The CPA Desk

A Thought Leader Production by PKFTexas

How the TCJA Has Made the “Kiddie Tax” More Dangerous

Once upon a time, some parents and grandparents would attempt to save tax by putting investments in the names of their young children or grandchildren in lower income tax brackets. To discourage such strategies, Congress created the “kiddie” tax back in 1986. Since then, this tax has gradually become more far-reaching. Now, under the Tax Cuts and Jobs Act (TCJA), the kiddie tax has become more dangerous than ever.

A Short History
Years ago, the kiddie tax applied only to children under age 14, which still provided families with ample opportunity to enjoy significant tax savings from income shifting. In 2006, the tax was expanded to children under age 18. And since 2008, the kiddie tax has generally applied to children under age 19 and to full-time students under age 24 (unless the students provide more than half of their own support from earned income).

What about the kiddie tax rate? Before the TCJA, for children subject to the kiddie tax, any unearned income beyond a certain amount ($2,100 for 2017) was taxed at their parents’ marginal rate (assuming it was higher), rather than their own likely low rate.

A Fiercer Kiddie Tax
The TCJA doesn’t further expand who’s subject to the kiddie tax. But it will effectively increase the kiddie tax rate in many cases.

For 2018–2025, a child’s unearned income beyond the threshold ($2,100 again for 2018) will be taxed according to the tax brackets used for trusts and estates. For ordinary income (such as interest and short-term capital gains), trusts and estates are taxed at the highest marginal rate of 37% once 2018 taxable income exceeds $12,500. In contrast, for a married couple filing jointly, the highest rate doesn’t kick in until their 2018 taxable income tops $600,000.

Similarly, the 15% long-term capital gains rate takes effect at $77,201 for joint filers but at only $2,601 for trusts and estates. And the 20% rate kicks in at $479,001 and $12,701, respectively.

In other words, in many cases, children’s unearned income will be taxed at higher rates than their parents’ income. As a result, income shifting to children subject to the kiddie tax will not only not save tax, but it could actually increase a family’s overall tax liability.

The Moral of the Story
To avoid inadvertently increasing your family’s taxes, be sure to consider the big, bad kiddie tax before transferring income-producing or highly appreciated assets to a child or grandchild who’s a minor or college student. If you’d like to shift income and you have adult children or grandchildren who’re no longer subject to the kiddie tax but in a lower tax bracket, consider transferring such assets to them.

Please contact us for more information about the kiddie tax — or other TCJA changes that may affect your family.

What is Foreign Derived Intangible Income?

Jen: This is the PKF Texas Entrepreneur’s Playbook. I’m Jen Lemanski, and I’m back again with Frank Landreneau, one of our international tax directors. Frank, welcome back to the Playbook.

Frank: Thank you, Jen. Great to be here.

Jen: So, we’ve done a whole series on international tax and the impact on tax reform. Are there any incentives to bring business to the United States?

Frank: Jen, I’m glad you asked about that. Remember last time we talked about the so-called GILTI tax?  Well, there’s something that’s kind of the corollary to that, and it’s called Foreign Derived Intangible Income. The purpose behind it is to incentivize companies to do business here in the United States.

Jen: So, what do they need to do with that Foreign Derived Intangible Income?

Frank: Well, it sounds kind of like a funny deal. Originally it was meant to incentivize companies that had intellectual property here in the states and tax it at a favorable rate, but it’s actually much more than that. It’s a special rate on goods and services that are provided to foreign customers that use those goods and services outside the U.S.

Jen: Okay. Is there any specific industry that this targets or it’s kind of across the board?

Frank: It really is across the board. It’s really meant for exporters of goods primarily, but it also could apply to exporters of services. So, if you’re providing professional services, for example, for a client that may be outside the U.S.

Jen: Well, great. I know there’s a lot more detail that we need to get into, and can we get you back to talk about it?

Frank: That’d be great. I’d love to dig in.

Jen: Perfect. To learn more about our international topics, visit PKFTexas.com/internationaldesk. This has been another Thought Leader production brought to you by PKF Texas the Entrepreneur’s Playbook.

How Private Foundations Can Avoid Costly IRS Attention

IRS rules governing private foundations are complex and include many exceptions, which is why your foundation needs to write and follow a detailed conflict-of-interest policy. Taking this proactive step can help you avoid potentially costly public and IRS attention.

Casting a Wide Net
Conflict-of-interest policies are critical for all not-for-profits. But foundations are subject to stricter rules and must go the extra mile to avoid anything that might be perceived as self-dealing. Specifically, transactions between private foundations and disqualified persons are prohibited.

The IRS casts a wide net when defining “disqualified persons,” including substantial contributors, managers, officers, directors, trustees and people with large ownership interests in corporations or partnerships that make substantial contributions to the foundation. Their family members are disqualified, too. In addition, when a disqualified person owns more than 35% of a corporation or partnership, that business is considered disqualified.

Avoiding Dangerous Transactions
Prohibited transactions can be hard to identify because there are many exceptions. But, in general, you should ensure that disqualified persons don’t engage in the following transactions with your foundation:

  • Selling, exchanging or leasing property,
  • Making or receiving loans or extending credit,
  • Providing or receiving goods, services or facilities, or
  • Receiving compensation or reimbursed expenses.

Disqualified persons also shouldn’t agree to pay money or property to government officials on your behalf.

Facing the Consequences
What happens if you violate the rules? Your foundation’s manager and the disqualified person may be subject to an initial excise tax (5% and 10%, respectively) of the amount involved and,if the transaction isn’t corrected quickly, an additional tax of up to 200% of the amount. Although liability is limited for foundation managers ($40,000 for any one act), self-dealing individuals enjoy no such limits. In some cases, private foundations that engage in self-dealing lose their tax-exempt status.

Private foundations that run afoul of the IRS usually have good intentions. You may assume, for example, that transactions with insiders are acceptable so long as they’re fair or benefit your foundation. Unfortunately, this isn’t the case. Most activities defined by the IRS as self-dealing — regardless of whom or what they reward — are off-limits.

If you’re unsure about whether a transaction might violate IRS rules, please contact us.

A Closer Look at the New QBI Deduction Wage Limit

The Tax Cuts and Jobs Act (TCJA) provides a valuable new tax break to noncorporate owners of pass-through entities: a deduction for a portion of qualified business income (QBI). The deduction generally applies to income from sole proprietorships, partnerships, S corporations and, typically, limited liability companies (LLCs). It can equal as much as 20% of QBI. But once taxable income exceeds $315,000 for married couples filing jointly or $157,500 for other filers, a wage limit begins to phase in.

Full vs. Partial Phase-In
When the wage limit is fully phased in, at $415,000 for joint filers and $207,500 for other filers, the QBI deduction generally can’t exceed the greater of the owner’s share of:

  • 50% of the amount of W-2 wages paid to employees during the tax year, or
  • The sum of 25% of W-2 wages plus 2.5% of the cost of qualified business property (QBP).

When the wage limit applies but isn’t yet fully phased in, the amount of the limit is reduced and the final deduction is calculated as follows:

  1. The difference between taxable income and the applicable threshold is divided by $100,000 for joint filers or $50,000 for other filers.
  2. The resulting percentage is multiplied by the difference between the gross deduction and the fully wage-limited deduction.
  3. The result is subtracted from the gross deduction to determine the final deduction.

Some Examples
Let’s say Chris and Leslie have taxable income of $600,000. This includes $300,000 of QBI from Chris’s pass-through business, which pays $100,000 in wages and has $200,000 of QBP. The gross deduction would be $60,000 (20% of $300,000), but the wage limit applies in full because the married couple’s taxable income exceeds the $415,000 top of the phase-in range for joint filers. Computing the deduction is fairly straightforward in this situation.

The first option for the wage limit calculation is $50,000 (50% of $100,000). The second option is $30,000 (25% of $100,000 + 2.5% of $200,000). So the wage limit — and the deduction — is $50,000.

What if Chris and Leslie’s taxable income falls within the phase-in range? The calculation is a bit more complicated. Let’s say their taxable income is $400,000. The full wage limit is still $50,000, but only 85% of the full limit applies:

($400,000 taxable income – $315,000 threshold)/$100,000 = 85%

To calculate the amount of their deduction, the couple must first calculate 85% of the difference between the gross deduction of $60,000 and the fully wage-limited deduction of $50,000:

($60,000 – $50,000) × 85% = $8,500

That amount is subtracted from the $60,000 gross deduction for a final deduction of $51,500.

That’s Not All
Be aware that another restriction may apply: For income from “specified service businesses,” the QBI deduction is reduced if an owner’s taxable income falls within the applicable income range and eliminated if income exceeds it.

Please contact us to learn whether your business is a specified service business or if you have other questions about the QBI deduction.

What Not-For-Profits Need to Know About Fraud

Jen: This is the PKF Texas Entrepreneur’s Playbook. I’m Jen Lemanski, and I’m back again with Danielle Supkis Cheek, a PKF Texas Director and one of our Certified Fraud Examiners. Danielle, welcome back to the Playbook.

Danielle: Thanks for having me.

Jen: In your fraud and forensics practice, I know you work with a lot of not-for-profits. There’s fraud in not-for-profit?

Danielle: Unfortunately, yes. One of the risks that non-profits have is that—we’ve done a session before on small businesses and how small businesses are more susceptible for fraud because of their ability to, in effect, invest in their infrastructure and the size of their resources. It takes it one step further for non-profits.

The problem is that most non-profits are not profit maximizing entities, by the name, but really some kind of social good maximization. Most of their money goes toward spending on their mission. Accounting is not usually the mission of most non-profits, as much as I’d like it to be, and so what ends up happening is that a lot of metrics for non-profits on their success are based on the percent spent towards their mission vs. what they spend on their admin, or actually fundraising as well, but I care most about the admin for this little conversation and topic, because where you prevent fraud is on IT resources and accounting resources.

Since they’re actually theoretically penalized for investing heavily in IT and accounting infrastructure because of that percent spend, through lesser donations is the penalty, they tend to push the limit as far as they can go on cutting costs on overhead and not investing in the technology—

Jen: Not a lot of oversight, either. A lot of not-for-profits are working with volunteers, too.

Danielle: Yes, which creates additional risk for them.

Jen: Is it more complicated then for a not-for-profit?

Danielle: Accounting for a non-profit is more complicated than a rank and file business, and the reason for that is that because they are getting donations from either the public, just soliciting general donations, or a private foundation, or even actual the public US government, or a state and local government. There’s a certain duty to spend the money that you’re receiving for your mission in accordance with the donor stipulations. That tracking is actually pretty darn complicated to do, especially on a bootstrapped infrastructure from a spend perspective.

Jen: How would a not-for-profit not necessarily prevent fraud but eliminate some risk?

Danielle: There’s a lot of things that can be done to eliminate some risk. The key control is around cash, really tightening down cash, using the tracking feature of different accounting softwares and kind of hacking together at various accounting softwares to be able to track those restriction. And actually understanding what’s going on in your books and not overcomplicating it for the sake of overcomplicating but making sure that you’re figuring out where that money is actually going. Doing your best practices book keeping, bank reconciliations, that kind of stuff. The most important is tightening down cash more so than anything else.

Jen: Good to know. We’ll get you back to talk a little bit more about that.

Danielle: Sure thing.

Jen: For more about this topic, visit pkftexas.com. This has been another Thought Leader Production brought to you by PKF Texas the Entrepreneur’s Playbook. Tune in next week for another chapter.

Thinking Like an Auditor for Your Not-For-Profit Revenue

Auditors examining a not-for-profit’s financial statements spend considerable time on the revenue figures. They look at the accounting methods used to record revenues and perform a detailed income analysis. You can use the same techniques to increase your understanding of your organization’s revenue profile.

In particular, consider:

Individual Contributions
Compare the donation dollars raised to past years to pinpoint trends. For example, have individual contributions been increasing over the past five years? What campaigns have you implemented during that period? You might go beyond the totals and determine if the number of major donors has grown.

Also estimate what portion of contributions is restricted. If a large percentage of donations are tied up in restricted funds, you might want to re-evaluate your gift acceptance policy or fundraising materials.

Grants
Grants can vary dramatically in size and purpose — from covering operational costs, to launching a program, to funding client services. Pay attention to trends here, too. Did one funder supply 50% of total revenue in 2015, 75% in 2016, and 80% last year? A growing reliance on a single funding source is a red flag to auditors and it should be to you, too. In this case, if funding stopped, your organization might be forced to close its doors.

Fees for Services
Fees from clients, joint venture partners or other third parties can be similar to fees for-profit organizations earn. They’re generally considered exchange transactions because the client receives a product or service of value in exchange for its payment. Sometimes fees are charged on a sliding scale based on income or ability to pay. In other cases, fees are subject to legal limitations set by government agencies. You’ll need to assess whether these services are paying for themselves.

Membership Dues
If your not-for-profit is a membership organization and charges dues, determine whether membership has grown or declined in recent years. How does this compare with your peers? Do you suspect that dues income will decline? You might consider dropping dues altogether and restructuring. If so, examine other income sources for growth potential.

Once you’ve gained a deeper understanding of your revenue picture, you can apply that knowledge to various aspects of managing your organization. This includes setting annual goals and preparing your budget.

Contact us for help interpreting and applying revenue data.

What Can Be Deductible When Volunteering

Because donations to charity of cash or property generally are tax deductible (if you itemize), it only seems logical that the donation of something even more valuable to you — your time — would also be deductible. Unfortunately, that’s not the case.

Donations of time or services aren’t deductible. It doesn’t matter if it’s simple administrative work, such as checking in attendees at a fundraising event, or if it’s work requiring significant experience and expertise that would be much more costly to the charity if it had to pay for it, such as skilled carpentry or legal counsel.

However, you potentially can deduct out-of-pocket costs associated with your volunteer work.

The Basic Rules
As with any charitable donation, for you to be able to deduct your volunteer expenses, the first requirement is that the organization be a qualified charity. You can use the IRS’s “Tax Exempt Organization Search” tool (formerly “Select Check”) at irs.gov to find out.

Assuming the charity is qualified, you may be able to deduct out-of-pocket costs that are:

  • Unreimbursed,
  • Directly connected with the services you’re providing,
  • Incurred only because of your charitable work, and
  • Not “personal, living or family” expenses.

Supplies, Uniforms and Transportation
A wide variety of expenses can qualify for the deduction. For example, supplies you use in the activity may be deductible. And the cost of a uniform you must wear during the activity may also be deductible (if it’s required and not something you’d wear when not volunteering).

Transportation costs to and from the volunteer activity generally are deductible, either the actual cost or 14 cents per charitable mile driven. But you have to be the volunteer. If, say, you drive your elderly mother to the nature center where she’s volunteering, you can’t deduct the cost.

You also can’t deduct transportation costs you’d be incurring even if you weren’t volunteering. For example, if you take a commuter train downtown to work, then walk to a nearby volunteer event after work and take the train back home afterwards, you won’t be able to deduct your train fares. But if you take a cab from work to the volunteer event, then you potentially can deduct the cab fare for that leg of your transportation.

Volunteer Travel
Transportation costs may also be deductible for out-of-town travel associated with volunteering. This can include air, rail and bus transportation; driving expenses; and taxi or other transportation costs between an airport or train station and wherever you’re staying. Lodging and meal costs also might be deductible.

The key to deductibility is that there is no significant element of personal pleasure, recreation or vacation in the travel. That said, according to the IRS, the deduction for travel expenses won’t be denied simply because you enjoy providing services to the charitable organization. But you must be volunteering in a genuine and substantial sense throughout the trip. If only a small portion of your trip involves volunteer work, your travel expenses generally won’t be deductible.

Keep Careful Records
The IRS may challenge charitable deductions for out-of-pocket costs, so it’s important to keep careful records.

If you have questions about what volunteer expenses are and aren’t deductible, please contact us.

ASU No. 2018-08 Clarifies Guidance for Not-For-Profit Entities: Contributions Received and Contributions Made

The Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) No. 2018-08, Not-for-Profit Entities (Topic 958): Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made. ASU No. 2018-08 provides clarifying and amended guidance concerning:

  • the determination of whether a transaction should be accounted for as an exchange or as a contribution, and
  • whether a contribution received is conditional or unconditional.

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Understanding Fraud in International Business

Jen: This is the PKF Texas Entrepreneur’s Playbook. I’m Jen Lemanski, and I’m back again with Danielle Supkis Cheek, a Director at PKF Texas and one of our Certified Fraud Examiners. Danielle, welcome back to the Playbook.

Danielle: Thanks for having me.

Jen: So, Houston’s an international city—we’ve had Frank Landreneau, one of our international tax directors on the program. There’s a lot of opportunity for fraud. What are you seeing in the international space?

Danielle: One of the concerns with the international space and fraud is actually the existence of the Foreign Corrupt Practices Act. It says you can’t bribe officials, which is a pretty obvious matter for international foreign officials.

Jen: One would think you don’t want to bribe people. So, what does the FCPA actually cover?

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How Data Analytics Can Help Solve Your Not-For-Profit’s Challenges

If your not-for-profit wants to improve its budgeting, forecasting, fundraising or other functions but is having a hard time identifying both problems and solutions, data analytics can help. This form of business intelligence is already considered invaluable in the for-profit world. But it can be just as useful to not-for-profits.

Informed Decision Making
Data analytics is the science of collecting and analyzing sets of data to develop useful insights, connections and patterns that can lead to more informed decision making. It produces such metrics as program efficacy, outcomes vs. efforts, and membership renewal that can reflect past and current performance and, in turn, predict and guide future performance.

The data usually comes from two sources:

  1. Internal – Examples include your organization’s databases of detailed information on donors, beneficiaries or members.
  2. External – This type of information can be obtained from government databases, social media and other organizations, both non- and for-profit.

Applied Advantages
Data analytics can help your organization validate trends, uncover root causes and improve transparency. For example, analysis of certain fundraising data makes it easier to target those individuals most likely to contribute to your nonprofit.

It typically facilitates fact-based discussions and planning, which is helpful when considering new initiatives or cost-cutting measures that stir political or emotional waters. The ability to predict outcomes can support sensitive programming decisions by considering data on a wide range of factors —  such as at-risk populations, funding restrictions, offerings available from other organizations and grantmaker priorities.

Needs Dictate Your Purchase
Your organization’s informational needs should dictate the data analytics package you buy. Thousands of potential performance metrics can be produced, but not all of them will be useful. So keeping in mind your most important programs, identify those metrics that matter most to stakeholders and that truly drive decisions. Also ensure that the technology solution you choose complies with any applicable privacy and security regulations, as well as your organization’s ethical standards.

You can adopt the most cutting-edge software, but if your staff aren’t on board, data analytics will be of little benefit. Note that you may need to hire or develop qualified staff to conduct data analytics and convert the results into actionable intelligence.

Make the Most of It
Before you choose a technology, make sure your organization, including your staff, is ready to make the most of it. We can help steer you in the right direction.