Category Archives: Business

Insuring Key People at Small Companies

At a multinational corporation, the loss of any single employee may hardly cause a ripple in its ongoing business. That’s often not true for a small business. If you’re the prime mover, your inability to work could have severe consequences. The same is true if you have partners or other vital personnel who can no longer do their jobs.

Building a strong team can hedge against this risk. Even so, your company may want to acquire insurance that will provide needed cash in a worst-case scenario. These policies have been called “key man” insurance, but today a more apt description is “key person” or “key employee” coverage.

Life insurance for your business

Key employee coverage usually includes life insurance. The insured individual probably would be you, the business owner, if you’re actively involved in operations. Partners or co-owners also could be covered; the same is true for, say, a sales or production employee whose absence would create a huge gap in profitability.

The typical structure of key employee life insurance is to have benefits paid to the company in case of the insured individual’s death. The cash flow could help keep the company viable while a replacement employee is sought and installed. In another situation, key employee insurance can be part of a buy-sell agreement.

Example: Diane Edwards and Frank Grant are co-owners of EG Corp. The company buys life insurance on both Diane and Frank. If Diane dies while her life is covered, the proceeds will go to EG, which can buy Diane’s shares from her heirs, leaving Frank as the principal owner. The reverse will happen if Frank is the one to die.

Coverage choices 

As is the case with any type of life insurance, some decisions must be made. Should key employee insurance be term or permanent? Term policies tend to have much lower premiums; they may make sense if the coverage will be needed only for a certain amount of time. A business owner who expects to sell the company or retire within 10 years might prefer a 10-year term policy, for example.

Permanent insurance (which might be known as whole life, universal life, or variable life) generally has much higher premiums. These policies usually have an investment account called the cash value. As the owner of the policy, the company might be able to tap the cash value via loans or withdrawals, if necessary. As the label indicates, permanent life could be worth buying for long-lasting coverage.

In addition to the type of policy, a small company buying key employee life insurance must decide how much coverage to acquire. Ideally, the amount should be sufficient to keep the company going until it recovers from the individual’s death, perhaps with a new hire or new owner. If such an amount is difficult to determine, you might go by a rule of thumb, such as buying coverage equal to 8 or 10 times the insured individual’s salary. The amount of insurance should be reviewed periodically and changed when appropriate.

Dealing with disability

If a key individual gets sick or injured and becomes unable to work, the impact on the company can be as serious as that person’s death. Therefore, key employee disability insurance also should be considered. Disability policies have many moving parts: the definition of disability, the waiting period before benefits begin, the length of time benefits will be paid, and so on. An experienced insurance professional may be able to help your company find effective disability coverage at an affordable price and also assist with key employee life insurance.

For both life and disability key employee policies, the premiums your company pays probably will not be tax deductible. Any life insurance benefits on an employee’s death that are payable to the company may be taxable income to the extent the benefits exceed the premiums and other amounts paid by the company for the policy. On the other hand, because key employee disability premiums are not deductible, benefits received from a policy generally are tax-free. Our office can explain the likely tax treatment of any key employee insurance you are considering.

Small Companies Need Plans for Natural Disasters

From East Coast to West Coast, hurricanes and wildfires recently created huge losses of lives, property, and emotional wellbeing. In the middle of the United States, crippling natural disasters can range from blizzards to river flooding to tornadoes. News reports naturally focus on homes and families, but local businesses also are among the victims.

There may be little a small company can do when it’s in the path of record winds or a wall of flames. However, there are steps a business owner can take when things are calm to reduce the impact of catastrophic conditions in the future.

 

Be sure about insurance

 

For example, relevant insurance should be in place. Whether you rent or own the facilities you use, you should have adequate property insurance from a well-established company. Business interruption coverage may provide cash if revenue producing operations are curtailed for any length of time. Your firm also may obtain special flood or earthquake insurance (or both) if that’s deemed necessary.

You probably won’t have the time or the inclination to evaluate all the coverage you might need. Therefore, you should work with an experienced agent or insurance consultant who can provide expertise. This professional also can suggest the scope of personal insurance needed by you and your employees, payable after a natural disaster. In the wake of a dreadful event, the less time people spend worrying about personal losses, the sooner your firm can get back to operating at full speed.

 

Staying online

 

Business interruption policies may or may not cover problems that disable information technology systems, which are vital to many small companies. Special cyber policies might be available. Besides insurance coverage, there are things you can do to proactively keep data and other records intact, even in worst case scenarios.

Backing up computer files is an obvious yet vital procedure. Store the backups offsite or use a cloud-based solution. If your company operates in different areas, one place might store backup records for the other place. Some small companies have gone from desktop computers and related accessories to laptops, which are easier to move quickly, if circumstances require swift action.

 

Power play

 

As we’ve seen, some storms bring high winds that can bring down power lines. Hurricane Irma impaired electricity for millions of users in Florida and surrounding states. If you have a generator that can supply emergency power for critical usage, that can reduce the time operations cease altogether.

Again, during and immediately after a disastrous event, it’s vital for employees to have power at home so they can go on with their lives and perhaps get some work done. Your company might inform key people about sources of backup power and even provide a financial incentive to have a residential generator installed.

These steps can serve as part of a natural disaster plan. To create a complete course of action, take on the role yourself or assign an employee to head this effort. The leader’s first job might be to find a local consultant or other expert to create a formal policy for your company. Asking your own company’s executives and staffers for suggestions can lead to valuable input from all areas of the firm. Once a plan has been adopted, it should be circulated to all employees so they know what to do and who to contact in case of a true emergency.

Year-End Thank You Gifts From Business Owners

During the holiday season, it’s natural for business owners to think about giving something to key individuals. On your list might be your employees, customers, suppliers, or others who helped your business during 2017. If you haven’t already made plans, do so quickly so the gifts may be distributed before year-end.

Lavish gifts may make an excellent impression, but you probably don’t want to go overboard by spending too much. You should have a budget for these gifts and stick to it. You also should know the tax consequences of your generosity.

Employee gifts

 Amounts you spend on gifts to your workers probably will be tax deductible for your company. However, the key question for employees is whether the gifts will be treated as taxable income.

Generally, a cash gift or anything that looks like cash, such as a gift card or gift certificate, will be taxable. The amount will be subject to federal and any state or local income tax withholding as well as unemployment tax and FICA taxes.

Non-cash gifts will be untaxed if they fall under the de minimis classification, meaning that the value is so low that it would not be reasonable for an employer to bother with record keeping, withholding, and so forth. The IRS has not spelled out an upper limit for spending on tax-exempt gifts. That said, you’re probably safe giving away hams or turkeys during the holidays.

If you wish to give other types of gifts, our office can advise you of the tax consequences. (More expensive gifts probably will generate taxable income.) In all price ranges, choices are vast and variable, from smartphone accessories (photo tripods, waterproof cases, and so on) to tickets to local entertainment.

Your gift will be even more meaningful if it’s accompanied by a thoughtful letter of thanks and wishes for good health in the coming year.

Business gifts

Instead of or in addition to employee gifts, you may want to give something to selected outsiders who helped your company during 2017. In this case, the issue is not whether the gift will be taxable income for the recipient, but whether you can deduct the cost of gifts to clients, vendors, and so on.

A business may deduct no more than $25 for business gifts per recipient. You can’t exceed this limit by making indirect gifts to a customer’s family member. Therefore, if you give a $200 sweater to the husband of a key customer, it will be considered an indirect gift over the $25 limit, and the excess amount will not be tax deductible. However, this rule does not apply if you have a bona fide, independent business connection with the family member receiving the gift, and it is not intended for the customer’s eventual use.

For this purpose, a partnership and its partners are treated as one taxpayer. Similarly, a married couple will be treated as one taxpayer subject to the $25 limit. It doesn’t matter whether the spouses each have their own company, are employed at different places, or have independent connections with the recipient.

Example: Steve Harrison’s company does business with ABC Corp., which is a valued customer. Steve and his wife Tina give four baskets of wine to ABC as a holiday gift.

The Harrisons paid $100 apiece for these baskets, for a $400 total. Four ABC executives each took a gift basket home for their personal use. The Harrisons have no independent business relationship with any of the executives’ other family members. They can deduct only $100 (4 times the $25 limit) of the cost of the gift baskets.

Incidental costs, such as engraving on jewelry, packaging, insuring, and mailing, are generally not included in determining the cost of a gift for purposes of the $25 limit. That’s true, as long as the incidental cost doesn’t add substantial value to the gift.

Beyond $25

 The following items aren’t considered gifts for purposes of the $25 limit:

  • An item that costs $4 or less that has your name clearly and permanently imprinted on the gift and is one of many identical items your company widely distributes. Such items might include pens, desk sets, plastic bags, and cases.
  • Signs, display racks, or other promotional material to be used on the business premises of the recipient.

Keeping good records can enable you to support deductions for business gifts, if those deductions are challenged.

Tax Court Approves 100% Business Meal Deduction

Many business owners, self-employed individuals, and other taxpayers are aware that business meals and entertainment expenses are only 50% deductible. You might treat a key client to a restaurant meal and spend $100. Even if this meal has a definite business purpose (you wind up with an important contract), only $50 will be tax deductible.

Nevertheless, some business meals can be fully deductible. The Tax Court recently overruled the IRS in a case regarding the pro hockey team, the Boston Bruins (Jacobs v. Commissioner, 148 T.C. No. 24, 6/26/17). Although the IRS claimed tax deficiencies totaling about $85,000 over two years’ tax returns, the court sided with the team’s owners and allowed 100% deductions for meal costs.

Pregame preparation 

As is the case with most professional sports teams, the Bruins play half of their games away from home. National Hockey League rules require teams to arrive well in advance, so the Bruins schedule hotel rooms for the players and other traveling employees. These hotel arrangements include the provision of rooms where meals are served, with specified menus, before the games.

All traveling employees are entitled to eat meals there at no personal cost. The players are required to eat there, on time, because considerable game planning occurs at these meals between players and coaches.

The Tax Court noted that the meal service was nondiscriminatory, as all traveling hockey employees could attend. Moreover, the meal expenses were associated with the active conduct of the taxpayer’s trade or business: winning hockey games.

The Bruins argument

The Bruins argued that the meals were 100% deductible, because the costs of the meals were excepted from the 50% meals and entertainment limitation because they were de minimis fringe benefits.

Five tests

The court found that the meals would qualify as de minimis fringe benefits if they were provided in a nondiscriminatory manner and five other tests relating to the meal were met:

  1. The eating facility is owned or leased by the employer.
  2. The facility is operated by the employer.
  3. The facility is located on or near the business premises of the employer.
  4. The meals furnished at the facility are provided during, or immediately before or after, the employees’ workday.
  5. The revenue or operating cost test is passed. (This last point will be satisfied if the meals are furnished for the employer’s convenience on the employer’s business premises.)

The court found that the team furnished the meals in a nondiscriminatory manner because it provided the meals to all traveling hockey employees. After analyzing the evidence presented, the court decided that the meals met the five tests. Consequently, it held that the costs of the meals was 100% deductible as de minimis fringe benefits not subject to the 50% meals and entertainment limitation in IRC Section 274(n)(2)(B).

Key takeaways

Although professional sports teams operate a very specialized business, the Tax Court’s reasoning in this case may apply to other situations, especially in sports and entertainment industries in which employees are provided meals away from home as part of their work schedule.

In addition, this decision can be a reminder that certain meal expenses can be 100% deductible. For example, employers might be entitled to deduct the full cost of food and drink at events primarily for the benefit of rank and file employees. Those occasions could be holiday parties, company outings, banquets, and so on. Also, meals, snacks, and beverages provided to employees at no charge, on or near the firm’s premises for valid business purposes, may be 100% deductible.

We can help you structure employee benefits of this nature so that your business will meet the requirements for full tax advantages.

R&D Tax Credits for Small Companies

Just as individuals get a dollar-for-dollar tax savings from tax credits, the same is true for businesses that qualify for tax credits. The Protecting Americans from Tax Hikes (PATH) Act of 2015, passed in 2016, expanded the ability of small companies to use the research and development (R&D) tax credit. The R&D credit is based not on the total amount a business spends on R&D, but on increases in R&D spending. Not only is a tax credit better than a tax deduction, but R&D costs not covered by the credit may not be immediately deductible.

The spending that counts for the R&D credit might be for in-house wages and supplies, as well as for outside contracts that are considered qualified research expenditures. Money spent on activities such as developing new or improved products, processes, or formulas; developing prototypes or models; developing new technology; and developing or applying for patents may qualify.

To obtain the R&D credit, diligent recordkeeping is required. Defining which outlays qualify as R&D can be a challenge, so companies should be able to support their claims. Moreover, certain small businesses may run into additional obstacles, such as the alternative minimum tax (AMT) and a lack of taxable income that prevents using tax credits currently.

Addressing the AMT

Generally, a company that owes the AMT cannot use the R&D tax credit to reduce its AMT obligation. However, in some cases, the PATH Act allows the R&D credit to offset the AMT. Eligible companies are sole proprietorships, partnerships, or nonpublic corporations with average annual gross receipts under $50 million for the prior three tax years. In the case of pass-through entities, partners and S corporation shareholders may be able to use the R&D credit against their individual AMT liability.

Offsetting payroll taxes

The R&D tax credit is nonrefundable, so it generally doesn’t help companies with no income tax liability. Another PATH provision addresses this problem for young companies that do substantial R&D yet have no tax liability to reduce. Eligible firms can use the credit to reduce payroll tax, rather than income tax.

To qualify, a corporation or partnership must have less than $5 million of gross receipts in the year of claiming the credit and no gross receipts in any year before the fourth preceding year. Thus, this tax break is mainly for startups. A company that qualifies can use up to $250,000 of R&D tax credits to reduce its employer share of Social Security payroll tax outlays, so cash can be retained. If current payroll tax doesn’t equal the amount of the R&D credit a company can claim, carryforwards may be possible.

The complexity of the R&D tax credit and the required recordkeeping may discourage small companies from claiming it. If your company is devoting resources to developing new products and technology, our office can determine if seeking this credit will be worthwhile and help you provide the necessary documentation.