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1031 Exchanges: what qualifies and where investors get tripped up

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April 01, 2025 | by Atherton & Associates, LLP

If you’re thinking about selling investment real estate, you’ve probably heard someone say, “Just do a 1031 exchange—you won’t pay any tax.” That’s partially accurate but also an oversimplification.

The IRS does allow you to defer capital gains taxes on the sale of certain property, but the rules around Section 1031 exchanges are a bit more nuanced than most people realize. And getting it wrong—especially on what qualifies—can result in unexpected tax liability.

What is a 1031 exchange?

In short, a 1031 exchange lets you sell one piece of investment or business-use real estate and defer the capital gains taxes by rolling the proceeds into another qualifying property. It’s named after Section 1031 of the Internal Revenue Code, and it’s been around in some form for over 100 years.

The key concept here is “like-kind.” You’re exchanging one like-kind property for another.

Importantly, the IRS requires that a third-party intermediary facilitate the exchange process. This entity is called a qualified intermediary (QI), and it plays a role in nearly all exchanges.

What types of property qualify?

Under current law, only real property qualifies for a 1031 exchange. That’s a change from pre-2018 rules—before then, certain personal property (like equipment or aircraft) could be exchanged, too. The Tax Cuts and Jobs Act (TCJA) narrowed it to real estate only (IRC §1031(a)(1)).

Now, eligible real property can include:

  • Commercial buildings
  • Rental properties (residential or mixed-use)
  • Raw land
  • Industrial facilities
  • Retail centers
  • Oil, gas, and mineral interests, in certain circumstances

Even long-term leasehold interests (typically 30 years or more) may qualify in some cases.

It’s also worth noting: the properties don’t have to be the same type. You can exchange raw land for an apartment complex or a strip mall for a warehouse. As long as both are held for investment or business use, the IRS generally treats them as like-kind (Treas. Reg. §1.1031(a)-1(b)).

What doesn’t qualify?

Several categories of property are ineligible for 1031 treatment. These include:

  • Property held primarily for resale (think fix-and-flip properties or land held for development and quick turnover)
  • Primary residences
  • Second homes or vacation homes, unless they meet strict rental and use requirements
  • Foreign property (U.S. property must be exchanged for U.S. property only)

Additionally, personal-use items such as vehicles, equipment, or artwork are excluded from eligibility under the current rules, regardless of how they are used in a business context.

Vacation rentals: a common gray area

Vacation homes used for both rental and personal purposes can fall into a gray area. The IRS has provided a safe harbor under Revenue Procedure 2008-16 that allows some vacation rentals to qualify, but strict requirements apply:

  • The property must be rented for at least 14 days per year;
  • Personal use must be limited to 14 days or 10% of the rental days, whichever is greater;
  • The taxpayer must meet these criteria for at least two years before and after the exchange.

If these thresholds aren’t met, the property is unlikely to qualify under 1031 rules.

Timing rules

Even if your properties qualify, the timeline rules are strict:

  • You have 45 days from the sale of your relinquished property to identify a replacement property.
  • You have 180 days to close on the replacement.

And yes, these timelines run concurrently. Day 180 doesn’t reset after Day 45—it’s all from the date of the first sale.

If either deadline is missed, the exchange fails, and the gain becomes taxable.

Intent matters

Although not explicitly stated in the statute, intent is a critical factor. The IRS and courts often evaluate whether the property was truly acquired for investment or business use.

For instance, if a taxpayer acquires a replacement property and sells it within a few months, the IRS may challenge the exchange based on a lack of investment intent. Similarly, attempting to exchange into a personal residence may raise concerns unless the property is held as a rental for a significant period first.

There’s no statutory holding period, but retaining the replacement property for at least one year is generally considered a prudent guideline.

The role of the qualified intermediary

Many taxpayers are surprised to learn that they cannot take direct possession of the sale proceeds in a 1031 exchange—not even temporarily. If you receive the funds, even for a day, the IRS considers the exchange invalid, and the gain becomes taxable.

That’s where the qualified intermediary comes in.

A QI—sometimes referred to as an exchange accommodator or facilitator—holds the proceeds from the sale of your relinquished property in escrow until they are used to purchase the replacement property. The QI may also prepare the necessary exchange documentation, ensure compliance with IRS regulations, and help manage the strict timeline requirements.

Why is a QI necessary?

Because IRS rules explicitly prohibit the taxpayer from having constructive receipt of the funds. Even if you never deposit the check, routing the proceeds through your own attorney or escrow agent can disqualify the exchange if not structured properly.

Clients often ask why this intermediary is necessary and why it comes with an out-of-pocket cost. The reality is that the QI is not just a formality—it’s a critical safeguard in keeping the exchange compliant. While fees vary, the cost is generally modest relative to the tax deferral benefit.

Advanced exchange options

Sometimes, your situation just doesn’t line up neatly with the typical 1031 exchange timeline or structure. Fortunately, there are more flexible options—but they come with extra complexity.

Reverse exchanges: buy first, sell later

In a standard exchange, the relinquished property is sold first. But what happens if you identify the ideal replacement property before you’ve finalized the sale?

That’s where a reverse exchange becomes useful. In this structure, a qualified intermediary—through an Exchange Accommodation Titleholder (EAT)—temporarily holds title to either the relinquished or replacement property during the transaction.

The 45-day and 180-day deadlines still apply, but in reverse sequence. This allows more flexibility in timing, but adds cost and complexity. Financing can also be more challenging, since the EAT holds legal title to the property during part of the exchange process.

Still, it’s a valuable tool when market timing doesn’t cooperate.

Build-to-suit exchanges: customize your replacement property

If the replacement property requires significant renovation—or if you intend to build on undeveloped land—you might consider a build-to-suit exchange, also known as an improvement exchange.

This structure allows exchange proceeds to be used for construction or renovation before the taxpayer takes legal title. Again, the intermediary (via an EAT) holds title during the build-out phase.

However, all improvements must be completed within the 180-day exchange window, and ownership must be formally transferred to the taxpayer within that period. If improvements are incomplete, only the value of what’s been completed by day 180 can be counted toward deferral.

These exchanges take careful planning and close coordination between your CPA, your intermediary, and your builder.

Laddering exchanges: long-term planning for real estate investors

Many experienced investors use laddering as a long-term strategy. Essentially, you start with one property, exchange into a larger or better-performing one, then do it again. And again. Each time, you defer the gain and build more equity.

Eventually, you may decide to cash out and recognize the gain (hopefully in a lower-tax year). Or, you may hold the final property until death—in which case your heirs get a step-up in basis, and the deferred gain essentially disappears.

It’s a long-game strategy, but it’s one that many successful investors use to build wealth and reduce taxes along the way.

A 1031 exchange can be a powerful tax strategy—if you get the details right

A well-structured exchange can preserve capital and open the door to better investment opportunities. But it’s not a DIY strategy. The rules around property type, timing, and use all require careful execution.

If you’re considering a sale or contemplating a new investment, we strongly recommend discussing your options with a tax advisor early in the process. We can help you weigh your options, identify potential roadblocks, and structure the exchange in a way that actually works.

For personalized guidance, please contact our office.

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FinCEN’s new BOI filing deadline: Implications for small businesses

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February 26, 2025 | by Atherton & Associates, LLP

Small business owners tracking their compliance obligations now have a new date to mark on their calendars: the Financial Crimes Enforcement Network (FinCEN) has announced March 21 as the revised deadline for most entities that must file Beneficial Ownership Information (BOI) reports under the Corporate Transparency Act (CTA). This announcement follows a series of legal challenges that briefly halted the filing requirement, only for the courts to lift the injunctions and revive the law. Below is a detailed overview of how the CTA and its BOI reporting rules affect small businesses, along with steps to prepare for compliance.

Understanding the Corporate Transparency Act (CTA) and Beneficial Ownership Information (BOI)

The Corporate Transparency Act was passed to bolster anti-money-laundering measures in the United States by collecting specific information about the real people who ultimately own or control certain small businesses. Although large entities usually have existing disclosure obligations, the CTA extends these requirements to smaller corporations, limited liability companies (LLCs), and similar structures. The goal is to prevent criminal actors from hiding their financial dealings behind corporate veils. However, small businesses find themselves at the heart of the CTA’s mandates, often due to limited awareness or resources to keep up with new federal filing obligations.

Under the CTA’s rules, these businesses must submit Beneficial Ownership Information directly to FinCEN, disclosing details about each beneficial owner. The CTA aims to make it more difficult for criminals to exploit shell companies, but it also places an administrative burden on many small businesses that have never before faced such federal disclosure requirements. Meanwhile, ongoing legal and legislative developments continue to shape the CTA’s enforcement timeline.

Recent Legal Developments and the New Filing Deadline

Background on Delays and Injunctions

The path to the current March 21 filing deadline was anything but straightforward. After the CTA became law, FinCEN initially set filing obligations to begin in early 2025 for most existing small businesses. However, in the wake of legal challenges filed in federal courts, injunctions paused the collection of BOI. The central argument in these lawsuits revolved around the reach of federal authority over small businesses, as well as concerns about potential privacy violations.

For a period, these injunctions meant that intended deadlines—such as January 13—were no longer in effect and businesses remained in limbo. The legal situation changed dramatically when courts lifted these injunctions, most recently through a case that granted a stay of a nationwide block on the CTA’s BOI reporting requirements. As soon as that final injunction was lifted, FinCEN reestablished a compliance window for BOI filings and pushed the overarching deadline to March 21. This new date applies to businesses that originally needed to file by early 2025 but were affected by the litigation delays. For entities created or registered on or after February 18, 2025, they must file their BOI report within 30 days of formation or registration.

Exceptions & Later Deadlines

Although March 21 applies broadly to the majority of small businesses, some entities have different timelines. If a company had already received a filing extension because of disaster relief or other circumstances, that later deadline remains valid. Businesses, for example, with an April 2025 extension should keep their previously assigned due date. Likewise, FinCEN has signaled it may further revise the deadlines if it determines that businesses need more time or if compliance can be prioritized towards higher-risk scenarios. Over the next 30 days, FinCEN will assess how to handle specific categories of small businesses that it believes pose lower short-term security risks.

Which Businesses Must File

Defining “Reporting Companies”

The CTA casts a wide net to cover most U.S.-based corporations, limited liability companies, and other similar entities formed by filing paperwork with a state authority. Many of these entities have fewer than 20 employees and might have minimal financial activity. Nonetheless, the law presumes these small businesses are potential vehicles for illicit financial activity if their ownership structures are not transparent.

There are exceptions. Sole proprietorships and general partnerships that have not registered with a state typically do not need to file, as they are not formed through the same formal processes as corporations or LLCs. Additionally, certain larger or more heavily regulated entities, such as publicly traded companies, generally already have robust disclosure frameworks and are outside the CTA’s BOI requirements.

Required Information

Reporting companies must disclose identification details for each “beneficial owner.” A beneficial owner is any individual who exercises substantial control or owns at least 25% of the business. The submitted information typically includes the individual’s full legal name, date of birth, current residential or business address, and a unique identifier (such as a passport or driver’s license number).

Additionally, for new entities formed on or after January 1, 2024, the CTA introduces the concept of “company applicants.” These are individuals directly responsible for filing the formation documents with a state, such as articles of incorporation. This provision expands the scope of required disclosures beyond just owners, aiming to identify those who set up new legal entities.

Steps Small Businesses Should Take Now

Gathering Documentation

Because the CTA calls for specific personal details, small business owners should begin by identifying all individuals who qualify as beneficial owners and confirming the accuracy of their information. Businesses that have multiple owners across various locations may find it takes time to collect the necessary residential or business addresses, dates of birth, and identifying document numbers. Having this data in one secure repository can streamline the filing process and reduce the chance of errors.

Even if there is a possibility that the filing deadline might shift, it’s wise to secure the documents well in advance. Proper planning will also help you recognize if your business structure creates any ambiguity regarding who holds “substantial control.” The sooner those questions are clarified, the easier it will be to submit correct information in case FinCEN issues any new guidance before March 21.

Filing the BOI Report

FinCEN provides an online system at BOIefiling.FinCEN.gov for submitting the required information. The agency does not impose any filing fee on businesses that choose to file directly through this platform, although some third-party service providers charge fees for assistance or on behalf of their clients. Businesses should be aware that they can handle the process themselves at no additional cost, especially if they have a straightforward ownership structure.

With the new March 21 deadline in mind, small business owners should file promptly once they have verified all details. For those that have obtained an extension beyond March, continue to observe the specific later filing date. Keep in mind that FinCEN has set a 30-day window in which it may further adjust deadlines. If you have formed a new entity but have yet to file, clarify whether you fall into any special categories that might extend your reporting date.

Potential Consequences of Non-Compliance

The CTA enforces its rules with considerable penalties designed to encourage timely, accurate reporting. Willfully failing to file a BOI report or submitting false information can lead to a fine of ~$606 per day, up to a maximum of $10,000, and the possibility of up to two years in prison.

Moreover, disclosing or using beneficial ownership information without proper authorization carries similarly severe punishments. FinCEN’s aim is to tighten anti-money-laundering compliance, and the agency has signaled an increased focus on ensuring that small entities do not slip through the cracks. Even if your business appears low-key with minimal revenue, you should not assume the CTA will overlook it. The high stakes highlight the importance of understanding the requirements and submitting information accurately and on time.

Upcoming Changes and Possible Relief

FinCEN’s Plans to Amend Reporting Rules

Although FinCEN is currently expecting businesses to meet the March 21 deadline (or a later extension date if granted), it has committed to reviewing its procedures within a 30-day window. One element of that review is determining whether smaller and lower-risk entities should have more relaxed reporting standards or extended deadlines. In the meantime, FinCEN wants to prioritize obtaining BOI from higher-risk companies that could pose national security concerns.

The potential revisions might include streamlined forms, reduced data entry requirements, or elongated timelines for businesses that have limited risk exposure. However, small businesses should remain prepared for the filing date at hand and not assume these potential modifications will relieve the compliance burden altogether.

Congressional Action

While the judicial arena has seen various challenges to the CTA, Congress is also weighing in with proposed legislation. One pending bill, known as HR736, aims to push the filing deadline for most companies to January 1, 2026. This would offer a significant reprieve for small businesses scrambling to gather ownership details. Another measure, the Repealing Big Brother Overreach Act, seeks to eliminate the reporting requirements entirely, arguing that the CTA places unnecessary burdens on small businesses.

Neither piece of legislation has become law, and their future remains uncertain. Whether or not they pass, small businesses must abide by the CTA as it presently stands. Some owners are hopeful that a legislative solution might reduce complexity or extend timelines, while others remain skeptical that any meaningful relief will arrive before the current March 21 deadline.

Best Practices for Compliance Preparation

With the CTA deadline approaching, businesses can adopt a few best practices to navigate the requirements effectively:

Act Early: Even though the possibility of extensions exists, gathering information and filing sooner rather than later helps reduce the risk of missing deadlines.

Monitor Official Channels: Keep an eye on FinCEN’s announcements and official guidance, particularly as it evaluates the need for further deadline extensions or modifications. Any postponements or amendments will likely be publicized promptly.

Seek Professional Guidance: Although many small businesses can file on their own, complex ownership structures, multi-state operations, or partial foreign ownership might require advice from an accountant or attorney. Engaging with professional services firms can ensure compliance and help you respond quickly to any changes.

As deadlines and legal rulings shift around the Corporate Transparency Act, one thing remains clear: small businesses shoulder significant responsibilities for disclosing ownership information. The March 21 deadline is now the central focus for most small entities, yet the CTA’s enforcement landscape remains fluid. If you own or manage a small business, preparation is essential. Compile accurate information about your beneficial owners, stay informed about any last-minute changes from FinCEN, and be mindful of potential legislative or judicial developments on the horizon. Though the CTA adds new tasks to your to-do list, prompt action and careful attention to detail will go a long way toward fulfilling your obligations and avoiding penalties.

This article is intended for general informational purposes only. It does not constitute legal advice or a substitute for legal or professional counsel. Businesses should consult qualified professionals to ensure compliance with the Corporate Transparency Act, FinCEN regulations, and any other relevant state or federal laws.

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Leveraging Audits for Strategic Growth in Companies

Posted on by [email protected]

February 25, 2025 | by Atherton & Associates, LLP

Leveraging Audits for Strategic Growth in Companies

I. Introduction

Audits have long been perceived primarily as a regulatory exercise or an obligation related to compliance. Yet, when approached strategically, an audit can yield powerful insights that go far beyond verifying numbers on financial statements. In fact, a thorough, well-planned audit can spotlight operational efficiencies, reinforce investor confidence, and prepare a company to capitalize on new opportunities for growth. Whether you’re eyeing expansion into new markets, preparing for a potential sale, or exploring new ways of financing, a robust auditing process ensures you can move forward with clarity and credibility.

II. The Strategic Value of Audits for Growing Companies

For organizations experiencing growth pressures or seeking to expand in the future, having regularly audited financials can be a game-changer. The transparency and credibility of audited statements often drive faster deal timelines and stronger valuations. Moreover, businesses that maintain audit-ready financials can act promptly when a compelling acquisition or partnership opportunity surfaces. Delays in getting finances in order, or the uncertainty surrounding unaudited numbers, can jeopardize a deal or reduce leverage in negotiations. This means regular audits aren’t just a “check-the-box” exercise; they are an insurance policy that ensures you’re ready to move swiftly when the unexpected but welcome knock comes at your door.

Another significant benefit stems from the oversight process itself. Experienced auditors scrutinize operational workflows, identify gaps in internal controls, and highlight areas where businesses may be vulnerable to risk. Consequently, the company can address these vulnerabilities proactively and emerge more resilient—better positioned not only to mitigate threats but also to optimize existing processes.

III. Key Considerations in Choosing the Right Audit Partner

Choosing your auditing partner is as vital as deciding to get audited in the first place. Different firms bring different strengths, and your choice should match your company’s future direction, not just its current needs.

Industry-specific know-how is one critical piece of this puzzle. Whether your focus is manufacturing, distribution, construction, agriculture, healthcare, or not-for-profit work, an auditor who navigates the particular nuances of your sector can provide more refined guidance on financial reporting, compliance, and evolving regulations. Similarly, if your company is expanding overseas or across various states, an audit firm equipped with a wide geographical reach can streamline processes, ensuring consistent service and advice.

While technical competence often stands out as a decisive factor, it’s equally important to find an audit team that fosters a collaborative and transparent relationship. An auditing process should spell a partnership—one that allows for open dialogue, iterative discussions, and clear, contextual feedback on what your financials and operational indicators reveal about your growth trajectory.

IV. Steps & Best Practices in Conducting a High-Value Audit

Crafting a productive audit experience involves careful planning and robust collaboration from the earliest stages. While each audit is unique, several foundational steps help ensure a smooth process.

  1. Planning & Preparation: It’s wise to set a roadmap for your audit engagement early, noting all deadlines and resources required. This planning stage clarifies who in your organization will be responsible for gathering key documents—from trial balances and general ledgers to relevant contracts and agreements. Preparing these materials upfront prevents last-minute scrambles and accelerates fieldwork.
  2. Fieldwork & Information Sharing: During fieldwork, auditors systematically review your financial statement areas, test internal controls, and reconcile data to confirm accuracy. Because some companies deal with sensitive or confidential information, be sure your chosen partner employs secure transmission methods that help protect data. Staying transparent and responsive to auditor questions will help avoid bottlenecks.
  3. Wrap-Up & Reporting: In many cases, auditors issue recommendations alongside your audited financials. This may include highlighting strengths in your processes, but more importantly addressing material weaknesses or significant deficiencies. It’s best practice to organize a management or board meeting to discuss these findings in depth, so you can make timely decisions on any suggested improvements.

V. Potential Gains Beyond Compliance

Beyond meeting regulatory obligations, there are strategic advantages to be gained from frequent audits. If your company is considering a merger or acquisition, having an updated record of audited financials strengthens your negotiating hand and lowers perceived risks from a buyer’s perspective. This often translates to more favorable valuations or terms in a deal. Additionally, the insights gleaned from an audit can function like a diagnostic check for your broader operations, flagging inefficiencies or strategic blind spots.

All these benefits add up to a stronger, more future-proof organization. By marking regular milestones for financial and operational transparency, you cultivate a discipline that permeates the entire enterprise, from cost management to revenue forecasting and contract negotiations.

VI. How Atherton & Associates LLP Can Help

Atherton & Associates LLP offers Assurance & Compliance Services that go beyond traditional audit functions. Our teams are immersed in industries ranging from manufacturing to agriculture to construction to not-for-profits. For each client, we tailor our process to your specific challenges and growth objectives. We also provide advisory support on emerging accounting standards and best practices, so you can adapt your processes in real time as your business evolves. If you’re looking to strengthen internal controls, navigate new revenue recognition rules, or expand your services, we have the expertise to guide you at every step. We believe that effective audits pave the way for better governance, higher profitability, and, ultimately, a more confident path to achieving your strategic goals.

VII. Conclusion

A well-executed audit sheds light on where your company stands and where it can go next. By revealing unknown risks, clarifying financial results, and sharpening operational discipline, audits help an enterprise become more transparent, agile, and growth-ready. And by partnering with an experienced and collaborative firm, you gain a trusted advisor who can guide you through the complexities of expansion, acquisitions, and future financing rounds. In this sense, audits stand out as far more than a box to check; they’re a cornerstone of a thoughtful, proactive growth strategy.

Contributing Experts

Loren Kuntz, Assurance Partner
Email: [email protected]
With nearly three decades of public accounting experience, Loren provides strategic oversight for Atherton & Associates LLP’s quality standards, offering expert counsel across sectors like manufacturing, wholesale distribution, healthcare, and beyond.

Marissa Williams, Assurance Partner
Email: [email protected]
Marissa brings deep expertise in financial statement audits, internal control improvements, and employee benefit plan audits, having led numerous engagements for businesses in manufacturing, construction, healthcare, and not-for-profit organizations.

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Mitigating liability as a 401(k) plan sponsor: your role as a fiduciary

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February 21, 2025 | by Atherton & Associates, LLP

Offering a 401(k) plan to your team is a meaningful way to invest in their future financial security. However, it also comes with a host of legal and administrative obligations. As a plan sponsor, you’re responsible for complying with regulations designed to protect your employees’ retirement savings and ensure prudent management of their investments.

Understanding these fiduciary duties can help you minimize liability, stay compliant, and safeguard your employees’ retirement assets.

The basics of fiduciary responsibility

The moment you establish a 401(k) plan, you assume fiduciary responsibilities under the Employee Retirement Income Security Act of 1974 (ERISA). This means you must act in the best interests of your employees and their beneficiaries. Failing to manage the plan prudently, comply with regulations, or address employees’ financial needs can expose you to significant liability.

Some plan sponsors mistakenly believe that hiring third-party service providers relieves them of all fiduciary duties. However, ERISA requires active oversight of these providers and careful decision-making on your part. Even if you delegate specific tasks, you retain ultimate responsibility for selecting and monitoring those service providers.

Fiduciary responsibility: what it means

ERISA broadly defines a fiduciary as anyone who exercises discretionary control or authority over the management or administration of a plan or its assets or who gives investment advice for a fee. This generally includes the plan sponsor, administrator, advisors, and investment managers. For the purposes of this article, we’re focusing on sponsors—the employers—and what you need to know to fulfill your responsibilities.

The plan administrator (sometimes the employer or a designated third party) oversees daily operations. This includes filing the necessary forms, providing timely participant notices, and maintaining plan records. Even if you outsource administration to a third party, you must ensure everything meets regulatory requirements. Inadequate oversight of plan operations could result in costly mistakes, including late filings, missing disclosures, and fines from government agencies.

Fiduciaries can also be “named” in the plan documents (such as the employer or investment manager) or “unnamed” by virtue of their actions (someone who effectively controls the plan’s decisions, even if not officially designated). Ultimately, if you or anyone in your organization has the power to influence the plan, that individual can be considered a fiduciary.

Core fiduciary duties under ERISA

Regardless of the number of fiduciaries involved, each must adhere to these key responsibilities:

  • Acting in the participants’ best interests

  • Performing duties prudently and with sufficient expertise

  • Following the plan documents and policies

  • Diversifying plan investments

  • Keeping plan expenses reasonable

At first glance, these requirements might seem vague. However, these rules have been in place long enough that there’s substantial guidance on how to interpret and apply them.

Common pitfalls and best practices for managing them

Even with diligent oversight, plan sponsors can face challenges that put compliance and employee retirement savings at risk. Below are some of the most frequent pitfalls sponsors encounter, along with best practices to address them effectively.

Insufficient oversight of service providers

Failing to properly monitor administrators, recordkeepers, or other third-party service providers can lead to regulatory violations or costly mistakes. Many sponsors assume that outsourcing absolves them of responsibility, but sponsors are required to oversee the performance of any providers they hire.

It’s important to establish a structured process for reviewing your service providers’ performance regularly. Schedule periodic evaluations to ensure they meet expectations and review contracts to confirm fees remain reasonable. Clear documentation of your oversight efforts will also demonstrate compliance during audits or regulatory reviews.

Recordkeeping Errors

Missing or inaccurate records—particularly for loans, hardship withdrawals, or contribution tracking—can lead to compliance issues and penalties. Poor documentation can also create unnecessary challenges during regulatory audits.

Maintain thorough, well-organized records for all aspects of plan administration, including meeting minutes, plan amendments, and loan documentation. Regularly audit your records to ensure they are complete and up to date. Use automated systems where possible to reduce manual errors and ensure consistency.

Misunderstood compensation definitions

Plan sponsors often miscalculate contributions due to unclear or incorrect definitions of compensation, such as excluding bonuses or overtime from eligible earnings.

Work with payroll and HR teams to clarify how compensation is defined in your plan documents and ensure systems are aligned to calculate contributions correctly. When necessary, consult experts to confirm compliance with IRS rules. Regular audits of payroll processes can help identify and address potential issues early.

Nondiscrimination testing failures

Plans that disproportionately benefit highly compensated employees may fail nondiscrimination tests, leading to penalties or required corrective contributions. Low participation rates among rank-and-file employees often exacerbate this issue.

Encourage broader employee participation by offering education sessions about the plan’s benefits, emphasizing matching contributions, or introducing automatic enrollment features. These steps can help create a more balanced plan and reduce the risk of failing nondiscrimination tests.

Delayed contributions

Delays in depositing employee deferrals can result in penalties from the Department of Labor (DOL), including the requirement to compensate participants for lost earnings. Even minor delays can trigger scrutiny.

Synchronize your payroll systems with the plan’s records to ensure timely deposits of employee contributions. Set up automated processes wherever possible to minimize delays. Conduct regular checks to verify contributions are being deposited within the required timeframes.

Audits, compliance, and regulatory changes

Plans with more than 100 participants typically undergo an external audit each year, which scrutinizes financial reporting and compliance practices.

The participant count is now based on the number of participants with account balances rather than just those who are “eligible.” This change took effect for the 2024 plan year and is intended to reduce the burden on plans where many workers may be eligible to participate but don’t maintain an active balance.

Even if an audit is not mandated, performing occasional internal or external reviews can reveal issues such as improper fees or administrative oversights before they become major problems.

Preparing for DOL or IRS Examinations

Regulatory agencies often look for missing documentation, incorrect plan definitions, and oversight failures when they conduct an examination. Plans that have kept comprehensive records, acted promptly to fix issues, and documented each important decision tend to fare better in these reviews. The DOL and IRS also encourage sponsors to self-correct or voluntarily disclose errors to secure more lenient treatment and reduced penalties.

Voluntary correction programs and self-reporting

Errors can and do happen, particularly if you manage a large plan or rely on multiple service providers. Both the IRS and the DOL have established programs allowing plan sponsors to report and fix mistakes before they escalate, typically resulting in reduced fees or no penalty at all. Proactive reviews—ideally yearly or semi-annually—are often the easiest way to catch potential issues. Self-correction not only saves money but also demonstrates your intention to prioritize the plan’s health and function.

Staying compliant

Sponsoring a 401(k) plan is both a valuable benefit for your employees and a serious legal and ethical responsibility. While these duties can feel daunting, the good news is that you don’t have to manage them alone.

Outsourcing key responsibilities to professionals can significantly reduce your burden. These experts bring the necessary expertise to handle the complexities of investment decisions, plan administration, and compliance. However, it’s important to remember that outsourcing doesn’t absolve you of all liability; you retain the responsibility to select and monitor these professionals carefully.

By staying informed, establishing strong internal controls, and relying on seasoned experts where appropriate, you can meet your fiduciary obligations with confidence while safeguarding your employees’ retirement savings.

This article is for informational purposes only and should not be considered legal advice. If you have specific questions or concerns about your 401(k) plan, consult with a qualified professional to ensure compliance and protect your organization and your employees.

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Understanding the Impact of ASU 2020-07 on Contributions of Nonfinancial Assets

Posted on by [email protected]

February 18, 2025 | by Atherton & Associates, LLP

The Financial Accounting Standards Board (FASB) has introduced Accounting Standards Update (ASU) 2020-07, focusing on the presentation and disclosure requirements for contributed nonfinancial assets by Not-for-Profit entities. This update aims at increasing the transparency and clarity of nonfinancial contributions, also known as gifts-in-kind.

Nonfinancial assets are essentially assets that aren’t financial, including land, buildings, equipment, materials, supplies, intangible assets, and specialized volunteer services. Unconditional promises to give nonfinancial assets, such as offering free use of buildings or facilities over a period, also fall under ASU 2020-07.

ASU 2020-07 brings forth several new requirements for the presentation and disclosure of nonfinancial contributions in an organization’s financial statements.

Firstly, gifts-in-kind must now be presented as a separate line item in the statement of activities, distinguishing them from contributions of cash and other financial assets. In addition, the financial statements must disaggregate the contributed nonfinancial assets by category, providing a clearer view of the types of nonfinancial contributions received. For instance, a donated building and pro bono legal services should be separately disclosed.

The disclosure requirements under ASU 2020-07 are equally comprehensive. Organizations are required to provide qualitative information regarding whether the nonfinancial contributions were monetized or utilized during the reporting period, and which activities or programs benefitted from them. They should also disclose their policy, if any, about whether to monetize or utilize the contributed nonfinancial assets. Furthermore, a description of the valuation methods and inputs used to arrive at fair value must be disclosed, along with any donor-imposed restrictions and the concepts of the principal market for arriving at a fair value measurement.

The introduction of ASU 2020-07 requires organizations to revisit their policies and procedures to ensure compliance. It would be beneficial to establish procedures and controls for tracking and categorizing contributions and to consider thresholds for disclosure items based on the organization’s size and the materiality of the contributions.

To facilitate the implementation, organizations could leverage their general ledger system to create separate accounts for tracking contributed nonfinancial assets. This approach allows for flexibility in reporting and can be instrumental in further disaggregating contribution revenue by types of in-kind contribution revenue.

Notably, ASU 2020-07 does not alter existing standards for the valuation and recognition of contributed nonfinancial assets nor does it change the criteria for recording contributed services. However, the introduction of this standard calls for a fresh look at existing gifts-in-kind valuation techniques and internal control systems to ensure they align with the new requirements.

In conclusion, ASU 2020-07 is a significant development for Not-for-Profit entities, requiring them to enhance transparency in their financial statements. With careful planning and the right approach, organizations can smoothly transition to the new standard while enhancing their financial reporting process. As always, professional advice should be sought to navigate these changes effectively. 

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Choosing between donor-advised funds and private foundations

Posted on by [email protected]

February 11, 2025 | by Atherton & Associates, LLP

Charitable giving allows individuals and families to create a lasting impact, aligning wealth with deeply held values. While donating directly to a nonprofit is straightforward, structured giving vehicles like donor-advised funds and private foundations offer advantages that go beyond convenience.

For most, donor-advised funds (DAFs) provide the ideal blend of simplicity, flexibility, and tax efficiency. Yet some families take things further by establishing private foundations, trading simplicity for greater control and versatility. Understanding the differences between these two vehicles can help you determine which best aligns with your financial goals and charitable ambitions.

When a donor-advised fund makes sense

Donor-advised funds (DAFs) are ideal for those seeking a low-maintenance way to manage their charitable contributions. A DAF, set up through a sponsoring organization, allows donors to make an immediate tax-deductible contribution while retaining the ability to recommend grants to public charities over time. The administrative burden – legal filings, compliance, and reporting – is handled entirely by the sponsoring organization. Additionally, donations may be made from the fund anonymously.

However, it’s important to note that sponsoring organizations establish their own policies, which can affect how a DAF operates. These organizations may enforce minimum donation requirements to open a fund, set rules around the types of assets they accept, charge fees for the management of the assets, and impose minimum grant distributions. While most sponsors readily accept cash contributions, more complex assets like real estate or private business interests may be rejected. They also reserve the final authority over fund distributions and investment decisions.

Tax benefits

Cash contributions to DAFs can be deducted up to 60% of adjusted gross income (AGI). Contributions of appreciated assets, such as publicly traded stocks or real estate held for more than one year, are deductible at their fair market value, up to 30% of AGI. These percentage limits apply separately; however, the total amount you can deduct in a single tax year cannot exceed 60% of your AGI. So, if you make both cash and appreciated asset contributions in the same year, your combined deductions are subject to the 60% AGI ceiling.

If contributions in any given year exceed the AGI limits for deductions, the IRS allows donors to carry forward the excess for up to five subsequent tax years.

Why some families choose private foundations

For families with significant resources and complex philanthropic ambitions, private foundations provide an appealing alternative to DAFs. While DAFs are simple and cost-effective, private foundations offer unparalleled control, flexibility, and opportunities to build a lasting legacy.

Typically established as 501(c)(3) organizations, private foundations enable families to make tax-deductible contributions, invest those funds, and use the returns to support charitable initiatives.

Control and flexibility

One of the greatest advantages of private foundations is the control they provide over charitable activities. Donors can decide how assets are invested, which organizations receive grants, and the specific terms of their giving. Unlike DAFs, which restrict grants to qualified public charities, private foundations can also fund scholarships, assist individuals in need, or support international and non-charitable initiatives within IRS guidelines. For instance, foundations can make program-related investments, allocate funds toward administrative costs, and engage in advocacy or public awareness efforts, provided they align with IRS rules and support the foundation’s charitable mission.

Private foundations also offer flexibility in the types of assets they can accept. Families can contribute cash, publicly traded stock, real estate, or even private business interests – options that may be limited or unavailable with some DAFs, depending on the rules of the sponsoring organization.

Another distinguishing feature is that a foundation can operate in one of two ways: as a non-operating foundation, primarily granting funds to other organizations, or as an operating foundation, directly running its charitable programs. If priorities change, a private foundation can be converted into a DAF; however, the reverse is not possible, as contributions to a DAF are irrevocable.

Donors also have the freedom to appoint their own board members, ensuring that governance reflects their values. This autonomy makes private foundations an ideal choice for those who want to maintain long-term oversight. While federal law doesn’t impose restrictions regarding board members, it’s worth noting that some states may require a minimum number of board members and encourage having at least one independent, non-family member on the board to strengthen governance.

Family involvement

For many families, private foundations serve as a means to engage multiple generations. Unlike DAFs, which typically limit family participation to naming successor advisors, private foundations allow children and grandchildren to take on active roles as board members or staff.

In some cases, foundations provide heirs with roles that serve as a philanthropic alternative to traditional employment. For instance, a family foundation might employ a grandchild to oversee grantmaking initiatives or manage day-to-day operations, helping families make an impact while developing leadership skills. Family members may even receive compensation for legitimate roles within the foundation. And future generations can continue operating the foundation long after the original donor’s passing, ensuring the legacy remains intact.

Tax benefits

Private foundations offer tax advantages, though the deductibility limits for contributions are lower than those for DAFs. Donors can deduct up to 30% of AGI for cash contributions and up to 20% of AGI for donations of appreciated assets, such as real estate or stock. Keep in mind that the total deduction cannot exceed 30% AGI in a single tax year, even if you contribute both cash and appreciated assets. If your total contribution exceeds these limits, the unused portion of the deduction can be carried forward for five additional tax years.

One notable advantage of private foundations is their ability to accept illiquid or hard-to-value assets, such as privately held stock, real estate, or artwork. Donating these assets often allows families to avoid capital gains taxes on their appreciation while enabling the foundation to manage or liquidate them strategically.

Private foundations also offer advanced financial planning opportunities that DAFs do not. For example, families anticipating a significant financial windfall, such as selling a business, can pre-fund a private foundation. By doing so, they secure an immediate tax deduction while retaining the flexibility to distribute the funds to charitable causes over time.

The difference in deductibility limits between private foundations and DAFs reflects how the IRS categorizes these vehicles. Contributions to DAFs are more deductible because distributions are limited to entities that directly serve public needs. Private foundations, by contrast, allow for greater donor control and flexibility, including funding activities that extend beyond traditional public charities. Because private foundations often lack the public accountability of DAFs and can be entirely controlled by a single individual or family, the IRS imposes tighter deduction limits to mitigate the potential for abuse and ensure that the public benefit justifies the tax advantages.

Legacy building and estate planning

For families with wealth that exceeds their generational needs, private foundations provide a structured way to steward that wealth for the public good.

Contributions are not only removed from the donor’s taxable estate but also provide the foundation with assets that can be strategically invested, generating returns to sustain charitable activities indefinitely. Families can employ future generations, involving them as board members or staff to carry on the foundation’s mission. This structure allows wealth to remain within the family’s purview, enabling them to dictate how the money serves the public rather than relying on the government to allocate those funds through taxes.

In essence, establishing a private foundation reflects a donor’s decision to direct wealth toward causes they care about most while ensuring that family members remain involved in purposeful, values-driven work for generations to come.

Potential downsides

Despite their many advantages, private foundations require significant resources and effort to establish and maintain. The process involves creating a legal structure, appointing a board of directors, and complying with complex reporting and regulatory requirements. Foundations must file annual tax returns and adhere to strict rules governing grantmaking and investment oversight.

The IRS requires private foundations to distribute at least 5% of their net assets annually and significant penalties can apply if distribution requirements are not met. However, grants and certain expenses qualify toward this requirement.

Managing a foundation is also time-intensive, requiring due diligence, compliance, and oversight. Larger foundations may require professional staff, including accountants, lawyers, and grant managers, to handle these responsibilities effectively.

Dissolving a private foundation can also be more complex. If a family decides they no longer wish to continue the foundation, the remaining assets must be distributed to a qualified charitable organization, and the process often involves detailed planning and administrative oversight. Unlike a DAF, where the sponsoring organization handles the liquidation of funds and ensures compliance, the dissolution of a private foundation requires direct involvement from the board or other responsible individuals.

The bottom line: aligning your philanthropic vision with the right tool

Both donor-advised funds and private foundations provide pathways to make a meaningful difference. Choosing the right vehicle depends on your financial goals, philanthropic ambitions, and desired level of involvement. It’s also important to recognize that your needs and priorities may evolve over time. A donor-advised fund might serve your family well for many years, while a significant wealth event could prompt you to consider establishing a foundation for greater control.

If you’d like expert guidance to determine which option aligns with your values and legacy, contact our office today. We’re here to help you create a lasting impact.

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Posted in Tax

2025 Federal Payroll Tax Changes

Posted on by [email protected]

February 04, 2025 | by Atherton & Associates, LLP

The start of 2025 brings important federal payroll tax and withholding changes that every employer needs to understand. From updates to Social Security wage limits to adjustments in retirement contributions and tax withholding rates, these changes directly impact payroll management and compliance. 

To help you stay ahead, we’ve outlined the most significant federal updates for the new tax year and what they mean for your business.

Social Security Tax Withholding

The Social Security tax wage base has increased to $176,100 for 2025. Both employees and employers will continue to contribute at a rate of 6.2% on wages up to this threshold. This adjustment raises the maximum Social Security tax withheld from wages to $10,918.20 for the year. Medicare tax remains unchanged at 1.45% for both employees and employers, applicable to all wages without a cap. Additionally, an extra 0.9% Medicare tax is imposed on individuals earning over $200,000 annually; employers are not required to match this additional tax. 

Federal Income Tax Withholding

The IRS has released the inflation-adjusted federal income tax brackets for 2025. For single filers, the standard deduction increases to $15,000, while married couples filing jointly see an increase to $30,000. 

Although the marginal tax rates remain unchanged, inflation adjustments have shifted the income thresholds that determine which tax rates apply.

Tax rate

Single filers

Married filing jointly

10%

$0 to $11,925

0 to $23,850

12%

$11,926 to $48,475

$23,851 to $96,950

22%

$48,476 to $103,350

$96,951 to $206,700

24%

$103,351 to $197,300

$206,701 to $394,600

32%

$197,301 to $250,525

$394,601 to $501,050

35%

$250,526 to $626,350

$501,051 to $751,600

37%

$626,451 or more

$751,601 or more

Federal Unemployment Tax Act (FUTA)

The FUTA taxable wage base remains at $7,000 per employee for 2025. The standard FUTA tax rate is 6.0%; however, most employers are eligible for a 5.4% credit for timely state unemployment tax payments, resulting in an effective rate of 0.6%. 

Retirement Contribution Limits

For 2025, the contribution limit for employees participating in 401(k), 403(b), and most 457 plans increases to $23,500. The catch-up contribution limit for employees aged 50 and over remains at $7,500. Notably, under the SECURE 2.0 Act, individuals aged 60 to 63 are eligible for a higher catch-up contribution limit of $11,250. 

Health Flexible Spending Arrangements (FSAs)

The annual contribution limit for health FSAs increases to $3,300 for 2025. For cafeteria plans that permit the carryover of unused amounts, the maximum carryover amount rises to $660. 

Additional Considerations

Employers are reminded to obtain updated Forms W-4 from employees to accurately reflect any changes in filing status or personal exemptions. Additionally, the federal minimum wage remains at $7.25 per hour; however, employers should verify if state or local minimum wage rates have changed to ensure compliance. 

Navigating payroll tax changes can be time-consuming, but you don’t have to do it alone. Our team can help you stay compliant in the face of evolving tax regulations. If you have questions about how these 2025 updates affect your business, contact our office today. We’re here to provide the personalized guidance you need to keep your payroll processes running smoothly.

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Maximize your QBI deduction with thoughtful planning

Posted on by [email protected]

January 28, 2025 | by Atherton & Associates, LLP

If you own a business organized as a pass-through entity, the Qualified Business Income (QBI) deduction offers a valuable opportunity for tax savings. Under the Tax Cuts and Jobs Act, this deduction can allow sole proprietors, partnerships, S corporations, and some LLCs to deduct up to 20% of qualified business income. Unfortunately, as it stands right now, this provision is set to expire at the end of 2025, although some observers believe Congress may consider extending it.

Because there is an uncertain end date, it makes sense to consider strategies that could help you capture a larger benefit while it is available. The following guidance outlines important background information on the QBI deduction, along with strategies to help maximize your potential tax savings. 

QBI basics

Qualified business income is essentially the net pass-through income earned from an eligible enterprise, excluding wages or salaries. 

The QBI deduction is open primarily to non-corporate taxpayers, namely individuals, trusts, and estates, who receive their share of business income from pass-through structures. Businesses that are set up under C corporation status do not qualify.

Complicating this deduction are special rules for certain “specified service trades or businesses” (SSTBs). When you operate in fields such as health, law, accounting, financial services, performing arts, or consulting, there are significant limits or a complete disallowance of this deduction once your total taxable income exceeds specific thresholds. These thresholds vary by filing status and are adjusted annually.

Limitations and phaseouts

One of the primary hurdles with the QBI deduction arises when your taxable income before the deduction exceeds predefined thresholds. If you file jointly, your allowable QBI deduction starts getting phased out once your taxable income crosses a certain line, and for single filers or other filing statuses, there is a different threshold.

If you end up within the “phase-out” range, your ultimate deduction may be reduced. Once your taxable income shoots above the fully phased-out threshold, the deduction is eliminated. 

For instance, in 2024, business owners with taxable income below $191,950 could claim the full deduction. Those with taxable income over $241,950 can’t claim the deduction. If income fell between those two thresholds, the individual could qualify for a partial deduction. The ranges for married filing jointly taxpayers are $383,900 and $483,900, respectively.

W-2 wage and UBIA limitation

For business owners with income that exceeds the threshold, the QBI deduction is limited to the greater of:

• 50% of W-2 wages paid by the business and properly allocated to QBI, or
• 25% of those W-2 wages plus 2.5% of the original cost basis (unadjusted basis immediately after acquisition, or UBIA) of any qualified tangible property used in the business.

UBIA-based limitations help capital-intensive operations like real estate development, manufacturing, or hotels, where significant property investments support production. If you operate in a business with substantial depreciable property, you can potentially preserve a greater portion of the deduction, even when a lack of W-2 wages or high income levels otherwise threaten to limit it.

Rules for SSTBs

If you practice in fields such as health, accounting, financial services, legal services, performing arts, or consulting, you may be part of a Specified Service Trade or Business. SSTBs face additional, more stringent limitations. Once your taxable income exceeds the phaseout range for your filing status, the IRS disallows the QBI deduction for SSTB income altogether.

Strategies to increase your QBI deduction

Aggregate multiple businesses

If you own several pass-through entities, grouping them for QBI purposes can boost your deduction. By making an aggregation election, you can treat separate qualifying businesses as a single entity for purposes of calculating W-2 wages, UBIA of property, and QBI. 

This approach often benefits owners whose different ventures complement each other in terms of wages or capital intensity. For instance, one activity might have high income but a low W-2 payroll, while another might have low overall profit but a sizable payroll. Combining them can boost the total W-2 wage factor, which in turn mitigates the QBI limitations. However, be aware that you generally cannot aggregate an SSTB with a non-SSTB; any attempt to merge them for QBI purposes is disallowed. There are also ownership and business commonality requirements to aggregate multiple entities.

Be strategic with depreciation

Depreciating assets reduces your taxable income but it also lowers QBI. If you’re near a threshold where QBI limits kick in, making certain depreciation elections could preserve a larger deduction. Balancing immediate tax savings with long-term benefits is key here.

On the one hand, you may want a large deduction in the first year to lower your overall tax burden; on the other, you risk decreasing QBI to the point where your 20% deduction shrinks. This is especially tricky if your income hovers near the thresholds that tip you into a W-2 wage limitation zone.

Rather than automatically claiming the maximum possible depreciation in the current year, consider the trade-off. In some instances, spreading out depreciation via the usual MACRS schedule could preserve a more substantial QBI deduction in the year of purchase, and if your tax rates rise in the future, those postponed depreciation deductions could have greater value later. Deciding whether to fully claim, partially claim, or entirely forego bonus depreciation should be done carefully with an eye on optimizing your total tax liability, not just this year.

Optimize retirement contributions

Contributions to self-employed retirement plans reduce taxable income and QBI. While this can shrink your QBI deduction, it might still help if it lowers your income below the phaseout threshold. Be strategic about how much you contribute to ensure you’re getting the best overall tax result.

If your income is on the edge of a QBI threshold, a modest additional retirement account contribution might safely move you below the key figure that triggers QBI limitations. Each situation is unique, and you should weigh the long-term value of retirement savings against the near-term objective of maximizing your QBI deduction. 

It’s worth noting that contributions to a personal IRA generally do not affect QBI since they are not tied directly to the self-employed activity.

Optimize your entity structure

Your choice of business entity can have a big impact on the final QBI calculations. A sole proprietorship might provide simpler bookkeeping, but you could miss out on added W-2 wages if you do not pay yourself a salary as an employee (which is only possible in certain corporate structures like S corporations).

In an S corporation (or an LLC taxed as an S corporation), part of the owner’s earnings can be taken as wages (subject to payroll taxes), and the rest flows through as income that counts toward QBI. However, you are required to pay yourself “reasonable compensation,” which will reduce that QBI portion. Yet paying a salary in an S corporation can also position you to harness the W-2 wage threshold for the QBI limitation. 

If you run both an SSTB and a non-SSTB in a single entity, you might explore whether restructuring them into separate companies is possible and beneficial. Splitting them out could preserve QBI deductions on the non-SSTB revenue stream rather than letting the SSTB label overshadow the entire operation.

Manage taxable income levels strategically

There are numerous tactics to keep taxable income within the QBI-favorable range. Accelerating deductions or deferring revenue from year to year can help you manage your income. If you are nearing an important threshold, it can make sense to push some income into the following tax year or to pull forward some expenses (such as planned repairs or purchases) into this year.

For married individuals whose joint income crosses a crucial line, filing separately might yield a better QBI deduction for the spouse who operates the pass-through entity. Doing so, however, can backfire if it triggers other tax disadvantages, including the loss of certain credits or a reduction in itemized deductions. It’s important to run the numbers carefully. 

Ensuring compliance and avoiding audits

As with all tax matters, accurate recordkeeping is critical. You should maintain meticulous documentation of:

• Business income and expense allocations
• W-2 wage computations and disbursements
• Depreciation schedules, including any elected Section 179 or bonus depreciation
• Basis in qualified property for UBIA calculations
• SSTB qualifications or non-qualifications (ensuring you are categorizing your operations correctly)

Consult with a knowledgeable CPA to confirm that you are on track and maintaining audit-ready documentation. 

Navigating complexity: a balancing act

The QBI deduction can be a game-changer, but the rules are undeniably complex—especially for higher earners or those operating in Specified Service Trades or Businesses. Maximizing the deduction often requires balancing multiple factors, such as income thresholds, W-2 wages, depreciation decisions, and retirement contributions.

A seasoned CPA can help you evaluate your unique circumstances, weigh the trade-offs, and design a strategy that maximizes your deduction while ensuring full compliance with IRS regulations.

Don’t let this opportunity slip by. Contact our office to get the tailored advice you need to optimize your tax savings. Let’s work together to ensure you’re making the right moves now and for the future.

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Don’t let payroll taxes derail your business

Posted on by [email protected]

January 28, 2025 | by Atherton & Associates, LLP

For many small business owners, managing payroll taxes can feel like working a complicated puzzle. One wrong piece – a missed deadline, a misclassified worker, a record-keeping slip – and you risk penalties, audits, or employee dissatisfaction. By understanding the common pitfalls and how to avoid them, you can keep payroll taxes from becoming an unnecessary source of stress.

Common payroll tax challenges – and how to avoid them

Worker misclassification

Misclassifying someone as an independent contractor when they should be an employee can create serious tax liabilities. Employees require tax withholding and prompt remittances to the IRS and relevant state agencies, whereas independent contractors handle their own taxes. 

The distinction isn’t always crystal clear, and relying on guesswork can lead to penalties, back taxes, and legal disputes. To avoid trouble, consult the IRS guidelines on classification factors or consider filing Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) to get an official ruling. 

If you’re uncertain, it’s often safer to treat the individual as an employee or seek guidance from a CPA. Ensuring proper classification at the start can save you a world of problems down the road.

Payroll calculation errors

A small miscalculation like applying the wrong withholding rate or overlooking an overtime payment can quickly snowball into expensive corrections and frustrated employees. Manual processes are especially prone to human error, and even outdated software can cause slip-ups if it isn’t regularly updated. 

Streamlining your payroll procedures with reliable payroll software helps ensure accuracy by automating tax calculations and applying the most recent rates. Periodic self-audits, spot-checking a handful of paychecks each month, and double-checking that employees’ withholding certificates are up to date can also go a long way toward maintaining accuracy and avoiding painful back-and-forth with tax authorities.

Late or missed tax payments

With so many demands on your time, it’s easy to let a payroll tax deadline slip by. Unfortunately, the IRS and state agencies don’t forgive these lapses easily, and penalties and interest can accumulate faster than you might expect. 

The simplest solution is to set clear reminders and create a dedicated calendar for tax obligations. Consider putting funds aside in a separate account for taxes as you run payroll, ensuring you’re never caught short when payment is due. Even better, automate as much of the payment process as possible through your payroll provider, reducing the risk that a busy season or unexpected crisis will make you late.

Inadequate record-keeping

Shoddy or incomplete records make it difficult to prove compliance, especially if you’re audited. Missing W-4 forms, disorganized timesheets, or incomplete payroll ledgers complicate the process of resolving disputes and can lead to penalties if you can’t substantiate your filings. 

Commit to a consistent filing system that you maintain throughout the year. Regular internal reviews help ensure everything is where it belongs. Consider scanning paper documents for electronic backup and using payroll software that stores key records securely. When you keep everything organized and easily accessible, audits become less daunting, and day-to-day payroll management runs more smoothly.

Technological challenges and integration issues

Relying on manual methods or outdated tools increases the likelihood of errors and makes routine payroll tasks labor-intensive. You might also struggle if your payroll and accounting systems don’t “talk” to each other, resulting in inconsistent data and time-consuming reconciliation. 

Upgrading to modern payroll software that integrates with your accounting and bookkeeping platforms is well worth the investment. Consider working with IT professionals or consultants to ensure a seamless setup. By embracing technology, you’ll reduce mistakes, speed up processing, and free your team to focus on more strategic tasks.

Keeping up with changing regulations

Payroll tax regulations aren’t carved in stone. Each year, the IRS updates income tax withholding tables, and the Social Security wage base is adjusted to reflect changes in average wages. States may periodically alter their unemployment tax rates, and local jurisdictions can introduce or modify their own payroll-related taxes. In a nutshell, laws evolve regularly, and missing an update can lead to errors. 

Staying informed means regularly checking official sources like the IRS website, subscribing to tax agency newsletters, or joining professional organizations that keep their members abreast of changes. It may also help to assign someone on your team to track these updates and relay important information to the rest of the business. By building a habit of continuous learning, you’ll avoid the panic and penalties that come with being caught off guard.

Consider outsourcing payroll

Managing payroll taxes requires time, expertise, and careful attention to detail. Outsourcing payroll to a professional accounting firm or third-party payroll provider can alleviate these burdens while reducing risks.

Outsourcing ensures that payroll taxes are calculated accurately and submitted on time, protecting your business from costly penalties. These providers stay up-to-date with ever-changing tax regulations, so you don’t have to worry about missing critical updates.

Additionally, an outsourced payroll partner can handle complex issues like worker classification and multistate payroll compliance, giving you confidence that every detail is managed correctly.

Keep your payroll compliance on track

This overview isn’t exhaustive; plenty of unusual scenarios and special rules can still arise. But by understanding the common challenges, staying alert to regulatory changes, using the right tools, and knowing when to call in an expert, you can reduce costly payroll tax errors. Taking action now paves the way for a smoother, more confident tax season and frees you to focus on long-term business growth. If you need guidance or want to ensure your payroll practices are up to par, don’t hesitate to contact our office – we’re here to help.

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Decoding income definitions: AGI, MAGI, and taxable income explained

Posted on by [email protected]

January 21, 2025 | by Atherton & Associates, LLP

If you’ve ever felt a bit lost sorting through terms like gross income, adjusted gross income (AGI), modified adjusted gross income (MAGI), and taxable income on your tax return, you’re not alone. Understanding these definitions isn’t just about numbers on a form – it’s about making informed decisions that can impact everything from your tax bill to your student loan payments. So, there is more than meets the eye. 

Let’s break down what each of these terms really mean and why they matter to you.

Understanding total income

Total (or gross) income is the total of all your income before any taxes or deductions are taken out. This includes wages, salaries, bonuses, interest income, rental income, and any other earnings. If you look closely at Form 1040, you’ll notice a long list of items considered income that you might not have considered, such as gambling winnings, cancellation of debt, jury duty pay, prizes and awards, and stock options, among many others.

It’s the starting point for calculating your taxes and is often the figure lenders look at when assessing your ability to repay a loan. While some might be tempted to overstate or underreport their gross income, both are generally recipes for disaster. 

Aside from avoiding legal issues – which is a strong incentive – being precise about your gross income also helps you make informed financial decisions. It affects your eligibility for loans, credit cards, and rental agreements and can influence factors like insurance premiums, interest rates, and support obligations such as alimony or child support. 

Adjusted Gross Income (AGI)

AGI is your total income minus specific “above-the-line” deductions. These deductions reduce your income before taxes are calculated, regardless of whether you itemize or take the standard deduction, potentially lowering your tax bill and affecting your eligibility for certain credits and deductions.

To calculate your AGI, you subtract allowable adjustments from your gross income. These adjustments can include:

  • Unreimbursed classroom expenses for qualified educators.

  • Qualified business expenses for specific professionals, such as reservists. 

  • Moving expenses related to a military order for members of the Armed Forces.

  • Health Savings Account (HSA) contributions.

  • Half of your self-employment taxes.

  • Contributions to self-employed retirement plans. 

  • Self-employed contributions to health insurance premiums.

  • Penalties incurred for early withdrawals of CD savings.

  • Alimony paid under a divorce or separation agreement executed before 2019. 

  • Contributions to a traditional IRA (depending on your income level and other conditions). 

Please note that this list isn’t exhaustive, and many of these adjustments are subject to specific conditions and limitations. It’s important to consult a CPA to determine which adjustments apply to your situation and how to calculate them accurately. 

Why AGI matters

Your AGI influences several tax credits and deductions, many of which are phased out or eliminated at higher AGI levels. For instance, the Earned Income Tax Credit (EITC) is phased out as your income increases, making you ineligible once your AGI exceeds specific thresholds.

Medical expense deductions are calculated based on a percentage of your AGI; only the portion of your medical expenses that exceeds this percentage is deductible, so a lower AGI can make it easier to benefit from this deduction. Charitable deductions are also limited to a percentage of your AGI. And, income-driven student loan repayment plans rely on your AGI to determine your monthly payment amounts. 

Modified Adjusted Gross Income (MAGI)

MAGI builds upon your AGI by adding back certain deductions and exclusions. For many taxpayers, MAGI will be the same as AGI, but there are specific types of non-taxable income that can increase your MAGI. 

Some tax benefits are designed specifically for those with lower or moderate incomes. By adding back specific exclusions, MAGI provides a more comprehensive picture of your disposable income. Even though some income isn’t taxable, it still reflects your overall financial capacity and is therefore included in MAGI calculations. 

To calculate your MAGI, you start with your AGI and add back specific exclusions, which generally include:

  • Tax-exempt interest from municipal bonds and tax-exempt securities

  • Foreign Earned Income Exclusion

  • Non-taxable social security benefits

  • Excluded foreign housing costs

  • Income from U.S. Savings Bonds used for education expenses

  • Excluded employer-provided adoption benefits

It’s important to note that the definition of MAGI can vary depending on the specific tax benefit or provision in question. This means that MAGI is not a single, universally defined number but can differ based on the context. 

By understanding how MAGI is calculated, you can anticipate how certain income sources might affect your eligibility for tax benefits. While you may have limited control over income sources like non-taxable Social Security benefits, being aware of their impact on MAGI allows you to plan accordingly. 

Why it matters

Your MAGI determines whether you can contribute to a Roth IRA or deduct contributions to a traditional IRA. Both begin to phase out at different MAGI limits and are eliminated entirely once MAGI exceeds a specific threshold, depending on your filing status. 

Eligibility for education-related tax credits, such as the American Opportunity Credit and Lifetime Learning Credit, also depends on your MAGI. The ability to deduct a portion of student loan interest paid is also phased out or eliminated based on your MAGI and filing status. 

Your MAGI also impacts eligibility for the Child Tax Credit and adoption tax credit. 

Under the Affordable Care Act, your MAGI is used to determine eligibility for Premium Tax Credits, which can lower your monthly health insurance premiums if you are not covered by an employer-sponsored plan and purchase insurance through the Health Insurance Marketplace. Essentially, a higher MAGI might disqualify you from receiving these subsidies, leading to increased healthcare costs. 

If your MAGI exceeds certain thresholds, depending on your filing status, you may also be subject to the 3.8% Net Investment Income Tax. This tax applies to net investment income, including dividends, interest, and capital gains, in addition to your regular income tax. 

Taxable income

While many people primarily focus on taxable income, it’s essential to understand how it fits within the broader context of your financial picture, alongside total income, AGI, and MAGI. 

Taxable income is the portion of your income that remains after subtracting certain deductions and exemptions from your AGI. It determines your tax bracket and the amount of federal income taxes you owe. Importantly, taxable income is the category where taxpayers have the most flexibility to optimize their tax situation through strategic financial decisions. 

To calculate your taxable income, you begin with your AGI and then subtract either the standard deduction or your itemized deductions – whichever provides a greater reduction. While the standard deduction simplifies the process, many taxpayers find that itemizing deductions can lead to significant tax savings if their deductible expenses exceed the standard amount. Common itemized deductions include mortgage interest paid on qualified home loans, state and local taxes (SALT) up to $10,000, medical and dental expenses that exceed 7.5% of your AGI, charitable contributions, and losses from federally declared disasters.

Additionally, pass-through business owners may deduct up to 20% of their Qualified Business Income from their AGI regardless of whether they itemize or take the standard deduction. However, the QBI deduction is subject to various limitations and thresholds based on income levels and the nature of the business. 

Why it matters

The most obvious reason to track and optimize taxable income is to minimize your federal taxes. However, there’s more to it. Taxable income influences the availability and extent of various tax benefits and obligations in ways that differ from AGI or MAGI. 

One key example is the Alternative Minimum Tax (AMT), which is calculated based on your taxable income. The AMT was designed to ensure that individuals with higher incomes pay a minimum level of tax, regardless of deductions and credits. 

Taxable income may also play a role in your state and local tax obligations. Some states use your federal taxable income as the starting point for their tax calculations, applying additional state-specific deductions, exemptions, and tax rates. This means that managing your taxable income effectively can help reduce not only your federal tax burden but also your state and local taxes. However, it’s important to note that some states deviate significantly from the federal tax system, so it’s crucial to consult with a local CPA for more specific guidance. 

Moreover, your taxable income can impact financial aid eligibility for college-bound children. By lowering your taxable income through eligible deductions and strategic planning, you can enhance your eligibility for need-based aid, making higher education more accessible and affordable for your children. 

Stay informed and seek professional advice

While this article provides a foundational overview, it’s not an exhaustive analysis of all the nuances involved. Understanding these income classifications can help you make better decisions, optimize your tax situation, and set yourself up for better financial health. 

Tax laws are complex and subject to frequent changes, making professional guidance a necessity. For personalized advice tailored to your specific circumstances, please contact our office. 

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