Michigan Sales Tax Complexities for Nonprofits

Many nonprofit organizations believe that since the IRS has granted them tax-exempt status, the organization is exempt from all taxes. However, that is not the case, and Michigan sales tax is one area that significantly impacts most nonprofit organizations. The default treatment for sales tax for a nonprofit organization is the same as for a for-profit organization unless there is an exemption. As a result, in many situations, a nonprofit organization should pay sales tax on items it purchases and charge sales tax on items it sells.

Paying sales tax on purchases

When a nonprofit organization makes a purchase, it can claim an exemption from paying sales tax only if all of the following four conditions are met:

The organization has been granted tax-exempt status as a 501(c)(3) or 501(c)(4).
The item being purchased is tangible personal property.
The item being purchased will be used or consumed primarily in carrying out the organization’s exempt purposes.
The transaction does not fall under an exception.

To illustrate the first three conditions, consider an organization that is purchasing cards and dice for a Las Vegas Night fundraising event. The organization is a 501(c)(3) and the items being purchased are tangible personal property. However, the items will not be used in carrying out the organization’s exempt purposes. Even though fundraising is a necessary activity for most nonprofits, it is a means to achieve financial goals and is not itself an exempt purpose. The organization should not claim an exemption and should pay sales tax on this purchase.

Once an organization has met the first three conditions, the exceptions described in the sales tax rules should be carefully reviewed for any large transactions that are being considered. For example, purchasing a vehicle costing more than $5,000 that will be used primarily for fundraising would result in the organization owing sales tax, even if the other conditions are met.

If an organization meets all four conditions, then a sales tax exemption can be claimed by providing the vendor with a completed Michigan Form 3372 – Sales and Use Tax Certificate of Exemption, and a copy of the IRS determination letter. The State of Michigan does not issue tax exempt numbers. Form 3372 must be provided to the seller with each purchase and retained in their records for four years.

It is important to note that items purchased by a nonprofit organization for resale are subject to the same rules as for a for-profit organization. The organization can claim a sales tax exemption on the purchase by filing Michigan Form 3372 with the vendor (a copy of the IRS determination letter is not necessary since the exemption is being claimed for resale instead of for use in the nonprofit’s exempt purpose), but will need to collect sales tax on the sale of those items according to the guidelines outlined next.

Nonprofit schools, nonprofit hospitals, churches, or governmental agencies are given separate statutory exemption. These organizations would provide vendors with Form 3372 but would not have to provide a copy of their IRS determination letter.

Collecting sales tax on sales

A nonprofit organization must register for sales tax with the Michigan Department of Treasury before selling tangible personal property, regardless of whether an exemption will apply. Once registered, a nonprofit organization is subject to the same filing requirements that a for-profit organization is, even if no sales tax is due. Registration can be done online through the Unemployment Insurance Agency or by completing Form 518 – Registration for Michigan Taxes.

Effective September 26, 2018, the State of Michigan changed the rules for certain nonprofits collecting sales tax on fundraising sales through an update to the Michigan Compiled Laws (MCL 205-540).

The old rule stated that if less than $5,000 of sales were made, the nonprofit could elect not to collect and not to remit sales tax on those sales. However, as soon as $5,000 in sales were made, sales tax would need to be remitted on every dollar of taxable sales.

The new rule now states that sales of the first $10,000 of tangible personal property in a calendar year for fundraising purposes are exempt from sales tax as long as the nonprofit has aggregate sales at retail in the calendar year of less than $25,000.

The amount of nontaxable fundraising sales has doubled from $5,000 to $10,000. Previously it was all or nothing for the exemption, and now it is truly an exemption for the first $10,000 sold. However, there are still planning and budgeting issues to consider because once aggregate sales at retail hit $25,000, there is no exemption. The $25,000 threshold is for gross sales for the calendar year, not per event.

It is important to note that all sales tax collected must be remitted to the State of Michigan unless it is first refunded to the customer. If the organization collects sales tax on all of its sales, then later determines that they have less than $25,000 in aggregate sales, they would still be required to remit all sales tax collected during the year or refund it to each customer for the first $10,000 of sales.

A conservative way to plan is that if the organization believes during the budget process that sales will be $10,000 or less, do not charge sales tax. Then, as things change during the year, if sales exceed $10,000, start to charge sales tax on those exceeding $10,000.

It is critical that an organization carefully review the sales tax rules before conducting any sales of tangible personal property, including serving meals at a fundraising event or holding an auction. These types of activities have special rules and additional recordkeeping that may be required, so appropriate steps should be taken before the event.

Planning ahead ensures compliance

The Michigan sales tax rules can be confusing for general taxpayers, and the exemptions and exceptions that apply specifically to nonprofit organizations only make them more complex. Nonprofit organizations should take the necessary steps to understand these rules to ensure compliance with the state. Also, if the organization has transactions in other states, those sales tax rules may be different from the Michigan rules discussed here.

For more information, please contact any member of Yeo & Yeo’s Nonprofit Services Group or visit the Sales and Use Tax section of the Michigan Department of Treasury website.

Additional resources regarding Michigan sales tax as applied to nonprofit organizations:

State of Michigan Revenue Administrative Bulletin 2016-04 – Sales and Use Tax Exemption Claim Procedures and Formats

State of Michigan Revenue Administrative Bulletin 1995-3 – Sales and Use Tax – Nonprofit Entities

Michigan Department of Treasury – Common Sales and Use Tax Exemptions and Requirements

As teachers head back for a new school year, they often pay for various expenses for which they don’t receive reimbursement. Fortunately, they may be able to deduct them on their tax returns. However, there are limits on this special deduction, and some expenses can’t be written off.

For 2019, qualifying educators can deduct some of their unreimbursed out-of-pocket classroom costs under the educator expense deduction. This is an “above-the-line” deduction, which means you don’t have to itemize your deductions in order to claim it.

Eligible deductions

Here are some details about the educator expense deduction:

For 2019, educators can deduct up to $250 of trade or business expenses that weren’t reimbursed. (The deduction is $500 if both taxpayers are eligible educators who file a joint tax return, but these taxpayers can’t deduct more than $250 each.)
Qualified expenses are amounts educators paid themselves during the tax year.
Examples of expenses that educators can deduct include books, supplies, computer equipment (including software), other materials used in the classroom, and professional development courses.
To be eligible, taxpayers must be kindergarten through grade 12 teachers, instructors, counselors, principals or aides. They must also work at least 900 hours a school year in a school that provides elementary or secondary education as determined under state law.

Educators should keep receipts when they make eligible expenses and note the date, amount and purpose of each purchase.

Ineligible deductions

Teachers or professors may see advertisements for job-related courses in out-of-town or exotic locations. You may have wondered whether traveling to these courses is tax-deductible on teachers’ tax returns. The bad news is that, for tax years 2018–2025, it isn’t, because the outlays are employee business expenses.

Prior to 2018, employee business expenses could be claimed as miscellaneous itemized deductions. However, under the Tax Cuts and Jobs Act, miscellaneous itemized deductions aren’t deductible by individuals for tax years 2018–2025.

The use of a company vehicle is a valuable fringe benefit for owners and employees of small businesses. This benefit results in tax deductions for the employer as well as tax breaks for the owners and employees using the cars. (And of course, they get the nontax benefits of driving the cars!) Even better, recent tax law changes and IRS rules make the perk more valuable than before.

Here’s an example

Let’s say you’re the owner-employee of a corporation that’s going to provide you with a company car. You need the car to visit customers, meet with vendors and check on suppliers. You expect to drive the car 8,500 miles a year for business. You also expect to use the car for about 7,000 miles of personal driving, including commuting, running errands and weekend trips with your family. Therefore, your usage 100c of the vehicle will be approximately 55% for business and 45% for personal purposes. You want a nice car to reflect positively on your business, so the corporation buys a new luxury $50,000 sedan.

Your cost for personal use of the vehicle will be equal to the tax you pay on the fringe benefit value of your 45% personal mileage. By contrast, if you bought the car yourself to be able to drive the personal miles, you’d be out-of-pocket for the entire purchase cost of the car.

Your personal use will be treated as fringe benefit income. For tax purposes, your corporation will treat the car much the same way it would any other business asset, subject to depreciation deduction restrictions if the auto is purchased. Out-of-pocket expenses related to the car (including insurance, gas, oil and maintenance) are deductible, including the portion that relates to your personal use. If the corporation finances the car, the interest it pays on the loan would be deductible as a business expense (unless the business is subject to business-interest limitation under the tax code).

In contrast, if you bought the auto yourself, you wouldn’t be entitled to any deductions. Your outlays for the business-related portion of your driving would be unreimbursed employee business expenses that are nondeductible from 2018 to 2025 due to the suspension of miscellaneous itemized deductions under the Tax Cuts and Jobs Act. And if you financed the car yourself, the interest payments would be nondeductible.

And finally, the purchase of the car by your corporation will have no effect on your credit rating.

Administrative tasks

Providing an auto for an owner’s or key employee’s business and personal use comes with complications and paperwork. Personal use will have to be tracked and valued under the fringe benefit tax rules and treated as income. This article only explains the basics.

Despite the necessary valuation and paperwork, a company-provided car is still a valuable fringe benefit for business owners and key employees. It can provide them with the use of a vehicle at a low tax cost while generating tax deductions for their businesses. We can help you stay in compliance with the rules and explain more about this prized perk.

Yeo & Yeo CPAs & Business Consultants was proud to join with the Young Professionals group of the Leading Edge Alliance (LEA YPs) for its annual LEA YP Global Volunteer Days. LEA member firms worldwide were encouraged to donate to or volunteer for a local charity. This year all member firms decided to rally around a single cause: the fight against hunger.

During July, more than 200 Yeo & Yeo employees throughout the firm’s nine offices donated food, made monetary donations and volunteered their time in local organizations. Through these efforts, Yeo & Yeo supported ten Michigan nonprofits including the Children’s Advocacy Center of Gratiot County, Detroit Rescue Mission Ministries, I Support the 1% Veterans Food Pantry, Food Bank of Eastern Michigan, Food Gatherers, Forgotten Harvest Farm, Greater Lansing Food Bank, Kalamazoo Loaves & Fishes, Midland County Emergency Food Pantry Network and St. Luke N.E.W. Life Center.

Alex Wilson, a member of the LEA YP Steering Committee and manager at Yeo & Yeo, said, “We are thankful to have been able to work together with the LEA to not only impact multiple Michigan communities, but to collectively spread our time, talent and treasures as a profession worldwide to fight hunger.”

This is the ninth consecutive year that Yeo & Yeo employees have participated in the annual LEA YP Global Volunteer Days. The firm is proud of its employees’ outreach and pleased to participate in these efforts to support communities both locally and globally.

Operating a business as an S corporation may provide many advantages, including limited liability for owners and no double taxation (at least at the federal level). Self-employed people may also be able to lower their exposure to Social Security and Medicare taxes if they structure their businesses as S corps for federal tax purposes. But not all businesses are eligible — and with changes under the Tax Cuts and Jobs Act, S corps may not be as appealing as they once were.

Compare and contrast

The main reason why businesses elect S corp status is to obtain the limited liability of a corporation and the ability to pass corporate income, losses, deductions and credits through to shareholders. In other words, S corps generally avoid double taxation of corporate income — once at the corporate level and again when it’s distributed to shareholders. Instead, tax items pass through to the shareholders’ personal returns, and they pay tax at their individual income tax rates.

But double taxation may be less of a concern today due to the 21% flat income tax rate that now applies to C corporations. Meanwhile, the top individual income tax rate is 37%. S corp owners may be able to take advantage of the qualified business income (QBI) deduction, which can be equal to as much as 20% of QBI.

In order to assess S corp status, you have to run the numbers with your tax advisor, and factor in state taxes to determine which structure will be the most beneficial for you and your business.

S corp qualifications

If you decide to go the S corp route, make sure you qualify and will stay qualified. To be eligible to elect to be an S corp or to convert, your business must:

Be a domestic corporation,
Have only one class of stock,
Have no more than 100 shareholders, and
Have only “allowable” shareholders, including individuals, certain trusts and estates. Shareholders can’t include partnerships, corporations and nonresident alien shareholders.

In addition, certain businesses are ineligible, such as financial institutions and insurance companies.

Base compensation on what’s reasonable

Another important consideration when electing S status is shareholder compensation. One strategy for paying less in Social Security and Medicare employment taxes is to pay modest salaries to yourself and any other S corp shareholder-employees. Then, pay out the remaining corporate cash flow (after you’ve retained enough in the company’s accounts to sustain normal business operations) as federal-employment-tax-free cash distributions.

However, the IRS is on the lookout for S corps that pay shareholder-employees unreasonably low salaries to avoid paying employment taxes and then make distributions that aren’t subject to those taxes.

Paying yourself a modest salary will work if you can prove that your salary is reasonable based on market levels for similar jobs. Otherwise, you run the risk of the IRS auditing your business and imposing back employment taxes, interest and penalties. We can help you decide on a salary and gather proof that it’s reasonable.

Consider all angles

Contact us if you think being an S corporation might help reduce your tax bill while still providing liability protection. We can help with the mechanics of making an election or making a conversion, under applicable state law, and then handling the post-conversion tax issues.

What is your business worth to you, to a third party, to your family, to your employees? You have built this business from the ground up, or acquired it many years ago, and turned it into the successful business it is today. How do you put a value to something you have dedicated your entire life to?

It is hard to plan for the future if you don’t have all the facts. With a baseline business valuation you can operate from a position of strength, because you’ll be relying on facts rather than estimates or opinions.

What is a baseline? A baseline is a fixed point of reference that is used for comparison purposes. A project’s results would be measured against a baseline number for costs, sales and all other variables; to determine if it was a success. Your company should be treated the same way you would treat a new project or venture. In order to determine a baseline of a business, a business valuation needs to be performed.

A baseline business valuation, prepared by an independent third-party will provide you with an objective view on where your business is today. A business valuation advisor will conduct a financial statement analysis. This analysis involves common size analysis, ratio analysis, trend analysis and industry comparative analysis. The advisor will use this financial statement analysis to compare your business to the other businesses in the industry. The value of the business is based on not only the multiples similar businesses in the industry are selling for, but it is important to determine the business’s annual cash flow. It may be determined that your business is performing better than the industry and has substantial more annual cash flow. In the end, a baseline value is determined.

Once a baseline business value has been determined, it is time to look to the future:

Goal Setting. We can look to improve the business through setting goals to increase revenues, cut costs, increase the bottom line, add divisions or add products/services. On an annual or semiannual basis, an updated business valuation can be performed. You can then compare the new value determined for the business, after your goals have been set and strategies implemented, to the baseline business value to measure the performance and see if you reached those goals.
Increase Value. In order to improve the overall value of the business, it may not be all about the bottom line. You can increase revenues and cut costs, improving the business’s net income, but that may not be the ultimate driver of value for your business. We may look to increase the overall cash flow, acquire new equipment, pay down outstanding debts, add divisions or acquire other businesses.
Exit Planning. You may have no intentions on selling your business today. Suppose you are unexpectedly approached by a potential buyer and they make you an offer on your business. It is imperative to know the true value of the business, to make a proper decision on the offer.

Perhaps you are not planning to sell the business, but rather pass it down to a family member or employee. Passing down the business involves several complicated issues, such as how to logically divide the business and allocate value. Business valuations help owners establish a baseline value that they can use as a springboard for future planning whether stock is intended to be purchased, gifted or inherited. Read more about succession planning here.

The business valuation advisors at Yeo & Yeo CPAs & Business Consultants can review your company’s financial position and determine its value. A valuation advisor can help you, your family and your attorney customize solutions to meet your goals and special needs. Read more about business valuations here.

Expect the unexpected. No one knows when their plans will change or what unforeseen circumstances may come along the way. Be prepared and confident for the future to come, when you know the true value of your business.

The long-awaited 2019 Compliance Supplement was released by the Office of Management and Budget (OMB) on July 1, 2019. It is effective for audits of fiscal years beginning after June 30, 2018. The new supplement includes many key changes after last year’s “skinny” version was released in May 2018. The most talked-about change was the inclusion of a mandate that each agency limit the number of requirements identified as being subject to the compliance audit to six. The only exception is the Research and Development cluster which was permitted to identify seven requirements. Part 2 of the supplement, Matrix of Compliance Requirements, identifies the requirements relevant to each major program this year, and the requirements are likely to be different from those in prior years.

What does this change for the audit? Not as much as you might imagine. While the respective agencies limited the number of requirements, due to the late release, the Michigan Department of Education (MDE) issued their 2018-2019 Michigan School Auditing Manual before the final version of the Compliance Supplement was available. As a result, some of the compliance requirements shown as being “not subject to audit” in the Compliance Supplement, i.e., Equipment/Real Property Management in the Child Nutrition Cluster, are still deemed relevant by MDE, thus still required to be tested by the school district’s auditor as part of the Single Audit.

Additional Changes

Increased Procurement Threshold

The 2017 and 2018 National Defense Authorization Acts (NDAA) increased the micro-purchase threshold to $10,000 for procurement under grants, first for institutions of higher education, nonprofit entities, nonprofit research organizations, or independent research institutes and, later, for effectively all auditees for all federal grants. However, these changes have not yet been formally codified in the Federal Acquisition Regulations at 48 CFR Subpart 2.1 and early implementation is not permissible. While OMB issued a memorandum (M-18-18) on June 20, 2018, that clarified the implementation date, it was recognized that there was confusion as to when it was truly applicable. As a result, OMB stated that auditors are not expected to develop audit findings for school districts that have implemented the increased purchase threshold, as long as the school district updated their federal procurement policy. If the policy contains a blanket statement that the district will follow federal requirements, it is expected that they are still complying with the $3,500 micro-purchase threshold.

Internal Controls

Part 6 of the Compliance Supplement received a major overhaul with increased requirements for internal controls, why they are important, and specific examples. These examples include both entity-wide controls and items specific to each type of compliance requirement. The updates were implemented to more closely align the audit requirements with the five components of internal controls as identified by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework: control environment, risk assessment, control activities, information and communication, and monitoring. School district auditors will have an increased focus on risk assessment this year and auditees should expect more questions relating to internal control than in the past.

The changes above are those that will be the most relevant to school districts as the 2019 fiscal year audits are underway. We recommend that district management review their policies and procedures that are currently in place to be as prepared as possible for their auditors. Districts should carefully go over their request or “prepared by client” (PBC) list, as there may be new or more extensive items requested. Internal control narratives should be updated with the most relevant and timely information. Communication is always key, but especially important during a year of change. Yeo & Yeo’s Education Services Group is here to help with any questions or concerns that you may have.

Redesigned Online Tool Makes it Easier to Do a Paycheck Checkup

IRS News Release August 6, 2019:

The Internal Revenue Service today launched the new Tax Withholding Estimator, an expanded, mobile-friendly online tool designed to make it easier for everyone to have the right amount of tax withheld during the year.

The Tax Withholding Estimator replaces the Withholding Calculator, which offered workers a convenient online method for checking their withholding. The new Tax Withholding Estimator offers workers, as well as retirees, self-employed individuals and other taxpayers, a more user-friendly step-by-step tool for effectively tailoring the amount of income tax they have withheld from wages and pension payments.

“The new estimator takes a new approach and makes it easier for taxpayers to review their withholding,” said IRS Commissioner Chuck Rettig. “This is part of an ongoing effort by the IRS to improve quality services as we continue to pursue modernization and enhancements of our taxpayer relationships.”

The IRS took the feedback and concerns of taxpayers and tax professionals to develop the Tax Withholding Estimator, which offers a variety of new user-friendly features including:

Plain language throughout the tool to improve comprehension.
The ability to more effectively target at the time of filing either a tax due amount close to zero or a refund amount.
A new progress tracker to help users see how much more information they need to input.
The ability to move back and forth through the steps, correct previous entries and skip questions that don’t apply.
Enhanced tips and links to help the user quickly determine if they qualify for various tax credits and deductions.
Self-employment tax for a user who has self-employment income in addition to wages or pensions.
Automatic calculation of the taxable portion of any Social Security benefits.
A mobile-friendly design.

In addition, the new Tax Withholding Estimator makes it easier to enter wages and withholding for each job held by the taxpayer and their spouse, as well as separately entering pensions and other sources of income. At the end of the process, the tool makes specific withholding recommendations for each job and each spouse and clearly explains what the taxpayer should do next.

The new Tax Withholding Estimator will help anyone doing tax planning for the last few months of 2019. Like last year, the IRS urges everyone to do a Paycheck Checkup and review their withholding for 2019. This is especially important for anyone who faced an unexpected tax bill or a penalty when they filed this year. It’s also an important step for those who made withholding adjustments in 2018 or had a major life change.

Those most at risk of having too little tax withheld include:

those who itemized in the past but now take the increased standard deduction,
two-wage-earner households,
employees with nonwage sources of income, and
those with complex tax situations.

To get started, check out the Tax Withholding Estimator on IRS.gov.

It has been a year since the landmark case of South Dakota v. Wayfair, Inc. was decided. One by one, states continue to pass economic nexus provisions for sales tax. Economic nexus requires out-of-state businesses to collect sales tax (on taxable goods and services) for states in which they are not physically present once the business reaches a certain sales dollar threshold or a set number of transactions. Businesses have been scrambling to assess their risk and ensure they are compliant with these new sales tax laws.

Since last June, when the Wayfair case was remanded back to South Dakota, states with laws similar to South Dakota’s have begun enforcement. Others without laws previously in place have drafted and passed legislation so they too could increase their collection of sales tax in a world of consumers who are increasingly moving from brick and mortar stores to online marketplaces. Five states (AK, DE, MT, NH and OR) do not have a state sales tax. Currently, three (FL, LA and MO) of the 45 states that do have sales tax have not yet adopted an economic nexus provision for sales tax. Of those three, each one has begun the drafting process, but final versions have not yet been signed into law.

If all states’ sales tax laws were consistent, it would not be such a hard pill for businesses to swallow. However, when we look at the various states’ rules to compare what is taxable, they are all across the board. The differences are especially evident in the tech realm: Some states tax downloads, others tax digital goods and yet others tax SaaS (software as a service). Some tax all three of these; others tax none of the three.

Some states have multiple tax rates for different types of items or buyers. Even more states have local taxes to be collected that vary by county, city, township or mandated taxing jurisdictions. These circumstances can make neighbors on the same street subject to different tax rates based on their exact address, and it adds an additional layer of complexity for business compliance.

In determining economic nexus, some states have a dollar threshold or a number of transactions threshold, whereby crossing either line would subject a business to collecting sales tax within the state. Others require both a dollar threshold and a number of transactions threshold to be met, so that both must be present to trigger the collection obligation. Some laws base the dollar amounts on taxable sales only, where others use gross receipts. “Transactions” too can be tricky, since what counts as a transaction is often not explicitly defined.

Further, determining how quickly a business needs to react to hitting the threshold is a concern. In some states, the next transaction after hitting the threshold is subject to tax collection. Others allow for implementation in the next month, quarter or year.

One misconception is that Wayfair applies only to online retailers. The implications are more far-reaching. In many states, in addition to tangible goods, services are also subject to sales tax. In this global economy, it is not only online retailers who cross state lines. Wayfair impacts all businesses with sales outside of their home state.

Yeo & Yeo is working with businesses to evaluate sales tax collection obligations. We assess risk and obligations by looking at not only what the business does, but also how it is done and where. We analyze sales by state along with other business activity. Working with key personnel within the business, we identify filing obligations and assist with registrations and voluntary disclosure agreements. This allows employees to focus on their business while we work through the intricacies state by state.

Could your business be at risk? We are available to discuss your business operations and determine whether an in-depth analysis is warranted. Please reach out to us at 800.968.0010.

If you’re lucky enough to be a winner at gambling or the lottery, congratulations! After you celebrate, be ready to deal with the tax consequences of your good fortune.

Winning at gambling

Whether you win at the casino, a bingo hall, or elsewhere, you must report 100% of your winnings as taxable income. They’re reported on the “Other income” line on Schedule 1 of your 1040 tax return. To measure your winnings on a particular wager, use the net gain. For example, if a $30 bet at the race track turns into a $110 win, you’ve won $80, not $110.

You must separately keep track of losses. They’re deductible, but only as itemized deductions. Therefore, if you don’t itemize and take the standard deduction, you can’t deduct gambling losses. In addition, gambling losses are only deductible up to the amount of gambling winnings. So you can use losses to “wipe out” gambling income but you can’t show a gambling tax loss.

Maintain good records of your losses during the year. Keep a diary in which you indicate the date, place, amount and type of loss, as well as the names of anyone who was with you. Save all documentation, such as checks or credit slips.

Winning the lottery

The chances of winning the lottery are slim. But if you don’t follow the tax rules after winning, the chances of hearing from the IRS are much higher.

Lottery winnings are taxable. This is the case for cash prizes and for the fair market value of any noncash prizes, such as a car or vacation. Depending on your other income and the amount of your winnings, your federal tax rate may be as high as 37%. You may also be subject to state income tax.

You report lottery winnings as income in the year, or years, you actually receive them. In the case of noncash prizes, this would be the year the prize is received. With cash, if you take the winnings in annual installments, you only report each year’s installment as income for that year.

If you win more than $5,000 in the lottery or certain types of gambling, 24% must be withheld for federal tax purposes. You’ll receive a Form W-2G from the payer showing the amount paid to you and the federal tax withheld. (The payer also sends this information to the IRS.) If state tax withholding is withheld, that amount may also be shown on Form W-2G.

Since your federal tax rate can be up to 37%, which is well above the 24% withheld, the withholding may not be enough to cover your federal tax bill. Therefore, you may have to make estimated tax payments — and you may be assessed a penalty if you fail to do so. In addition, you may be required to make state and local estimated tax payments.

We can help

If you’re fortunate enough to hit a sizable jackpot, there are other issues to consider, including estate planning. This article only covers the basic tax rules. Different rules apply to people who qualify as professional gamblers. Contact us with questions. We can help you minimize taxes and stay in compliance with all requirements.

The record-high lifetime exemption amount currently in effect means that fewer families are affected by gift and estate taxes. As a result, the estate planning focus for many people has shifted from transfer taxes to income taxes. However, the Tax Cuts and Jobs Act (TCJA) imposed limitations on certain itemized deductions that affected many taxpayers.

The TCJA imposed a $10,000 limitation on combined state and local income taxes and property taxes while also increasing standard deductions to $12,000 for a single filer and $24,000 for a joint filer. These changes made it much more difficult for most taxpayers to itemize their deductions and impacted traditional tax planning strategies. However, strategies are still available that will allow you to deduct both state and local income taxes and property taxes over the $10,000 limit.

The use of one or several nongrantor trusts can be an effective option to reduce income taxes. Nongrantor trusts offer a way around the itemized deduction limitations imposed by the TCJA and may increase the overall benefit of the newly-created qualified business income (QBI) deduction.

What is a nongrantor trust?

A nongrantor trust is simply a trust that is a separate taxable entity from the grantor, or creator of the trust. The trust owns the assets it holds and is responsible for taxes on any income those assets generate. A grantor trust, in contrast, is one in which the grantor retains certain powers and, therefore, is treated as the owner for income tax purposes.

Both grantor and nongrantor trusts can be structured so that contributions are considered “completed gifts” for transfer tax purposes (thereby removing contributed assets from the grantor’s taxable estate). Traditionally, grantor trusts have been the estate planning tool of choice because the trust’s income is taxed to the grantor. This ultimately reduces the size of the grantor’s estate and allows the trust assets to grow tax-free, leaving more wealth for beneficiaries. Essentially, the grantor’s tax payments serve as an additional tax-free gift.

With less emphasis today on gift and estate tax savings, nongrantor trusts have become a viable option for individuals to reduce their overall income tax liabilities while still maintaining their estate planning strategy.

How can nongrantor trusts reduce income taxes?

Nongrantor trusts may offer a way to avoid the itemized deduction limitations imposed by the TCJA. By placing assets in nongrantor trusts, it may be possible to increase your deductions, because each trust enjoys its own $10,000 state and local income tax and property tax deduction.

For example, Randy and Kate, a married couple filing jointly, pay well over $10,000 per year in state income taxes. They also own two homes, each of which generates $20,000 per year in property taxes. Under the TCJA, the couple’s state and local income tax deduction is limited to $10,000, which covers a portion of their state income taxes, but they receive no tax benefit for the $40,000 they pay in property taxes.

To avoid this limitation, Randy and Kate transfer the two homes to an LLC, together with assets that earn approximately $40,000 per year in income. Next, they give 25% LLC interests to four nongrantor trusts. Each trust earns around $10,000 per year, which is offset by its $10,000 property tax deduction. Essentially, this strategy allows the couple to deduct their entire $40,000 property tax bill.

In addition to avoiding the itemized deduction limitations, nongrantor trusts also enjoy their own qualified business income deduction. This deduction can be as much as 20% of a taxpayer’s qualified business income from a pass-through entity (partnership or S-Corp) or sole proprietorship; C-Corporations and their owners are not eligible for this deduction. However, the qualified business income deduction itself has several limitations, one of which disallows an individual’s entire QBI deduction if their adjusted gross income is over a certain threshold.

Since a nongrantor trust is a separate taxable entity, it is allowed its own QBI deduction. If structured correctly, an individual taxpayer not eligible for his or her own QBI deduction, or whose deduction is being limited, may be able to maximize their overall QBI deduction by spreading business income across one or several nongrantor trusts. Since this would involve gifting shares or interests in a company to the nongrantor trusts and potentially triggering transfer taxes, this option should be considered as part of an overall estate planning strategy.

Beware the multiple trust rule

If you’re considering this strategy, be aware that the tax code contains a provision that treats multiple trusts with substantially the same grantors and beneficiaries as a single trust if their purpose is tax avoidance. To ensure that this rule doesn’t erase the benefits of the nongrantor trust strategy, designate a different beneficiary for each trust.

If you would like additional information about other ways to reduce your future tax liabilities, please contact a Yeo & Yeo tax professional.

Pen and paper are great, but spreadsheets can maximize efficiency and assist users with the interpretation of data by presenting financial information both numerically and graphically. Spreadsheets allow for the input and manipulation of data that may enhance decision-making. Graphs that help tell the story can be created in a matter of moments. Following are factors to keep in mind when using spreadsheets. The commands provided are for Microsoft Excel 2016, but most work with other versions.

Uses for a Spreadsheet

Budgets and forecasts
Reconciling financial information such as property taxes and grants
Analyzing situations with variable financial elements
Complex calculations

Naming Conventions

Defining ahead of time how naming conventions will be used will increase the organization of documents, and make locating those documents easier. When information pertains to a specific fiscal year, we recommend starting the naming convention with the fiscal year end date. For instance, the original budget for the year ended June 30, 2019, could be saved as 2019-06 Original Budget.

Access to Documents

Consider who needs access to electronic documents. If multiple people will be using the documents, ensure that the documents are saved in a location accessible by others. If sensitive information is included that should be seen by a limited group, consider password-protecting the document. Limiting access to the document can be accomplished by selecting File>Info>Protect Workbook>Encrypt with Password.

Verify Formulas

When work has been completed in the spreadsheet, take a few moments to review it; look for input and formula errors. To quickly view the formulas, navigate to the Formulas tab on the ribbon and select the Show Formulas button that is located in the section labeled Formula Auditing. When this option is selected, you can view formulas throughout the spreadsheet. If you navigate to the cell that includes the formula, the cells included in the formula will be highlighted.

Tips & Tricks

“Alt =” is a keyboard shortcut that brings up the =SUM formula and automatically sums the numbers above the cell selected.
Format Painter allows you to copy the format from one cell to another cell. To use it, highlight the cell that has the formatting you desire and click the Format Painter. Then click in the cell you want formatted.
Double-clicking on the Format Painter button keeps it selected so you can format more than one cell.
On the ribbon, select View and then New Window to open a second copy of the same document. This feature will allow you to view a second copy of the workbook if you need to compare numbers between multiple tabs.
To modify information in a cell, using the F2 button on the keyboard will take you to the end of the cell.
To create a chart, input information with column and row headers. Then, on the ribbon, select the Insert tab and then click on Recommended Charts. Several options that fit the data input will be presented.

Want to learn more? Click here for how Yeo & Yeo Technology can provide training solutions tailored for you.

Bitcoin and other forms of virtual currency are gaining popularity. But many businesses, consumers, employees and investors are still confused about how they work and how to report transactions on their federal tax returns. And the IRS just announced that it is targeting virtual currency users in a new “educational letter” campaign.

The nuts and bolts

Unlike cash or credit cards, small businesses generally don’t accept bitcoin payments for routine transactions. However, a growing number of larger retailers — and online businesses — now accept payments. Businesses can also pay employees or independent contractors with virtual currency. The trend is expected to continue, so more small businesses may soon get on board.

Bitcoin has an equivalent value in real currency. It can be digitally traded between users. You can also purchase and exchange bitcoin with real currencies (such as U.S. dollars). The most common ways to obtain bitcoin are through virtual currency ATMs or online exchanges, which typically charge nominal transaction fees.

Once you (or your customers) obtain bitcoin, it can be used to pay for goods or services using “bitcoin wallet” software installed on your computer or mobile device. Some merchants accept bitcoin to avoid transaction fees charged by credit card companies and online payment providers (such as PayPal).

Tax reporting

Virtual currency has triggered many tax-related questions. The IRS has issued limited guidance to address them. In a 2014 guidance, the IRS established that virtual currency should be treated as property, not currency, for federal tax purposes.

As a result, businesses that accept bitcoin payments for goods and services must report gross income based on the fair market value of the virtual currency when it was received. This is measured in equivalent U.S. dollars.

From the buyer’s perspective, purchases made using bitcoin result in a taxable gain if the fair market value of the property received exceeds the buyer’s adjusted basis in the currency exchanged. Conversely, a tax loss is incurred if the fair market value of the property received is less than its adjusted tax basis.

Wages paid using virtual currency are taxable to employees and must be reported by employers on W-2 forms. They’re subject to federal income tax withholding and payroll taxes, based on the fair market value of the virtual currency on the date of receipt.

Virtual currency payments made to independent contractors and other service providers are also taxable. In general, the rules for self-employment tax apply and payers must issue 1099-MISC forms.

IRS campaign

The IRS announced it is sending letters to taxpayers who potentially failed to report income and pay tax on virtual currency transactions or didn’t report them properly. The letters urge taxpayers to review their tax filings and, if appropriate, amend past returns to pay back taxes, interest and penalties.

By the end of August, more than 10,000 taxpayers will receive these letters. The names of the taxpayers were obtained through compliance efforts undertaken by the IRS. The IRS Commissioner warned, “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics.”

Last year, the tax agency also began an audit initiative to address virtual currency noncompliance and has stated that it’s an ongoing focus area for criminal cases.

Implications of going virtual

Contact us if you have questions about the tax considerations of accepting virtual currency or using it to make payments for your business. And if you receive a letter from the IRS about possible noncompliance, consult with us before responding.

ASU 2016-14, Presentation of Financial Statements for Non-Profit Entities, went into effect for year ends December 31, 2018, and later. One of the changes brought about by this standard was the required liquidity disclosure in the financial statements. As a result, nonprofit organizations should consider updating or creating a liquidity policy.

The policy should address how the organization manages its liquidity needs or, in other terms, the cash needs of the organization. How does the organization meet cash needs for general expenditures? The organization should set goals for liquid assets, such as maintaining enough liquid assets to cover a certain number of monthly expenses. Liquid assets include items such as cash, receivables and investments. Other items used to manage liquidity could be board designated reserves, endowments, investments and lines of credit. The methods and plan will vary based on the activities, size and complexity of the organization.

Please contact Yeo & Yeo if you have questions.

Check Out Our eBook on Creating Policies for Your Nonprofit

Download eBook

As the way we conduct business continues to change at a rapid pace due to technology, political changes, and changes in standards, one must stop and look at whether the services an organization needs are being adequately provided. Selecting a trusted advisor is one of those needs that can sometimes be overlooked. Nonprofits often ask us how they should go about selecting a trusted advisor, whether it is for legal services, accounting services, human resource support, banking, investing or something else.

Keep the following factors in mind when considering a relationship with a trusted advisor.

Reputation – Ask around. Nonprofits are a very connected group. They talk and work together regularly to better serve their programs and communities. Reach out to other nonprofits and ask who they are using. What do they like and dislike? Who would they recommend and why?

Specializations – Who specializes in what you need? A lawyer may be very well known and successful in their field, but they may not serve any nonprofit organizations or be familiar with the nonprofit experience your organization needs. Look for advisors who specialize in nonprofit organizations and the matters with which you need assistance.

Willingness to serve – Is the advisor willing to coach and advise? A true advisor helps your organization grow. Are you getting the most out of the relationship? Advisors should not only want to complete the task at hand, but look for ways to improve and better serve the organization and their mission going forward. You want advisors who are looking into the future and not just analyzing the past.

Fees – While we would all like to have the best and brightest advisor, nonprofits are often mindful of the price tag. The organization is trying to do the most with limited funds to fulfill its programs and help those in need. Therefore, it’s imperative to ask about fees and compare. Be sure to inquire how fees are charged for a quick phone call or email. Some advisors charge for every minute and others may include those quick, one-time questions that come up throughout the year as part of their normal fees. Like many things in the consumer world, be aware that you often get what you pay for, so find the balance between fees and services that works best for the nonprofit. Too, remember that if your information is organized and accurate, fees will likely be less.

Working from home has its perks. Not only can you skip the commute, but you also might be eligible to deduct home office expenses on your tax return. Deductions for these expenses can save you a bundle, if you meet the tax law qualifications.

Under the Tax Cuts and Jobs Act, employees can no longer claim the home office deduction. If, however, you run a business from your home or are otherwise self-employed and use part of your home for business purposes, the home office deduction may still be available to you.

If you’re a homeowner and use part of your home for business purposes, you may be entitled to deduct a portion of actual expenses such as mortgage, property taxes, utilities, repairs and insurance, as well as depreciation. Or you might be able to claim the simplified home office deduction of $5 per square foot, up to 300 square feet ($1,500).

Requirements to qualify

To qualify for home office deductions, part of your home must be used “regularly and exclusively” as your principal place of business. This is defined as follows:

1. Regular use. You use a specific area of your home for business on a regular basis. Incidental or occasional business use isn’t considered regular use.

2. Exclusive use. You use a specific area of your home only for business. It’s not required that the space be physically partitioned off. But you don’t meet the requirements if the area is used for both business and personal purposes, such as a home office that you also use as a guest bedroom.

Your home office will qualify as your principal place of business if you 1) use the space exclusively and regularly for administrative or management activities of your business, and 2) don’t have another fixed location where you conduct substantial administrative or management activities.

Examples of activities that meet this requirement include:

Billing customers, clients or patients,
Keeping books and records,
Ordering supplies,
Setting up appointments, and
Forwarding orders or writing reports.

Other ways to qualify

If your home isn’t your principal place of business, you may still be able to deduct home office expenses if you physically meet with patients, clients or customers on the premises. The use of your home must be substantial and integral to the business conducted.

Alternatively, you may be able to claim the home office deduction if you have a storage area in your home — or in a separate free-standing structure (such as a studio, workshop, garage or barn) — that’s used exclusively and regularly for your business.

An audit target

Be aware that claiming expenses on your tax return for a home office has long been a red flag for an IRS audit, since many people don’t qualify. But don’t be afraid to take a home office deduction if you’re entitled to it. You just need to pay close attention to the rules to ensure that you’re eligible — and make sure that your recordkeeping is complete.

The home office deduction can provide a valuable tax-saving opportunity for business owners and other self-employed taxpayers who work from home. Keep in mind that, when you sell your house, there can be tax implications if you’ve claimed a home office. Contact us if you have questions or aren’t sure how to proceed in your situation.

If you’re considering buying or selling a business — or you’re in the process of a merger or acquisition — it’s important that both parties report the transaction to the IRS in the same way. Otherwise, you may increase your chances of being audited.

If a sale involves business assets (as opposed to stock or ownership interests), the buyer and the seller must generally report to the IRS the purchase price allocations that both use. This is done by attaching IRS Form 8594, “Asset Acquisition Statement,” to each of their respective federal income tax returns for the tax year that includes the transaction.

What’s reported?

When buying business assets in an M&A transaction, you must allocate the total purchase price to the specific assets that are acquired. The amount allocated to each asset then becomes its initial tax basis. For depreciable and amortizable assets, the initial tax basis of each asset determines the depreciation and amortization deductions for that asset after the acquisition. Depreciable and amortizable assets include:

Equipment,
Buildings and improvements,
Software,
Furniture, fixtures and
Intangibles (including customer lists, licenses, patents, copyrights and goodwill).

In addition to reporting the items above, you must also disclose on Form 8594 whether the parties entered into a noncompete agreement, management contract or similar agreement, as well as the monetary consideration paid under it.

IRS scrutiny

The IRS may inspect the forms that are filed to see if the buyer and the seller use different allocations. If the IRS finds that different allocations are used, auditors may dig deeper and the investigation could expand beyond just the transaction. So, it’s in your best interest to ensure that both parties use the same allocations. Consider including this requirement in your asset purchase agreement at the time of the sale.

The tax implications of buying or selling a business are complicated. Price allocations are important because they affect future tax benefits. Both the buyer and the seller need to report them to the IRS in an identical way to avoid unwanted attention. To lock in the best postacquisition results, consult with us before finalizing any transaction.

During your working days, you pay Social Security tax in the form of withholding from your salary or self-employment tax. And when you start receiving Social Security benefits, you may be surprised to learn that some of the payments may be taxed.

If you’re getting close to retirement age, you may be wondering if your benefits are going to be taxed. And if so, how much will you have to pay? The answer depends on your other income. If you are taxed, between 50% and 85% of your payments will be hit with federal income tax. (There could also be state tax.)

Important: This doesn’t mean you pay 50% to 85% of your benefits back to the government in taxes. It means that you have to include 50% to 85% of them in your income subject to your regular tax rates.

Calculate provisional income

To determine how much of your benefits are taxed, you must calculate your provisional income. It starts with your adjusted gross income on your tax return. Then, you add certain amounts (for example, tax-exempt interest from municipal bonds). Add to that the income of your spouse, if you file jointly. To this, add half of the Social Security benefits you and your spouse received during the year. The figure you come up with is your provisional income. Now apply the following rules:

If you file a joint tax return and your provisional income, plus half your benefits, isn’t above $32,000 ($25,000 for single taxpayers), none of your Social Security benefits are taxed.
If your provisional income is between $32,001 and $44,000, and you file jointly with your spouse, you must report up to 50% of your Social Security benefits as income. For single taxpayers, if your provisional income is between $25,001 and $34,000, you must report up to 50% of your Social Security benefits as income.
If your provisional income is more than $44,000, and you file jointly, you must report up to 85% of your Social Security benefits as income on Form 1040. For single taxpayers, if your provisional income is more than $34,000, the general rule is that you must report up to 85% of your Social Security benefits as income.

Caution: If you aren’t paying tax on your Social Security benefits now because your income is below the floor, or you’re paying tax on only 50% of those benefits, an unplanned increase in your income can have a significant tax cost. You’ll have to pay tax on the additional income, you’ll also have to pay tax on (or on more of) your Social Security benefits, and you may get pushed into a higher tax bracket.

For example, this might happen if you receive a large retirement plan distribution during the year or you receive large capital gains. With careful planning, you might be able to avoid this tax result.

Avoid a large tax bill

If you know your Social Security benefits will be taxed, you may want to voluntarily arrange to have tax withheld from the payments by filing a Form W-4V with the IRS. Otherwise, you may have to make estimated tax payments.

Contact us to help you with the exact calculations on whether your Social Security will be taxed. We can also help you with tax planning to keep your taxes as low as possible during retirement.

Small businesses may find it beneficial to barter for goods and services instead of paying cash for them. If your business engages in bartering, be aware that the fair market value of goods that you receive in bartering is taxable income. And if you exchange services with another business, the transaction results in taxable income for both parties.

Income is also realized if services are exchanged for property. For example, if a construction firm does work for a retail business in exchange for unsold inventory, it will have income equal to the fair market value of the inventory.

Barter clubs

Many business owners join barter clubs that facilitate barter exchanges. In general, these clubs use a system of “credit units” that are awarded to members who provide goods and services. The credits can be redeemed for goods and services from other members.

Bartering is generally taxable in the year it occurs. But if you participate in a barter club, you may be taxed on the value of credit units at the time they’re added to your account, even if you don’t redeem them for actual goods and services until a later year. For example, let’s say that you earn 2,000 credit units one year, and that each unit is redeemable for $1 in goods and services. In that year, you’ll have $2,000 of income. You won’t pay additional tax if you redeem the units the next year, since you’ve already been taxed once on that income.

If you join a barter club, you’ll be asked to provide your Social Security number or employer identification number. You’ll also be asked to certify that you aren’t subject to backup withholding. Unless you make this certification, the club will withhold tax from your bartering income at a 24% rate.

Required forms

By January 31 of each year, the barter club will send you a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” which shows the value of cash, property, services, and credits that you received from exchanges during the previous year. This information will also be reported to the IRS.

If you don’t contract with a barter exchange but you do trade services, you don’t file Form 1099-B. But you may have to file a form 1099-MISC.

Many benefits

By bartering, you can trade away excess inventory or provide services during slow times, all while hanging onto your cash. You may also find yourself bartering when a customer doesn’t have the money on hand to complete a transaction. As long as you’re aware of the federal and state tax consequences, these transactions can benefit all parties. Contact us for more information.

The IRS uses Audit Techniques Guides (ATGs) to help IRS examiners get ready for audits. Your business can use the same guides to gain insight into what the IRS is looking for in terms of compliance with tax laws and regulations.

Many ATGs target specific industries or businesses, such as construction, aerospace, art galleries, child care providers and veterinary medicine. Others address issues that frequently arise in audits, such as executive compensation, passive activity losses and capitalization of tangible property.

How they’re used

IRS auditors need to examine all types of businesses, as well as individual taxpayers and tax-exempt organizations. Each type of return might have unique industry issues, business practices and terminology. Before meeting with taxpayers and their advisors, auditors do their homework to understand various industries or issues, the accounting methods commonly used, how income is received, and areas where taxpayers may not be in compliance.

By using a specific ATG, an auditor may be able to reconcile discrepancies when reported income or expenses aren’t consistent with what’s normal for the industry or to identify anomalies within the geographic area in which the business is located.

For example, one ATG focuses specifically on businesses that deal in cash, such as auto repair shops, car washes, check-cashing operations, gas stations, laundromats, liquor stores, restaurants., bars, and salons. The “Cash Intensive Businesses” ATG tells auditors “a financial status analysis including both business and personal financial activities should be done.” It explains techniques such as:

How to examine businesses with and without cash registers,
What a company’s books and records may reveal,
How to analyze bank deposits and checks written from known bank accounts,
What to look for when touring a business,
Ways to uncover hidden family transactions,
How cash invoices found in an audit of one business may lead to another business trying to hide income by dealing mainly in cash.

Auditors are obviously looking for cash-intensive businesses that underreport their cash receipts but how this is uncovered varies. For example, when examining a restaurants or bar, auditors are told to ask about net profits compared to the industry average, spillage, pouring averages and tipping.

Learn the red flags

Although ATGs were created to help IRS examiners ferret out common methods of hiding income and inflating deductions, they also can help businesses ensure they aren’t engaging in practices that could raise audit red flags. Contact us if you have questions about your business. For a complete list of ATGs, visit the IRS website here: https://bit.ly/2rh7umD