Propel Tax Savings with Opportunity Zones

The Tax Cuts and Jobs Act of 2017 (tax reform) made several changes to the tax code impacting both business and individual taxpayers. Some of the more prominent changes included a reduction in the corporate tax rate, new Qualified Business Income (QBI) deduction, expanded depreciation opportunities, and changes to meal and entertainment deductions. For individuals, there was a doubling of the standard deduction, reduction in certain tax brackets, and the elimination of the personal exemption. While these changes reduced overall taxes, they also eliminated many of the planning tools previously available. The good news is in all the changes, tax reform created Qualified Opportunity Zone (QOZ) investments as a new tax-saving opportunity. Taxpayers are able to defer the tax on gains made in the sale of property or assets when invested in a QOZ. To help clients, prospects, and others, Selden Fox has provided a summary of key QOZ points below.

What is a Qualified Opportunity Zone (QOZ)?

A QOZ is an economically distressed area where new investments, meeting specific criteria, may be eligible for preferential tax treatment. QOZs have been selected based on a nomination process managed by each state and submitted to the Treasury Secretary for final selection. There are currently 327 opportunity zones in Illinois with 133 located within the greater Chicagoland area.

What is a Qualified Opportunity Fund (QOF)?

QOF is a fund that invests at least 90% of holdings into businesses or properties within a QOZ. These funds are required to be invested in businesses or activities that help build infrastructure and create economic opportunities. Those who invest in a QOZ through a QOF can defer capital gains taxes into the future, in some cases, paying a significantly lower amount.

Tax Benefits of QOF Investments

The major tax benefit of a QOF investment is the deferral to capital gains tax until December 31, 2026, or whenever the QOF investment is sold. To receive this benefit, a taxpayer must move realized capital gains from the sale of an asset into a QOF within 180 days from the sale date. The deferral of taxes not only reduces tax owed in the years following the sale but also allows them to use funds in a new investment that would have otherwise been paid to the IRS. It is important to note there are additional circumstances under which additional tax saving is available, including:

  • 5 Year QOF Investment – If a taxpayer holds a QOF investment for at least five years prior to December 31, 2026, they can reduce the deferred gain liability by 10% through a step-up in basis.
  • 7 Year QOF Investment – To sweeten the savings, if a taxpayer holds a QOF investment for an additional two years, they can reduce the deferred gain liability by an additional 5%. This means any taxpayer holding a QOF investment for seven years prior to December 31, 2026, can reduce the deferred gain liability by 15%.
  • 10 Year QOF Investment – The biggest tax savings comes when a QOF investment is held for a period of 10 years. When QOF gains earned from QOZ investments are held for a period of 10 years, there is a permanent exclusion from capital gains tax.

Program Details

As mentioned above, a taxpayer has a maximum of 180 days after the sale of their property or assets to invest in a QOF. It is important to note an investor is not required to live or work within a QOZ to participate in the program. The IRS has provided a list of Frequently Asked Questions (FAQs) and answers for interested taxpayers to review.

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Making an investment in an Opportunity Zone offers an important deferral opportunity that companies and individuals need to consider. While some will still benefit from electing a 1031 like-kind exchange, the opportunity available through QOZs is compelling. If you have questions about the information outlined above or need assistance with tax planning or compliance, Selden Fox can help. For additional information call us at 630.954.1400 or click here to contact us. We look forward to speaking with you soon.

Tax Credits on Amended Payroll Tax Returns

Historically, credits due to a company from an amended Illinois payroll tax return would need to be approved by the state prior to being taken on future payroll tax returns. It has come to our attention that more recently, the Illinois Department of Revenue (IDOR) instead has issued and mailed refund checks to these companies for this credit. These checks are typically not accompanied by any correspondence. If you happen to receive an unidentified check from the IDOR you may want to communicate with your internal team as well as the accountant that prepares and files your payroll tax returns to let them know a refund check has been issued.

Illinois to Start Taxing Nonresidents if They Work in Illinois

Effective for tax years ending on or after December 31, 2020, employers are now required to withhold Illinois income tax from compensation paid to a non-resident employee if:

  • The employee performs services in Illinois;
  • The employee’s services that are performed within Illinois are not incidental to services that the employee performs outside of Illinois; and
  • The employee performs services within Illinois for more than 30 working days during the tax year.

Prior to this change in the law, if an employee had performed services partly within Illinois and partly outside Illinois, prior law required the employee’s compensation to be sourced to Illinois only if the employee’s base of operations was in Illinois. Therefore, in the past either all wages were sourced to Illinois or none of the compensation was sourced to Illinois.

Under the new law, the employee’s compensation earned while in Illinois is taxable in the state only after a nonresident employee has spent 31 work days in Illinois. Once that threshold has been met, the compensation associated with all days worked in Illinois is taxable.

For example, under the old law if a Florida resident worked in Florida for 10 months and Illinois for two months, all wages would have been sourced to Florida, a state with no state income tax. Under the new law, this individual would have to pay Illinois tax for the compensation associated with the two months spent in Illinois.

A working day is any day during the year in which the employee performs services on behalf of the employer. Therefore, weekends, vacation days, sick days, and holidays are not working days. A working day is considered spent in Illinois if the employee spends more time that day performing services for the employer within Illinois than the employee spends performing services for the employer outside of Illinois. It is also considered a working day in Illinois if the only services that the employee performs for the employer on that day is traveling to Illinois and the employee arrives on that day.

For purposes of determining compensation paid in Illinois, if an employer maintains a time and attendance system that tracks where employees perform services on a daily basis, then data from the time and attendance system must be used. In all other cases, the employer must obtain a written statement from the employee of the number of days reasonably expected to be spent performing services in Illinois during the taxable year.

This means that employers must withhold Illinois income tax for nonresident employees who spend more than 30 working days in Illinois starting in 2020. To calculate withholding amounts, the new law requires employers to multiply an employee’s total compensation for the tax year by a ratio of the working days the employee spends performing services in Illinois over the total working days the employee spends performing services both within and outside of Illinois during a tax year.

Illinois has not addressed whether withholding should be done when the employee first starts working in Illinois or after 30 days. For companies with Illinois non-residents, employees may be hitting the 30 days threshold soon, therefore employers should maintain a withholding policy with their payroll providers.

The new law does not effect residents of Iowa, Kentucky, Michigan, and Wisconsin. The reciprocal agreement still applies for those states.

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If you have questions about the new nonresident withholding requirements, please contact Selden Fox for additional information. We look forward to speaking with you soon.

Tax Incentives for Illinois Companies

As a new year begins, many Chicago and Illinois companies spend time reviewing their performance and profitability over the past 12 months. It’s often a time for candid reflection about where the organization met or exceeded goals and where efforts fell short. There is also a review of key financial metrics, overall performance and budget preparation for 2020. At the same time, many business owners also use this time to review year-end tax planning to ensure all opportunities have been leveraged. While these are essential steps necessary to maintain the vitality of the company, it’s important not to forget about tax saving incentives offered by the state. To help clients, prospects and others learn more about these programs, Selden Fox has provided a summary of key items below.

Illinois Enterprise Zone Program

This program is designed to encourage investment in economically challenged areas by offering qualifying companies expanding to, or located in, a zone with various incentives. The most notable is the Enterprise Zone Investment Credit which provides qualifying companies with a .5% credit against state income tax for investments in property placed into service within an enterprise zone. Beyond this, businesses may also qualify for the sales tax exemption, equipment sales tax deduction, utility tax exemption, and various property tax incentives. There are currently 140 zones located within the city of Chicago and dozens more across the metropolitan area.

Illinois Angel Investment Tax Credit

This incentive encourages investment in early stage companies to provide the capital needed to drive growth. Investments made in Qualified New Business Ventures (QNBV) are eligible to receive a state tax credit equal to 25% of the total investment (limit $2 million). In general, the business must be principally engaged in innovation, and the business must have the potential for increasing jobs in the state. To be considered as a QNBV, companies must meet the additional following criteria:

  • The principal place of business must be located in Illinois;
  • Registered in good standing with the Secretary of State;
  • At least 51% of employees must be located in the state;
  • Have fewer than 100 total employees;
  • Maintained operations in Illinois for less than 10 consecutive years; and,
  • Agree to maintain a minimum employee number within the state for three years from issuance of state credit certificate.

Since qualification requires state certification, it’s important to note Illinois will start accepting QNBV applications on January 2, 2020.

Illinois Film Tax Credit

This incentive provides film producers a credit of 30% of all qualified expenditures including those incurred during postproduction. The credit is available for qualified Illinois production spending, salaries of up to $100,000 per worker and an additional 15% credit on salaries of individuals that live in economically depressed areas (where unemployment is 150% of the state’s annual average).

Economic Development for a Growing Community (EDGE)

The EDGE Program provides annual corporate tax credits to qualifying businesses which support job creation, capital investment, and improve the standard of living for all Illinois residents. Qualifying companies can receive a credit equal to 50% of state income tax withheld from the salaries of employees in newly created positions. In addition, 10% of training costs can be added to the overall incentive. The credit is non-refundable but can be carried forward over a period of five years.

Withholding Tax Credit For Small Employers

This credit is designed to help small businesses cope with the increase in the state’s minimum wage. Employers with 50 or fewer employees that make minimum wage may qualify for the credit. Note that employees who have worked less than 90 days before the reporting period are excluded. To be eligible, the employer’s average wage paid to each employee must have increased over the average wage paid in the prior year for those earning less than $55,000. The credit is non-refundable and is a percentage of the difference between prior and increased wages under the new law.

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Not every Chicago business will qualify to take advantage of these programs. However, for organizations that meet qualifying criteria, a significant savings often results. If you have questions about the incentives outlined above or need assistance with a tax or accounting issue, Selden Fox can help. For additional information call us at 630.954.1400 or click here to contact us. We look forward to speaking with you soon.

Saving Opportunities with the R&D Tax Credit

Many Chicago area companies have benefited from the changes ushered in by the Tax Cuts and Jobs Act of 2017 (tax reform). However, while tax reform opened the door to new opportunities, it doesn’t mean that existing credits and incentives should be overlooked. For virtually all companies producing or distributing goods, this means taking another look at the Research and Development (R&D) tax credit. Don’t be deceived into thinking a company needs an elaborate research and development department to claim the credit. In fact, many smaller Illinois companies have qualifying activities that can help save them significantly on federal and Illinois income tax liabilities. To help clients, prospects, and others understand the criteria and how they can benefit, Selden Fox has provided a summary of key information below.

Qualifying for the Credit

Many companies have ongoing activities, which can qualify them for the credit, and the IRS has developed a four-part test which must be satisfied in order to qualify, including:

  • Section 174 Test – This requires that qualifying activities and expenses be incurred in connection with the company’s trade or business and represent a research and development cost in the experimental or laboratory sense. These are defined as expenditures for activities intended to discover information that would eliminate uncertainty about the development process or improvement of a product.
  • Discovering Technological Information Test – In order to satisfy this test, the research conducted must fundamentally rely on principles of the physical or biological sciences, engineering, or computer sciences. A taxpayer may rely on existing principles of these sciences when conducting the research in order to satisfy the requirement.
  • Business Component Test – A taxpayer must intend to apply the information being discovered to develop a new or improved business component. This may include a product, process, software, technique, formula, or invention which will be used for sale, licensing, or lease. It’s essential for a company to be able to connect the research and the relevant business component to pass this test.
  • Process of Experimentation – This test requires that a process of experimentation be used in the R&D activities. Regulations define this process as identifying the uncertainty, identifying one or more alternatives, and identifying and conducting a process of evaluating all alternatives. The IRS has stated that merely demonstrating that an uncertainty has been eliminated is not sufficient to satisfy this test.

Credit Calculation

The credit is computed as a percentage of the wages and contracted research expenses paid in the R&D process. The amount of credit varies by taxpayers and is partially determined by the amount of Qualifying Expenses they had over the past three years. Companies can use the credit to reduce a company’s federal and state income tax liabilities during the current year and may be able to go back to previously filed returns to retrieve unclaimed credits. Finally, those companies who currently have no federal income tax liability may still benefit from certain provisions that allow the credit to be carried over to future years or applied against payroll tax liabilities of new start-ups.

Documentation

The key to successfully claiming this credit is in the documentation. The IRS has strict rules about the documentation which must be provided as part of the claim process. Companies are required to evaluate and document their research to identify the qualifying expenses paid as part of the process. While the option to estimate expenses is available, it’s essential to be able to provide contemporaneous documentation, which can include payroll records, expense records, projects records and notes, and copies of lab results. It’s also permittable to share copies of emails and other records.

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The R&D tax credit is a powerful tax savings tool which allows qualifying companies to save a significant amount in income tax liabilities. While many Chicago companies may believe they don’t qualify, it’s important to consult with a tax advisor to review your situation. If you have questions about the R&D tax credit or need assistance compiling your documentation, Selden Fox can help. For additional information call us at 630.954.1400 or contact us. We look forward to speaking with you soon.

Selecting Your Entity Type

There’s a certain spirit about entrepreneurs that sets them apart from other business professionals. They have a creative spark and imagination that allows them to envision a new product, innovative service offering, and the market it will best serve. They are able see all the variables coming together like puzzle pieces interlocking to form a complete picture. Similarly, when entering a new venture there are many issues to consider including financing, production processes, facilities acquisition, and marketing. It’s no surprise that the choice of entity selection often falls near the bottom of the priority list, but it’s an essential exercise that must be given careful consideration because it will impact how the company and its owners are taxed. The challenge is understanding which is optimal for your situation. Here we look at the types and benefits of each option that may prove helpful in the decision-making process.

S-Corporations

This entity structure is created by filing Articles of Incorporation with your Secretary of State usually completed with the assistance of an attorney. Since it’s a company, there are shares of stock issued amongst the shareholders and various individuals that serve as directors and officers. This entity structure protects the shareholders from legal liability by protecting shareholder’s personal assets such as bank accounts from being taken to satisfy business obligations. It’s important to note this entity type is considered a “pass-through” entity which means the company doesn’t pay any federal income tax on profits earned, but rather the income tax is passed through to each shareholder’s individual return. The drawbacks to a S-Corporation are the formation and administrative expenses, stock ownership restrictions, limit on the number and type of shareholders, and the need to tax fringe benefits.

C-Corporations

This entity structure is like S-Corporations in many ways including the establishment process; presence of shareholders, directors, and officers; and the legal protection of personal assets to satisfy business debts. There are many advantages to using this entity structure such as deductible business expenses and no limit on the number and type of shareholders. Drawbacks include cost of formation and administration, possibility of double taxation as profits are taxed both on corporate and shareholders tax returns, and limitation on the ability to deduct business losses.

Limited Liability Company (LLC)

This entity structure is created by filing Articles of Organization and an Operating Agreement to define how the company will operate. Like S-Corporations and C-Corporations, LLCs offer legal protection of personal assets to satisfy business debts and obligations (but does require clear separation between business and personal finances). What makes LLCs attractive to many is the opportunity to determine how they want to be taxed including Single Member LLC, Partners in LLC, or LLC Filing as Corporation. Each type offers various benefits and drawbacks determined by the specific set up and needs of the company. The drawbacks to LLCs are they can be subject to self-employment tax, lack formal titles such as officer and directors which can lead to confusion about roles and responsibilities, and have a limited life. In many states, it’s a common requirement that when one member of the LLC departs then it must be dissolved and recreated.

Limited Liability Partnerships (LLPs)

This entity type is created by establishing Limited Liability Partnership Agreements and satisfying other filing requirements as mandated by your state. There is legal protection as partners are shielded from the possibility of having their personal assets taken to satisfy business debts. It also provides protection from the wrongful action of other partners but holds them accountable for their own liabilities. The LLP is a pass-through entity like a S-Corporation as the partnership pays no federal taxes, but the income passes through to each partner’s individual tax return. There are several drawbacks to LLPs including the limitation by some states that partners need to be licensed in the specific field where the partnership provides services (i.e. CPA, attorney, architect, or engineer).

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There are many variables to consider when determining the correct entity type for your business including tax structure, cost of administration, and level of legal liability. The information provided above focused mainly on tax liability, but it’s important to make your final decision based on all three criteria. If you have questions about choice of entity selection or need assistance with an accounting, tax or other issue, Selden Fox can help. For additional information please call us at 630.654.1400 or click here to contact us. We look forward to speaking with you soon.

Reap the Benefits of Gain-Loss Harvesting to Lower Your Tax Bill

Losing money is not anyone’s investment plan, however a well-diversified portfolio will usually contain some investments that have lost value. A silver lining in having losing investments is that you may be able to use them to lower your tax liability. In this article, we will look at not only using your losses to offset your gains, but also realizing gains at the correct time to reduce your tax liabilities associated with these positions.

The key to an effective tax harvesting strategy is to evaluate your investments and your goals with these investments combined with creating effective tax strategies to minimize your tax liability without altering your investment diversification strategies.

The general principle behind tax harvesting is fairly straightforward and is generally lining up your gains and your losses. If you have already sold a stock this year for a large gain then you generally want to sell a stock for a loss to offset that gain and minimize your tax liability. However, below are some more in depth ideas for tax harvesting.

Short-term versus long-term gains and losses

Long-term capital gains (investments held longer than one year) are taxed at either 0%, 15%, or 20% depending on your income, while short-term capital gains are taxed at your ordinary income rate, which could range anywhere from 10% to 37%. Your short-term and long-term capital gains do get netted together, so it is important to remember that if you are in the 37% tax bracket and have a short-term gain, you can offset this 37% tax by selling a long-term stock at a loss. Even though the long-term stock is taxed at a lower rate, it can offset ordinary short-term capital gains.

When capital losses exceed capital gains for the year, a taxpayer is allowed to deduct $3,000 in losses with the remaining losses carried forward to offset future gains. Therefore, even if you do not have any capital gains, it may be beneficial to sell a long-term stock at a $3,000 loss and use that capital loss to offset ordinary income.

Should I consider gain harvesting?

Whether it is in retirement, the result of a business loss or a net operating loss, or another reason, sometimes your taxable income is lower than other years. This may be the time to consider selling stocks at a gain and taking advantage of the low tax bracket that you are in. In 2018, capital gains are taxed at 0% if your income is $38,600 or less if single and $77,200 or less if married filing jointly. This means if your income is under these thresholds, you can sell investments at a gain and not pay any federal tax on that gain. Therefore, if your income is not normally under these levels, but it is for some reason in one year, then you want to sell these stocks in that year tax-free.

Beware of wash sales

Once you sell an investment for a loss, make sure that you do not buy that investment back within 30 days. If you buy that investment back within 30 days, the original loss is disallowed to prevent taxpayers from claiming artificial losses. One way to avoid a wash sale of an individual stock is to invest with exchange-traded funds (ETF). The IRS does not consider ETFs that track different indexes to be substantially identical, therefore one ETF can be replaced with another ETF that is highly correlated but tracks a different index.

Harvesting gains and losses regularly and proactively can save you money over the long run, effectively boosting your after-tax return. It is important to consider all aspects of your tax return when trying to harvest gains and losses.

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If you need assistance or have questions about harvesting gains and losses and general tax planning, Selden Fox can help. Our tax team has considerable experience and can assist in your tax planning and tax return preparation. For additional information please call us at 630.954.1400 or click here to contact us.

Considering a Gift Before Year Ends?

The 2018 gift and estate tax exemption of $11.18 million is considerably larger than it has ever been. In addition to the tax benefits, making a gift during your lifetime allows your children or other beneficiaries to benefit from the gift.  Below are the factors to consider when making a gift in 2018.

How long will the $11.18 million tax exemption last?

The 2017 Tax Cuts and Jobs Act of 2017 doubled the gift and estate tax exemption in 2018, however the future of the estate tax is unknown. Unless Congress acts sooner, the 2017 Act expires at the end of 2025 and will revert to $5.49 million, adjusted for inflation. With the future of the estate and gift tax unknown, 2018 may be the perfect time of make a gift. If you have a large enough estate that you expect to pay estate tax when you pass away, it may be beneficial to do so now while the exemption is as high as it is.

What are the best and worst assets to gift?

The best assets to give are those most likely to appreciate as they can be gifted now at their fair market value instead of having the appreciated assets subject to estate tax. Therefore, the more the asset appreciates, the larger the tax benefit. If you are gifting to charities, give appreciated securities rather than cash. By donating securities with a higher fair market value than your original purchase price, you can deduct the fair market value as a charitable contribution. For example, if you have appreciated stock worth $5,000 that you purchased for $3,000, instead of selling the stock and paying tax on your $2,000 capital gain, you can give the stock directly to charity, pay no taxes, and still deduct $5,000.

Alternatively, if you are generously gifting to a relative, you may want to give cash instead of gifting appreciated assets. If you give appreciated stock to a relative, the cost basis will transfer to the donee, and they will have to pay taxes on the gain when they sell the stock.

If you are age 70 ½ or older you can exclude from income up to $100,000 in distributions from a traditional or inherited IRA if given directly to a charity. This distribution meets the required minimum distribution requirements and is really useful if you are going to be taking the new increased standard deduction anyways.

Lastly, if looking for a deduction now, but not sure which charity to donate to? Consider gifting to a donor-advised fund where the funds can be set aside for future gifting to charities.

What if I want to give to a child that is a minor?

If you want to provide a gift to a minor child, consider setting up a trust, such as an irrevocable trust, as trusts allow for more donor control of the assets, even after the donor’s death. By setting up a trust, donors can direct how they want the money to be managed and the circumstances under which the money can be distributed. Donors can also specify whether their children will be able to control the money at a certain age. An irrevocable trust can also be an effective tool for transferring assets to adult child while potentially reducing estate taxes and directing how you would like the assets to be handled after you have passed away.

The most common trust for a minor is known as a custodial account (UTMA account). The Uniform Gift to Minors Act established a simple way for a minor to own securities without requiring the services of an attorney to prepare trust documents or the court appointment of a trustee.

Should I gift part of my business?

If you gift away part of a business, the gift will qualify for discounts for lack of control and lack of marketability and can take up less of the exemption than the business is really worth. The ownership of a non-controlling interest in a company does not have the ability to make any decisions in the business, therefore it is generally less valuable than a controlling ownership interest. In addition, there are certain marketability differences between an ownership interest in a privately held company and an ownership interest in the stock of a publicly-traded company. These discounts combined could generally reduce the value of the business interest by as much as 35 percent. Therefore, a partnership interest with a pre-discounted value of $10 million would only use $6.5 million of your exemption.

A big advantage of gifting away a business interest is that any future appreciation in the business will be excluded from your estate, and therefore won’t be subject to gift tax. Conversely, when a business interest is gifted, the tax basis in the business will transfer to the donee, whereas if the business interest were inherited then it would receive a stepped-up basis at the time of death. When considering gifting a business interest, it is important to consider all of these factors and to have a business valuation done as well.

Along with the lifetime gifting exclusion, it is also important to note than each person is allowed to gift $15,000 each year to any individual without counting against your lifetime exemption. Therefore, a married couple can give $30,000 to each of their children and grandchildren, or anyone else, and not have to use any of their lifetime exemption. If you do exceed the annual exclusion, you will need to file a gift tax return.

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If you need assistance or have questions about gifting or business valuations, Selden Fox can help. Our team has considerable experience in this area and can identify the appropriate solution for your needs. For additional information please call us at 630-954-1400 or click here to contact us.