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Losses and Your Rental Property

The general rule is that rental activity is passive, whichs limits the amount of losses you can claim on your tax return.

PASSIVE-LOSS LIMITS

Except for real estate professionals, most taxpayers will be limited on the amount of rental loss they can deduct from their tax return. The amount of passive loss you can deduct on your tax return is typically limited to the lesser amount of your investment that is at risk or your total passive income. You aren’t allowed to offset passive losses against other income types (e.g., wages or capital gains). If you have excess losses, they can be carried forward to offset future passive income.

$25,000 EXCEPTION

The IRS allows an exception. If you participate in your rental activity and have an adjusted gross income (AGI) of less than $100,000, you may be able to deduct up to $25,000 of your loss from non-passive income sources. The deduction amount begins phasing out until it’s completely eliminated when your AGI reaches $150,000.

Active participation involves significant and bona fide involvement like approving tenants and deciding on rental terms.

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Control Cash Flow and Costs with Just-In-Time Inventory Management

Holding small amounts of inventory with a Just-In-Time (JIT) inventory system can improve cash flow and create operating efficiencies.

FREE CASH

JIT involves ordering inventory for production and customer sales only when it’s needed to produce goods, not before. When you no longer have to hold huge stockpiles of inventory, you free cash for other uses. And you’ll reduce storage costs.

REDUCE WASTE

Because you’re not making products in advance, there’s no risk that you’ll have a supply of finished goods that outweighs demand or have raw materials left unused.

SHORTER RUNS

When you’re making products only when needed, it’s easier to halt one product’s production and switch to a different one to fill orders. With shorter production times, mistakes can be spotted quickly and corrected, resulting in fewer defects and waste.

STRONG SUPPLIERS

JIT systems are sensitive to disruptions in the supply chain. A single supplier with a machine breakdown or inability to secure raw materials can stall or shut down your manufacturing process.

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July 2021 Client Profile

My business is located in Michigan, but I’m considering hiring remote employees who live in other states. How will this impact my payroll taxes?

You’ll need to withhold federal payroll taxes just as you would for your in-state employees. But you’ll also need to withhold state and possibly local payroll taxes in the state where your remote worker lives.

This will require you to register your business with that state’s revenue department so you can follow their filing schedule and pay the tax on time. You’ll also need to register your company with that state’s unemployment department to pay unemployment tax.

It can get even more complicated. Now your company may also be subject to that state’s sales tax laws. Each state has different rules for when you meet the minimum requirements of doing business there. And having an employee can be the trigger.

Similarly, having an employee in another state can trigger corporate income tax for your company.

Client Profile is based on a hypothetical situation. The solutions we discuss may or may not be appropriate for you.

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Managing Inflation Risk During Your Retirement

Longer retirements mean inflation can put a serious dent in the best-laid plans. Most people factor in inflation when planning how much they will need when they reach retirement. But inflation does not stop the day you retire. In fact, your budget on the day you retire could look very different five, 10, or 20 years into retirement.

BE REALISTIC

It’s important to set realistic expectations for both how long you may be in retirement and how much income you’ll need. Designing a realistic budget that considers essential, discretionary and unexpected costs is a smart first step.

With that as a start, you can review the ways high inflation and low interest rates may affect total rates of return on your investments and your annual income.

WITHDRAWAL PLANNING

Maybe you’ll try to address inflation risk on your own by withdrawing no more than 4% of an asset and then increasing the withdrawal by the rate of inflation each year. But as those withdrawals grow, they could represent a large piece of your retirement account over time. This can seriously erode funds.

Some fixed index annuities and index variable annuities offer potential income increases every year to help address the effects of inflation. These annual increases are available by purchasing optional riders for an additional charge.

CHOOSE TO DELAY

If you can delay applying for Social Security benefits until you’re 70, consider doing so. Each year you put off collecting Social Security increases your annual payments 8%. This a cost-effective way to maximize your inflation-protected income.

As you think through your future expenses and how inflation may impact them, it’s essential to manage expectations, be realistic and focus on what you can control. Working with your financial professional can help address longevity, inflation risk and rising health care costs in retirement.

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Tax Diversification in Retirement Planning

In the same way that you diversify your investments, you’ll want tax diversification too. Tax diversification involves making decisions today based upon what you think tax rates will be in the future. This will help to minimize the total amount of tax you’ll pay in retirement.

Choose the right tax vehicle for the correct tax purpose. For example, keeping dividend-paying stocks in a traditional IRA allows your account to grow quickly when you reinvest the dividends while you defer paying income tax.

Keeping growth stocks in your Roth IRA allows you to enjoy the appreciation tax-free when you make withdrawals after age 59 ½ and have held the Roth IRA for five years. All retirement planning should include cash invested in brokerage accounts to avoid paying early withdrawal penalties when you need money before retirement. Since you’ll pay tax on earnings from your brokerage account each year, keep the funds invested in municipal bonds for generally tax-free interest.

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Paying Yourself as a Business Owner

Owning a business is challenging and hard work, so you’ll want to compensate yourself appropriately. How you do that depends on the structure of your business.

SOLE PROPRIETORS (SOLE PROP)

As self-employed taxpayers, sole props aren’t employees and aren’t paid a salary. Therefore, when sole props need to take money from the business to pay themselves, they take draws.

Draws aren’t taxed when they are taken. Instead, because a sole prop is a pass-through entity, all of the business’s income is taxed on the owner’s tax return using Schedule C. And self-employment tatx will be calculated on Schedule SE.

PARTNERSHIPS

Like sole-props, partners in a partnership aren’t employees. Profits from the business are distributed per the partnership agreement. These are called distributions or guaranteed payments.

Partnerships are another type of pass-through entity. Partners receive a Schedule K-1 that reports their share of the partnership’s income. And partners pay income and self-employment tax on their individual tax returns similarly to sole props.

LIMITED LIABILITY COMPANIES (LLC)

If an LLC has only one owner, called a member, it’s treated the same as a sole prop for tax purposes. If there are two or more members, it’s treated as a partnership for tax purposes by default. Regardless of the number of members, any LLC can elect to be taxed as an S-corporation by filing Form 8832.

S-CORPORATIONS

As an S-corp owner, you are also an employee and will need to be paid a reasonable salary. What’s considered reasonable depends on many factors including your industry, responsibilities and experience. This means the owner and the S-corp must submit payroll taxes. The owner reports these W-2 wages on their tax return, and the remaining business profit flows through to the owner’s tax return via a Schedule K-1. However, since the IRS doesn’t consider the owner of an S-corp to be self-employed, these earnings aren’t subject to self-employment tax.

STATE TAXES

State income taxes vary so consult with your tax professional about how your company’s profits will be taxed locally.

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July 2021 Client Line

Paying Yourself as a Business Owner – how you compensate yourself depends on the structure of your business.

Tax Diversification in Retirement Planning – making decisions today based upon what you think tax rates will be in the future.

Managing Inflation Risk During Your Retirement – most people factor in inflation when planning for retirement, but inflation doesn’t stop the day you retire.

July 2021 Client Profile

Control Cash Flow and Costs with Just-In-Time Inventory Management – holding small amounts in inventory can improve cash flow and create operating efficiencies.

Losses and Your Rental Property – rental activity passive, which limits the amount of losses you can claim on your tax return

July 2021 Questions and Answers

July 2021 Short Bits

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June 2021 Short Bits

STATE BUDGETS

While many states prepared for a substantial revenue shortfall in 2020 due to the effects of the pandemic, states only saw a 1.6% revenue decline according to the National Association of State Budget Officers. Vermont, Colorado, and Alabama experienced revenue increases of more than 3%, boosting the national average. States are expecting a 4.4% decline for the fiscal year ending on June 30, 2021.

RECORD BREAKERS

Consumer debt totaled $14.6 trillion at the end of 2020 according to the Federal Reserve. Historically low mortgage interest fueled the rise in debt. Mortgage debt passed $10 trillion for the first time and rose at the fastest pace since 2006. Credit card debt declined by $108 billion in 2020, while student loans and auto loans increased slightly.

BACK TAXES

A report from the Treasury Inspector General for Tax Administration revealed that nearly 700,000 taxpayers who earn more than $200,000 annually owed the IRS $38.5 billion as of May 2019. But the majority, 69%, owed less than $25,000 each. And high-income taxpayers, those making at least $1.5 million a year, paid just 30% of the taxes they owed, leaving about $2.4 billion still due.

FINAL NUMBERS

The final 2020 numbers for the airline industry are in. According to the Bureau of Transportation Statistics, U.S. airlines carried 557 million fewer passengers in 2020 than in 2019, a 60% decline. In 2019, U.S. airlines carried 927 million passengers. Passenger air traffic in 2020 was the lowest on U.S. airlines since the mid-1980s, while April 2020 saw the lowest monthly airline fuel usage on record.

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June 2021 Questions and Answers

Question:

Can I choose my tax filing status?

Answer:

Generally, your marital status on December 31 determines your filing status for that year. And choosing the proper status affects the amount of tax you’ll owe. When multiple filing statuses apply, select the one that results in the least amount of tax due. If you’re unmarried, you’ll generally file as single unless you have a dependent; then you may be able to file as head of household. And if you become a widow or widower, but don’t remarry and have a dependent, you may claim the Qualified Widow(er) status for the two tax years after your spouse passes, which gives you the same tax perks as married filing jointly. Married taxpayers can file a joint return or file separately. Married filing separately can be used when it results in less tax owed or when one spouse wants to be responsible for their own tax.

Question:

I am a sole proprietor but need to hire an employee. Are fringe benefits taxable to my employee?

Answer:

As a general rule, all fringe benefits are taxable to your employee unless the IRS has expressly excluded them. Common fringe benefits that are tax free include health insurance, life insurance, employee discounts, employer-provided cell phones, certain commuting benefits, and de minimis (minimal) benefits like small non-cash holiday gifts or office-supplied coffee and drinks.

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Understanding Patents

Have you ever considered getting a patent for an innovative idea or product? There are different types of patents, so work with a patent attorney.

INVENTIONS

Utility patents protect the creation of useful products, processes or machines. It provides legal protection for up to 20 years should anyone copy your invention without a licensing agreement with you. Initial filing fees with the U.S. Patent and Trademark Office range from $80.00 to $860.00, but that doesn’t include the preliminary search for competitors, examination and maintenance fees which can tack on thousands more. Application processing can take a long time, so start early if you have a patentable product.

PROTECTING DESIGNS

If you want to protect an item’s design or aesthetics, not how it is produced, you’ll need a design patent. These patents have a 14-year life and overall cost is less than a utility patent.

PROS & CONS

In addition to protecting your product from copycats, a patent also can increase your chance of selling your idea.