Covington Louisiana CPA

Saving tax on restricted stock awards with the Sec. 83(b) election

Today many employees receive stock-based compensation from their employer as part of their compensation and benefits package. The tax consequences of such compensation can be complex — subject to ordinary-income, capital gains, employment and other taxes. But if you receive restricted stock awards, you might have a tax-saving opportunity in the form of the Section 83(b) election.

Convert ordinary income to long-term capital gains

Restricted stock is stock your employer grants you subject to a substantial risk of forfeiture. Income recognition is normally deferred until the stock is no longer subject to that risk (that is, it’s vested) or you sell it.

At that time, you pay taxes on the stock’s fair market value (FMV) at your ordinary-income rate. The FMV will be considered FICA income, so it also could trigger or increase your exposure to the additional 0.9% Medicare tax.

But you can instead make a Sec. 83(b) election to recognize ordinary income when you receive the stock. This election, which you must make within 30 days after receiving the stock, allows you to convert future appreciation from ordinary income to long-term capital gains income and defer it until the stock is sold.

The Sec. 83(b) election can be beneficial if the income at the grant date is negligible or the stock is likely to appreciate significantly. With ordinary-income rates now especially low under the Tax Cuts and Jobs Act (TCJA), it might be a good time to recognize such income.

Weigh the potential disadvantages

There are some potential disadvantages, however:

You must prepay tax in the current year — which also could push you into a higher income tax bracket or trigger or increase the additional 0.9% Medicare tax. But if your company is in the earlier stages of development, the income recognized may be relatively small.
Any taxes you pay because of the election can’t be refunded if you eventually forfeit the stock or sell it at a decreased value. However, you’d have a capital loss in those situations.
When you sell the shares, any gain will be included in net investment income and could trigger or increase your liability for the 3.8% net investment income tax.

It’s complicated

As you can see, tax planning for restricted stock is complicated. Let us know if you’ve recently been awarded restricted stock or expect to be awarded such stock this year. We can help you determine whether the Sec. 83(b) election makes sense in your specific situation.

Should you file Form SS-8 to ask the IRS to determine a worker’s status?

Classifying workers as independent contractors — rather than employees — can save businesses money and provide other benefits. But the IRS is on the lookout for businesses that do this improperly to avoid taxes and employee benefit obligations.

To find out how the IRS will classify a particular worker, businesses can file optional IRS Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” However, the IRS has a history of reflexively classifying workers as employees, and filing this form may alert the IRS that your business has classification issues — and even inadvertently trigger an employment tax audit.

Contractor vs. employee status

A business enjoys several advantages when it classifies a worker as an independent contractor rather than as an employee. For example, it isn’t required to pay payroll taxes, withhold taxes, pay benefits or comply with most wage and hour laws.

On the downside, if the IRS determines that you’ve improperly classified employees as independent contractors, you can be subject to significant back taxes, interest and penalties. That’s why filing IRS Form SS-8 for an up-front determination may sound appealing.

But because of the risks involved, instead of filing the form, it can be better to simply properly treat independent contractors so they meet the tax code rules. Among other things, this generally includes not controlling how the worker performs his or her duties, ensuring you’re not the worker’s only client, providing Form 1099 and, overall, not treating the worker like an employee.

Be prepared for workers filing the form

Workers seeking determination of their status can also file Form SS-8. Disgruntled independent contractors may do so because they feel entitled to health, retirement and other employee benefits and want to eliminate self-employment tax liabilities.

After a worker files Form SS-8, the IRS sends a letter to the business. It identifies the worker and includes a blank Form SS-8. The business is asked to complete and return it to the IRS, which will render a classification decision. But the Form SS-8 determination process doesn’t constitute an official IRS audit.

Passing IRS muster

If your business properly classifies workers as independent contractors, don’t panic if a worker files a Form SS-8. Contact us before replying to the IRS. With a proper response, you may be able to continue to classify the worker as a contractor. We also can assist you in setting up independent contractor relationships that can pass muster with the IRS.

Tax Accounting, Tax Preparation, and Business Consulting. Charles Renwick Covington, Louisiana
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Defer tax with a Section 1031 exchange, but new limits apply this year

Normally when appreciated business assets such as real estate are sold, tax is owed on the appreciation. But there’s a way to defer this tax: a Section 1031 “like kind” exchange. However, the Tax Cuts and Jobs Act (TCJA) reduces the types of property eligible for this favorable tax treatment.

What is a like-kind exchange?

Section 1031 of the Internal Revenue Code allows you to defer gains on real or personal property used in a business or held for investment if, instead of selling it, you exchange it solely for property of a “like kind.” Thus, the tax benefit of an exchange is that you defer tax and, thereby, have use of the tax savings until you sell the replacement property.

This technique is especially flexible for real estate, because virtually any type of real estate will be considered to be of a like kind, as long as it’s business or investment property. For example, you can exchange a warehouse for an office building, or an apartment complex for a strip mall.

Deferred and reverse exchanges

Although a like-kind exchange may sound quick and easy, it’s relatively rare for two owners to simply swap properties. You’ll likely have to execute a “deferred” exchange, in which you engage a qualified intermediary (QI) for assistance.

When you sell your property (the relinquished property), the net proceeds go directly to the QI, who then uses them to buy replacement property. To qualify for tax-deferred exchange treatment, you generally must identify replacement property within 45 days after you transfer the relinquished property and complete the purchase within 180 days after the initial transfer.

An alternate approach is a “reverse” exchange. Here, an exchange accommodation titleholder (EAT) acquires title to the replacement property before you sell the relinquished property. You can defer capital gains by identifying one or more properties to exchange within 45 days after the EAT receives the replacement property and, typically, completing the transaction within 180 days.

Changes under the TCJA

There had been some concern that tax reform would include the elimination of like-kind exchanges. The good news is that the TCJA still generally allows tax-deferred like-kind exchanges of business and investment real estate.

But there’s also some bad news: For 2018 and beyond, the TCJA eliminates tax-deferred like-kind exchange treatment for exchanges of personal property. However, prior-law rules that allow like-kind exchanges of personal property still apply if one leg of an exchange was completed by December 31, 2017, but one leg remained open on that date. Keep in mind that exchanged personal property must be of the same asset or product class.

Complex rules

The rules for like-kind exchanges are complex, so these arrangements present some risks. If, say, you exchange the wrong kind of property or acquire cash or other non-like-kind property in a deal, you may still end up incurring a sizable tax hit. If you’re exploring a like-kind exchange, contact us. We can help you ensure you’re in compliance with the rules.

Small business owners: A SEP may give you one last 2017 tax and retirement saving opportunity

Are you a high-income small-business owner who doesn’t currently have a tax-advantaged retirement plan set up for yourself? A Simplified Employee Pension (SEP) may be just what you need, and now may be a great time to establish one. A SEP has high contribution limits and is simple to set up. Best of all, there’s still time to establish a SEP for 2017 and make contributions to it that you can deduct on your 2017 income tax return.

2018 deadlines for 2017

A SEP can be set up as late as the due date (including extensions) of your income tax return for the tax year for which the SEP is to first apply. That means you can establish a SEP for 2017 in 2018 as long as you do it before your 2017 return filing deadline. You have until the same deadline to make 2017 contributions and still claim a potentially hefty deduction on your 2017 return.

Generally, other types of retirement plans would have to have been established by December 31, 2017, in order for 2017 contributions to be made (though many of these plans do allow 2017 contributions to be made in 2018).

High contribution limits

Contributions to SEPs are discretionary. You can decide how much to contribute each year. But be aware that, if your business has employees other than yourself: 1) Contributions must be made for all eligible employees using the same percentage of compensation as for yourself, and 2) employee accounts are immediately 100% vested. The contributions go into SEP-IRAs established for each eligible employee.

For 2017, the maximum contribution that can be made to a SEP-IRA is 25% of compensation (or 20% of self-employed income net of the self-employment tax deduction) of up to $270,000, subject to a contribution cap of $54,000. (The 2018 limits are $275,000 and $55,000, respectively.)

Simple to set up

A SEP is established by completing and signing the very simple Form 5305-SEP (“Simplified Employee Pension — Individual Retirement Accounts Contribution Agreement”). Form 5305-SEP is not filed with the IRS, but it should be maintained as part of the business’s permanent tax records. A copy of Form 5305-SEP must be given to each employee covered by the SEP, along with a disclosure statement.

Additional rules and limits do apply to SEPs, but they’re generally much less onerous than those for other retirement plans. Contact us to learn more about SEPs and how they might reduce your tax bill for 2017 and beyond.

TCJA temporarily lowers medical expense deduction threshold

With rising health care costs, claiming whatever tax breaks related to health care that you can is more important than ever. But there’s a threshold for deducting medical expenses that may be hard to meet. Fortunately, the Tax Cuts and Jobs Act (TCJA) has temporarily reduced the threshold.

What expenses are eligible?

Medical expenses may be deductible if they’re “qualified.” Qualified medical expenses involve the costs of diagnosis, cure, mitigation, treatment or prevention of disease, and the costs for treatments affecting any part or function of the body. Examples include payments to physicians, dentists and other medical practitioners, as well as equipment, supplies, diagnostic devices and prescription drugs.

Mileage driven for health-care-related purposes is also deductible at a rate of 17 cents per mile for 2017 and 18 cents per mile for 2018. Health insurance and long-term care insurance premiums can also qualify, with certain limits.

Expenses reimbursed by insurance or paid with funds from a tax-advantaged account such as a Health Savings Account or Flexible Spending Account can’t be deducted. Likewise, health insurance premiums aren’t deductible if they’re taken out of your paycheck pretax.

The AGI threshold

Before 2013, you could claim an itemized deduction for qualified unreimbursed medical expenses paid for you, your spouse and your dependents, to the extent those expenses exceeded 7.5% of your adjusted gross income (AGI). AGI includes all of your taxable income items reduced by certain “above-the-line” deductions, such as those for deductible IRA contributions and student loan interest.

As part of the Affordable Care Act, a higher deduction threshold of 10% of AGI went into effect in 2014 for most taxpayers and was scheduled to go into effect in 2017 for taxpayers age 65 or older. But under the TCJA, the 7.5%-of-AGI deduction threshold now applies to all taxpayers for 2017 and 2018.

However, this lower threshold is temporary. Beginning January 1, 2019, the 10% threshold will apply to all taxpayers, including those over age 65, unless Congress takes additional action.

Consider “bunching” expenses into 2018

Because the threshold is scheduled to increase to 10% in 2019, you might benefit from accelerating deductible medical expenses into 2018, to the extent they’re within your control.

However, keep in mind that you have to itemize deductions to deduct medical expenses. Itemizing saves tax only if your total itemized deductions exceed your standard deduction. And with the TCJA’s near doubling of the standard deduction for 2018, many taxpayers who’ve typically itemized may no longer benefit from itemizing.

Contact us if you have questions about what expenses are eligible and whether you can qualify for a deduction on your 2017 tax return. We can also help you determine whether bunching medical expenses into 2018 will likely save you tax.