Polaris Tax & Accounting Newsletter – August 2024

Maximize Deductions on Long-Term Care Insurance Premiums

Long-term care costs can be a significant burden, and traditional Medicare or Medicaid often fall short in providing comprehensive coverage. Investing in long-term care insurance is a smart way to protect your financial future. Depending on your business structure, you may even qualify to deduct the premiums, reducing your taxable income.

Key Points to Consider:

  • C Corporations: These entities can offer long-term care insurance as a fully deductible, tax-free benefit to owners, providing both protection and tax savings.
  • Sole Proprietors & Single-Member LLCs: If you have a spouse as the only employee, you might be able to deduct 100% of the premiums under a Section 105-HRA plan, making it a tax-efficient strategy.
  • S Corporation Owners, Partners, & Other Sole Proprietors: You may qualify to deduct premiums, but be aware of age-based limits that could affect the deduction amount.
  • Individual Taxpayers: If business-related deductions don’t apply, you might still deduct premiums as itemized deductions, subject to age-based limits and the 7.5% AGI threshold.

Optimize Social Security and Medicare Taxes with These Strategies

Social Security and Medicare taxes are essential considerations for every business owner, especially with the Social Security tax ceiling rising to $168,600 in 2024. For high-earners, this means a maximum Social Security tax of $20,906. The Social Security Administration expects this ceiling to climb, potentially reaching $242,700 by 2033. Additionally, all wages and self-employment income are subject to a 2.9% Medicare tax, with an extra 0.9% for high-income earners.

Tax Reduction Strategies:

  • Operate as an S Corporation: This structure allows you to pay yourself a reasonable salary and distribute the rest as profits, exempt from self-employment taxes.
  • Leverage Community Property Rules: If you’re married and live in a community property state, IRS rules can help reduce self-employment taxes by eliminating or creating a spouse partnership.
  • Avoid Husband-Wife Partnership Classification: By carefully managing partnership attributes, you can reduce self-employment taxes by avoiding this classification.

Each of these strategies comes with specific requirements and potential trade-offs, so it’s essential to consult with a tax professional before implementation.

Estate Planning with S Corporation-Owned Rental Properties

If your S corporation owns rental property as its sole asset, you might wonder what happens to the property when you pass away. A key concern is whether the property gets a step-up in basis, which could significantly affect your heirs’ tax liability.

Here’s the Good News:

  • Your heirs inherit the S corporation stock at its stepped-up fair market value.
  • When the S corporation sells the rental property, it recognizes a gain.
  • This gain increases your heirs’ basis in the S corporation stock.
  • Upon liquidation of the S corporation, your heirs may recognize a capital loss that offsets the gain, potentially leading to no federal income tax liability.

This strategy can achieve a similar tax outcome as a traditional basis step-up in a personal rental property.

Tax Efficiency with Cryptocurrency: Choosing the Right Accounting Method

Let’s say you bought one Bitcoin for $15,000 over a year ago and another for $40,000 six months later. Today, you sell one Bitcoin for $60,000. The big question is: Is your taxable gain $45,000 or $20,000?

The Answer Lies in Your Accounting Method:

  • Default FIFO Method: The IRS requires FIFO (First-In, First-Out) as the default. Here, your basis is $15,000, leading to a $45,000 taxable gain.
  • Alternative Methods – HIFO and LIFO: HIFO (Highest-In, First-Out) and LIFO (Last-In, First-Out) can reduce your taxable gain by using the highest possible tax basis for each unit sold. With HIFO, your basis would be $40,000, and your taxable gain only $20,000.

However, these methods require detailed record-keeping, and improper records may force the IRS to default to FIFO during an audit, increasing your taxable gain. To simplify, many crypto traders use specialized software to automate basis and gain/loss calculations.

You can switch your accounting method annually without IRS permission, offering flexibility in managing your crypto tax liabilities.

Avoid the Accumulated Earnings Penalty Tax

If you operate a C corporation, the IRS might impose an Accumulated Earnings Tax (AET) if you retain excessive earnings instead of distributing them as dividends. While retaining earnings can be a strategic decision, the AET is a 20% penalty tax on corporations that the IRS deems to have accumulated earnings without a reasonable business need.

How to Avoid the AET:

  • Elect S Corporation Status: By switching to an S corporation, you can avoid AET altogether.
  • Limit Retained Earnings: Keep retained earnings under $250,000 ($150,000 for certain personal service corporations) to stay below the AET threshold.
  • Justify Retained Earnings: Document the business reasons for retaining earnings above these thresholds, such as working capital needs, expansion plans, or debt repayment.

The key is maintaining thorough documentation that justifies retaining earnings in corporate minutes, board resolutions, business plans, or budget documents.