If your small business is strapped for cash (or likes to save money), you may find it beneficial to barter or trade for goods and services. Bartering isn’t new — it’s the oldest form of trade — but the internet has made it easier to engage in with other businesses.

However, if your business begins bartering, be aware that the fair market value of goods that you receive in these types of transactions is taxable income. And if you exchange services with another business, the transaction results in taxable income for both parties.

Fair market value

Here are some examples of an exchange of services:

• A computer consultant agrees to offer tech support to an advertising agency in exchange for free advertising.
• An electrical contractor does repair work for a dentist in exchange for dental services.

In these cases, both parties are taxed on the fair market value of the services received. This is the amount they would normally charge for the same services. If the parties agree to the value of the services in advance, that will be considered the fair market value unless there’s contrary evidence.

In addition, if services are exchanged for property, income is realized. For example:

• If a construction firm does work for a retail business in exchange for unsold inventory, it will have income equal to the fair market value of the inventory.
• If an architectural firm does work for a corporation in exchange for shares of the corporation’s stock, it will have income equal to the fair market value of the stock.

Joining a club

Many businesses join barter clubs that facilitate barter exchanges. These clubs generally use a system of “credit units,” which are awarded to members who provide goods and services. The credits can be redeemed for goods and services from other members.

In general, bartering is taxable in the year it occurs. But if you participate in a barter club, you may be taxed on the value of credit units at the time they’re added to your account, even if you don’t redeem them for actual goods and services until a later year. For example, let’s say that you earn 2,500 credit units one year, and that each unit is redeemable for $2 in goods and services. In that year, you’ll have $5,000 of income. You won’t pay additional tax if you redeem the units the next year, since you’ve already been taxed on that income.

If you join a barter club, you’ll be asked to provide your Social Security number or Employer Identification Number. You’ll also be asked to certify that you aren’t subject to backup withholding. Unless you make this certification, the club is required to withhold tax from your bartering income at a 24% rate.

Tax reporting

By January 31 of each year, a barter club will send participants a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” which shows the value of cash, property, services and credits that you received from exchanges during the previous year. This information will also be reported to the IRS.

Exchanging without exchanging money

By bartering, you can trade away excess inventory or provide services during slow times, all while hanging on to your cash. You may also find yourself bartering when a customer doesn’t have the money on hand to complete a transaction. As long as you’re aware of the federal and state tax consequences, these transactions can benefit all parties involved. Contact us if you need assistance or would like more information.

© 2024

Some people mistakenly believe that Social Security benefits are always free from federal income tax. Unfortunately, that’s often not the case. In fact, depending on how much overall income you have, up to 85% of your benefits could be hit with federal income tax.

While the truth about the federal income tax bite on Social Security benefits may be painful, it’s better to understand it. Here are the rules.

Calculate provisional income

The amount of Social Security benefits that must be reported as taxable income on your tax return depends on your “provisional income.” To arrive at provisional income, start with your adjusted gross income (AGI), which is the number that appears on Page 1, Line 11 of Form 1040. Then, subtract your Social Security benefits to arrive at your adjusted AGI for this purpose.

Next, take that adjusted AGI number and add the following:

1. 50% of Social Security benefits,
2. Any tax-free municipal bond interest income,
3. Any tax-free interest on U.S. Savings Bonds used to pay college expenses,
4. Any tax-free adoption assistance payments from your employer,
5. Any deduction for student loan interest, and
6. Any tax-free foreign earned income and housing allowances, and certain tax-free income from Puerto Rico or U.S. possessions.

The result is your provisional income.

Find your tax scenario

Once you know your provisional income, you can determine which of the following three scenarios you fall under.

Scenario 1: All benefits are tax-free

If your provisional income is $32,000 or less, and you file a joint return with your spouse, your Social Security benefits will be federal-income-tax-free. But you might owe state income tax.

If your provisional income is $25,000 or less, and you don’t file jointly, the general rule is that Social Security benefits are totally federal-income-tax-free. However, if you’re married and file separately from your spouse who lived with you at any time during the year, you must report up to 85% of your Social Security benefits as income unless your provisional income is zero or a negative number, which is unlikely.

Having federal-income-tax-free benefits is nice, but, as you can see, this favorable outcome is only allowed when provisional income is quite low.

Scenario 2: Up to 50% of your benefits are taxed

If your provisional income is between $32,001 and $44,000, and you file jointly with your spouse, up to 50% of your Social Security benefits must be reported as income on Form 1040.

If your provisional income is between $25,001 and $34,000, and you don’t file a joint return, up to 50% of your benefits must be reported as income.

Scenario 3: Up to 85% of your benefits are taxed

If your provisional income is above $44,000, and you file jointly with your spouse, you must report up to 85% of your Social Security benefits as income on Form 1040.

If your provisional income is above $34,000, and you don’t file a joint return, the general rule is that you must report up to 85% of your Social Security benefits as income.

As mentioned earlier, you also must report up to 85% of your benefits if you’re married and file separately from your spouse who lived with you at any time during the year — unless your provisional income is zero or a negative number.

Turn to us

This is only a very simplified explanation of how Social Security benefits are taxed. With the necessary information, we can precisely calculate the federal income tax, if any, on your Social Security benefits.

© 2024

Unemployment has been holding steady recently at 3.7%. But there are still some people losing their jobs — particularly in certain industries including technology and media. If you’re laid off or terminated from employment, taxes are likely the last thing on your mind. However, there are tax implications due to your altered employment circumstances.

Depending on your situation, the tax aspects can be complex and require you to make decisions that may affect your tax bill for this year and for years to come. Be aware of these three areas.

1.Unemployment and payments from your former employer

Many people are surprised to find out that federal unemployment compensation is taxable. (Some states exempt unemployment comp from state tax.) In addition, payments from a former employer for any accumulated vacation or sick time are taxable. Although severance pay is also taxable and subject to federal income tax withholding, some elements of a severance package may get special treatment. For example:

• If you sell stock acquired by way of an incentive stock option (ISO), part or all of your gain may be taxed at lower long-term capital gain rates rather than at ordinary income tax rates, depending on whether you meet a special dual holding period.
• If you received — or will receive — what’s commonly referred to as a “golden parachute payment,” you may be subject to an excise tax equal to 20% of the portion of the payment that’s treated as an “excess parachute payment” under very complex rules, along with the excess parachute payment also being subject to ordinary income tax.
• The value of job placement assistance you receive from your former employer usually is tax-free. However, the assistance is taxable if you had a choice between receiving cash or outplacement help.

2.Health insurance costs

Under the COBRA rules, employers that offer group health coverage generally must provide continuation coverage to most terminated employees and their families. While the cost of COBRA coverage is usually expensive, the amount of any premium you pay for insurance that covers medical care is an eligible medical expense for tax purposes. That means it’s deductible if you itemize deductions and if your total medical expenses exceed 7.5% of your adjusted gross income.

If your former employer pays some of your medical coverage for a period of time after termination, you won’t be taxed on the value of the benefit.

3.Retirement plan balance

Employees whose employment is terminated may need tax planning help to determine the best option for amounts they’ve accumulated in retirement plans sponsored by former employers, such as a 401(k) plan. In many cases, a direct, tax-free rollover to an IRA is the best move. You may also choose to leave the account in your previous employer’s 401(k) plan (although the employer may elect to distribute the funds to you). Or, if you get a new job, you may want to transfer the money in the account with your former employer to your new employer’s 401(k) plan.

If you’re under age 59½, and make withdrawals from your former company’s plan or IRA to supplement missing income, you may owe an additional 10% penalty tax unless you qualify for an exception.

If a distribution from the retirement plan includes employer securities in a lump sum, the distribution is taxed under the lump-sum rules, except that “net unrealized appreciation” in the value of the stock isn’t taxed until the securities are sold or otherwise disposed of in a later transaction.

Further, any loans you’ve taken out from your former employer’s retirement plan, such as a 401(k)-plan loan, may be required to be repaid immediately, or within a specified period. If they aren’t, they may be treated as if the loan is in default. If the balance of the loan isn’t repaid within the required period, it will typically be treated as a taxable deemed distribution.

If you need assistance, contact us. We can help you navigate the best path forward during this transition period.

© 2024

With the high cost of college, many parents begin saving with 529 plans when their children are babies. Contributions to these plans aren’t tax deductible, but they grow tax deferred. Earnings used to pay qualified education expenses can be withdrawn tax-free. However, earnings used for other purposes may be subject to income tax plus a 10% penalty.

What if you have a substantial balance in a 529 plan but your child doesn’t need all the money for college? Perhaps your child decided not to attend college or received a scholarship. Or maybe you saved for private college, but your child attended a lower-priced state university.

What should you do with unused funds? One option is to pay the tax and penalties and spend the money on whatever you wish. But there are more tax-efficient options, including a new 529-to-Roth IRA transfer.

Nuts and bolts

Beginning in 2024, you can transfer unused funds in a 529 plan to a Roth IRA for the same beneficiary, without tax or penalties. These rollovers are subject to several rules and limits:

• Transfers have a lifetime maximum of $35,000 per beneficiary.
• The 529 plan must have existed for at least 15 years.
• The rollover must be through a direct trustee-to-trustee transfer.
• Transferred funds can’t include contributions made within the preceding five years or earnings on those contributions.
• Transfers are subject to the annual limits on contributions to Roth IRAs (without regard to income limits).

For example, let’s say you opened a 529 plan for your son after he was born in 2001. When your son graduated from college in 2023, there was $30,000 left in the account. In 2024, under the new option, you can begin transferring funds into your son’s Roth IRA. Since the 529 plan was opened at least 15 years ago (and no contributions were made in the last five years), the only restriction on rollover is the annual Roth IRA contribution limit. Assuming your son hasn’t made any other IRA contributions for 2024, you can roll over up to $7,000 (if your son has at least that much earned income for the year).

If your son’s earned income for 2024 is less than $7,000, the amount eligible for a rollover will be reduced. For example, if he takes an unpaid internship and earns $4,000 during the year from a part-time job, the most you can roll over for the year is $4,000.

A 529-to-Roth IRA rollover is an appealing option to avoid tax and penalties on unused funds, while helping the beneficiaries start saving for retirement. Roth IRAs are a great savings vehicle for young people because they’ll enjoy tax-free withdrawals decades later.

Other options

Roth IRA rollovers aren’t the only option for avoiding tax and penalties on unused 529 plan funds. You can also change a plan’s beneficiary to another family member. Or you can use 529 plans for continuing education, certain trade schools, or even up to $10,000 per year of elementary through high school tuition. In addition, you can withdraw funds tax-free to pay down student loan debt, up to $10,000 per beneficiary.

It’s not unusual for parents to end up with unused 529 funds. Contact us if you have questions about the most tax-wise way to handle them.

© 2024