Under tax law, businesses can generally deduct advertising and marketing expenses that help keep existing customers and bring in new ones. This valuable tax deduction can help businesses cut their taxes.

However, in order to be deductible, advertising and marketing expenses must be “ordinary and necessary.” As one taxpayer recently learned in U.S. Tax Court, not all expenses are eligible. An ordinary expense is one that’s common and accepted in the industry. And a necessary expense is one that’s helpful and appropriate for the business.

According to the IRS, here are some advertising expenses that are usually deductible:

• Reasonable advertising expenses that are directly related to the business activities.
• An expense for the cost of institutional or goodwill advertising to keep the business name before the public if it relates to a reasonable expectation to gain business in the future. For example, the cost of advertising that encourages people to contribute to the Red Cross or to participate in similar causes is usually deductible.
• The cost of providing meals, entertainment, or recreational facilities to the public as a means of advertising or promoting goodwill in the community.

Facts of the recent case

An attorney deducted his car-racing expenses and claimed they were advertising for his personal injury law practice. He contended that his racing expenses, totaling over $303,000 for six tax years, were deductible as advertising because the car he raced was sponsored by his law firm.

The IRS denied the deductions and argued that the attorney’s car racing wasn’t an ordinary and necessary expense paid or incurred while carrying on his business of practicing law. The Tax Court agreed with the IRS.

When making an ordinary and necessary determination for an expense, most courts look to the taxpayer’s primary motive for incurring the expense and whether there’s a “proximate” relationship between the expense and the taxpayer’s occupation. In this case, the taxpayer’s car-racing expenses were neither necessary nor common for a law practice, so there was no “proximate” relationship between the expense and the taxpayer’s occupation. And, while the taxpayer said his primary motive for incurring the expense was to advertise his law business, he never raced in the state where his primary law practice was located and he never actually got any legal business from his car-racing activity.

The court noted that the car “sat in his garage” after he returned to the area where his law practice was located. The court added that even if the taxpayer raced in that area, “we would not find his expenses to be legitimate advertising expenses. His name and a decal for his law firm appeared in relatively small print” on his car.

This form of “signage,” the court stated, “is at the opposite end of the spectrum from (say) a billboard or a newspaper ad. Indeed, every driver’s name typically appeared on his or her racing car.” (TC Memo 2023-18)

Keep meticulous records

There are no deductions allowed for personal expenses or hobbies. But as explained above, you can deduct ordinary and necessary advertising and marketing expenses in a bona fide business. The key to protecting your deductions is to keep meticulous records to substantiate them. Contact us with questions about your situation.

© 2023

If you’re buying or replacing a vehicle that you’ll use in your business, be aware that a heavy SUV may provide a more generous tax break this year than you’d get from a smaller vehicle. The reason has to do with how smaller business cars are depreciated for tax purposes.

Depreciation rules

Business cars are subject to more restrictive tax depreciation rules than those that apply to other depreciable assets. Under the so-called “luxury auto” rules, depreciation deductions are artificially “capped.” Those caps also extend to the alternative deduction that a taxpayer can claim if it elects to use Section 179 expensing for all or part of the cost of a business car. (It allows you to write-off an asset in the year it’s placed in service.)

These rules include smaller trucks or vans built on truck chassis that are treated as cars. For most cars that are subject to the caps and that are first placed in service in calendar year 2023, the maximum depreciation and/or expensing deductions are:

• $20,200 for the first tax year in its recovery period (2023 for calendar-year taxpayers);
• $19,500 for the second tax year;
• $11,700 for the third tax year; and
• $6,960 for each succeeding tax year.

Generally, the effect is to extend the number of years it takes to fully depreciate the vehicle.

Because of the restrictions for cars, you may be better off from a tax timing perspective if you replace your business car with a heavy SUV instead of another car. That’s because the caps on annual depreciation and expensing deductions for passenger automobiles don’t apply to trucks or vans that are rated at more than 6,000 pounds gross (loaded) vehicle weight. This includes large SUVs, many of which are priced over $50,000.

The result is that in most cases, you’ll be able to write-off a majority of the cost of a new SUV used entirely for business purposes by utilizing bonus and regular depreciation in the year you place it into service. For 2023, bonus depreciation is available at 80%, but is being phased down to zero over the next few years.

If you consider electing Section 179 expensing for all or part of the cost of an SUV, you need to know that an inflation-adjusted limit, separate from the general caps described above, applies ($28,900 for an SUV placed in service in tax years beginning in 2023, up from $27,000 for an SUV placed in service in tax years beginning in 2022). There’s also an aggregate dollar limit for all assets elected to be expensed in the year that would apply. Following the expensing election, you would then depreciate the remainder of the cost under the usual rules without regard to general annual caps.

Please note that the tax benefits described above are all subject to adjustment for non-business use. Also, if business use of an SUV doesn’t exceed 50% of total use, the SUV won’t be eligible for the expensing election, and would have to be depreciated on a straight-line method over a six-tax-year period.

Contact us for more details about this opportunity to get hefty tax write-offs if you buy a heavy SUV for business.

© 2023

Many people began working from home during the COVID-19 pandemic — and many still work from their home offices either all the time or on a hybrid basis. If you’re self-employed and run your business from home or perform certain functions there, you might be able to claim deductions for home office expenses against your business income. There are two methods for claiming this tax break: the actual expense method and the simplified method.

How to qualify

In general, you qualify for home office deductions if part of your home is used “regularly and exclusively” as your principal place of business.

If your home isn’t your principal place of business, you may still be able to deduct home office expenses if:

1. You physically meet with patients, clients or customers on your premises, or
2. You use a storage area in your home (or a separate free-standing structure, such as a garage) exclusively and regularly for business.

Expenses you can deduct

Many eligible taxpayers deduct actual expenses when they claim home office deductions. Deductible home office expenses may include:

• Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,
• A proportionate share of indirect expenses, including mortgage interest, rent, property taxes, utilities, repairs and insurance, and
• Depreciation.

But keeping track of actual expenses can take time and it requires organized recordkeeping.

The simpler method

Fortunately, there’s a simplified method: You can deduct $5 for each square foot of home office space, up to a maximum of $1,500.

The cap can make the simplified method less valuable for larger home office spaces. Even for small spaces, taxpayers may qualify for bigger deductions using the actual expense method. So, tracking your actual expenses can be worth it.

Changing methods 

When claiming home office deductions, you’re not stuck with a particular method. For instance, you might choose the actual expense method on your 2022 return, use the simplified method when you file your 2023 return next year and then switch back to the actual expense method for 2024. The choice is yours.

What if I sell the home?

If you sell — at a profit — a home on which you claimed home office deductions, there may be tax implications. We can explain them to you.

Also be aware that the amount of your home office deductions is subject to limitations based on the income attributable to your use of the office. Other rules and limitations may apply. But any home office expenses that can’t be deducted because of these limitations can be carried over and deducted in later years.

Different rules for employees

Unfortunately, the Tax Cuts and Jobs Act suspended the business use of home office deductions from 2018 through 2025 for employees. Those who receive paychecks or Form W-2s aren’t eligible for deductions, even if they’re currently working from home because their employers closed their offices due to COVID-19.

We can help you determine if you’re eligible for home office deductions and how to proceed in your situation.

© 2023

Merger and acquisition activity dropped dramatically last year due to rising interest rates and a slowing economy. The total value of M&A transactions in North America in 2022 was down 41.4% from 2021, according to S&P Global Market Intelligence.

But some analysts expect 2023 to see increased M&A activity in certain industries. If you’re considering buying or selling a business, it’s important to understand the tax implications.

Two approaches

Under current tax law, a transaction can basically be structured in two ways:

1. Stock (or ownership interest). A buyer can directly purchase a seller’s ownership interest if the target business is operated as a C or S corporation, a partnership, or a limited liability company (LLC) that’s treated as a partnership for tax purposes.

The current 21% corporate federal income tax rate makes buying the stock of a C corporation somewhat more attractive. That’s because the corporation will pay less tax and generate more after-tax income. Plus, any built-in gains from appreciated corporate assets will be taxed at a lower rate when they’re eventually sold.

The current individual federal tax rates have also made ownership interests in S corporations, partnerships and LLCs more attractive. Reason: The passed-through income from these entities also is taxed at lower rates on a buyer’s personal tax return. However, individual rate cuts are scheduled to expire at the end of 2025.

2. Assets. A buyer can also purchase the assets of a business. This may happen if a buyer only wants specific assets or product lines. And it’s the only option if the target business is a sole proprietorship or a single-member LLC that’s treated as a sole proprietorship for tax purposes.

What buyers want

For several reasons, buyers usually prefer to buy assets rather than ownership interests. In general, a buyer’s primary goal is to generate enough cash flow from an acquired business to pay any acquisition debt and provide an acceptable return on the investment. Therefore, buyers are concerned about limiting exposure to undisclosed and unknown liabilities and minimizing taxes after a transaction closes.

A buyer can step up (or increase) the tax basis of purchased assets to reflect the purchase price. Stepped-up basis lowers taxable gains when certain assets, such as receivables and inventory, are sold or converted into cash. It also increases depreciation and amortization deductions for qualifying assets.

What sellers want

In general, sellers prefer stock sales for tax and nontax reasons. One of their objectives is to minimize the tax bill from a sale. That can usually be achieved by selling their ownership interests in a business (corporate stock, or partnership or LLC interests) as opposed to selling assets.

With a sale of stock or other ownership interest, liabilities generally transfer to the buyer and any gain on sale is generally treated as lower-taxed long-term capital gain (assuming the ownership interest has been held for more than one year).

Seek advice before a transaction

Be aware that other issues, such as employee benefits, can also cause tax issues in M&A transactions. Buying or selling a business may be the largest transaction you’ll ever make, so it’s important to seek professional assistance before finalizing a deal. After a transaction is complete, it may be too late to get the best tax results. Contact us about how to proceed.

© 2023

Many businesses in certain industries employ individuals who receive tips as part of their compensation. These businesses include restaurants, hotels and salons.

Tip definition

Tips are optional payments that customers make to employees who perform services. They can be cash or noncash. Cash tips include those received directly from customers, electronically paid tips distributed to employees by employers and tips received from other employees under tip-sharing arrangements. Generally, workers must report cash tips to their employers. Noncash tips are items of value other than cash. They may include tickets, passes or other items that customers give employees. Workers don’t have to report noncash tips to employers.

For tax purposes, four factors determine whether a payment qualifies as a tip:

1. The customer voluntarily makes the payment,
2. The customer has the unrestricted right to determine the amount,
3. The payment isn’t negotiated with, or dictated by, employer policy, and
4. The customer generally has the right to determine who receives the payment.

Tips can also be direct or indirect. A direct tip occurs when an employee receives it directly from a customer, even as part of a tip pool. Directly tipped employees include wait staff, bartenders and hairstylists. An indirect tip occurs when an employee who normally doesn’t receive tips receives one. Indirectly tipped employees include bussers, service bartenders, cooks and salon shampooers.

Daily tip records

Tipped workers must keep daily records of the cash tips they receive. To keep track of them, they can use Form 4070A, Employee’s Daily Record of Tips. It is found in IRS Publication 1244.

Workers should also keep records of the dates and value of noncash tips. Although the IRS doesn’t require workers to report noncash tips to employers, they must report them on their tax returns.

Reporting to employers

Employees must report tips to employers by the 10th of the month following the month they were received. The IRS doesn’t require workers to use a particular form to report tips. However, a worker’s tip report generally should include:

• The employee’s name, address, Social Security number and signature,
• The employer’s name and address,
• The month or period covered, and
• Total tips received during the period.

Note: Employees whose monthly tips are less than $20 don’t need to report them to their employers but must include them as income on their tax returns.

Employer requirements

Employers should send each employee a Form W-2 that includes reported tips. Employers also must:

• Keep their employees’ tip reports.
• Withhold taxes, including income taxes and the employee’s share of Social Security tax and Medicare tax, based on employees’ wages and reported tip income.
• Pay the employer share of Social Security and Medicare taxes based on the total wages paid to tipped employees as well as reported tip income.
• Report this information to the IRS on Form 941, Employer’s Quarterly Federal Tax Return.
• Deposit withheld taxes in accordance with federal tax deposit requirements.

In addition, “large” food or beverage establishments must file an annual report disclosing receipts and tips on Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips.

Tip tax credit

If you’re an employer with tipped workers providing food and beverages, you may qualify for a federal tax credit involving the Social Security and Medicare taxes that you pay on employees’ tip income. The tip tax credit may be valuable to you. If you have any questions about the tax implications of tips, don’t hesitate to contact us.

© 2023

An array of tax-related limits that affect businesses are indexed annually, and due to high inflation, many have increased more than usual for 2023. Here are some that may be important to you and your business.

Social Security tax

The amount of employees’ earnings that are subject to Social Security tax is capped for 2023 at $160,200 (up from $147,000 for 2022).

Deductions 

• Section 179 expensing:
  • Limit: $1.16 million (up from $1.08 million)
  • Phaseout: $2.89 million (up from $2.7 million)
• Income-based phase-out for certain limits on the Sec. 199A qualified business income deduction begins at:
  • Married filing jointly: $364,200 (up from $340,100)
  • Other filers: $182,100 (up from $170,050)

Retirement plans 

• Employee contributions to 401(k) plans: $22,500 (up from $20,500)
• Catch-up contributions to 401(k) plans: $7,500 (up from $6,500)
• Employee contributions to SIMPLEs: $15,500 (up from $14,000)
• Catch-up contributions to SIMPLEs: $3,500 (up from $3,000)
• Combined employer/employee contributions to defined contribution plans (not including catch-ups): $66,000 (up from $61,000)
• Maximum compensation used to determine contributions: $330,000 (up from $305,000)
• Annual benefit for defined benefit plans: $265,000 (up from $245,000)
• Compensation defining a highly compensated employee: $150,000 (up from $135,000)
• Compensation defining a “key” employee: $215,000 (up from $200,000)

Other employee benefits

• Qualified transportation fringe-benefits employee income exclusion: $300 per month (up from $280)
• Health Savings Account contributions:
  • Individual coverage: $3,850 (up from $3,650)
  • Family coverage: $7,750 (up from $7,300)
  • Catch-up contribution: $1,000 (no change)
• Flexible Spending Account contributions:
  • Health care: $3,050 (up from $2,850)
  • Dependent care: $5,000 (no change)

These are only some of the tax limits and deductions that may affect your business and additional rules may apply. Contact us if you have questions.

© 2023