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What Happens in Divestitures

What Is a Divestiture?

A divestiture is the partial or full disposal of a business unit through sale, exchange, closure, or bankruptcy. A divestiture most commonly results from a management decision to cease operating a business unit because it is not part of a company's core competency. A divestiture may also occur if a business unit is deemed to be redundant after a merger or acquisition, if the disposal of a unit increases the sale value of the firm, or if a court requires the sale of a business unit to improve market competition. Key Takeaways - A divestiture is when a company or government disposes of all or some of its assets by selling, exchanging, closing them down, or through bankruptcy. - As companies grow, they may become involved in too many business lines, so divestiture is the way to stay focused and remain profitable. - Divestiture allows companies to cut costs, repay their debts, focus on their core businesses, and enhance shareholder value.

Understanding Divestitures

A divestiture is the disposition or sale of an asset by a company as a way to manage its portfolio of assets. As companies grow, they may find they're in too many lines of business and must close some operational units to focus on more profitable lines. Many conglomerates face this problem. Companies may also sell off business lines if they are under financial duress. For example, an automobile manufacturer that sees a significant and prolonged drop in competitiveness may sell off its financing division to pay for the development of a new line of vehicles. Divested business units may be spun off into their own companies. Companies may be required to divest some of their assets as part of the terms of a merger or acquisition. Governments may divest some of their interests or property—called privatization—to raise money to pay off debt or give the private sector a chance to profit. By divesting some of its assets, a company may be able to cut its costs, repay its outstanding debt, reinvest, focus on its core business(es), and streamline its operations. This, in turn, can enhance shareholder value. Large companies experiencing unstable market conditions and competitive pressures may divest part of their business. Divestiture

Divesting Assets

There are many different reasons why a company may decide to sell off or divest itself of some of its assets. Here are some of the most common ones: - Bankruptcy: Companies that are going through bankruptcy will need to sell off parts of the business. - Cutting back on locations: A company may find it has too many locations. When consumers just aren't coming through the doors, the company may be forced to close or sell some of its locations. This is especially true in the retail sector, including in fashion, banking, insurance, food service, and travel. - Selling losing assets: If the demand for a product or service is weaker than expected, a company may need to sell it. Continuing to produce and sell an underperforming asset can cut into the company's bottom line when it can concentrate on those that are performing well. Government regulation may require corporations to divest some of their assets, especially to avoid a monopoly.

Examples of Divestitures

Divestitures can come about in many different forms, including the sale of a business unit to improve financial performance and due to an antitrust violation. Thomson Reuters Thomson Reuters, a multinational media and information company, based in Canada, sold its Intellectual Property and Science division in July 2016. The company initiated the divestiture, in part, to reduce the amount of debt on its balance sheet. The division was purchased by Onex and Baring Private Equity for $3.55 billion in cash. In 2015, Thomson Reuters generated $12.209 billion in annual revenue. The Intellectual Property and Science division grew its existing revenue by 1% year-over-year and earned nearly $1 billion in revenue for 2015, representing 8% of Thomson's total revenue. The division employed 3,400 of Thomson's 52,000 employees. AT&T Divestitures can also come about due to necessity. One of the most famous cases of court-ordered divestiture involves the breakup of the old AT&T in 1982. The U.S. government determined AT&T controlled too large a portion of the nation's telephone service and brought antitrust charges against the company in 1974. The divestiture created seven different companies, including one retaining the name AT&T, as well as new equipment manufacturers. Read the full article

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Who Can File Taxes as Head of Household (HOH)?

What Is Head of Household (HOH)?

Taxpayers may file tax returns as head of household (HOH) if they are unmarried and pay more than half the cost of supporting and housing a qualifying person. Taxpayers eligible to classify themselves as an HOH get higher standard deductions and lower tax rates than taxpayers who file as single or married filing separately.  Key Takeaways - To qualify for head of household (HOH) tax filing status, you must file a separate individual tax return, be considered unmarried, and have a qualifying child or dependent. - The qualifying person must generally be either a child or parent of the HOH. - The HOH must pay for more than one-half of the qualifying person’s support and housing costs.

Understanding Head of Household (HOH)

Head of household is a filing status available to taxpayers who meet certain qualifying thresholds. They must file separate individual tax returns, be considered unmarried, and have a qualifying dependent, such as a child or parent. Further, the HOH must pay more than one-half the cost of supporting the qualifying person and more than one-half the cost of maintaining that qualifying person’s primary home. The IRS provides a breakdown of what constitutes a qualified person in Table 4 of Publication 501. Unmarried To be considered unmarried, the HOH must be single, divorced, or regarded as unmarried. For example, married taxpayers would be regarded as unmarried if they did not live with their spouse during the last six months of the tax year. The status further requires that the HOH meet either of these two requirements: - The HOH is married to a nonresident alien whom they elect not to treat as a resident alien. - The HOH is legally separated under a divorce or separate maintenance decree by the last day of the tax year. Married taxpayers are considered unmarried if they have not lived with their spouse for the last six months of the tax year. Financially support a qualifying person An HOH must pay for more than one-half of the cost of a qualifying person’s support and housing costs. The HOH must also pay more than one-half of the rent or mortgage, utilities, repairs, insurance, taxes, and other costs of maintaining the home where the qualifying person lives for more than half of the year. The home must be the taxpayer’s own home, unless the qualifying person is the taxpayer’s parent and the home is the property of that parent.  If the qualifying person is a parent who lives at another address, it's still possible to file as head of household—provided they are dependent on you and you cover more than half the cost of keeping up their home. Personal exemption suspended The enactment of the Tax Cuts and Jobs Act of 2017 (TCJA) led the personal exemption to be suspended through 2025. Back when there was one, HOH filers had to be able to claim an exemption for their qualifying person. Taxpayers could release their exemption to a noncustodial parent in a divorce proceeding or a legal separation agreement and remain eligible to file as an HOH.

Examples of Filing as Head of Household (HOH)

Filing as an HOH can provide significant savings for taxpayers. Below we compare the tax burden for an individual earning $70,000 using the different filing statuses. HOH vs. single or married filing separately For 2021 tax returns, which are due April 2022, the HOH has a standard deduction of $18,800, reducing their $70,000 taxable income to $51,200. From that amount, $14,200 will be taxed at 10%, and $37,000 at 12%, bringing the total tax bill to $1,420 + $4,440 = $5,860. In comparison, a taxpayer filing as single or married filing separately qualifies for a standard deduction of $12,550, reducing their taxable income from $70,000 to $57,450. Of that $57,450, $9,950 will be taxed at 10%, $30,574 at 12%, and the remaining $16,926 at 22%, resulting in a total tax bill of $995 + $3,668.88 + $3,723.72 = $8,387.60. Thus, filing as an HOH saved this hypothetical taxpayer $2,527.60. For the 2022 tax year, these savings will increase even more as income limits are adjusted for inflation, and the standard deduction rises $600 for HOH to $19,400, versus $400 to $12,950 for single filers. 2022 Tax Brackets for Single Filers, Married Couples Filing Jointly, and Heads of Households 2022 Tax Rate For Single Filers For Married Individuals Filing Joint Returns For Heads of Households  10% $0 to $10,275 $0 to $20,550 $0 to $14,650  12% $10,276 to $41,775 $20,551 to $83,550 $14,651 to $55,900  22% $41,776 to $89,075 $83,551 to $178,150 $55,901 to $89,050  24% $89,076 to $170,050 $178,151 to $340,100 $89,051 to $170,050  32% $170,051 to $215,950 $340,101 to $431,900 $170,051 to $215,950  35% $215,951 to $539,900 $431,901 to $647,850 $215,951 to $539,900  37% $539,901 or more $647,851 or more $539,901 or more Source: Internal Revenue Service

Who Qualifies as Head of Household?

To file taxes as head of household, you must be considered unmarried, pay at least half of the household expenses, and have either a qualified dependent living with you more than half the year or a parent whose housing costs you cover at least half of.

Is It Better to File as Single or Head of Household?

For tax purposes, it is better to be head of household. Head of household filers have a lower tax rate and higher standard deductions than single filers.

What Is the Standard Deduction for Head of Household?

In the 2021 tax year, the portion of income not subject to tax for heads of households is $18,800. In the 2022 tax year, that threshold increases to $19,400. Read the full article

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What Does Cost of Capital Mean?

What Is Cost of Capital?

Cost of capital is a company's calculation of the minimum return that would be necessary in order to justify undertaking a capital budgeting project, such as building a new factory. The term cost of capital is used by analysts and investors, but it is always an evaluation of whether a projected decision can be justified by its cost. Investors may also use the term to refer to an evaluation of an investment's potential return in relation to its cost and its risks. Many companies use a combination of debt and equity to finance business expansion. For such companies, the overall cost of capital is derived from the weighted average cost of all capital sources. This is known as the weighted average cost of capital (WACC). Key Takeaways - Cost of capital represents the return a company needs to achieve in order to justify the cost of a capital project, such as purchasing new equipment or constructing a new building. - Cost of capital encompasses the cost of both equity and debt, weighted according to the company's preferred or existing capital structure. This is known as the weighted average cost of capital (WACC). - A company's investment decisions for new projects should always generate a return that exceeds the firm's cost of the capital used to finance the project. Otherwise, the project will not generate a return for investors. Cost Of Capital  

Understanding Cost of Capital

The concept of the cost of capital is key information used to determine a project's hurdle rate. A company embarking on a major project must know how much money the project will have to generate in order to offset the cost of undertaking it and then continue to generate profits for the company. Cost of capital, from the perspective of an investor, is an assessment of the return that can be expected from an acquisition of stock shares or any other investment. This is an estimate and might include best- and worst-case scenarios. An investor might look at the volatility (beta) of a company's financial results to determine whether a stock's cost is justified by its potential return. Weighted Average Cost of Capital (WACC) A firm's cost of capital is typically calculated using the weighted average cost of capital formula that considers the cost of both debt and equity capital. Each category of the firm's capital is weighted proportionately to arrive at a blended rate, and the formula considers every type of debt and equity on the company's balance sheet, including common and preferred stock, bonds, and other forms of debt. Finding the Cost of Debt The cost of capital becomes a factor in deciding which financing track to follow: debt, equity, or a combination of the two. Early-stage companies rarely have sizable assets to pledge as collateral for loans, so equity financing becomes the default mode of funding. Less-established companies with limited operating histories will pay a higher cost for capital than older companies with solid track records since lenders and investors will demand a higher risk premium for the former.   ​Cost of debt=Total debtInterest expense​×(1−T)where:Interest expense=Int. paid on the firm’s current debtT=The company’s marginal tax rate​ The cost of debt can also be estimated by adding a credit spread to the risk-free rate and multiplying the result by (1 - T). Finding the Cost of Equity The cost of equity is more complicated since the rate of return demanded by equity investors is not as clearly defined as it is by lenders. The cost of equity is approximated by the capital asset pricing model as follows:   ​CAPM(Cost of equity)=Rf​+β(Rm​−Rf​)where:Rf​=risk-free rate of returnRm​=market rate of return​ Beta is used in the CAPM formula to estimate risk, and the formula would require a public company's own stock beta. For private companies, a beta is estimated based on the average beta among a group of similar public companies. Analysts may refine this beta by calculating it on an after-tax basis. The assumption is that a private firm's beta will become the same as the industry average beta. The firm’s overall cost of capital is based on the weighted average of these costs. For example, consider an enterprise with a capital structure consisting of 70% equity and 30% debt; its cost of equity is 10% and the after-tax cost of debt is 7%.(0.7 times 10%) + (0.3 times 7%) = 9.1% (0.7×10%)+(0.3×7%)=9.1% This is the cost of capital that would be used to discount future cash flows from potential projects and other opportunities to estimate their net present value (NPV) and ability to generate value. Companies strive to attain the optimal financing mix based on the cost of capital for various funding sources. Debt financing is more tax-efficient than equity financing since interest expenses are tax-deductible and dividends on common shares are paid with after-tax dollars. However, too much debt can result in dangerously high leverage levels, forcing the company to pay higher interest rates to offset the higher default risk The Difference Between Cost of Capital and the Discount Rate  The cost of capital and discount rate are somewhat similar and the terms are often used interchangeably. Cost of capital is often calculated by a company's finance department and used by management to set a discount rate (or hurdle rate) that must be beaten to justify an investment. That said, a company's management should challenge its internally-generated cost of capital numbers, as they may be so conservative as to deter investment. Cost of capital may also differ based on the type of project or initiative; a highly innovative but risky initiative should carry a higher cost of capital than a project to update essential equipment or software with proven performance.  

Real-World Examples

Every industry has its own prevailing average cost of capital. The numbers vary widely. Homebuilding has a relatively high cost of capital, at 6.35, according to a compilation from New York University's Stern School of Business. The retail grocery business is relatively low, at 1.98%. The cost of capital is also high among both biotech and pharmaceutical drug companies, steel manufacturers, Internet software companies, and integrated oil and gas companies. Those industries tend to require significant capital investment in research, development, equipment, and factories. Among the industries with lower capital costs are money center banks, power companies, real estate investment trusts (REITs), and utilities (both general and water). Such companies may require less equipment or may benefit from very steady cash flows.

Why Is Cost of Capital Important?

Most businesses strive to grow and expand. There may be many options: expand a factory, buy out a rival, build a new, bigger factory. Before the company decides on any of these options, it determines the cost of capital for each proposed project. This indicates how long it will take for the project to repay what it cost, and how much it will return in the future. Such projections are always estimates, of course. But the company must follow a reasonable methodology to choose between its options.

What Is the Difference Between the Cost of Capital and the Discount Rate

The two terms are often used interchangeably, but there is a difference. In business, cost of capital is generally determined by the accounting department. It is a relatively straightforward calculation of the breakeven point for the project. The management team uses that calculation to determine the discount rate, or hurdle rate, of the project. That is, they decide whether the project can deliver enough of a return to not only repay its costs but reward the company's shareholders. Read the full article

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What Are the Best Ways to Lower Taxable Income?

How to lower taxes is one of the most common financial planning concerns among individuals and business owners. The increased standard deductions under the Tax Cuts and Jobs Act (TCJA) provided tax savings for many (even though the TCJA did eliminate many other itemized deductions and the personal exemption). Taxable income can be reduced further with a few strategic steps. Key Takeaways - An effective way to reduce taxable income is to contribute to a retirement account through an employer-sponsored plan or an individual retirement account (IRA). - Both health spending accounts and flexible spending accounts help reduce taxable income during the years in which contributions are made. - A lengthy list of deductions remains available to lower taxable income for full- or part-time self-employed taxpayers.

Save for Retirement

One of the most straightforward ways to reduce taxable income is to maximize retirement savings. Although there are many types of retirement savings accounts to choose from, below are two of the most common that can help reduce taxable income in the tax year in which a contribution is made. Employer-Sponsored Plan Those whose company offers an employer-sponsored plan, such as a 401(k) or 403(b), can make pretax contributions up to a maximum of $19,500 in 2021 (also $19,500 in 2020). Those 50 and older can make catch-up contributions of $6,500 in 2021 (also $6,500 for 2020) above that limit. Because contributions are made pretax through paycheck deferrals, the money saved in an employer-sponsored retirement account directly lowers taxable income. In other words, the contributions reduce an employee's income for that tax year before income taxes are applied. lndividual Retirement Account (IRA) Individuals can also save by contributing to a traditional individual retirement account (IRA). The annual contribution amount to an IRA for the 2021 tax year is $6,000 (same as for 2020), with a catch-up provision of an additional $1,000 allowed for those 50 and older. Traditional IRA contributions can be deducted from a person's tax return, reducing the taxes owed in the tax year of the contribution. However, unlike contributions to an employer-sponsored plan, IRA contributions are made with after-tax dollars, meaning the money has already had income taxes taken out. Taxpayers (or their spouses) who have employer-sponsored retirement plans may also be able to deduct some or all of their traditional IRA contribution from taxable income. The IRS has detailed rules about whether—and how much—they can deduct depending on their income. In December 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law. For 2019 and years prior, taxpayers over the age of 70½ could not contribute to a traditional IRA. As of 2020, the age limit no longer applies. Taxpayers beyond the age of 70½ can contribute a maximum of $7,000 per year and receive the full tax benefit.

Consider Flexible Spending Plans

Some employers offer flexible spending plans that allow money to be socked away pretax for expenses such as medical expenses. A flexible spending account (FSA) provides a way to reduce taxable income by setting aside a portion of earnings in a separate account managed by an employer. An employee can contribute up to $2,750 during the 2021 plan year (unchanged from 2020). Under the use-or-lose provision, participating employees often must incur eligible expenses by the end of the plan year or forfeit unspent amounts. Under a special rule, employers may offer participating employees more time through either a carryover option or a grace period (2.5 months). Under the carryover option, an employee can carry over up to $550 of unused funds to the following plan year. Under the grace period option, an employee has until 2.5 months after the end of the plan year to incur eligible expenses. Employers can offer either option, but not both, or none at all. The IRS has released new guidance that allows employers more flexibility for benefit plans for 2020 and 2021 as part of the Consolidated Appropriations Act. Employers can allow employees to carry over all unused funds from 2020 to 2021 and from 2021 to 2022—or they can extend the grace period from 2.5 months to 12 months—either way, all unused funds can be carried over and used throughout the entire year.

Health Savings Account (HSA)

A health savings account (HSA) is similar to an FSA in that it allows pretax contributions to be used for healthcare costs later. HSAs are only available to employees with high deductible health insurance plans. Minimum Annual Deductible According to the Internal Revenue Service (IRS), for 2021 and 2022, a high deductible health plan has a minimum annual deductible of $1,400 for self-only coverage or $2,800 for family coverage. Annual Contribution Limit The annual contribution limit for 2021 is $3,600 for individuals and $7,200 for families. However, the 2022 contribution limit is $3,650 for individuals and $7,300 for families. Maximum Annual Out-of-Pocket Expenses Also, under a high-deductible plan, annual out-of-pocket expenses, which include deductibles, co-payments, but not premiums, do not exceed $7,000 for self-only coverage or $14,000 for family coverage for 2021, but for 2022, do not exceed $7,050 for self-only coverage or $14,100 for family coverage. Unlike FSA balances, HSA contributions can be rolled over if unused in the year in which they were saved. Both HSAs and FSAs provide for a reduction in tax bills during the years in which contributions are made.

Take Business Deductions

A lengthy list of deductions remains available to lower taxable income for full- or part-time self-employed taxpayers. Home Office Deduction A home office deduction, for instance, is calculated using either a simplified or regular method to reduce taxable income if a portion of a home is used as dedicated office space. The self-employed can also deduct a portion of their self-employment tax and the cost of health insurance, among other expenses, to lower taxable income. Business Expenses Business owners or those with professional, deductible expenses can make upcoming necessary purchases or expenditures by the end of the tax year. This can make a significant difference for those buying a major item for which the purchase price can be put on business expenses. Retirement Savings Plans A variety of retirement savings plans exist for the self-employed, including an individual 401(k) and a simplified employee pension (SEP) IRA. Both options provide an opportunity to lower taxable income through pre-tax contributions and allow for higher limits on contributions each year. The SIMPLE IRA allows contributions of up to $13,500 in 2021 (unchanged from 2020), plus an extra $3,000 for those older than 50. The Solo 401(k) allows contributions of up to $19,500 tax-free for 2021, also unchanged from 2020. The SEP IRA allows tax-deductible contributions of up to 25% of compensation, up to $58,000 (up by $1,000 from 2020). The SECURE Act The SECURE Act has implications for small business owners. The Act encourages business owners to set up retirement plans for employees by providing tax incentives if they collaborate with other small businesses to offer Multiple Employer Plans or MEPs. The SECURE Act also allows more part-timers to save through employer-sponsored retirement plans, starting in 2021. To do so, workers will need to put in at least 500 hours a year for three consecutive years to be eligible.

The Bottom Line

Tax reform eliminated many itemized deductions for most taxpayers, but there are still ways to save for the future and trim their current tax bill. To learn more about deductions and tax savings, consult a tax expert. Read the full article

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Being Audited? Here Are Your Tax Audit Defense Options

When Alisa* got audited, an honest mistake on her part underscored a cold, hard truth: the IRS is not anyone’s friend. If you’ve ever been audited, you probably feel a lot like Alisa. Maybe a little scared or confused. Maybe a little angry and agitated. Being audited is not fun.  If the IRS were a friend to Alisa, it would have kindly let her fix her error when she accidentally submitted the paperwork for her business tax returns instead of her personal tax returns. She was the one under audit, not her business, after all.  As it happened, her business return had its share of problems, and the IRS was more than happy to jump on an opportunity to collect. For the auditor to be presented with an opportunity to recover even more unpaid tax, it must have seemed like a gift.  But for Alisa, it caused unimaginable stress, a ton of anxiety, and of course, a lot of money.  Had she known her rights as a taxpayer under audit, things could have turned out differently. But how could she have known the ins and outs of the tax code and how to use that information to protect her rights?  *Alisa is not a real person. But her story is true, and there are many quite like it. 

Why Do People Get Audited?

Alisa got audited due to a math error on her personal return. But things snowballed for her after she submitted the wrong return during the audit process and the IRS found more reasons to start digging into her business tax returns.  The IRS doesn’t publish when and why they audit taxpayers. But there are some general criteria that seem to be common factors in the audits seen by the team at Tax Relief USA. Some of the common red flags we see from clients who are getting audited include:  Claiming very high vehicle mileage: Many individual and business taxpayers can rightfully claim vehicle mileage on their tax return. But when the mileage being claimed creeps into the range of tens of thousands of dollars, it can start to look suspicious.  Inconsistent filings: Tax payments for most people are fairly straightforward and predictable. When you deviate from the norm, it could be noticed by the IRS. For example: you have filed a joint return with your spouse for years, and then switch your status to married filing separately – this could flag your account for a closer look. Inconsistent tax filings for businesses can earn even more scrutiny.  Schedule E: If you file a Schedule E, you’re reporting supplemental  income or losses from rental property, royalties, partnerships and S corporations, or the like. Your. Schedule E can start to look suspect if rental income and expenses are not being properly reported, calculation errors on rental depreciation may throw a flag 1099 mismatch: If you are an independent contractor, you should be receiving 1099 forms from reporting any taxable income you earn. The organization issuing those 1099 forms also reports this information to the IRS. If what you’re reporting as 1099 income does not match up with the 1099 income reported to the IRS and attributed to you, then your return automatically gets flagged and you’ll receive a notice from the IRS.   Losses every year: If you are using your business expenses to claim income tax deductions every year, but you consistently report losses, your account may be flagged for review. If you report a loss for three years in a five-year period, the IRS considers your expenses to be the result of a hobby and not a profit-seeking business. The so-called “Hobby Loss Rule” is in place to keep people from writing off business expenses on endeavors that do not make a profit.  Complex stock options: Many workers in the tech sector get stock options as a perk of the job. But stock options have their own tax complexity. While these can be a valuable employee benefit, it is wise to consult with a tax advisor before exercising any stock options to ensure you understand your tax liability.  Random audit: Even if your tax return is buttoned up and perfect as can be, you can still be audited. Between 15,000 and 20,000 people are randomly selected for an audit every year.  There are, of course, many more reasons that could trigger a tax audit. Whether you’re an individual or a business, the best defense against an audit is to know your position, know the tax code, and know your rights, so if the IRS does audit you, you’re prepared. Working with a reputable tax advisor is wise if you don’t have the time, energy, or patience to deal with an audit.

Types of Tax Audits

Being audited can connote a monolithic picture of the IRS showing up at your door and demanding to see years of receipts. But there are actually three different types of audit, and they come with different levels of intensity that range from simple bookkeeping to legal challenges. Adjustment - With this type of audit, the IRS mails you an adjustment letter detailing changes it made to your returns, any increase or decrease in taxes, and if applicable, penalties and interest. Taxpayers typically have an option to appeal if they disagree with the changes. Mail audit - When you get notice of an audit in the mail, it means someone at the IRS has looked at your returns and needs information from you. For the most part, the mail audit requests documentation to prove an item the IRS is questioning on your return.  Field audit - This is the classic scenario of someone from the IRS coming to your door. If you are involved in a field audit, there will be an IRS auditor assigned to your case and you or your representative will have to meet with them and answer questions. Field audits typically last the longest and can take multiple years for the most complex cases..

What Happens After an Audit?

The ideal scenario after an audit is no change, no balance due. This happens when you or your tax professionals are successful in arguing your case.  The other outcome of an audit is having a balance due. If you get audited and the end result is more money owed, it can feel overwhelming and frustrating. What if you had other plans for the money instead of paying it as tax? What if you can’t afford to pay what is owed?  Fortunately,  you have some options. Offer in compromise - If your audit says you owe and you’re in the stressful position of being unable to pay, you might be able to negotiate an offer in compromise (OIC). If you enter an OIC, you’ll have either six months or 24 months to pay off your tax bill. You then have to remain compliant for at least the next three years. If you fail to pay what you owe after agreeing to an OIC, the entire tax liability gets assessed back.  Installment agreement - What if you just need more time to get things in order before you have to pay an unexpected tax bill? An installment agreement is essentially a payment plan for your tax balance due. Most agreements spread payment over 72 months or 84 months. Taxpayers can enter installment agreements based on their financial status or based on the amount owed and the repayment time frame. It is possible to use an installment agreement to pay less than what you owe without going through the process of an OIC.  Fresh Start - While it’s true the IRS is not your friend, the IRS is not your enemy, either. Fresh Start is a good example of an IRS program designed to help taxpayers who can’t afford to pay the taxes they owe. Fresh Start includes OICs and some installment agreements. Learn more about the Fresh Start program here. Appealing - If you disagree with the IRS’s decision your first emotion might be anger. If you really have something to fight over, you can appeal the decision. But if you’re going to appeal, you need to know exactly what part of the return is causing your discrepancy and have documentation for what the numbers should be. When you file for an appeal, you’ll get an appeals officer and your case will go to a new IRS auditor for an independent review. If you’re going to appeal you really need to have representation by a tax professional who can do research and fight for your tax position. If you have strong representation, you can often win the appeal or at least soften the blow of the assessment. If appealing is unsuccessful, you will need to be ready to go to tax court if you still want to pursue your position. 

What is the Best Defense against an Audit? Go on the Offensive.

Know your rights. Alisa in the story at the top of this post made an honest mistake that gave the IRS an unexpected look at her business. She didn’t have enough knowledge about her rights as a taxpayer to stop the IRS from coming at her with a head full of steam. Being honest and prepared is the best defense you can have when you are being audited. If you have messy books or if your claims look bogus it’s not going to do you any favors.  But if you’d rather be playing offense than defense, the page to turn to in the playbook is working with a tax professional. While you can never fully preempt an audit, having your taxes done by a professional can help you avoid the pitfalls that commonly get tax returns flagged for an audit. You don’t want to end up like Alisa and get needlessly pushed around by an overzealous and aggressive auditor trying to claw revenue back into the IRS. Working with an expert tax representative is a sure-fire way to know your rights are being protected and that you are paying your fair share – and no more. 

The Benefits of Working with a Tax Professional

When you work with a trusted partner like Tax Relief USA, you’ll have the benefit of expert knowledge and decades of experience working directly with the IRS on every imaginable tax situation. We have more relevant expertise and flexibility than most CPAs or attorneys. As enrolled agents, the team at Tax Relief USA is federally licensed to practice before the IRS in all 50 states and federally, and we can speak on your behalf, and submit returns and other documentation for you as well.  Additionally, our status as enrolled agents means we have to play by the rules and follow the law. This puts us in a position of mutual understanding and respect with the IRS, which in our experience, helps get our clients’ issues resolved quickly.  Want to learn more about how Tax Relief USA can help you resolve your issues with the IRS? Give us a call at (408) 533-1814 or answer a few questions here to get tax help now. Read the full article

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Tax-Savvy Investment Strategies for Retirement Accounts

While most people receive Social Security, a secure financial retirement depends on also having significant savings in a retirement account. Typically these savings must last nearly 20 years (assuming the average age for retirement is 63, and the average life expectancy as of 2021 for someone who reaches that age is 12.1 more years for a man and 17.5 more years for a woman). Of course, many now live beyond this average expectancy. The amount of money saved in retirement accounts depends not only on what you contribute during your work life (and how well those investments did), but on your investment returns after you retire. These depend on investment strategies. Key Takeaways - The amount of money in retirement accounts depends not only on what you contribute during your work life, but on your investment returns after you retire. - The longer you have until your expected retirement, the more risk you can afford to take. - Retirement accounts are either tax-deferred or tax-free vehicles.  

A Coordinated Approach

If you have more than one retirement account, such as a 401(k) at work and a personal individual retirement account (IRA), it’s essential to coordinate investment strategies across all your holdings. Without coordination, you may duplicate your holdings and not take full advantage of the diversification benefits on return and volatility of a portfolio. If you're married, you may want to coordinate investment choices with your spouse's retirement accounts. You may also want to coordinate your holdings in your taxable and tax-deferred accounts. So if in addition to retirement accounts, you may have a taxable investment portfolio at a brokerage firm or with a mutual fund and will want to review your holdings in all such accounts. This enables you to put investments in the appropriate accounts depending on tax considerations and other factors. For example, tax-free municipal bonds belong in your taxable account. If you put them in your tax-deferred retirement account, you will double penalize yourself by accepting lower returns and at the same forgoing the tax advantages of munis. In addition, the interest earned effectively becomes taxable, because distributions are taxed as ordinary income regardless of the source of the earnings.  

Factors in Making Investment Choices

There's no single strategy for all individuals. Many factors come into play when choosing investments for retirement plans: Your savings horizon The longer you have until your expected retirement, the more risk you can afford to take. The stock market does experience severe downs. If you have years to go before you need the funds, you can weather the downs and expect to see the value of your account not only return to its pre-decline level but to an even higher level over time. For example, the Dow Jones Industrial Average hit a low of 6,626.94 on March 6, 2009, causing many accounts to decline 20% or more. But if you didn’t sell and your savings remained until now, with the market at about 31,000 as of January 2021, your account could have more than quadrupled. If you have more than one retirement account, it’s essential to coordinate investment strategies across all your holdings. Your risk tolerance If you lose sleep when the stock market declines, your risk tolerance is low. This means you should invest in securities that are not impacted (or at least not impacted severely) by market swings, weighting your investments more heavily with bond funds, U.S. Treasury bonds and similar securities. Taxes Retirement accounts are either tax-deferred vehicles such as 401(k) plans and traditional IRAs, where income tax is deferred until distributions are taken. Or they are tax-free vehicles such as designated Roth accounts and Roth IRAs, where distributions from the account become tax-free after five years and other conditions are met. Choose investments with taxes in mind. For example, you don't pay capital gains on stock appreciation or on stock dividends, so you can park your capital gains stocks in your tax-advantaged retirement accounts. By the same token, recognize that even in tax-advantaged accounts you may have current income subject to tax (e.g., some types of Schedule K-1 income), something you may want to avoid. Inflation Inflation has been relatively mild over the past several years. However, it has heated up in 2021 as economies emerge from the COVID-19 pandemic, and prices have increased more than 5% (annualized) for several months. Still, the market has no real guidance on whether this inflation is transitory or if it won't be going down anytime soon. Because of this, it is essential to keep a diversified portfolio and not be exclusively or even predominantly in bond funds or other investments that are adversely impacted by inflation. (As inflation pushes interest rates higher, the value of an investment in a bond fund declines.) Investment fees and costs Some investments have higher fees than others. Certificates of deposit don't have fees, for example, but there are fees for investments in mutual funds, annuities and various other types of investments. Compare the fees and consider them a factor in your investment strategy.  

Selecting Investments

If you are in an employer-sponsored plan, you are offered a menu of benefits. For example, the average 401(k) plan offers a dozen or more investment options. It's up to you to select the type of investments suitable to your situation. If you have an IRA, you have more freedom in what you can choose for your portfolio. However, the law bars certain types of assets from being included in IRAs. Among them: - Collectibles. If you invest in any of the following, it's considered a distribution to you: artworks, rugs, antiques, metals, gems, stamps, coins, alcoholic beverages, and certain other tangible personal property. Not treated as collectibles are certain gold, silver platinum coins, as well as certain gold, silver, palladium, and platinum bullion. - Certain real estate. There’s no bar to investing in real estate, but there are various restrictions that make direct investments in real estate impractical for most people. (If you want to do it nonetheless, you need to use a self-directed IRA where the trustee can hold the realty for the account). You can, of course, hold real estate through a real estate investment trust (REIT).  

The Bottom Line

In most cases, investment strategies are up to you. Take advantage of investment advice that may be offered by your employer or the mutual fund hosting your account. And regularly monitor your accounts so you can shift investment strategies when appropriate. Read the full article

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What Are the Best Ways to Lower Taxable Income?

How to lower taxes is one of the most common financial planning concerns among individuals and business owners. The increased standard deductions under the Tax Cuts and Jobs Act (TCJA) provided tax savings for many (even though the TCJA did eliminate many other itemized deductions and the personal exemption). Taxable income can be reduced further with a few strategic steps. Key Takeaways - An effective way to reduce taxable income is to contribute to a retirement account through an employer-sponsored plan or an individual retirement account (IRA). - Both health spending accounts and flexible spending accounts help reduce taxable income during the years in which contributions are made. - A lengthy list of deductions remains available to lower taxable income for full- or part-time self-employed taxpayers.

Save for Retirement

One of the most straightforward ways to reduce taxable income is to maximize retirement savings. Although there are many types of retirement savings accounts to choose from, below are two of the most common that can help reduce taxable income in the tax year in which a contribution is made. Employer-Sponsored Plan Those whose company offers an employer-sponsored plan, such as a 401(k) or 403(b), can make pretax contributions up to a maximum of $19,500 in 2021 (also $19,500 in 2020). Those 50 and older can make catch-up contributions of $6,500 in 2021 (also $6,500 for 2020) above that limit. Because contributions are made pretax through paycheck deferrals, the money saved in an employer-sponsored retirement account directly lowers taxable income. In other words, the contributions reduce an employee's income for that tax year before income taxes are applied. lndividual Retirement Account (IRA) Individuals can also save by contributing to a traditional individual retirement account (IRA). The annual contribution amount to an IRA for the 2021 tax year is $6,000 (same as for 2020), with a catch-up provision of an additional $1,000 allowed for those 50 and older. Traditional IRA contributions can be deducted from a person's tax return, reducing the taxes owed in the tax year of the contribution. However, unlike contributions to an employer-sponsored plan, IRA contributions are made with after-tax dollars, meaning the money has already had income taxes taken out. Taxpayers (or their spouses) who have employer-sponsored retirement plans may also be able to deduct some or all of their traditional IRA contribution from taxable income. The IRS has detailed rules about whether—and how much—they can deduct depending on their income. In December 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law. For 2019 and years prior, taxpayers over the age of 70½ could not contribute to a traditional IRA. As of 2020, the age limit no longer applies. Taxpayers beyond the age of 70½ can contribute a maximum of $7,000 per year and receive the full tax benefit.

Consider Flexible Spending Plans

Some employers offer flexible spending plans that allow money to be socked away pretax for expenses such as medical expenses. A flexible spending account (FSA) provides a way to reduce taxable income by setting aside a portion of earnings in a separate account managed by an employer. An employee can contribute up to $2,750 during the 2021 plan year (unchanged from 2020). Under the use-or-lose provision, participating employees often must incur eligible expenses by the end of the plan year or forfeit unspent amounts. Under a special rule, employers may offer participating employees more time through either a carryover option or a grace period (2.5 months). Under the carryover option, an employee can carry over up to $550 of unused funds to the following plan year. Under the grace period option, an employee has until 2.5 months after the end of the plan year to incur eligible expenses. Employers can offer either option, but not both, or none at all. The IRS has released new guidance that allows employers more flexibility for benefit plans for 2020 and 2021 as part of the Consolidated Appropriations Act. Employers can allow employees to carry over all unused funds from 2020 to 2021 and from 2021 to 2022—or they can extend the grace period from 2.5 months to 12 months—either way, all unused funds can be carried over and used throughout the entire year.

Health Savings Account (HSA)

A health savings account (HSA) is similar to an FSA in that it allows pretax contributions to be used for healthcare costs later. HSAs are only available to employees with high deductible health insurance plans. Minimum Annual Deductible According to the Internal Revenue Service (IRS), for 2021 and 2022, a high deductible health plan has a minimum annual deductible of $1,400 for self-only coverage or $2,800 for family coverage. Annual Contribution Limit The annual contribution limit for 2021 is $3,600 for individuals and $7,200 for families. However, the 2022 contribution limit is $3,650 for individuals and $7,300 for families. Maximum Annual Out-of-Pocket Expenses Also, under a high-deductible plan, annual out-of-pocket expenses, which include deductibles, co-payments, but not premiums, do not exceed $7,000 for self-only coverage or $14,000 for family coverage for 2021, but for 2022, do not exceed $7,050 for self-only coverage or $14,100 for family coverage. Unlike FSA balances, HSA contributions can be rolled over if unused in the year in which they were saved. Both HSAs and FSAs provide for a reduction in tax bills during the years in which contributions are made.

Take Business Deductions

A lengthy list of deductions remains available to lower taxable income for full- or part-time self-employed taxpayers. Home Office Deduction A home office deduction, for instance, is calculated using either a simplified or regular method to reduce taxable income if a portion of a home is used as dedicated office space. The self-employed can also deduct a portion of their self-employment tax and the cost of health insurance, among other expenses, to lower taxable income. Business Expenses Business owners or those with professional, deductible expenses can make upcoming necessary purchases or expenditures by the end of the tax year. This can make a significant difference for those buying a major item for which the purchase price can be put on business expenses. Retirement Savings Plans A variety of retirement savings plans exist for the self-employed, including an individual 401(k) and a simplified employee pension (SEP) IRA. Both options provide an opportunity to lower taxable income through pre-tax contributions and allow for higher limits on contributions each year. The SIMPLE IRA allows contributions of up to $13,500 in 2021 (unchanged from 2020), plus an extra $3,000 for those older than 50. The Solo 401(k) allows contributions of up to $19,500 tax-free for 2021, also unchanged from 2020. The SEP IRA allows tax-deductible contributions of up to 25% of compensation, up to $58,000 (up by $1,000 from 2020). The SECURE Act The SECURE Act has implications for small business owners. The Act encourages business owners to set up retirement plans for employees by providing tax incentives if they collaborate with other small businesses to offer Multiple Employer Plans or MEPs. The SECURE Act also allows more part-timers to save through employer-sponsored retirement plans, starting in 2021. To do so, workers will need to put in at least 500 hours a year for three consecutive years to be eligible.

The Bottom Line

Tax reform eliminated many itemized deductions for most taxpayers, but there are still ways to save for the future and trim their current tax bill. To learn more about deductions and tax savings, consult a tax expert. Read the full article

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The Tax Benefits of Real Estate Investing: What to Know

A rental property owner can get many benefits from tax deductions. Most of the expenses associated with your building can be deducted for tax purposes. If your building brings in $1,000 in rental income, you have to pay taxes on the full $1,000 if you don't deduct a single rental expense. But, if you believe in the long-term returns on your building, you'll invest in new paint or new roofing. You might install new windows to keep the heat in. Instead of paying taxes on $1,000, you can pay taxes on $600, $700, or even $300. That's a couple of hundred dollars you saved, and it puts money back in your pocket.

Rental Investor Starter Kit

Mynd Property Management manages residential properties in Atlanta, Houston, Phoenix and 16 additional markets.  Mynd’s CEO Doug Brien owns 12 buildings, all of which are managed by the company. One of the critical components to their success as a property management firm is that they can handle the tax liabilities and the tax benefits that come with owning rental real estate. Today, they’re sharing some of the lessons and best practices they have learned from hundreds of clients and their founder's success, so you can make use of every rental property tax deduction you can use. Take Advantage of Tax Reform Passed by the Trump Administration The Tax Cuts and Jobs Act of 2017 (TCJA) added new tax benefits and deductions for real estate investors. Real estate has always been tax-efficient.  Mynd’s new real estate tax deduction opportunity after 2019 is that you can take advantage of the Qualified Business Income Deduction (QBI), or Section 199A of the Internal Revenue Code. This new tax law allows 20% of your rental income to be immediately deducted from your taxes. So, regardless of what you earn, you get a 20% deduction right out of the gate. Maintain Good Records Keeping excellent records can set you up for success at tax time. Make sure you keep all your receipts. Organize what you spent on your building when you visit and what types of investments you made in your properties. It works to your benefit to be organized, and it's better for you at tax return time. Your accountant will love you, and your bottom line will benefit. Mynd has a proprietary system that captures as much information as possible about your building, right down to the unit level. They can work with your accountant to provide day-to-day tax information for easier tax preparation. Owners who do this are meticulous, highly organized, and good at keeping records. They save more money on their taxes than less organized owners.  Get Creative: Invest in Qualified Opportunity Zones Qualified Opportunity Zones allow investors to get creative with managing their taxes. These Qualified Opportunity Zones are based on the premise that investing in low-income neighborhoods will improve buildings and make the community a better place for people to live. Take the money you make on other rental properties or different investments and invest it in an Opportunity Zone. When you do this and follow a few rules, you can lower your tax liability by 15%. So, if you made $100 investing and put that money in a Qualified Opportunity Zone, you might pay taxes on only $85. That's a huge tax benefit. Opportunity Zones also require you to invest in and improve the property. That's exciting because you'll have a beautiful building, and your whole neighborhood will benefit. You can also forgive any capital gains tax from that moment on. So, invest that $100, turn it into $200, and you pay zero taxes. There are lots of opportunities for leverage. Other Tax Deductions You May Want to Consider There are other benefits associated with owning investment real estate. If you don't live in the state that the property exists and you need to fly there to visit it, you can deduct your travel expenses. You can also deduct your landscaping bills and the cost of showing the building when you have a vacancy, among other things.  Here’s a partial list of 31 tax deductions real estate investors can take: - Business Startup Costs - Costs Incurred While Looking For New Property - Education - Employees - Energy-Efficiency - Homeowners Association Dues - Interest Paid On Loans Or Credit Cards - Internet and Cell Phone Plans - Legal Fees for an Eviction - Meals and Entertainment - Ordinary and Necessary Advertising Expenses - Petty Cash Expenses - Preparing Documents - Maintenance - Property Management Company Fees - Rent for Equipment and Tools - Repairs - Subscriptions and Memberships - Utilities Paid By The Landlord

Capital Gains Tax Instead of Income Taxes

Capital gains are taxes you pay when you sell a property. They can be at a lower tax rate than your ordinary taxable income rate.  - Property held for one year or less can incur short-term capital gains taxes between 10% to 37% depending on your income tax bracket.  - Property held for a year and one day or more can be taxed between 0% and 20%, depending on your income tax bracket. Aside from house-flipping and wholesaling, the most commonly used real estate strategies entail holding onto a home for more than a year, which means that, ultimately, you’ll pay fewer taxes if you sell your home than if that income was made by another means. Depreciation Deduction Depreciation is a tax write-off that makes investing in real estate more manageable.  Depreciation is applied to both property and improvements. Depreciation isn’t applied all at once, though, because the value of property and improvements extends beyond a single tax year. For this reason, depreciation is applied over the useful life of a property or improvement. In real estate, “improvement” and “repair” are technical terms that refer to specific things.  Sometimes, it can be hard to distinguish between an improvement and a repair. For now, this distinction should suffice: - Improvements: Add value to your property. - Repairs: Return your property to its original condition. A roof is a great place to appreciate this difference. Patching a hole in your roof is a repair, but replacing your roof is an improvement.  One thing to keep in mind is that you have to pay a tax on the amount you save because of depreciation. This tax is known as depreciation recapture. Depreciation recapture is applied whether or not you make use of depreciation. Meaning that even if you choose not to depreciate the cost of a purchase, you will be taxed as if you did.  However, if you sell at or below the depreciated value of your property, you don’t have to pay depreciation recapture. You can also avoid paying depreciation recapture if you do a 1031 exchange, also known as a Starker exchange.  100% Bonus Depreciation and Section 179 Deductions Bonus depreciation and Section 179 deductions let you depreciate an eligible deductible expense right away in the year in which the purchase is put into service. Bonus depreciation used to only be 50%, but the TCJA bumped it up to 100%! However, the TCJA also set an expiration date on bonus depreciation. Starting in 2023, bonus depreciation will go down 20% each year until it’s entirely off the table in 2027, unless Congress chooses to act otherwise.  Purchases eligible for a Section 179 deduction can also be depreciated in the year they are purchased. While bonus depreciation can be applied even if a business is not profitable, Section 179 requires profitability to use. If your business made $20,000 and your purchase is $30,000, you can only apply Section 179 to $20,000. The remaining sum will have to be depreciated the next year. 

Investing in Real Estate with a Self-Directed IRA (SDIRA)

Knowing how to invest in real estate with a self-directed IRA (SDIRA) allows you to enjoy all the tax relief that comes from investing in real estate along with all the tax benefits of an IRA. There are two types of SDIRAs:  - Custodian Managed: An account holder directs a custodian to make and manage real estate investments. - Self-managed: Also known as a checkbook controlled, this entails opening a limited liability company (LLC) to make and manage the investments yourself. As with a 401(k), your taxes will be taken out at the time of your withdrawal. You can also choose a Roth SDIRA, in which case your taxes will be taken out when you make your deposits. If you’re investing in real estate, a Roth SDIRA can be particularly beneficial if your property experiences significant appreciation. Whichever route you go, purchases of real estate can be funded by money outside of the IRA, but any operating expenses must be covered by money from the IRA. If you’re going the self-managed route, you can partner with others to help fund purchases. You can also take out a non-recourse loan, a loan that uses your property as collateral. That’s important because if, for whatever reason, you end up having to default on the loan, you lose your money, but your IRA remains untouched.  The reason people choose to have their SDIRAs managed professionally is because there are so many rules to follow when it comes to managing an IRA. If you take the wrong step, it can cost you big time! Done correctly, using your SDIRA will make you a more resilient investor because of diversification, especially if the real estate you invest in is also geographically diverse. Remember, don't keep all your eggs in one basket, and don't keep all those baskets in the same box! Measure Everything You Do If you want to be tax-efficient, you need to have a lot of data on your property. Track the last time you put in a new tub, and make sure you know the old tub model. Document what kind of roof you have. At Mynd, they have built a system to capture all of this. It helps investment clients find more value for their building, and they can do their taxes a little smarter. Talk to a Tax Professional About Your Rental Properties Mynd also loves talking about what's best for your property and the benefits of investing in real estate. While they aren't tax professionals, they see many tax benefits for the clients they currently serve, and they’re happy to share what they know. Read the full article