One popular fringe benefit is an education assistance program that allows employees to continue learning and perhaps earn a degree with financial assistance from their employers. One way to attract, retain and motivate employees is to provide education fringe benefits so that team members 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 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 individuals pursuing programs leading to a business, medical, law or other advanced academic or professional degrees.

More requirements

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 (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.

Job-related education

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:

• Maintain or improve skills required for the employee’s then-current job, or
• Comply with certain express employer-imposed conditions for continued employment.

“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.

Assistance with student loans

In addition to education assistance, some employers offer student loan repayment assistance as a recruitment and retention tool. Starting next year, employers can help more. Under the SECURE 2.0 law, an employer will be able to make matching contributions to 401(k) and certain other retirement plans with respect to “qualified student loan payments.” The result of this provision is that employees who can’t afford to save money for retirement because they’re repaying student loan debt can still receive matching contributions from their employers. This will take effect in 2024.

Contact us to learn more about setting up an education assistance or student loan repayment plan at your business.

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If you’re the owner of an incorporated business, you know 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. Therefore, 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.

Steps to help protect yourself

There’s no simple way to determine what’s reasonable. If the IRS audits your tax return, it will examine 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 four steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation:

1. Keep compensation in line with what similar businesses are paying their executives (and keep whatever evidence you can get of what others are paying to support what you pay).
2. In the minutes of your corporation’s board of directors’ meetings, contemporaneously document the reasons for compensation paid. For example, if compensation is being increased in the current year to make up for earlier years in which it was low, be sure that the minutes reflect this. (Ideally, the minutes for the earlier years should reflect that the compensation paid then was at a reduced rate.) Cite any executive compensation or industry studies that back up your compensation amounts.
3. Avoid paying compensation in direct proportion to the stock owned by the corporation’s shareholders. This looks too much like a disguised dividend and will probably be treated as such by the IRS.
4. If the business is profitable, pay at least some dividends. This avoids giving the impression that the corporation is trying to pay out all of its profits as compensation.

You can avoid problems and challenges by planning ahead. Contact us if you have questions or concerns about your situation.

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If your business occupies substantial space and needs to increase or move from that space in the future, you should keep the rehabilitation tax credit in mind. This is especially true if you favor historic buildings.

The credit is equal to 20% of the qualified rehabilitation expenditures (QREs) for a qualified rehabilitated building that’s also a certified historic structure. A qualified rehabilitated building is a depreciable building that has been placed in service before the beginning of the rehabilitation and is used, after rehabilitation, in business or for the production of income (and not held primarily for sale). Additionally, the building must be “substantially” rehabilitated, which generally requires that the QREs for the rehabilitation exceed the greater of $5,000 or the adjusted basis of the existing building.

A QRE is any amount chargeable to capital and incurred in connection with the rehabilitation (including reconstruction) of a qualified rehabilitated building. QREs must be for real property (but not land) and can’t include building enlargement or acquisition costs.

The 20% credit is allocated ratably to each year in the five-year period beginning in the tax year in which the qualified rehabilitated building is placed in service. Thus, the credit allowed in each year of the five-year period is 4% (20% divided by 5) of the QREs with respect to the building. The credit is allowed against both regular federal income tax and alternative minimum tax.

The Tax Cuts and Jobs Act, which was signed at the end of 2017, made some changes to the credit. Specifically, the law:

• Requires taxpayers to take the 20% credit ratably over five years instead of in the year they placed the building into service
• Eliminated the 10% rehabilitation credit for pre-1936 buildings

Contact us to discuss the technical aspects of the rehabilitation credit. There may also be other federal tax benefits available for the space you’re contemplating. For example, various tax benefits might be available depending on your preferences as to how a building’s energy needs will be met and where the building is located. In addition, there may be state or local tax and non-tax subsidies available.

Getting beyond these preliminary considerations, we can work with you and construction professionals to determine whether a specific available “old” building can be the subject of a rehabilitation that’s both tax-credit-compliant and practical to use. And, if you do find a building that you decide you’ll buy (or lease) and rehabilitate, we can help you monitor project costs and substantiate the compliance of the project with the requirements of the credit and any other tax benefits.

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If you’re thinking about setting up a retirement plan for yourself and your employees, but you’re worried about the financial commitment and administrative burdens involved, there are a couple of options to consider. Let’s take a look at a “simplified employee pension” (SEP) or a “savings incentive match plan for employees” (SIMPLE).

SEPs are intended as an attractive alternative to “qualified” retirement plans, particularly for small businesses. The features that are appealing include the relative ease of administration and the discretion that you, as the employer, are permitted in deciding whether or not to make annual contributions.

SEP involves easy setup

If you don’t already have a qualified retirement plan, you can set up a SEP simply by using the IRS model SEP, Form 5305-SEP. By adopting and implementing this model SEP, which doesn’t have to be filed with the IRS, you’ll have satisfied the SEP requirements. This means that as the employer, you’ll get a current income tax deduction for contributions you make on behalf of your employees. Your employees won’t be taxed when the contributions are made but will be taxed later when distributions are made, usually at retirement. Depending on your needs, an individually-designed SEP — instead of the model SEP — may be appropriate for you.

When you set up a SEP for yourself and your employees, you’ll make deductible contributions to each employee’s IRA, called a SEP-IRA, which must be IRS-approved. The maximum amount of deductible contributions that you can make to an employee’s SEP-IRA, and that he or she can exclude from income, is the lesser of: 25% of compensation and $66,000 for 2023. The deduction for your contributions to employees’ SEP-IRAs isn’t limited by the deduction ceiling applicable to an individual’s own contribution to a regular IRA. Your employees control their individual IRAs and IRA investments, the earnings on which are tax-free.

There are other requirements you’ll have to meet to be eligible to set up a SEP. Essentially, all regular employees must elect to participate in the program, and contributions can’t discriminate in favor of the highly compensated employees. But these requirements are minor compared to the bookkeeping and other administrative burdens connected with traditional qualified pension and profit-sharing plans.

The detailed records that traditional plans must maintain to comply with the complex nondiscrimination regulations aren’t required for SEPs. And employers aren’t required to file annual reports with IRS, which, for a pension plan, could require the services of an actuary. The required recordkeeping can be done by a trustee of the SEP-IRAs — usually a bank or mutual fund.

SIMPLE Plans

Another option for a business with 100 or fewer employees is a “savings incentive match plan for employees” (SIMPLE). Under these plans, a “SIMPLE IRA” is established for each eligible employee, with the employer making matching contributions based on contributions elected by participating employees under a qualified salary reduction arrangement. The SIMPLE plan is also subject to much less stringent requirements than traditional qualified retirement plans. Or, an employer can adopt a “simple” 401(k) plan, with similar features to a SIMPLE plan, and automatic passage of the otherwise complex nondiscrimination test for 401(k) plans.

For 2023, SIMPLE deferrals are up to $15,500 plus an additional $3,500 catch-up contributions for employees ages 50 and older.

Contact us for more information or to discuss any other aspect of your retirement planning.

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Summer is around the corner so you may be thinking about hiring young people at your small business. At the same time, you may have children looking to earn extra spending money. You can save family income and payroll taxes by putting your child on the payroll. It’s a win-win!

Here are four tax advantages.

1. 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 $13,850 standard deduction for 2023 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.

2. Claiming income tax withholding exemption
   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 $1,250 for 2023 (and includes more than $400 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.

3. Saving Social Security tax
   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 aren’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.

4. Saving for retirement
   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 $66,000 for 2023).

   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.

If you’re starting a business with some partners and wondering what type of entity to form, an S corporation may be the most suitable form of business for your new venture. Here are some of the reasons why.

A big benefit of an S corporation over a partnership is that as S corporation shareholders, you won’t be personally liable for corporate debts. In order to receive this protection, it’s important that:

• The corporation be adequately financed,
• The existence of the corporation as a separate entity be maintained, and
• Various formalities required by your state be observed (for example, filing articles of incorporation, adopting by-laws, electing a board of directors and holding organizational meetings).

Dealing with losses

If you expect that the business will incur losses in its early years, an S corporation is preferable to a C corporation from a tax standpoint. Shareholders in a C corporation generally get no tax benefit from such losses. In contrast, as S corporation shareholders, each of you can deduct your percentage share of losses on your personal tax return to the extent of your basis in the stock and in any loans you made to the entity. Losses that can’t be deducted because they exceed your basis are carried forward and can be deducted by you in the future when there’s sufficient basis.

Once the S corporation begins to earn profits, the income will be taxed directly to you whether or not it’s distributed. It will be reported on your individual tax return and be aggregated with income from other sources. Your share of the S corporation’s income won’t be subject to self-employment tax, but your wages will be subject to Social Security taxes. To the extent the income is passed through to you as qualified business income (QBI), you’ll be eligible to take the 20% pass-through deduction, subject to various limitations.

Note: Unless Congress acts to extend it, the QBI deduction is scheduled to expire after 2025.

If you’re planning to provide fringe benefits such as health and life insurance, you should be aware that the costs of providing such benefits to a more than 2% shareholder are deductible by the entity but are taxable to the recipient.

Protecting S status

Also be aware that the S corporation could inadvertently lose its S status if you or your partners transfer stock to an ineligible shareholder such as another corporation, a partnership or a nonresident alien. If the S election was terminated, the corporation would become a taxable entity. You would not be able to deduct any losses and earnings could be subject to double taxation — once at the corporate level and again when distributed to you. In order to protect against this risk, it’s a good idea for each shareholder to sign an agreement promising not to make any transfers that would jeopardize the S election.

Before finalizing your choice of entity, consult with us. We can answer any questions you have and assist in launching your new venture.

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