Buy-Sell agreements Require Careful Planning
Does your business have multiple owners? If so, you need a buy-sell agreement. This type of binding contract determines how (and at what price) ownership shares of a privately held business will change hands should an owner depart. There are also potential tax consequences to consider.
Unique Challenges
Unlike public companies, private ones have no ready or established market on which to sell ownership shares. This can create difficult circumstances for businesses when something unexpected happens. Say an owner suddenly dies. The owner’s shares may pass on to heirs, but how much are those shares worth and to whom can the heirs sell them? A buy-sell agreement will remove uncertainty by stipulating that remaining owners will buy the ownership interest at a price determined by the stated valuation method. Plus, the agreement will help to prevent an unfamiliar and perhaps unwanted owner from suddenly joining the business.
Setting Parameters
A buy-sell agreement sets up parameters for the transfer of ownership interests following any of a number of “triggering events,” such as an owner’s:
- Death,
- Long-term disability,
- Loss of professional license,
- Retirement,
- Bankruptcy, or
- Divorce.
The agreement will also specify a valuation method for appraising the departing owner’s interest at the appropriate time. In choosing a method, you and your fellow owners should carefully define buyout terms and specify the financial data to be used in the agreement. For example, a sound buy-sell agreement will spell out a required end-date for the financial statements that must be used to appraise business interests following a triggering event. Some also mandate a particular level of assurance (compilation, review or audit) regarding those financial statements.
Different Approaches
In most cases business owners don’t have the cash readily available to buy out a departing owner. So most buy-sell agreements include insurance policies to fund the agreement. This is where different types of agreements come into play. Under a cross-purchase agreement, each owner buys life or disability insurance (or both) on each of the other owners. Should one owner die or become incapacitated, the other owners collect on their policies and use the proceeds to buy the deceased or incapacitated owner’s shares.
Another type is a redemption agreement. Here, the company (not each owner) buys the insurance policies and acquires the deceased or incapacitated owner’s shares. This approach can help businesses with a lot of owners, because fewer policies are needed. In some cases, a company will create a hybrid buy-sell agreement that combines aspects of the cross-purchase and redemption approaches. These agreements may stipulate that the business gets the first opportunity to redeem ownership shares. And, if the company is unable to buy the shares, the remaining owners are then responsible for buying the departing owner’s interests. Alternatively, the owners may have the first opportunity to redeem the shares.
Tax Consequences
The life insurance used to fund buy-sell agreement can also have undesirable tax consequences without proper planning. Life insurance proceeds generally are excluded from the beneficiary’s taxable income, whether the beneficiary is a corporation, another shareholder or a separate entity. An exception is the transfer-for-value rule, under which proceeds will be taxable if an existing policy was acquired for value by someone other than the insured or a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is an officer or shareholder.
This issue often arises when structuring or changing a buy-sell agreement using existing insurance policies. It’s important to structure the agreement so that the transfer-for-value rule won’t have an impact; otherwise, the amount of after-tax insurance proceeds will be reduced.
If your business is structured as a C corporation and has a redemption agreement funded by life insurance, you’ll need to watch out for another possible adverse tax consequence: When the departing shareholder’s shares are redeemed, the value of the remaining owners’ shares will probably rise without increasing their basis. This, in turn, could drive up their tax liability in the event they sell their interests.
You may be able to manage this problem by revising your buy-sell as a cross-purchase agreement. Under this approach, owners will buy additional shares themselves, increasing their basis. But there are downsides. If owners are required to buy a departing owner’s shares but the company redeems the shares instead, the IRS may characterize the purchase as a taxable dividend. Your business may be able to mitigate this risk by crafting a hybrid agreement that names the corporation as a party to the transaction and allows the remaining owners to buy back the stock without requiring them to do so.
Complex but Important
Buy-sell agreements can help closely held businesses ensure a smooth transition when an owner leaves the business. But they also require careful planning to be effective, including properly addressing potential tax issues.
© 2023
Tax Implications to Be Aware of After a Job Loss
Despite the generally robust job market, some people are still losing their jobs. If you’re laid off or terminated from employment, taxes are probably the last thing on your mind. However, you may face tax implications due to your changed personal and professional circumstances. Depending on your situation, these can be complex and require you to make decisions that may affect your tax picture, both this year and in the future.
Unemployment and Severance Pay
Unemployment compensation is taxable for federal tax purposes, as are payments for any accumulated vacation or sick time. Although severance pay is also taxable and subject to federal income tax withholding, some elements of a severance package may be specially treated. For example:
- If you sell stock acquired by way of an incentive stock option, part or all of your gain may be taxed at lower long-term capital gains rates rather than at ordinary income tax rates, depending on whether you meet a special dual holding period.
- If you received (or will receive) what’s commonly referred to as a “golden parachute payment,” you may be subject to an excise tax equal to 20% of the portion of the payment that’s treated as an “excess parachute payment” under complex rules. In addition, the excess parachute payment also is subject to ordinary income tax.
- The value of job placement assistance you receive from your former employer usually is tax-free. However, the assistance is taxable if you had a choice between receiving cash or outplacement help.
Health Insurance
Under the COBRA rules, employers that offer group health coverage typically must provide continuation coverage to most terminated employees and their families. While the cost of COBRA coverage may be expensive, the cost of any premium you pay for insurance that covers medical care is a medical expense, which is deductible if you itemize deductions and to the extent that your total medical expenses exceed 7.5 percent of your adjusted gross income.
If your ex-employer pays for some of your medical coverage for a period of time following termination, you won’t be taxed on the value of this benefit.
Retirement Plans
Employees whose employment is terminated may also need tax planning help to determine the best option for amounts they’ve accumulated in retirement plans sponsored by their former employers. For most employees, a tax-free rollover to an IRA is the best move, if the terms of the plan allow a pre-retirement payout.
If the distribution from the retirement plan includes employer securities in a lump sum, the distribution is taxed under the lump-sum rules except that “net unrealized appreciation” in the value of the stock isn’t taxed until the securities are sold or otherwise disposed of in a later transaction.
If you’re under the age of 59½ and must make withdrawals from your company plan or IRA to supplement your income, there may be an additional 10% penalty tax (on top of an ordinary income tax due), unless you qualify for an exception.
Further, any loans you’ve taken out from your employer’s retirement plan, such as a 401(k)-plan loan, may be required to be repaid immediately, or within a specified period. If such a loan isn’t repaid, it may be treated as if the loan is in default. If the balance of the loan isn’t repaid within the required period, it typically will be treated as a taxable deemed distribution.
Next Steps
While taxes aren’t the most critical concern after a job loss, they are still important to consider. Contact the office for help charting the best tax course for you during this transition period.
© 2023
An “Innocent Spouse” May Be Able to Escape Tax Liability
When a married couple files a joint tax return, each spouse is “jointly and severally” liable for the full amount of tax on the couple’s combined income. That means the IRS can pursue either spouse to collect the entire tax, not just the part that’s attributed to one spouse or the other. This includes any tax deficiency that the IRS assesses after an audit, as well as any penalties and interest. In some cases, however, one spouse may be eligible for “innocent spouse relief.” This generally occurs when one spouse was unaware of a tax understatement that was attributable to the other spouse.
Qualifying for Relief
To qualify for innocent spouse relief, you must show not only that you didn’t know about the understatement, but also that there was nothing that should have made you suspicious. In addition, the circumstances must make it inequitable to hold you liable for the tax. Innocent spouse relief is available even if you’re still married and living with your spouse. In addition, if you’re widowed, divorced, legally separated or have lived apart for at least one year, you may be able to limit liability for any tax deficiency on a joint return.
Election to Limit Liability
If you make the innocent spouse relief election, the tax items that gave rise to the deficiency will be allocated between you and your spouse as if you’d filed separate returns. For example, you’d generally be liable for the tax on any unreported wage income only to the extent that you earned the wages.
The election won’t provide relief from your spouse’s tax items if the IRS proves that you knew about the items or had reason to know when you signed the return, unless you can show that you signed the return under duress. Also, the limitation on your liability is increased by the value of any assets that your spouse transferred to you in order to avoid the tax.
An “Injured” Spouse
In addition to innocent spouse relief, there’s also relief for “injured” spouses. What’s the difference? An injured spouse claim asks the IRS to allocate part of a joint refund to one spouse.
In these cases, an injured spouse has had all or part of a refund from a joint return applied against past-due federal tax, state tax, child or spousal support, or a federal nontax debt (such as a student loan) owed by the other spouse. If you’re an injured spouse, you may be entitled to recoup your share of the refund.
Moving On
Whether, and to what extent, you can take advantage of the above relief depends on the facts of your situation. If you’re interested in trying to obtain relief, there’s paperwork that must be filed and deadlines that must be met. Even if you’re not in need of any such relief now, as you file tax returns in the future, be mindful of “joint and several liability.” Generally filing a joint tax return results in lower taxes for a married couple. But if you want to ensure that you’re responsible only for your own tax, filing separate returns might be a better choice for you, even if your marriage is intact. Contact the office with any questions.
© 2023
IRS Provides Guidance on SECURE 2.0 Catch-Up Contribution Changes
In Notice 2023-62, the IRS addressed a technical error in the SECURE 2.0 Act that wouldn’t have allowed catch-up contributions to 401(k)s and similar plans after 2023.
Generally, taxpayers who’re age 50 or older are allowed to make additional “catch-up” contributions to employer-sponsored retirement plans such as 401(k)s. When Congress included a requirement in SECURE 2.0, signed into law at the end of 2022, that certain higher-income taxpayers make catch-up contributions only to Roth accounts, it inadvertently left out language needed to allow any catch-up contributions to employer-sponsored plans, whether pre-tax or Roth and regardless of income. The notice clarifies that catch-up contributions can be made after 2023.
The notice also pushes out the requirement that taxpayers who earned more than $145,000 (indexed for inflation) in Social Security wages the previous year be made on a Roth (after-tax) basis. The new rule was to go into effect in 2024, but plan administrators requested additional time to modify systems to implement the change. The IRS has extended the effective date to 2026.
What Certain IRS Notices Mean
What does it mean if a business receives a Notice CP2100 or CP2100A from the IRS? These notices tell recipients that the Form 1099 information returns they’ve submitted contain missing or incorrect Taxpayer Identification Numbers, names or both.
To respond, payers need to compare accounts listed on the notice with their own records and make corrections, if necessary. They may also need to amend backup withholding for payments made to payees. Typically, the IRS sends these notices twice a year, in April and in either September or October. As always, you should promptly respond to any IRS communication. Contact the office with questions.
Tax Season Is Long Over, but Tax Scams Are Thriving
The IRS is warning taxpayers about emails and text messages that promise refunds and credits, but that actually result in identity theft. Many current schemes involve the third Economic Impact Payment (originally made in 2021). Messages may also reference the Employee Retention Credit, assert that the taxpayer is owed a refund or say there’s problem with a return that must be fixed. They encourage recipients to click links that download malware.
The fake messages usually contain misspellings and typos and come from a suspicious-looking email address. If you receive one like this, don’t click on anything! Report it to phishing@irs.gov.
QuickBooks: When Should You Use Sales Receipts? Invoices? Statements?
QuickBooks is good at providing tools for creating the business forms you need. If you’ve already created records for your customers and vendors and the products and/or services you sell, filling them out is easy. You just complete a few fields and select from lists for the rest. You can print them or email them, and QuickBooks keeps records of what you’ve sent.
But do you always know for sure which type of sales forms you should be choosing for different situations? Your version of QuickBooks may or may not includes sales orders, but there are three that it will include: sales receipts, invoices, and statements. You should know when each kind is appropriate so your bookkeeping is accurate and your customers aren’t confused. Here’s a look at these three forms.
1. Sales Receipts: On the Spot Sales
Depending on the type of business you own, you may never need to create a sales receipt for a customer. These are appropriate only if you receive payment at the same time a customer receives a product or service from you.
You send a sales receipt when you get paid at the time you deliver a product or service.
To create a sales receipt, click Create Sales Receipts on the homepage or open the Customers menu and select Create Sales Receipts. You’ll see a form that looks like the partial one pictured above. Click the down arrow in the CUSTOMER:JOB field and choose the correct customer or job.
TIP: If this sale is part of a new job for an existing customer, go to the customer record and add the job before you create the sales receipt. Go to Customers | Customer Center and right-click on the customer’s name. Select Add Job and at least enter a JOB NAME. You can complete the record later.
Select a CLASS if you use them and the type of payment. Then complete the fields in the table below to describe the sale. Save the transaction and print or email to the customer.
2. Invoices, for Later Payment
If a customer does not pay you at the time of the sale, you send them an invoice. Select Create Invoices on either the homepage or in the Customers menu.
Invoice forms contain more fields than sales receipts.
In the image above, you’ll notice that invoices are more complex than sales receipts and require more data entry. You select customers and items like you do for a receipt, but there are other fields you may need to complete, like P.O. NUMBER, TERMS, and VIA (shipping method). You’ll also have to designate a Tax code if sales tax is required on any sales form. Your options will appear at the bottom of the invoice if you’ve set up sales tax (we can help with this).
TIP: QuickBooks comes with a default set of fields in its sales forms. You have some control over these. Let us know if you want to learn how to edit and delete fields from your forms.
3. Comprehensive StatementsStatements are lists of transactions (invoices, payments, etc.) that you’ve entered in QuickBooks. You can send individual ones or prepare multiple statements simultaneously. You might want to send them when a customer:
- Is past due on payments
- Wants a record of payments and invoices and sales receipts
You can prepare and send statements to one customer or a group that shares a specific characteristic.
Click Statements on the homepage or go to Customers | Create Statements. A window like the partial one shown above will open. First, make sure the Statement Date (“as-of” date) is correct. Then you can choose between designating a Statement Period or isolating customers who have transactions that are a specific number of days past due.
You can further define your group by selecting from the options in the image above, like All Customers or Multiple Customers (you’d choose from the drop-down list). There are additional options displayed on the right side of this window (not pictured), like Show invoice items details on statements and Do not create statements with a zero balance. You can View Selected Customers when you’re ready to print or email and Preview the statements. They’ll appear one at a time in a vertical column.
Fall Is on the Way
We’re heading into a very busy time of the year. Schools are open again and the holidays are just around the corner. Now might be a good time to run an A/R Aging Detail report to see the status of your invoices and send statements to past-due customers before they get wrapped up in their own fall activities. Please contact the office with questions you might have about sales forms – or any of QuickBooks’ other features.
Tax Due Dates for September 2023
September 15
Individuals – Paying the third installment of 2023 estimated taxes, if not paying income tax through withholding (Form 1040-ES).
Calendar-Year Corporations – Paying the third installment of 2023 estimated income taxes.
Calendar-Year S Corporations – Filing a 2022 income tax return (Form 1120-S) and paying any tax, interest and penalties due, if an automatic six-month extension was filed.
Calendar-Year S Corporations – Making contributions for 2022 to certain employer-sponsored retirement plans, if an automatic six-month extension was filed.
Calendar-Year Partnerships – Filing a 2022 income tax return (Form 1065 or Form 1065-B), if an automatic six-month extension was filed.
October 2
Trusts and estates – Filing an income tax return for the 2022 calendar year (Form 1041) and paying any tax, interest and penalties due, if an automatic five-and-a-half-month extension was filed.
Employers – Establishing a SIMPLE or a Safe-Harbor 401(k) plan for 2022, except in certain circumstances.
October 10
Employees Who Work for Tips – Reporting September tip income of $20 or more to employers (Form 4070).
