

Cannabusiness accounting and compliance

Proper and adequate accounting systems and controls are even more critical in a cannabis business where the business “touches the plant.” Growers, processors and distributors have unique accounting and compliance needs unlike any other industry. The potential for large cash transactions and banking restrictions common in the industry further emphasize the need for proper accounting controls and procedures.

As states begin to legalize marijuana for medical and recreational use, businesses will need to consider the unique challenges the industry faces at the onset. The federal government considers business operations in this space to be “trafficking in controlled substances.” As such, proper accounting and reporting should incorporate the nuances of Internal Revenue Code Sec. 280E and 471 relating to cost accounting and inventory. In addition, state regulations require industry tracking and reporting of “seed to sale.” Most states with legalized marijuana industry require businesses to have inventory control and reporting systems in place as well as an interface with state mandated tracking systems. Therefore, the accounting system must provide reports and analysis to support compliance with federal and local regulations.

In this highly regulated environment, the business can be audited at any moment. All records must be available and in order to prove compliance with state and federal regulations. Furthermore, the accounting for businesses in this industry will need to provide for transactions to and from related entities, segment or separate “lines of business” reporting and consolidation. Business structures often include related entity relationships and investments. These advanced accounting issues are uncommon for most young or start-up businesses in other industries.

While many businesses entering the Cannabusiness space are new businesses, they cannot approach their accounting and bookkeeping in a manner often seen with new business start-ups. It’s common for a start-up to lack a proper accounting system and accounting controls before the business is up and running. A Cannabusiness business must have their system and controls in place well before they start operations.

We’ve got your back

Cannabusiness is a developing industry with many complicated factors. If you’re starting a business in this space, don’t go it alone! Contact Managing Partner Maria Rollins at [email protected] or 201.655.7411 to discuss your situation.

Real Estate FAQs from Last Month

Answers to real estate FAQs on 1031s and more

My team and I regularly receive questions on real estate-related topics. In this blog post, I answer some of those questions as they are important and others likely need the answers.

Realty Transfer Fee

Question: What is the realty transfer fee and who can expect to pay it?
Answers to this month's real estate FAQs
Answer:  The Realty Transfer Fee, also known as “RTF,” is a fee imposed by the State of New Jersey to offset the costs of tracking real estate transactions. Upon the transfer of the deed to the buyer, the seller pays the RTF, which is based upon the property sales price.

The RTF rate is a graduated rate and there are two different structures, depending on whether the total consideration is over or under $350,000.

It is important to note that a 1% fee must be paid by the buyer on all real estate transactions over $1 million in all commercial and residential property classes. This is also known as the “Mansion Tax.”

1031 Exchange Identification Rule

Question: What happens if you list three properties as replacement properties for your 1031 exchange, but all properties are no longer available?

Answer: One of the requirements of a 1031 exchange is taxpayers must identify a list of properties for potential purchase within 45 calendar days. Whichever property is ultimately purchased must be on this list. The rule allows taxpayers to identify three properties without limitation. Those listed are property that may be purchased, however not all are required to be purchased. If more than three properties are identified, the IRS rules become narrower and stringent.

The list can be changed an infinite amount of times until midnight of the 45th day. If the taxpayer is beyond the 45th day, the list is unchangeable and only properties listed can be chosen to complete the exchange. If the properties are not available after the 45th day, a 1031 exchange cannot be completed and the transaction is not eligible for deferral under Code Section 1031.

Section 179 Expensing

Question: Did the Tax Cut and Jobs Act (TCJA) change 179 expensing for rental property owners?

Answer: A provision of the tax code, commonly known as Section 179 deduction, allows taxpayers to deduct the entire cost of eligible property in the first year it is placed in service. For rental real estate owners, eligible property includes the majority of improvements to the interior portion of a nonresidential building, provided the improvement is put to use after the date the building was placed in service

The TCJA expanded the definition of eligible property to include expenditures for nonresidential roofs, HVAC equipment, fire protection and alarm systems, and security systems.

We’ve got your back

Have a burning real estate question? Email me and I’ll answer it in an upcoming post.