Taxes Archives - MGO CPA | Tax, Audit, and Consulting Services

Navigating the Future of Tax Policy: A Guide for Corporate Boards

Key Takeaways:

The upcoming election cycle has introduced uncertainty in U.S. tax policy, so corporate boards should be ready for potential changes — namely the expiration of the 2017 TCJA provisions.
Boards should stay flexible in their tax planning. Divergent tax policies from both parties mean the election outcome could yield drastic differences in tax rates, capital gains treatment, and deductions.
Boards should regularly review tax strategies for alignment with corporate goals and regulatory standards, maintaining oversight of the corporate tax posture.
Stakeholders expect companies to be transparent and socially responsible in tax. Boards should prioritize this.

The upcoming U.S. election cycle gives rise to ambiguity in business tax planning. Companies must prepare for a shifting tax landscape while considering differing priorities of Republicans and Democrats regarding U.S. tax policies, such as the approaching expiration of some components of the 2017 Tax Cuts and Jobs Act (TCJA). This environment emphasizes the importance of the board’s oversight role and its understanding of a company’s total tax strategy, emerging compliance complexities, the impact of potential election results and associated tax planning scenarios, and the need for a broad perspective on total tax posture and associated social responsibility of the company.

The TCJA

The TCJA brought significant changes to the U.S. tax code, but many of its provisions are set to expire in 2025. Notably, the corporate tax rate will remain at 21%, but other aspects of the act will sunset, potentially leading to increased tax liabilities for businesses and individuals. Future tax policies will be shaped by the House of Representatives, the Senate, and the White House, and a resulting mix of political power within these bodies will necessitate compromises to pass proposed legislation.

Political Corporate Tax Priority Outlines

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Boards should have a clear understanding of their company’s current tax strategy, which takes into consideration the total tax liability – the composite total of all taxes owed by a taxpayer for the year. Next, consideration of the impact of and response to various tax scenarios and business operations, while ensuring compliance with existing tax law and regulations, should inform oversight of the company’s tax strategy.

Regular reviews of the company’s current tax strategy is a fundamental component of the board’s oversight responsibility. Key questions for management and tax advisors include:

What is the company’s current tax strategy? Do they support the company’s corporate strategy?
Is the tax department evaluating how potential tax scenarios may impact the company?
Is management developing alternative action plans in response?

Tax Considerations and Questions the Board Should be Asking: Big Picture

Election-related risk factors, such as potential tax code changes, are top of mind in boardrooms. Directors know changes may be coming, and proactive management will facilitate a timely response. An effective tax strategy can positively impact the company’s bottom line, help to mitigate risks, and drive growth. Boards play a pivotal role in overseeing these efforts, ensuring management remains vigilant in weighing tax impacts in making informed and responsible strategic decisions. Read on for key tax considerations for boards and the questions they should be asking of management.

Total Tax Posture

Understanding the company’s total tax posture is essential. This includes not only corporate income tax liability but also other tax responsibilities such as payroll, real estate, sales, and value-added taxes (VAT). For example, a company with large net operating losses (NOLs) may not pay corporate income taxes but may still have other tax obligations to consider.

Has risk oversight responsibility for total tax posture been allocated to the full board or a committee of the board? If so, has the company disclosed this at the board or appropriate committee level?
Who is responsible for managing and reporting total tax posture? Does the company have adequate resources to fulfill this responsibility?
What KPIs are being used to track the company’s total tax posture?
How do company KPIs compare to those of competitors?

Global Tax Compliance

Global tax compliance is a complex undertaking, involving issues such as the U.S. global intangible low-taxed income (GILTI) and the base erosion and anti-abuse tax (BEAT). Global tax compliance requires a deep understanding and active monitoring of current and evolving international tax laws and regulations in multiple jurisdictions. Boards need to be proactive in overseeing how management is addressing these complexities to ensure compliance and avoid potential legal and financial risks.

Who is responsible for and how is the company monitoring global tax compliance?
Does the company have adequate resources dedicated to tax compliance?
Have there been instances of noncompliance? How were they resolved?
How does the company monitor evolving domestic and international regulations and legislation impacting compliance?

Tax Transparency and Social Responsibility

Tax transparency and social responsibility are increasingly important in today’s business environment. Companies should strive to be transparent about their tax practices within financial reporting and demonstrate their contributions to society through tax postures. Boards should consider how stakeholders, including investors and the community, see the company’s contribution to social responsibility through taxes. This includes evaluating the company’s tax practices and their alignment within the context of broader social goals.

Who is responsible for drafting and monitoring all tax disclosure?
Is the company conducting any stakeholder engagement around tax transparency and social responsibility?
How is the company using information obtained from stakeholders to adjust its tax planning strategy?
How do the company’s tax contributions align with competitors and stakeholder expectations?

Engineering Value Chain Efficiencies

Proactive tax structuring and value-chain planning are crucial for optimizing tax efficiency. Boards need to consider how much engineering for tax efficiency is acceptable and what might be perceived negatively by the tax authorities or the public. While manipulating the value chain for tax mitigation is generally acceptable, significant legal structuring and non-arm’s-length transactions, such as the use of shell companies or intercompany transfers, may raise speculation and scrutiny.

What options are available for value chain efficiencies?
Does the company have policies regarding tax structuring and value-chain planning?
Were any structuring and planning policies considered and rejected? If so, why did we decide not to adopt them?

Conclusion

As the expiration of the 2017 TCJA approaches and pending November 2024 U.S. election results clarify which political priorities may evolve into legislation, companies must stay informed and prepare for potential changes in tax policy. By understanding their current tax strategy, planning for various domestic and international taxation scenarios, and emphasizing tax transparency and social responsibility, businesses can better navigate the complexities of the tax landscape and ensure compliance. Boards have the responsibility to play a critical oversight role in guiding these efforts and ensuring that the company management remains proactive and responsible in formulating its tax practices and executing its tax strategy.

How MGO Can Help

Our tax team is here to help your board navigate today’s complex tax landscape with tailored strategies that directly address shifting policies and compliance challenges as they arise. From strategic planning and global compliance support to enhancing overall tax transparency and optimizing value chain efficiencies, we provide proactive solutions that align with your company’s goals — as well as your shareholders’.

Be prepared for whatever changes come your way, all while maintaining robust tax oversight and committing to social responsibility and long-term success. Reach out to our team today.

Managing Personal Property Taxes: A Guide for Vineyards and Wineries

Key Takeaways:

Vineyards and wineries must report all fixed asset changes, including obsolete or abandoned property, for accurate tax assessments.

Properly classifying assets as either personal property or real estate impacts tax obligations.

Investing in fixed asset management software can help you track and report assets to minimize your vineyard or winery’s personal property tax liability.

Vineyards and wineries are unique in their operations — combining agriculture, manufacturing, and hospitality. This complexity brings specific challenges in managing personal property taxes.

Common Personal Property Tax Challenges for Vineyards and Wineries

Let’s look at a few specific aspects of vineyards and wineries that make personal property tax compliance unique:

Obsolescence and Abandonment

Continued taxation of obsolete or abandoned property is one of the most common issues for vineyards and wineries. It’s not unusual to see old tractors, farm equipment, or other machinery sitting unused on vineyard land — sometimes for decades.

Although these assets are no longer functional and are not being depreciated on the books, they continue to appear on the personal property tax rolls and are subject to tax. Vineyard owners must take action to remove obsolete items from both their property and property tax renditions (personal property returns).

Asset Classification

Another challenge in managing personal property taxes for vineyards and wineries is correctly identifying and classifying the property type. The classification determines whether the asset is considered depreciable or real property, as each has different tax implications.

For example, mobile equipment — such as tractors used in the field and carts for transporting grapes to the processing center — is classified as personal property and assessed immediately upon being placed in service. On the other hand, in California, vines planted in the ground are not assessed until three years after the season of planting in vineyard form, giving them time to become productive.

Storing wine or grape juice in large vats adds another layer of complexity. Whether these vats are classified as real estate or personal property depends on whether they are affixed to the ground or movable.

In a tasting room, there may be tables, racks, and stools, all of which are depreciable property. However, if the room has a built-in bar, it is considered part of the building, having a much longer depreciable life.

It takes a deep understanding of the multitude of tax rules and the various types of property used in vineyard and winery operations to optimize the company’s tax position.

Technology

Modern wineries might also have high-tech equipment, such as computers and specialized machinery, that should be listed separately on tax renditions. These assets often have shorter depreciation lives, and accurate tracking helps avoid overpaying taxes.

Exemptions

The wine industry benefits from many specialized tax rules and exemptions.

For example, changes to the California property tax rules in 2017 allowed vineyards to write off certain planting costs, such as fertilizer, stakes, and wires, rather than capitalizing and depreciating them. Additionally, some counties offer exemptions for startup vineyards, which can provide significant tax savings.

If you (or your tax advisor) aren’t familiar with these exemptions, they are easy to overlook.

Multiple Entities or Locations

It’s not uncommon for larger operations to have separate entities for growing grapes and producing wines. An operator might also owe tax to multiple jurisdictions because the property is located in different towns and counties. Staying on top of property tax obligations for various entities and locations can be confusing and time-consuming.

Resources for Personal Property Tax Compliance

Your annual business property tax affidavit — California form BOE-571-L or BOE-571-A, operation dependent) — is typically due to the county on January 1. Once submitted, the county uses the property tax affidavit to calculate the business property tax liability.

Many companies remember to add new property purchased during the year and remove sold property but neglect to report obsolete and abandoned property. It’s the property owner’s responsibility to document and report obsolete items to prevent unnecessary tax payments. Neglecting this aspect of property tax reporting leads to overpaying taxes and issues during audits.

Investing in fixed asset software can help ensure accuracy. These tools help track acquisitions, disposals, and other changes in the asset base, making certain you report up-to-date and accurate information to the county.

Given the specialized nature of personal property tax issues in the wine industry, you can benefit from working with a firm that has experience and expertise in this area. This knowledge can be invaluable for understanding the various personal property tax exemptions available to vineyards and wineries.

How MGO Can Help

MGO offers comprehensive tax services — including income taxes, property taxes, and sales and use taxes — tailored to the unique needs of vineyards and wineries.

Reach out to our Vineyards and Wineries team for help reconciling your internal records with the county’s asset lists to identify and correct discrepancies. We can also recommend fixed asset software to help you maintain accurate records going forward. Then, you can focus on what you do best: producing exceptional wines.

Are You Ready to Optimize Your Tax Efficiency for Rescheduling?

Key Takeaways:

Cannabis companies face critical tax decisions following the notice of proposed rulemaking to reschedule cannabis.
Areas of consideration include reviewing open and estimated tax years, as well as assessing your current structure and its costs/benefits moving forward
Companies should also prepare for potential M&A opportunities and explore tax credits and incentives that could become available in a post-rescheduling world.

The federal government’s proposal to move cannabis from Schedule I to Schedule III carries significant tax implications beyond the (non-)application of 280E. It’s essential for your business to navigate this new landscape and make informed decisions to optimize your tax position.

Here are four key areas to consider:

1. Reviewing Open and Estimated Tax Years

Now is the time to review prior year tax returns, considering recent court cases and other factors to determine if protective claims or amended returns are warranted and could be beneficial. Evaluating how recent events should impact your 2024 quarterly estimated tax payments and future tax strategies is crucial.

2. Structuring for Post-280E Tax Efficiency

Legal and operating structures designed for a 280E environment may no longer be optimal post-rescheduling. Assess the costs and benefits of maintaining your current structure and explore tax-efficient alternatives to avoid phantom income and simplify transactions between related companies.

3. Navigating M&A Tax Considerations

With merger and acquisition (M&A) activity expected to accelerate, it is crucial to optimize your company’s tax structure for potential transactions. Whether you’re an acquirer or a target, understanding the tax due diligence process and making informed decisions in light of the rescheduling announcement is essential.

4. Leveraging Tax Credits and Incentives

Post-rescheduling, cannabis companies can finally take advantage of federal, state, and local tax credits and incentives previously unavailable. Identifying and qualifying for credits related to research and development, employees, clean energy, and more will be beneficial for your business.

How MGO Can Help You

MGO’s dedicated Cannabis practice has the experience and knowledge to help you navigate the complex tax implications and opportunities of rescheduling. Reach out to our team today.

Update: How the Latest Ruling on Farhy v. Commissioner Could Affect Your Penalty Assessments

Executive Summary

In April 2023, the U.S. Tax Court made news when it ruled in favor of businessman Alon Farhy, who challenged the Internal Revenue Service (IRS)’s authority to assess penalties for the failure to file IRS Form 5471.
IRS Form 5471 is the Information Return of U.S. Persons With Respect to Certain Foreign Corporations.
In May 2024, the U.S. Court of Appeals for the D.C Circuit reversed the Tax Court’s initial ruling — underscoring the significance of context in assessing penalties for international information returns.

UPDATE (May 2024):

Recent developments in the Farhy v. Commissioner case have captured significant attention in the tax and legal sectors. On May 3, 2024, the U.S. Court of Appeals reversed the Tax Court’s initial decision, highlighting the importance of statutory context in penalty assessments for international information returns. This ruling emphasizes the need for a closer examination of statutory language, altering perspectives on penalty applicability for non-compliance.

The implications of this case extend to taxpayers and practitioners, as detailed in analyses by MGO (see below). The decision underscores the need for meticulous compliance practices and adept navigation of the complexities of U.S. international tax law, along with a deep understanding of judicial interpretations of tax regulations.

MGO’s professionals are well-positioned to assist clients in navigating the complexities arising from the recent Farhy v. Commissioner decision. With a comprehensive understanding of the changing landscape in penalty assessments for international information returns, we provide guidance to help companies adapt to new judicial interpretations and maintain compliance with evolving tax regulations.

ORIGINAL ARTICLE (published June 8, 2023):

On April 3, 2023, the U.S. Tax Court came to a decision in the case Farhy v. Commissioner, ruling that the Internal Revenue Service (IRS) does not have the statutory authority to assess penalties for the failure to file IRS Form 5471, or the Information Return of U.S. Persons With Respect to Certain Foreign Corporations, against taxpayers. It also ruled that the IRS cannot administratively collect such penalties via levy.

Now that the IRS doesn’t have the authority to assess certain foreign information return penalties according to the court, affected taxpayers may want to file protective refund claims, even if the case goes to appeals — especially given the short statute of limitations of two years for claiming refunds.

Our Tax Controversy team breaks down the Farhy case, as well as what it may mean for your international filings — and the future of the IRS’s penalty collections.

The IRS Case Against Farhy

Alon Farhy owned 100% of a Belize corporation from 2003 until 2010, as well as 100% of another Belize corporation from 2005 until 2010. He admitted he participated in an illegal scheme to reduce his income tax and gained immunity from prosecution. However, throughout the time of his ownership of these two companies, he was required to file IRS Forms 5471 for both — but he didn’t.

The IRS then mailed him a notice in February 2016, alerting him of his failure to file. He still didn’t file, and in November 2018, he assessed $10,000 per failure to file, per year — plus a continuation penalty of $50,000 for each year he failed to file. The IRS determined his failures to file were deliberate, and so the penalties were met with the appropriate approval within the IRS.

Farhy didn’t dispute he didn’t file. He also didn’t deny he failed to pay. Instead, he challenged the IRS’s legal authority to assess IRC section 6038 penalties.

The Tax Court’s Initial Ruling

The U.S. Tax Court then held that Congress authorized the assessment for a variety of penalties — namely, those found in subchapter B of chapter 68 of subtitle F — but not for those penalties under IRC sections 6038(b)(1) and (2), which apply to Form 5471. Because these penalties were not assessable, the court decided the IRS was prohibited from proceeding with collection, and the only way the IRS can pursue collection of the taxpayer’s penalties was by 28 U.S.C. Sec. 2461(a) — which allows recovery of any penalty by civil court action.

How This Decision Affects Your International Penalty Assessments

This case holds that the IRS may not assess penalties under IRC section 6038(b), or failure to file IRS Form 5471. The case’s ruling doesn’t mean you don’t have an obligation to file IRS Form 5471 — or any other required form.

Ultimately, this decision is expected to have a broad reach and will affect most IRS Form 5471 filers, namely category 1, 4, and 5 filers (but not category 2 and 3 filers, who are subject to penalties under IRC section 6679).

However, the case’s impact could permeate even deeper. For years, some practitioners have spoken out against the IRS’s systemic assessment of international information return (IIR) penalties after a return is filed late, making it impossible for taxpayers to avoid deficiency procedures. The court’s decision now reveals how a taxpayer can be protected by the judicial branch when something is deemed unfair. Farhy took a stand, challenged the system, and won — opening the door for potential challenges in the future.

It’s uncertain as to whether the IRS will appeal the court’s decision. But it seems as though the stakes are too high for the IRS not to appeal. While we don’t know what will happen, a former IRS official has stated he expects that, for cases currently pending review by IRS Appeals, Farhy will not be viewed as controlling law yet.

The impact of the ruling is clear and will most likely impact many taxpayers who are contesting — or who have already paid — IRC 6038 penalties. It may also affect other civil penalties where Congress has not prescribed the method of assessment in the future.

How You Should Respond to the Court’s Decision

You should move quickly to take advantage of the court’s decision, as there is a two-year statute of limitations from the time a tax is paid to make a protective claim for a refund. It’s likely this legislation wouldn’t affect refund claims since that would be governed by the law that existed when the penalties were assessed. Note that per IRC section 6665(a)(2), there is no distinction between payments of tax, addition to tax, penalties, or interest — so all items are treated as tax.

If you’ve previously paid the $10,000 penalty, it’s important to file your protective claim now, unless you’ve entered into an agreement with the IRS to extend the statute of limitations, which can occur during an examination. Requesting a refund won’t ever hurt, but some practitioners believe the IRS may try to keep any penalty money it collected, even if the assessment is invalid — because, in its eyes, the claim may not be. Just know, you can file your protective claim for a refund, but may not get it (at least not any time soon).

The Farhy decision could likewise be applied to other US IRS forms, such as 5472, 8865, 8938, 926, 8858, 8854. Some argue the Farhy decision may also be applied to IRS Form 3520.

How MGO Can Help

Only time will tell if the court’s decision will open the government up to additional criticisms for other penalty assessments. If you have paid your penalties and are wondering what your current options are, MGO’s experienced International Tax team can help you determine if you’re eligible to file a refund claim.

10 Vital Tax and Accounting Tips for Artists and Creators

This article was created in collaboration with HUG, a global community for artists and art lovers.

Executive Summary:

Implementing basic accounting practices and understanding tax implications can help individuals working independently in creative fields gain clarity, meet obligations, and maximize income.
Separating business and personal finances, tracking income and expenses, and budgeting for estimated taxes can help creators be proactive in their financial planning.
Creators earning income across state lines or internationally need to be aware of varying taxation requirements in different jurisdictions.

Today’s artists need to view themselves as both businesses and creatives. Whether you are a painter, digital artist, photographer, website designer, YouTuber, Instagrammer, or any type of artist, creator, or influencer, understanding and managing your financial obligations is a crucial aspect of sustaining a thriving career.

Here are 10 tips to help you meet your tax reporting responsibilities and get the most from your hard-earned income:

1. Separate Your Finances

To make your accounting more efficient and streamline the tax-filing process, it is a smart idea to separate your business and personal finances. Designate a dedicated business account to track income and expenses related to your artistic endeavors. This separation not only simplifies tax reporting but also enhances financial clarity, making it easier to assess the overall health of your creative enterprise.

Tip: Establish a separate account for business transactions, or multiple business accounts to allocate money for categories such as expenses, taxes, and savings.

2. Record All Transactions

Sometimes it can be challenging to determine what constitutes income. That’s why it’s important to track everything. Gifts received by sponsors are often taxable, especially if they are products in exchange for services (e.g., promotion of product). “Donations” from various fundraising activities like Kickstarter are also considered revenue. On the other hand, crypto and non-fungible tokens (NFTs) are considered property. Selling them usually generates a capital gain or loss.

Tip: Log all payments and gifts received, even if you are unsure, so your tax preparer can report appropriately.

3. Track Your Expenses

Creators and artists can benefit from various tax deductions tailored to their industry. Deductible expenses may include art supplies, equipment, software subscriptions, professional development, and even a portion of your home used as a dedicated workspace. While expenses should not be excessive, any “ordinary and necessary” expenses of your craft can be deducted.

Tip: Save receipts and track expenses in real-time using a spreadsheet, app, or software for easy recording and reporting.

4. Consider Forming an Entity

Creators who run their own business are often independent contractors. Consider setting up an entity for the business — which can help protect your personal assets from your business assets and offer tax savings. S Corporations and LLCs are common for smaller businesses. For larger businesses where investors are coming in, C Corporation may make sense.

Tip: Do some research or talk to a tax professional to find out if setting up an entity makes business and financial sense for you.

5. Explore Credits You May Be Eligible For

Artists also may be eligible for various tax credits that can help offset their tax liability. Research and Development (R&D) credits can be applicable to certain creative processes, rewarding innovation in your artistic pursuits. For instance, software development is considered to be R&D for income tax purposes.

Tip: Consult a tax professional about ways to maximize credits and minimize your tax liability.

6. Don’t Overlook State and Local Taxes (SALT)

Beyond federal taxes, SALT significantly impact overall tax liability. When selling art online (whether physical or digital), be mindful of sales tax requirements, which are determined by local laws. Whether revenue is from “tangible” versus “intangible” products (physical objects versus services, ideas, software, etc.) can dictate where taxation occurs — affecting if your income is subject to sales tax or not.

Tip: Stay informed about varying tax rates, and be cautious of sales and use tax implications tied to transmitting creative art across state lines.

7. Plan for Estimated Taxes

As an independent contractor with variable income streams, you should plan for estimated taxes to avoid financial surprises. These quarterly payments encompass income taxes on your profits plus the self-employment tax (covering Social Security and Medicare). For those earning up to $160,200 in net income, the self-employment tax rate currently stands at 15.3%. The silver lining is that you can deduct half of this self-employment tax when filing your income taxes.

Tip: Set aside a portion of your income for estimated tax payments, ensuring proactive financial planning throughout the year.

8. Report Global Income and Claim Foreign Tax Credits

United States (U.S.) citizens or residents earning abroad must report all worldwide income to the Internal Revenue Service (IRS). If you’re earning income in or from foreign countries, it’s crucial to understand foreign tax credits, filing requirements, and deductibility in various jurisdictions. Every tax jurisdiction may have a different method to tax your creation; and different tax implications may arise based on where brands and intellectual property are created and protected.

Tip: Work with a tax professional to evaluate the potential benefits of foreign tax credits for non-U.S. income.

9. Learn Your Options for Transferring Wealth

Digital assets such as domain names, electronically stored photos, and videos to email and social media accounts all have value. When transferring these as gifts or bequests, there may be tax implications that can be circumvented if the transfer is appropriately structured or organized.

Tip: Consider trusts and estate planning for more tax-efficient wealth transfer.

10. Adapt a Business Owner Mindset

As an artist, embracing a business owner’s perspective is essential for long-term success. Understanding basic financial statements like balance sheets and profit and loss (P&L) statements allows you to gauge profitability, identify your most valuable revenue sources, and streamline your efforts. Elevating your financial literacy empowers you to make more informed decisions — which can lead to greater freedom and flexibility in your artistic career.

Quick Tip: Learn to read a balance sheet and create a basic P&L statement for a clearer financial picture.

Integrate Financial Management into Your Creative Journey

Effective financial planning is like a great work of art — every brushstroke matters. By taking these steps today you can better position yourself to continue pursuing your creative passion tomorrow.

Need a hand with taxes and accounting for your creative venture? Our Entertainment, Sports, and Media practice works with a diverse range of artists — from musicians to photographers to online creators — and our International Tax and State and Local Tax teams can provide guidance to help you address areas like sales tax or foreign tax credits. Reach out to MGO today.

California Moves to Crack Down on Out-of-State Trusts

Executive Summary

California Governor Newsom strives to amend the personal income tax laws to prevent wealthy taxpayers from utilizing Incomplete Gift Non-Grantor trusts.
California residents use this by transferring assets into trusts held by nonresident trustees in states without income tax.
If this legislation passes, taxpayers will no longer be able to take advantage of the strategy.

If you reduce California income tax with an ING, Newsom is onto you

Californian legislators propose to amend the personal income tax laws to close a little-known-but-effective loophole for the wealthy by targeting Incomplete Gift Non-Grantor (ING) trusts set up in other states with more favorable income tax rules. To date, California residents have had the opportunity to transfer assets into these trusts held by nonresident trustees in states without income tax, utilizing the state’s sourcing rules to avoid the tax. If approved, this new legislation will put a stop to this tax planning strategy.

Taxing the rich in California

As it stands, the ING trust is not commonly used. There are about 1,500 California residents with this trust in states without income tax — and if implemented, California would see a minimal revenue increase (about $30 million in the first year and $15 million in the following years). However, this would put an end to a tax planning strategy the wealthy have been using to their benefit for about 20 years.

Because California is home to more billionaires than any other state at the same time as it also has the highest rate of poverty in the U.S., the concept of taxing the rich holds a certain appeal. In the past, Newsom has opposed proposals to raise taxes — but this proposal was included in the governor’s $223.6 billion budget plan for the next fiscal year, which begins in July. Whether the item survives the legislative process remains to be seen, but if New York’s passage of a similar law in 2014 is any indication, we are likely to see the end of this tax planning strategy for California’s ultra-rich.

Moreover, this proposal has a retroactive element, differentiating it from New York’s and opening it up to potential lawsuits (New York trust holders had a five-month period to move their accounts to a different type of trust without incurring the tax). Newsom is pushing for the measure to begin the calendar year after its implementation.

How the ING works (worked)

What is an ING, and why is Newsom trying to prevent its use? California taxpayers can transfer their assets into out-of-state, incomplete, non-grantor trusts (INGs), which constitute separate, taxable entities under state and federal tax law, and this move avoids California income tax on any appreciation or gains from those assets because it is “sourced” to another state based on the location of the trustee (i.e., the bank or whatever financial institution offers the trustee services in the other state). The non-grantor aspect comes into play when the taxpayer establishing the trust (the “grantor”) gives up control over managing investments or distributing assets to the trustee (contrast with a “grantor trust” in which the grantor continues to control how money is invested/distributed within the trust during their lifetime). For the trust to be deemed “incomplete,” the grantors specify how the money can be used.

Some of the states where these trusts are typically established include Florida, Wyoming, Delaware, Nevada, Tennessee, and South Dakota. For example, a California resident (TP) may decide to transfer stock in their business into an ING established in South Dakota. If TP held the stock directly, then as a resident, all the dividends (or if he sold it, the gain) would be taxable by California on their personal income tax return. But since TP doesn’t hold the asset – the ING does – the ING recognizes the income relating to the stock. California’s current rules provide that the income is sourced to (and thus taxable in) the state where the trustee is domiciled, and for this ING that location is South Dakota, which, incidentally, does not tax this sort of income.

Newsom is hoping that by eliminating this tax-free option, the state of California will be able to increase tax revenue in a way that will not alienate a large number of voters.

How MGO can help

If you are a California resident and currently use an ING as a tax strategy, there are steps to take now to avoid a negative impact. MGO’s experienced Private Client Services team can help you identify and implement an effective response.

Tax Deadlines for California Storm Victims Extended

The IRS and the Franchise Tax Board (FTB) have granted California taxpayers affected by winter storms who reside or have a principal place of business in a county where a federal disaster declaration was made more time to file tax returns and to make tax payments. Taxpayers not in a covered disaster area, but whose records necessary to meet a deadline are in one, also qualify for relief.

The tax relief postpones tax filing and payment deadlines occurring between January 8, 2023, and May 15, 2023, to a new due date of October 15, 2023.

Some of the filings and payments postponed include:

Individual income tax returns due on April 18
Business tax returns normally due on March 15 and April 18
2022 contributions to IRAs and health savings accounts
Quarterly estimated tax payments normally due January 17 and April 18
Quarterly payroll and excise tax returns normally due on January 31 and April 30

The current list of counties that qualify for this relief can be found here.

If you qualify for this postponement, you generally do not need to contact the IRS or FTB to obtain relief. Relief is automatically granted for affected taxpayers who have an address of record located in one of the designated counties. However, if you still receive a late filing or late payment notice and the notice shows the original or extended filing, payment, or deposit due date falling within the postponement period, you should call the number on the notice to have the penalty abated.

If you have questions or need assistance, contact MGO’s experienced State and Local Tax team.

Disasters and Your Taxes. What you need to know.

Homeowners and businesses across the country have experienced weather-related disasters in recent months. From hurricanes, tornadoes and other severe storms to the wildfires again raging in the West, natural disasters have led to significant losses for a wide swath of taxpayers. If you’re among them, you may qualify for a federal income tax deduction, as well as other relief from the IRS.

Eligibility for the casualty loss deduction

Casualty losses can result from the damage, destruction or loss of property due to any sudden, unexpected or unusual event. Examples include floods, hurricanes, tornadoes, fires, earthquakes and volcanic eruptions. Normal wear and tear or progressive deterioration of property doesn’t constitute a deductible casualty loss. For example, drought generally doesn’t qualify.

The availability of the tax deduction for casualty losses varies depending on whether the losses relate to personal-use or business-use items. Generally, you can deduct casualty losses related to your home, household items and personal vehicles if they’re caused by a federally declared disaster — meaning a disaster that occurred in an area that the U.S. president declares eligible for federal assistance. Casualty losses related to business or income-producing property (for example, rental property) can be deducted regardless of whether they occur in a federally declared disaster area.

Casualty losses are deductible in the year of the loss, usually the year of the casualty event. If your loss stemmed from a federally declared disaster, you can opt to treat it as having occurred in the previous year. You may receive your refund more quickly if you amend the previous year’s return than if you wait until you file your return for the casualty year.

The role of reimbursements

If your casualty loss is covered by insurance, you must reduce the loss by the amount of any reimbursement or expected reimbursement. (You also must reduce the loss by any salvage value). Reimbursement also could lead to capital gains tax liability.

When the amount you receive from insurance or other reimbursements (less any expense you incurred to obtain reimbursement, such as the cost of an appraisal) exceeds the cost or adjusted basis of the property, you have a capital gain. You’ll need to include that gain as income unless you’re eligible to postpone reporting the gain.

You may be able to postpone the reporting obligation if you purchase property that’s similar in service or use to the destroyed property within the specified replacement period. You also can postpone if you buy a controlling interest (at least 80%) in a corporation owning similar property or if you spend the reimbursement to restore the property.

Alternatively, you can offset casualty gains with casualty losses not attributable to a federally declared disaster. This is the only way you can deduct personal-use property casualty losses incurred in areas not declared disaster areas.

The loss amount vs. the deduction

For personal-use property, or business-use or income-producing property that isn’t completely destroyed, your casualty loss is the lesser of:
• The adjusted basis of the property immediately before the loss (generally, your original cost, plus improvements and less depreciation), or
• The drop in fair market value (FMV) of the property as a result of the casualty (that is, the difference between the FMV immediately before and immediately after the casualty).

For business-use or income-producing property that’s completely destroyed, the amount of the loss is the adjusted basis less any salvage value and reimbursements.

If a single casualty involves more than one piece of property, you must figure the loss on each separately. You then combine these losses to determine the casualty loss.

An exception applies to personal-use real property, such as a home. The entire property (including improvements such as landscaping) is treated as one item. The loss is the smaller of the decline in FMV of the entire property and the entire property’s adjusted basis.

Other limits may apply to the amount of the loss you may deduct, too. For personal-use property, you must reduce each casualty loss by $100 (after you’ve subtracted any salvage value and reimbursement).

If you suffer more than one casualty loss during the tax year, you must reduce each loss by $100 and report each on a separate IRS form. If two or more taxpayers have losses from the same casualty, the $100 rule applies separately to each taxpayer.

But that’s not all. For personal-use property, you also must reduce your total casualty losses by 10% of your adjusted gross income, after you’ve applied the $100 rule. As a result, smaller personal-use casualty losses often provide little or no tax benefit.

The requisite records

Documentation is critical to claim a casualty loss deduction. You’ll need to be able to show:
• That you were the owner of the property or, if you leased it, that you were contractually liable to the owner for the damage,
• The type of casualty and when it occurred,
• That the loss was a direct result of the casualty, and
• Whether a claim for reimbursement with a reasonable expectation of recovery exists.

You also must be able to establish your adjusted basis, reimbursements and, for personal-use property, pre- and post-casualty FMVs.

Additional relief

The IRS has granted tax relief this year to victims of numerous natural disasters, including “affected taxpayers” in Alabama, California, Kentucky, Louisiana, Michigan, Mississippi, New Jersey, New York, Oklahoma, Pennsylvania, Tennessee, and Texas. The relief typically extends filing and other deadlines. (For detailed information for your state visit: https://bit.ly/3nzF2ui.)

Note that you can be an affected taxpayer even if you don’t live in a federally declared disaster area. You’re considered affected if records you need to meet a filing or payment deadline postponed during the applicable relief period are located in a covered disaster area. For example, if you don’t live in a disaster area, but your tax preparer does and is unable to pay or file on your behalf, you likely qualify for filing and payment relief.

A team effort

If you’ve incurred casualty losses this year, tax relief could mitigate some of the financial pain. We can help you maximize your tax benefits and ensure compliance with any extensions.

Potential Tax Law Changes Hang Over Year-End Tax Planning for Individuals

As if another year of the COVID-19 pandemic wasn’t enough to produce an unusual landscape for year-end tax planning, Congress continues to negotiate the budget reconciliation bill. The proposed Build Back Better Act (BBBA) is certain to include some significant tax provisions, but much uncertainty remains about their impact. While we wait to see which tax provisions are ultimately included in the BBBA, here are some year-end tax planning strategies to consider to reduce your 2021 tax liability.

Accelerate and defer with care

One of the most reliable year-end tactics for reducing taxes has long been to accelerate your deductible expenses and defer your income. For example, self-employed individuals who use cash-basis accounting can delay invoices until late December and move up the planned purchase of equipment or the payment of estimated state income taxes from early next year to this year.

This technique has always carried the caveat that you generally shouldn’t pursue it if you expect to be in a higher tax bracket the following year. Potential provisions in the BBBA also may make it advisable for certain taxpayers to reverse the strategy for 2021 — that is, accelerate income and defer deductible expenses.

The current version of the BBBA would impose a new “surtax” of 5% on modified adjusted gross income (MAGI) that exceeds $10 million, with an additional 3% on income of more than $25 million. As a result, the highest earners could pay a 45% federal marginal income tax on wages and business income (the current 37% income tax rate plus 8%). It could be even higher when combined with the net investment income tax, which might be expanded to include active business income for pass-through entities.

In addition, there’s a proposal to temporarily increase the $10,000 cap on the state and local tax deduction to $80,000. Individuals in high-tax states should consider whether there may be an advantage to accelerating a 2022 property or estimated state income tax payment into 2021, or whether the deduction might be more valuable next year, particularly if they’ll face a higher effective tax rate.

Leverage your losses

Taxpayers with substantial capital gains in 2021 could benefit from “harvesting” their losses before year-end. Capital losses can be used to offset capital gains, and up to $3,000 ($1,500 for married persons filing separately) of excess losses (those that exceed the amount of gains for the year) can be applied against ordinary income. Any remaining losses can be carried forward indefinitely.

Beware, however, of the wash-sale rule. Generally, the rule prohibits the deduction of a loss if you acquire “substantially identical” investments within 30 days, before or after, of the date of the sale.

Taxpayers who itemize their deductions could compound their tax benefits by donating the proceeds from the sale of a depreciated investment to a charity. They can both offset realized gains and claim a charitable contribution deduction for the donation.

Satisfy your charitable inclinations

For 2021, charitable contributions can reduce taxes for both itemizers and non-itemizers. Taxpayers who take the standard deduction can claim an above-the-line deduction of $300 ($600 for married couples filing jointly) for cash contributions to qualified charitable organizations.

The adjusted gross income limit for cash donations is 100% for 2021; it’s scheduled to return to 60% for 2022. That means you could offset all of your taxable income with charitable contributions this year. (Donations to donor advised funds and private foundations don’t qualify, though.)

Taxpayers who don’t generally itemize can benefit by “bunching” their charitable contributions. In other words, delaying or accelerating contributions into a tax year to exceed the standard deduction and claim itemized deductions. For example, if you usually make your donations at the end of the year, you could bunch donations in alternative years — say, donate in January and December of 2022 and January and December of 2024.

Retired taxpayers who are age 70½ and older can reduce their taxable income by making qualified charitable contributions of up to $100,000 from their non-Roth IRAs. Retired or not, individuals age 72 and older can use such contributions to satisfy their annual required minimum distributions (RMDs). Note that RMDs were suspended for 2020 but are effective for 2021.

So long as the assets would be considered long-term if they were sold, donations of appreciated assets offer a double-barreled tax benefit. You avoid the capital gains tax on the appreciation and can deduct the asset’s fair market value as of the date of the gift.

Convert traditional IRAs to Roth IRAs

As in 2020, when many taxpayers saw lower than typical income, 2021 could be a smart time to convert funds in traditional pre-tax IRAs to an after-tax Roth IRA. Roth IRAs have no RMDs, and distributions are tax-free.

You’ll have to pay income tax on the converted funds, but it’s better to do so while subject to lower tax rates. Similarly, if you convert securities that have dropped in value, your tax may well be lower now than down the road — and any subsequent appreciation while in the Roth IRA will be tax-free.

It’s worth noting that President Biden had proposed including a provision in the BBBA that would limit the ability of wealthy individuals to engage in Roth conversions. There was a lot of back-and-forth with respect to these provisions, and the latest version of the House bill includes certain restrictions. Whether these provisions will make it past any Senate amendments remains to be seen, but the proposal could be a harbinger of future proposed restrictions.

Proceed with caution

The strategies outlined above always come with pros and cons, but perhaps never more so than now, when potentially significant tax legislation that would take effect next year is under negotiation. We can help you chart the best course in light of any developments.