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If you run a business “on the side” and derive most of your income from another source (whether from another business you own, employment or investments), you may face a peculiar risk: Under certain circumstances, this on-the-side business might not be a business at all in the eyes of the IRS. It may be a hobby.

The hobby loss rules

Generally, a taxpayer can deduct losses from profit-motivated activities, either from other income in the same tax year or by carrying the loss back to a previous tax year or forward to a future tax year. But, to ensure these pursuits are really businesses — and not mere hobbies intended primarily to offset other income — the IRS enforces what are commonly referred to as the “hobby loss” rules.

If you haven’t earned a profit from your business in three out of five consecutive years, including the current year, you’ll bear the burden of proof to show that the enterprise isn’t merely a hobby. But if this profit test can be met, the burden falls on the IRS. In either case, the agency looks at factors such as the following to determine whether the activity is a business or a hobby:

  • Do you carry on the activity in a business-like manner?
  • Does the time and effort put into the activity indicate an intention to make a profit?
  • Do you depend on income from the activity?
  • If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
  • Have you changed methods of operation to improve profitability?
  • Do you (or your advisors) have the knowledge needed to carry on the activity as a successful business?
  • Have you made a profit in similar activities in the past?
  • Does the activity make a profit in some years?
  • Do you expect to make a profit in the future from the appreciation of assets used in the activity?

Dangers of reclassification
If your enterprise is reclassified as a hobby, you can’t use a loss from the activity to offset other income. You may still write off certain expenses related to the hobby, but only to the extent of income the hobby generates. If you’re concerned about the hobby loss rules, we can help you evaluate your situation.

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An agreed upon procedures (AUP) engagement uses procedures similar to an audit, but on a smaller and limited scale. Here’s how a customized AUP engagement differs from an audit and can be used to identify specific problems that require immediate action. 

How do AUPs compare to audits?

The American Institute of Certified Public Accountants (AICPA) regulates both audits and AUP engagements. But the natures of these two types of accounting services are quite different. When a CPA firm performs an audit, its client is the company. With an AUP engagement, the client is typically the company’s lender or another third party — a fact that usually alleviates potential conflicts of interest.

Another key difference is that of responsibility. Audits require CPAs to provide a formal opinion on whether the company’s financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP). 

On the other hand, CPAs make no formal conclusions when performing AUPs; they simply act as finders of fact. It’s the client’s responsibility to draw conclusions based on the CPA’s findings. 

AUP engagements may target specific financial data (such as accounts payable, accounts receivable or related party transactions), nonfinancial information (such as a review of internal controls or compliance with royalty agreements), a specific financial statement (such as the income statement or balance sheet) or even a complete set of financial statements.

When do you need AUPs?

AUPs boast several advantages over audits. They can be performed at any time during the year — not just at year end. And because you have the flexibility to choose only those procedures you feel are necessary, they can be cost-effective. 

Lenders may, for example, request an AUP engagement, if they have doubts or questions about a borrower’s financials — or if they want to check on the progress of a distressed company’s turnaround plan. Or a business owner may decide to hire a CPA to perform an AUP engagement, if he or she suspects that the CFO is misrepresenting the company’s financial results or the plant manager is stealing inventory. These engagements can also be useful in mergers and acquisition due diligence.

Who can help?

An AUP engagement can be used to dig deeper into financial results and identify specific problems that require immediate action. We can help you customize an AUP engagement that can identify problems and resolve issues quickly and effectively. 

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Here are some of the key tax-related deadlines affecting businesses and other employers during the second quarter of 2017. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements. 

April 18

  •  If a calendar-year C corporation, file a 2016 income tax return (Form 1120) or file for an automatic six-month extension (Form 7004), and pay any tax due. If the return isn’t extended, this is also the last day to make 2016 contributions to pension and profit-sharing plans.
  •  If a calendar-year C corporation, pay the first installment of 2017 estimated income taxes.

May 1    

  • Report income tax withholding and FICA taxes for first quarter 2017 (Form 941), and pay any tax due. (See exception below.)

May 10

  • Report income tax withholding and FICA taxes for first quarter 2017 (Form 941), if you deposited on time and in full all of the associated taxes due.

June 15

  • If a calendar-year C corporation, pay the second installment of 2017 estimated income taxes.
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If you have a child in college, you may be eligible to claim the American Opportunity credit on your 2016 income tax return. If, however, your income is too high, you won’t qualify for the credit — but your child might. There’s one potential downside: If your dependent child claims the credit, you must forgo your dependency exemption for him or her. And the child can’t take the exemption. 

The limits

The maximum American Opportunity credit, per student, is $2,500 per year for the first four years of postsecondary education. It equals 100% of the first $2,000 of qualified expenses, plus 25% of the next $2,000 of such expenses.

The ability to claim the American Opportunity credit begins to phase out when modified adjusted gross income (MAGI) enters the applicable phaseout range ($160,000–$180,000 for joint filers, $80,000–$90,000 for other filers). It’s completely eliminated when MAGI exceeds the top of the range. 

Running the numbers

If your American Opportunity credit is partially or fully phased out, it’s a good idea to assess whether there’d be a tax benefit for the family overall if your child claimed the credit. As noted, this would come at the price of your having to forgo your dependency exemption for the child. So it’s important to run the numbers.

Dependency exemptions are also subject to a phaseout, so you might lose the benefit of your exemption regardless of whether your child claims the credit. The 2016 adjusted gross income (AGI) thresholds for the exemption phaseout are $259,400 (singles), $285,350 (heads of households), $311,300 (married filing jointly) and $155,650 (married filing separately). 

If your exemption is fully phased out, there likely is no downside to your child taking the credit. If your exemption isn’t fully phased out, compare the tax savings your child would receive from the credit with the savings you’d receive from the exemption to determine which break will provide the greater overall savings for your family. 

We can help you run the numbers and can provide more information about qualifying for the American Opportunity credit.

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Two buildings with arrows in between, trading places.   Like Kind Exchange. Section 131. Delaware accountantLike many business owners, you might also own highly appreciated business or investment real estate. Fortunately, there’s an effective tax planning strategy at your disposal: the Section 1031 “like kind” exchange. It can help you defer capital gains tax on appreciated property indefinitely.

How it works

Section 1031 of the Internal Revenue Code allows you to defer gains on real or personal property used in a business or held for investment if, instead of selling it, you exchange it solely for property of a “like kind.” In fact, these arrangements are often referred to as “like-kind exchanges.” Thus, the tax benefit of an exchange is that you defer tax and, thereby, have use of the tax savings until you sell the replacement property.

Personal property must be of the same asset or product class. But virtually any type of real estate will qualify as long as it’s business or investment property. For example, you can exchange a warehouse for an office building, or an apartment complex for a strip mall.

Executing the deal

Although an exchange may sound quick and easy, it’s relatively rare for two owners to simply swap properties. You’ll likely have to execute a “deferred” exchange, in which you engage a qualified intermediary (QI) for assistance.

When you sell your property (the relinquished property), the net proceeds go directly to the QI, who then uses them to buy replacement property. To qualify for tax-deferred exchange treatment, you generally must identify replacement property within 45 days after you transfer the relinquished property and complete the purchase within 180 days after the initial transfer.

An alternate approach is a “reverse” exchange. Here, an exchange accommodation titleholder (EAT) acquires title to the replacement property before you sell the relinquished property. You can defer capital gains by identifying one or more properties to exchange within 45 days after the EAT receives the replacement property and, typically, completing the transaction within 180 days.

The rules for like-kind exchanges are complex, so these arrangements present some risks. If, say, you exchange the wrong kind of property or acquire cash or other non-like-kind property in a deal, you may still end up incurring a sizable tax hit. Be sure to contact us when exploring a Sec. 1031 exchange.

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Welcome to our state road sign.  Delaware CPA, Delaware Accounting Firm, Wilmington Delaware CPAsIf your not-for-profit solicits funds online — or uses other fundraising methods that cross state boundaries — it may need to register in multiple jurisdictions. We’ve answered some commonly asked questions.

My charity receives occasional contributions from out-of-state donors. Do I need to register with those states? Yes, but only if you’re actually asking for donations in those states. The critical activity is soliciting, not accepting, funds. Remember, email and text blasts and social media appeals are likely to be considered multistate solicitations.

That said, some nonprofits are generally exempt from registering or may need to register but aren’t required to file annually. For example, many states exempt houses of worship as well as nonprofits with total annual income under certain thresholds.

So registration rules vary by state? That’s right. A handful of states don’t require charities to register at all. The remaining ones have varying rules, income thresholds, exceptions, registration fees and fines for violations. Even the agencies that regulate charities differ by state.

How much does it cost to register? Again, this varies by state — generally ranging from $0 to $2,000.

Is there a simple way to register with every state? Unfortunately not. Most states require you to complete a general information form and submit it with your last financial statement, a list of officers and directors, a copy of your originating document and your IRS-issued tax-exempt determination letter.

First-time registrants can use a Unified Registration Statement in most states. However, even those states mandate that annual renewals and reports be submitted using individual state forms.

What are the consequences of not registering in states where my nonprofit raises funds? Your organization, officers and board members could face civil and criminal penalties. Your charity might lose its ability to solicit funds in certain states or lose its tax-exempt status with the IRS.

Do I need to tell the IRS where my nonprofit is registered? Yes; Form 990 asks you to list the states where you’re required to file a copy of your return.

Given the resources involved, you may wonder if out-of-state donations are worth the trouble. For some nonprofits, it may make sense to focus exclusively on local fundraising. Contact us and we’ll help you weigh the pros and cons.

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Piggy bank next to an alarm clock with coins stacked in front.  Delaware accountantYes, there’s still time to make 2016 contributions to your IRA. The deadline for such contributions is April 18, 2017. If the contribution is deductible, it will lower your 2016 tax bill. But even if it isn’t, making a 2016 contribution is likely a good idea.

Benefits beyond a deduction

Tax-advantaged retirement plans like IRAs allow your money to grow tax-deferred — or, in the case of Roth accounts, tax-free. But annual contributions are limited by tax law, and any unused limit can’t be carried forward to make larger contributions in future years.

This means that, once the contribution deadline has passed, the tax-advantaged savings opportunity is lost forever. So it’s a good idea to use up as much of your annual limit as possible.

Contribution options

The 2016 limit for total contributions to all IRAs generally is $5,500 ($6,500 if you were age 50 or older on December 31, 2016). If you haven’t already maxed out your 2016 limit, consider making one of these types of contributions by April 18:

1. Deductible traditional. If you and your spouse don’t participate in an employer-sponsored plan such as a 401(k) — or you do but your income doesn’t exceed certain limits — the contribution is fully deductible on your 2016 tax return. Account growth is tax-deferred; distributions are subject to income tax.

2. Roth. The contribution isn’t deductible, but qualified distributions — including growth — are tax-free. Income-based limits, however, may reduce or eliminate your ability to contribute.

3. Nondeductible traditional. If your income is too high for you to fully benefit from a deductible traditional or a Roth contribution, you may benefit from a nondeductible contribution to a traditional IRA. The account can still grow tax-deferred, and when you take qualified distributions you’ll be taxed only on the growth. Alternatively, shortly after contributing, you may be able to convert the account to a Roth IRA with minimal tax liability.

Want to know which option best fits your situation? Contact us.

cup of copy next to document: Last Will and Testiment.  Delaware CPA, Wilmington Accountant, Delaware Accounting FirmAlthough probate can be time consuming and expensive, perhaps its biggest downside is that it’s public — anyone who’s interested can find out what assets you owned and how they’re being distributed after your death. The public nature of probate can also draw unwanted attention from disgruntled family members who may challenge the disposition of your assets, as well as from other unscrupulous parties.

However, by implementing the right estate planning strategies, you can keep much or even all of your estate out of probate.

Probate, defined

Probate is a legal procedure in which a court establishes the validity of your will, determines the value of your estate, resolves creditors’ claims, provides for the payment of taxes and other debts and transfers assets to your heirs.

Is probate ever desirable? Sometimes. Under certain circumstances, you might feel more comfortable having a court resolve issues involving your heirs and creditors. Another possible advantage is that probate places strict time limits on creditor claims and settles claims quickly.

Choose the right strategies

There are several ways you can avoid (or minimize) probate. (You’ll still need a will — and probate — to deal with guardianship of minor children, disposition of personal property and certain other matters.)

The right strategies depend on the size and complexity of your estate. The simplest ways to avoid probate involve designating beneficiaries or titling assets in a manner that allows them to be transferred directly to your beneficiaries outside your will. So, for example, be sure that you have appropriate, valid beneficiary designations for assets such as life insurance policies, annuities and retirement plans.

For assets such as bank and brokerage accounts, look into the availability of “pay on death” (POD) or “transfer on death” (TOD) designations, which allow these assets to avoid probate and pass directly to your designated beneficiaries. However, keep in mind that, while the POD or TOD designation is permitted in most states, not all financial institutions and firms make this option available.

For homes or other real estate — as well as bank and brokerage accounts and other assets — some people avoid probate by holding title with a spouse or child as “joint tenants with rights of survivorship” or as “tenants by the entirety.” Be aware that drawbacks exist for this technique.

Contact us with all of your probate questions.
 

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Standing at a fork in the orad. Text reads: Management now faces a tough decision.Financial statements are generally prepared under the assumption that the business will remain a “going concern.” That is, it’s expected to continue to generate a positive return on its assets and meet its obligations in the ordinary course of business. But sometimes conditions put that assumption into question.

Recently, the responsibility for making going concern assessments shifted from auditors to management. So, it’s important for you to identify the red flags that going concern issues exist.

Make the call

Under Accounting Standards Update No. 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, management is responsible for assessing whether there are conditions or events that raise “substantial doubt” about the company’s ability to continue as a going concern within one year after the date that the financial statements are issued — or available to be issued. (The alternate date prevents financial statements from being held for several months after year end to see if the company survives.)

When going concern issues arise, auditors may adjust balance sheet values to liquidation values, rather than historic costs. Footnotes also may report going concern issues. And the auditor’s opinion letter — which serves as a cover letter to the financial statements — may be downgraded to a qualified or adverse opinion. All of these changes forewarn lenders and investors that the company is experiencing financial distress.

Meet the threshold

When evaluating the going concern assumption, look for signs that your company’s long-term viability may be questionable, such as:

  • Recurring operating losses or working capital deficiencies,
  • Loan defaults and debt restructuring,
  • Denial of credit from suppliers,
  • Dividend arrearages,
  • Disposals of substantial assets,
  • Work stoppages and other labor difficulties,
  • Legal proceedings or legislation that jeopardizes ongoing operations,
  • Loss of a key franchise, license or patent,
  • Loss of a principal customer or supplier, and
  • An uninsured or underinsured catastrophe.

The existence of one or more of these conditions or events doesn’t automatically mean that there’s a going concern issue. Similarly, the absence of these conditions or events isn’t a guarantee that your company will meet its obligations over the next year.

Comply with the new guidance

Compliance with the new accounting standard starts with annual periods ending after December 15, 2016. So, managers of calendar-year entities will need to make the going concern assessment starting with their 2016 year-end financial statements. Contact us for more information about making going concern assessments and how it will affect your financial reporting.

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Did you work as a sole proprietor or independent contractor in 2016? If you earned more than $400 during 2016 from the work you did, you may owe self-employment tax. That's true no matter what your age – even if you're receiving social security benefits.

The tax is assessed on your earnings from self-employment. In this context, "earnings" generally means your self-employed income after deducting expenses incurred while operating your business. If you have multiple businesses, you combine the net income and losses. For your 2016 return, the self-employment tax rate is 15.3% on the first $118,500 that you earned.

What happens when you earn social security wages or tips from an employer and also have a side business? Your wages count toward the taxable base. Depending on how much you earn as an employee, your self-employment income may be subject to part or all of the tax.

You can pay self-employment tax on a quarterly basis as part of your estimated tax payments. One half of the total self-employment tax that you pay during the year is deductible on your income tax return, and you don't have to itemize to claim the deduction.

Are you new to self-employment? Give us a call. We're happy to help you make smart tax decisions.

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