September 2023

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.

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.

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.

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.

Save Time By Memorizing Transactions in QuickBooks

Accounting involves a lot of repetition. You send invoices and receive payments and pay bills, over and over. Sometimes they’re similar enough every month that you’d swear you already processed them.

QuickBooks has a feature that can both save time by reducing duplicate data entry and minimize errors. Once you’ve created a transaction, but before you save it, you can memorize it. Then when it comes up again, the software will have created a template that you can either send as is or make any changes necessary. If more than one transaction is due on the same day, you can save all of them as a group and dispatch them together.

This repetition is easy to set up, but you need to take care with it. Here’s how it works:

Sales and Purchase Forms

You can memorize multiple types of transactions, including invoices, sales orders, and bills. Let’s look at this process by creating a repeating invoice. You might want to use a sample file to practice. Open the File menu and highlight Open Previous Company, then select either a product or service-based company.

Click Create Invoices on the home page (or Customers | Create Invoices). Fill out the form using the sample data. In our example, we’re billing the customer for four weekly gardening sessions. Click Memorize in the toolbar or Edit | Memorize Invoice. This small window will open:

Figure 1: When you memorize a transaction, you have multiple options for setting up its processing.

QuickBooks gives you three ways to handle the transaction. You can:

Add to my Reminders List. QuickBooks will add an entry in your Reminders list X number of days before the invoice should be entered. In order to get it, of course, you need to have Reminders turned on. Open the Edit menu and select Preferences, then Reminders | My Preferences. Click in the box in front of Show Reminders List when opening a Company file. Then click Company Preferences and select Show Summary or Show List next to Memorized Transactions Due and enter the number of days before the due date that you want to be reminded. Click OK.

Do Not Remind Me. You might select this for a transaction that doesn’t have a set schedule, just so it’s available when you need it.

Automatic Transaction Entry. Just like it sounds. QuickBooks will automatically enter the transaction according to the schedule you establish, changing only the date. If you select this option, you need to select How Often the transaction will be processed (Weekly, Monthly, etc.) and what the Next Date will be (be sure this date is in the future). In our example above, the customer only had a contract for a year, so we entered 12 (months), which included the Next Date. Then choose the Days In Advance To Enter.

When you’re done, click OK.

Adding to a Group

There’s a fourth option in this window: Add to Group. You can set up groups of memorized transactions whose due dates are the same, or similar enough to be stored together. Open the Lists menu and select Memorized Transaction List. Once you’ve memorized a transaction, you’ll see it listed there. Right click anywhere on that screen and select New Group to open this window:

Figure 2: You can create Groups of transactions that have similar due dates.

Give your Group a recognizable name and fill out the rest of the fields, then click OK. It will now appear in the list of memorized transactions. Open or create a transaction that you want to include in the Group and click Memorize again. In the window that opens, click the button in front of Add to Group and click the down arrow next to the field for Group Name to open the list. Select the correct one and click OK.

Bills, Too

You can memorize bills, too, following a similar process, but we’d caution you about using the automated transaction entry option for these unless your payment is exactly the same every month.

If you do automate a transaction and the amount changes, or if you want to edit a memorized transaction for any reason, open the Memorized Transaction List. There are two ways to edit. If you want to change your reminder option, frequency, etc., highlight the one you want to edit and right click on it. Select Edit Memorized Transaction and make your modifications, then click OK.

If you want to alter the content of the transaction itself, double click on it, make your changes, and click Memorize. Click on Replace in the small window that opens, then save the transaction. You can also choose Delete Memorized Transaction and create a new one.

It’s not difficult to memorize transactions in QuickBooks, but you can get tangled up when you try to edit them or when you’re setting up the automated entry option. If you’re unsure of these features, or anything else when dealing with QuickBooks that is unfamiliar or complicated, don’t hesitate to contact the office. As always, if you need support for your small business accounting operations, help is just a phone call away.

Tax Due Dates for September 2023