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ESOPs Present Tax and Other Benefits

Wouldn’t it be great if your employees worked as if they owned the company? An employee stock ownership plan (ESOP) could make that a reality.

Under an ESOP, employee participants take part ownership of the business through a retirement savings arrangement. Meanwhile, the business and its existing owner(s) can benefit from some tax breaks, an extra-motivated workforce and potentially a smoother path for succession planning.

How ESOPs work

To implement an ESOP, you establish a trust fund and either:

  • Contribute shares of stock or money to buy the stock (an “unleveraged” ESOP), or
  • Borrow funds to initially buy the stock, and then contribute cash to the plan to enable it to repay the loan (a “leveraged” ESOP).

The shares in the trust are allocated to individual employees’ accounts, often using a formula based on their respective compensation. The business must formally adopt the plan and submit plan documents to the IRS, along with certain forms.

Tax impact

Among the biggest benefits of an ESOP is that contributions to qualified retirement plans such as ESOPs typically are tax-deductible for employers. However, employer contributions to all defined contribution plans, including ESOPs, are generally limited to 25% of covered payroll. But C corporations with leveraged ESOPs can deduct contributions used to pay interest on the loans. That is, the interest isn’t counted toward the 25% limit.

Dividends paid on ESOP stock passed through to employees or used to repay an ESOP loan may be tax-deductible for C corporations, so long as they’re reasonable. Dividends voluntarily reinvested by employees in company stock in the ESOP also are usually deductible by the business. (Employees, however, should review the tax implications of dividends.)

In another potential benefit, shareholders in some closely held C corporations can sell stock to the ESOP and defer federal income taxes on any gains from the sale, with several stipulations. One is that the ESOP must own at least 30% of the company’s stock immediately after the sale. In addition, the sellers must reinvest the proceeds (or an equivalent amount) in qualified replacement property securities of domestic operation corporations within a set period.

Finally, when a business owner is ready to retire or otherwise depart the company, the business can make tax-deductible contributions to the ESOP to buy out the departing owner’s shares or have the ESOP borrow money to buy the shares.

Risks to consider

An ESOP’s tax impact for entity types other than C corporations varies somewhat from what we’ve discussed here. And while an ESOP offers many potential benefits, it also presents risks such as complexity of setup and administration and a strain on cash flow in some situations. For help determining whether one may make sense for your business, contact Holbrook & Manter today. 

Ohio Residency Changes for Tax Purposes

By: David J. Herbe Jr., CPA, MAcc- Tax Manager

The state of Ohio has issued an information release in regards to a change in the way they look at residency of a taxpayer. This is effective for tax years starting January 1, 2018. Below is a list of criteria that must be met to be considered a nonresident of Ohio. 

Providing irrebutable presumption that the taxpayer is of non-Ohio domicile (essentially the burden of proof to provide the state that the taxpayer is a nonresident).

All four criteria must be met:

1.       The individual(s) did not change their residence in or out of Ohio for the taxable year

2.       The individual files a statement with the state of Ohio that claims

          a.       They had less than 212 contact periods with Ohio for the taxable year

                       i.      A contact period is a time period of consecutive days when a resident stays overnight in Ohio away from their non-Ohio home. i.e. John was in Ohio Monday and Tuesday  this would be considered a contact period (one period). If John was in Ohio Monday and then left and came back to Ohio this would not be considered a contact period he is not staying overnight.

          b.      The individual has a home outside the state of Ohio for the full tax year

          c.       The individual doesn’t hold a driver’s license

          d.      The homestead exemption and/or owner-occupancy property tax was not claimed

3.       The statement can’t be false or misleading regarding the requirement above

4.       The statement must be filed on or before October 15th.

 One of the biggest changes that we found is the due date for the affidavit to be filed with the state of Ohio. The due date in prior years was May 30th; it has now changed to October 15th.

This will mostly apply to individuals who filed their tax return in Ohio as a resident last year but this year plan to file as a non-resident. It will also apply to individuals who have a home and spend a good chunk of time in Ohio but do not actually file or plan to file a tax return because they have no income sourced in the state. Really if there is believed to be a change in residency status that will raise any red flags with the Ohio Department of Taxation it may make sense to file the affidavit statement. It is a quick one page form that can be filed with the state department.

Should any questions arise concerning these new changes, Holbrook & Manter has plenty of experience in this area and would be glad to help!

Changes to the Home Mortgage Interest Deduction

A home is the most valuable asset many people own. So, it’s important to remain aware of the tax impact of homeownership and to carefully track the debt you incur to buy, build or improve your home — known as “acquisition indebtedness.”

Among the biggest tax perks of buying a home is the ability to deduct your mortgage interest payments. But this deduction has undergone some changes recently, so you may need to do some catching up.

Before the passage of the Tax Cuts and Jobs Act (TCJA) late last year, a taxpayer could deduct the interest on up to $1 million in acquisition indebtedness on a principal residence and a second home. And this still holds true for mortgage debt incurred before December 15, 2017. But the TCJA tightens limits on the itemized deduction otherwise.

Specifically, for 2018 to 2025, it generally allows a taxpayer to deduct interest only on mortgage debt of up to $750,000. The new law also generally suspends the deduction for interest on home equity debt: For 2018 to 2025, taxpayers can’t claim deductions for such interest, unless the proceeds are used to buy, build or substantially improve the taxpayer’s principal or second home.

Step carefully if you own a second residence and use it as a rental. For a home to qualify as a second home for tax purposes, its owner(s) must use it for more than 14 days or greater than 10% of the number days it’s rented out at fair market value (whichever is more). Failure to meet these qualifications means the home is subject to different tax rules.

Please contact Holbrook & Manter for assistance in properly deducting mortgage interest, as well as fully understanding how the TCJA has impacted other aspects of personal tax planning.

Should you Adjust your Estimated Tax Payments?

Bryan Davidson, CPA- Tax Manager

Have you switched jobs in the past year?  Did you start a business? Do you own interest in a pass-through entity?  These are all scenarios that you should consider when making your 3rd and 4th quarter tax estimates.  In addition to these individual specific situations taxpayers also need to consider the 2017 Tax Cuts and Jobs Act.  This legislation drastically overhauled the tax code for the first time in decades.  Many of the changes will directly impact your tax situation for 2018. 

Some of the highlights include:

1.       New income tax rates and brackets

2.       Standard deduction increased

3.       Personal exemptions suspended

4.       Child tax credit increased

5.       State and local (Sch A) deduction limited

6.       Miscellaneous itemized deductions suspended

7.       Domestic production activities deduction repealed

8.       New deduction for pass-through income

When you combine the individual specific changes and the tax law changes there’s a lot of room for adjustments. 

The typical tests that are applied when looking at estimated taxes (and underpayment penalties) are exception 1 and 2.  Exception 1 states you need to have 100% of your prior year tax paid in through either withholding or timely estimates.  If your AGI in the prior year was greater than $150,000 then you need 110% of your prior year tax paid in.  Exception 2 states you need 90% of your current year tax paid in through either withholding or timely estimates.  If you’re currently paying quarterly estimates it may be worth reviewing since the above mentioned items can both increase and decrease your overall taxes. Contact Holbrook & Manter today for assistance with this matter. We would be happy to assist you. 

Is it time to take a second look at the cash method for income tax purposes?

By: Dave Herbe, CPA, MAcc- Tax Manager

The new tax law has changed the tax landscape significantly. There are changes to depreciation, tax rates, credits, deductions, you name it. One of the biggest changes that came with the Tax Cuts and Jobs Act (TCJA) was the threshold for small businesses that qualify for the cash method of accounting for income tax purposes. Under the old tax laws, for a small business to qualify for the cash method of accounting their gross receipts over the three previous tax years had to average $5 million or less. However, under the TCJA the threshold is average gross receipts of $25 million or less. Let’s look at an example below to help illustrate:

XYZ Corporation has had gross receipts of $8, $10, & $12 million over the last three calendar years. When they file their 2017 tax return, their average gross receipts for the previous three years totals $10 million. Under the old tax laws they would not be eligible to elect the cash method of accounting for income tax purposes. However, under the new law they would be eligible because their average gross receipts are under $25 million.

This allows small businesses who didn’t previously qualify to now make this election as their accounting method for tax purposes.

There are also some other advantages that come with choosing the cash method over the accrual method when eligible. It allows for more tax planning flexibility, as the business can control if they want to delay invoices to defer income to next year or escalate expenses before the end of the year to increase the deductions taken on the tax return. It also allows for potential cash flow benefits as it allows the business to pay tax on the actual cash it received v what has been earned but not into the bank account yet.  The business can also keep accrual financials for internal record keeping, but with the help of a tax accountant an easy accrual to cash adjustment can be made to convert the financials to a true cash basis. These are just some of the advantages that the cash method offers small businesses.

Although there are many benefits, it may not be the best option for every business that is eligible. There are some limitations besides the gross receipts test that can disallow a certain type of business from being allowed to convert to the cash method. It also might make sense to use the accrual method based on the type of business you are and how income is recognized. Before you switch from accrual to cash be sure to consult with your tax adviser to ensure it makes sense and is done properly.  Holbrook & Manter would be happy to assist you, please contact us today.

Department of Labor Increases Scrutiny of Defined Benefit Plans

Sponsors of defined benefit plans — commonly known as pensions — might be facing tighter scrutiny from the U.S. Department of Labor. Just last year, at an ERISA Advisory Council meeting, the agency’s Employee Benefits Security Administration (EBSA) announced that it had ramped up pension audit operations in its Philadelphia office and later decided to do so elsewhere. If your organization offers its employees a defined benefit plan, here’s what you should know.

Required statement

The focus of the audits is on pension plan sponsors’ efforts to deliver benefits to terminated vested participants. According to EBSA’s Reporting and Disclosure Guide for Employee Benefit Plans, plan administrators must provide a “Statement of Accrued and Nonforfeitable Benefits” to participants on request, on termination of service with the employer or after the participant has a one-year break in service. However, only one statement is required in any 12-month period for statements provided on request.

Best practices

Timothy Hauser, EBSA’s Deputy Assistant Secretary for Program Operations, offered some best practices for satisfying the agency’s notification requirements. He advised, first and foremost, that plan sponsors keep good records on how to reach plan participants and relay those records to other corporate entities in a merger or acquisition.

A good starting point, according to Hauser, is for plan sponsors to send participants a certified letter using the participant’s last known address. If mail is returned from the former employee’s last known address, he suggested trying to contact the participant by phone. It’s possible the phone number on record is a mobile phone that wouldn’t be pinned to a previous mailing address.

When other methods fail, Hauser recommended reaching out to former co-workers of the separated participant who might have remained in contact. With so much information available through social media, employers should also consider using the Internet to help find terminated missing participants.

Further concerns

In October 2017, the American Benefits Council submitted a letter to EBSA, requesting more detailed guidance because some of its members had been harshly penalized for failing to find missing participants. From EBSA’s perspective, a plan sponsor’s failure to track down separated vested participants represents a fiduciary breach — not an accusation that any plan’s sponsor would want to face in an audit.

In addition, EBSA continues to focus attention on the quality of audits of defined benefit plans’ financial records by “independent qualified public accountants.” This is in response to a 2015 EBSA report after it “audited” a sampling of plan audits. The review found “major deficiencies” with 39% of the audits it reviewed.

Up to speed

Pension plans may not be as widely used as they used to be, but the compliance rules related to them remain strict. Make sure you stay up to speed on everything that’s required. Contact Holbrook & Manter today for assistance. 

TCJA draws a silver lining around the individual AMT

The Tax Cuts and Jobs Act (TCJA) didn’t eliminate the individual alternative minimum tax (AMT). But the law did draw a silver lining around it. Revised rules now lessen the likelihood that many taxpayers will owe substantial taxes under the AMT for 2018 through 2025.

Parallel universe

Think of the AMT as a parallel universe to the regular federal income tax system. The difference: The AMT system taxes certain types of income that are tax-free under the regular tax system and disallows some regular tax deductions and credits.

The maximum AMT rate is 28%. By comparison, the maximum regular tax rate for individuals has been reduced to 37% for 2018 through 2025 thanks to the TCJA. For 2018, that 28% AMT rate starts when AMT income exceeds $191,100 for married joint-filing couples and $95,550 for others (as adjusted by Revenue Procedure 2018-18).

Exemption available

Under the AMT rules, you’re allowed a relatively large inflation-adjusted AMT exemption. This amount is deducted when calculating your AMT income. The TCJA significantly increases the exemption for 2018 through 2025. The exemption is phased out when your AMT income surpasses the applicable threshold, but the TCJA greatly increases those thresholds for 2018 through 2025.

If your AMT bill for the year exceeds your regular tax bill, you must pay the higher AMT amount. Originally, the AMT was enacted to ensure that very wealthy people didn’t avoid paying tax by taking advantage of “too many” tax breaks. Unfortunately, the AMT also hit some unintended targets. The new AMT rules are better aligned with Congress’s original intent.

Under both old and new law, the exemption is reduced by 25% of the excess of AMT income over the applicable exemption amount. But under the TCJA, only those with high incomes will see their exemptions phased out, while others — particularly middle-income taxpayers — will benefit from full exemptions.

A Note for High-Income Earners

Before the Tax Cuts and Jobs Act (TCJA), many high-income taxpayers weren’t affected by the alternative minimum tax (AMT). That’s because, after multiple legislative changes, many of their tax breaks were already cut back or eliminated under the regular income tax rules. So, there was no need to address the AMT.

If one’s income exceeds certain levels, phaseout rules chip away or eliminate other tax breaks. As a result, higher-income taxpayers had little or nothing left to lose by the time they got to the AMT calculation, while many upper-middle-income folks still had plenty left to lose. Also, the highest earners were in the 39.6% regular federal income tax bracket under prior law, which made it less likely that the AMT — with its maximum 28% rate — would hit them.

In addition, the AMT exemption is phased out as income goes up. This amount is deducted in calculating AMT income. Under previous law, this exemption had little or no impact on individuals in the top bracket, because the exemption was completely phased out. But the exemption phaseout rule made upper-middle-income taxpayers more likely to owe AMT under previous law. Suffice it to say that, under the TCJA, high-income earners are back in the AMT spotlight. So, proper planning is essential.

Need to plan

For many taxpayers, the AMT rules are less worrisome than they used to be. Let Holbrook & Manter assess your liability and help you plan accordingly.

The Pitfalls of DIY Estate Planning

There’s no law that says you can’t prepare your own estate plan. And with an abundance of online services that automate the creation of wills and other documents, it’s easy to do. But unless your estate is small and your plan is exceedingly simple, the pitfalls of do-it-yourself (DIY) estate planning can be many.

Dotting the i’s and crossing the t’s

A common mistake people make with DIY estate planning is to neglect the formalities associated with the execution of wills and other documents. Rules vary from state to state regarding the number and type of witnesses who must attest to a will and what, specifically, they must attest to.

Also, states have different rules about interested parties (that is, beneficiaries) serving as witnesses to a will or trust. In many states, interested parties are ineligible to serve as witnesses. In others, an interested-party witness triggers an increase in the required number of witnesses (from two to three, for example).

Keeping abreast of tax law changes

Legislative developments during the last several years demonstrate how changes in the tax laws from one year to the next can have a dramatic impact on your estate planning strategies. DIY service providers don’t offer legal or tax advice — and provide lengthy disclaimers to prove it. Thus, they cannot be expected to warn users that tax law changes may adversely affect their plans.

Consider this example: A decade ago, in 2008, George used an online service to generate estate planning documents. At the time, his estate was worth $4 million and the federal estate tax exemption was $2 million.

George’s plan provided for the creation of a trust for the benefit of his children, funded with the maximum amount that could be transferred free of federal estate tax, with the remainder going to his wife, Ann. If George died in 2008, for example, $2 million would have gone into the trust and the remaining $2 million would have gone to Ann.

Suppose, however, that George dies in 2018, when the federal estate tax exemption has increased to $11.18 million and his estate has grown to $10 million. Under the terms of his plan, the entire $10 million — all of which can be transferred free of federal estate tax — will pass to the trust, leaving nothing for Ann.

While even a qualified professional couldn’t have predicted in 2008 what the estate tax exemption would be at George’s death, he or she could have structured a plan that would provide the flexibility needed to respond to tax law changes.

Don’t try this at home

These are just a few examples of the many pitfalls associated with DIY estate planning. To help ensure that you achieve your estate planning objectives, contact Holbrook & Manter to review your existing plan.

Addressing long-term care costs with a tax-qualified LTC insurance policy

No matter how diligently you prepare, your estate plan can quickly be derailed if you or a loved one requires long-term home health care or an extended stay at a nursing home or assisted living facility.

The annual cost of long-term care (LTC) can reach as high as six figures, and this expense isn’t covered by traditional health insurance policies, Social Security or Medicare. So it’s important to have a plan to finance these costs, either by setting aside some of your savings or purchasing insurance.

LTC insurance

An LTC insurance policy supplements your traditional health insurance by covering services that assist you or a loved one with one or more activities of daily living (ADLs). Generally, ADLs include eating, bathing and dressing.

LTC coverage is relatively expensive, but it may be possible to reduce the cost by purchasing a tax-qualified policy. Generally, benefits paid in accordance with an LTC policy are tax-free. In addition, if a policy is tax-qualified, your premiums are deductible (as medical expenses) up to a specified limit.

To qualify, a policy must:

  • Be guaranteed renewable and noncancelable regardless of health,
  • Not delay coverage of pre-existing conditions more than six months,
  • Not condition eligibility on prior hospitalization,
  • Not exclude coverage based on a diagnosis of Alzheimer’s disease, dementia, or similar conditions or illnesses, and
  • Require a physician’s certification that you’re either unable to perform at least two of six ADLs or you have a severe cognitive impairment and that this condition has lasted or is expected to last at least 90 days.

It’s important to weigh the pros and cons of tax-qualified policies. The primary advantage is the premium deduction. But keep in mind that medical expenses, including LTC insurance premiums, are deductible only if you itemize and only to the extent they exceed 7.5% of your adjusted gross income (AGI) in 2018 or 10% of AGI in future years (unless Congress extends the lower threshold). So some people may not have enough medical expenses to benefit from this advantage. It’s also important to weigh any potential tax benefits against the advantages of nonqualified policies, which may have less stringent eligibility requirements.

Think long term

Given the potential magnitude of long-term care expenses, the earlier you begin planning, the better. Holbrook & Manter can help you review your options and analyze the relative benefits and risks.

H&M Team Members Hold Art Supply Drive for Nationwide Children’s Hospital

Our team members are passionate about supporting a number of causes. Collectively, we continue to support Nationwide Children’s Hospital. Our team was asked to bring in art supplies over part of the summer that could then be donated to the patients at the hospital.  From markers and crayons… to coloring books and scissors… we covered all of the artistic bases. We had so much fun gathering up all of these colorful items in the hopes to brighten the day of those at Nationwide Children’s. As always, the process to drop off our donation was an easy one. It was our pleasure to deliver all that we collected to the friendly staff at the hospital. Happy art-creating to all of the patients! 

Looking to learn more about Nationwide Children’s Hospital? They share this write-up on their website:

Nationwide Children’s Hospital is a destination academic pediatric medical center designed to manage the most complex of diseases. We treat the sickest of patients from across the country and around the world. We build research programs to assure tomorrow’s breakthroughs help children everywhere. And we train the next generation of physicians, scientists and health care professionals.

Beyond our walls, we invest in building social equity in our communities, address the social determinants of health, and develop payment models to better serve unique populations of children. Our unparalleled investment in Behavioral Health services and research further cements our role as an ambitious champion for the well-being of children everywhere.