Basis: The Essential Tax and Investing Term
First, let’s start with what “basis” means; your basis is usually what you paid for an asset. According to the IRS, a capital gain or loss is the difference between your basis and the amount you get when you sell an asset. So, if you sell an asset that is worth more than you paid for it, you will have to pay taxes on the gain.
If, for example, you had purchased stock many years ago for $10 a share and you sold it today for $75 a share, the $65-per-share gain would have to be taxed. These capital gains taxes will vary depending on whether they are considered short-term gains (assets held for less than one year and taxed as ordinary income) or long-term gains (assets held for more than one year and taxed at between 0 percent and 23.8 percent, depending on your income level). Basically, for long-term capital gains, the rates are 0 percent, 15 percent, or 20 percent, based on income, with an additional 3.8 percent for certain high-earners as part of the Affordable Care Act.
Tax reform passed in late 2017 didn’t change the capital gains rates, but bracket adjustments may have changed your situation, so don’t assume that your tax obligations may be the same this year.
Although capital gains taxes can be significant, the government gives heirs a break when they inherit appreciated stock. When someone inherits an asset, the cost basis of the asset is “stepped up to value” on the date of death.
Let’s assume that an elderly parent leaves a home to her grown children. The home was purchased forty years ago for $50,000—the original basis—and is valued at $400,000 on the date of death. The beneficiaries may have to pay estate or inheritance taxes depending on the size of the estate, but they will not be responsible for capital gains tax on $350,000 worth of gains if they decide to sell the house. The government immediately resets that $50,000 basis to $400,000.
Since they received a step-up in basis, they will be responsible only for gains that might occur from the point at which they inherit the asset and then sell it. So, if the beneficiaries later sell the home for $425,000, only the $25,000 is considered a gain, as it represents the increase in value after the original owner passed away.
Now that you know about this, you should examine the cost basis of assets before you think of gifting as the preferred means of transferring wealth.
Estate planning attorneys note that too often an emphasis is made on gift-giving to avoid a modest amount of estate tax, because then the recipient of the gift is confronted with a large capital gain to be paid when selling the gifted item. Holding the property rather than gifting it to the beneficiary could relieve that beneficiary of any capital gains tax if there is no additional gain on the value of the property. It’s a good idea to consider this for any highly appreciated property, as gifting could result in capital gains taxes that could have been avoided.
Note also that the federal estate tax now has such a high floor that very few families will be subject to it, but some states have much lower floors.
Using a step-up in basis can lead to big tax savings, but there are limitations to consider. For instance, it doesn’t apply for tax-deferred accounts such as IRAs or 401(k)s.
Optimizing an estate plan to minimize inheritance, estate, and capital gains taxes is no easy task. Complexities in the tax code certainly don’t make it easy for the average person to address these issues. Your situation is unique, and that’s why you may want to consider speaking to your legal, tax, and financial advisors to determine the most appropriate planning approach for you and before making a major decision.
What Is Zero Trust Security?
Ever since cybersecurity first became an issue, we’ve been trying to protect data. Traditionally, we’ve assumed that all threats would come from the outside and that everyone within our network was “safe.” Several high-profile hacks proved that theory false, but it didn’t change how we did things.
Trust but Verify
In 2010, John Kindervag, then a principal analyst at Forrester Research, Inc., announced a different model for securing data. This model, called zero trust security, had a more realistic premise: no one can be considered safe, whether they are inside or outside the perimeter of the particular system, because hacks can come from anywhere. “Trust but verify” applied to everyone, whether they were inside or outside the network. Kindervag’s model has evolved, but his core concept has remained: your network is only as secure as the user’s level of access.
This shift in how people think about security caught the attention of IT professionals. In fact, IDG’s 2018 Security Priorities Survey found that 71% of security-focused IT decision makers were aware of the zero trust model, 8 percent were actively using it in their organizations and 10 percent were piloting it.
Zero Trust Security
Zero trust security is based on an identity and access management (IAM) system. IAM systems begin with the premise that your network is being accessed by users and devices in unsecured locations, such as coffee shops and airports, so individual users must be identified as “friends” before they can gain access. Note that some systems are more sophisticated than others and that businesses need to conduct an in-depth analysis of the how, when, where, and why different users might want to gain access. Zero trust systems are used to enhance security in two primary ways:
1. Privileged access: Privileged access grants as-needed access to different levels of employees. For example, salespeople might have access to data concerning their customers, whereas sales managers might have access to their direct reports’ data. Neither group would have access to manufacturing data because that information is not directly related to their jobs.
Each level of permission unlocks additional data. Each unlocked data level (or micro-segment) increases the company’s risk exposure. Consequently, once a user is identified, the IAM system verifies every element of access whether it is stored on the company’s in-house servers, in the cloud, or managed by third-party SaaS apps.
2. Integrated multi factor authentication (MFA): MFA is another important aspect of zero trust security. It should be in place for all privileged accounts and business-critical systems. The two types of MFAs are flexible authentication policies and risk-based authentication:
Flexible authentication policies both enhance security and provide ease of use.
Risk-based authentication is a form of strong authentication that calculates a risk score for any given access attempt in real time. For example, a user might be locked out if he or she used an incorrect password too many times within a set time period. Certain situations require multiple levels of identification.
Cybersecurity is a complex area–one that is becoming increasingly important. This may be the time to think about how your data is protected. Contact us if you have concerns about cybersecurity at your business.
Charitable Gifts: Getting the Paperwork Right
If you offer gifts or money to qualified organizations eligible to receive tax-deductible charitable contributions, you must do two things to ensure that donation is deductible:
- Have a bank record or written communication from the charity for any monetary contributions.
- Get a written acknowledgment from the charity for any single donation of $250 or more.
Here are the key rules you should remember about donations and written acknowledgments:
- If you make single donations of $250 or more to a charity, you must have one of the following to claim a deduction: (1) a separate acknowledgment from the organization for each donation of $250 or more or (2) a single acknowledgment from the charity listing the amount and date of each contribution of $250 or more. The $250 threshold doesn’t mean you need to add up separate contributions of less than $250 throughout the year. For example, if you gave a $25 offering to your church each week, you don’t need an acknowledgment from the church, even though your total contributions for the year are more than $250.
- Contributions made by payroll deduction are treated as separate contributions for each pay period.
- If you make a payment that’s partly for goods and services, your deductible contribution is the amount of the payment that exceeds the value of the goods and services.
- You must get the acknowledgment for your donation on or before the earlier of these two dates: the date you file your return for the year you make the contribution, or the due date, including extensions, for filing the return.
- If the acknowledgment doesn’t show the date of the contribution, you also must have a bank record or receipt that shows the date.
Of course, you also have to make sure the organization you are donating to is qualified. Not every nonprofit can grant you the right to an income tax deduction. You can donate to civic leagues, social and sports clubs, labor unions and chambers of commerce, but you can’t deduct your gifts to these organizations as a charitable expense. The same goes for donations to candidates for public office.
This is just an introduction to a complex topic; there are additional rules and exceptions. If you’re unclear about your donations, be sure to check with R&A..
Capitalization and Safe Harbor: Know the Rules
Whenever you spend money on your business, the expense is either deducted on your federal tax return in the year it is incurred or depreciated over time. But much more is involved than just that. And when you hear terms like capitalization and safe harbor, it can feel even more complicated. Here are details to help you better understand the process.
- Deductible costs: These are the day-to-day costs of operating your business, such as rent, insurance, maintenance, and office supplies. The Internal Revenue Service lets you deduct all these “ordinary and necessary expenses” during the taxable year in which they are incurred.
- Capital costs: These are payments you make to acquire or improve your building and equipment. These costs, such as upgrading an HVAC system, are considered to be business investments that add to the value of your asset. Capital costs are depreciated on tax returns over the course of their “useful life” as determined by the IRS. The useful life of a laptop, for instance, is five years, whereas the useful life of telecommunications equipment is seven years. Sometimes, intangible assets, such as patents and trademarks, are considered capital expenses.
It seems straightforward. But, in fact, determining whether a cost must be capitalized over X number of years isn’t as easy as it looks. And, to make accounting even more fun, the IRS has a “de minimis safe harbor election” that lets you deduct expenses that you otherwise would capitalize.
The de minimis (Latin for “concerning the smallest things”) safe harbor is a yearly tax return election that allows you to deduct expenses for tangible property that costs below a certain threshold. Essentially, it gives taxpayers an immediate but limited tax break on items that otherwise would take many years to depreciate.
The IRS has been busy lately increasing the threshold from $500 to $2,500 for businesses that don’t have an audited financial statement, which is something that many small businesses don’t have. This means that if your small business bought, for example, a computer for $2,499, you might be able to deduct the entire amount on that year’s tax return, instead of over many years. For businesses that maintain an audited financial statement, the threshold continues to be $5,000.
De minimis safe harbor is considered to be a good thing because taking immediate tax deductions simplifies record-keeping and increases tax refunds.
How to Make “de maximis” of Your de minimis
- Ensure that you expense all tangible property costs below $2,500.
- Ensure that your bookkeeping staff applies the threshold to each qualifying item, because the de minimis safe harbor threshold can be appied to any and all tangible property purchases below $2,500.
This is just an introduction to an important topic—there’s a lot more to know. Give R&A a call, and we’ll help you take charge of your purchases.
12 Things to Do If You Suspect Internal Fraud
Discovering that you are the victim of an internal fraud is a harrowing experience, particularly when the perpetrator is someone you’ve trusted. The feeling of betrayal is strong. Your instincts tell you to react immediately.
It’s hard to go against that instinct, but that is exactly what you should do so you can learn what happened and prevent it from happening again. Most internal fraud goes on for an average of sixteen months before being detected. This usually means there’s a glitch in your internal controls. Reacting in the moment can cause you to miss important facts you could use to protect your company going forward.
Once you suspect a fraud has been committed, you should take specific action:
- Identify people you trust. Identify a few employees you can trust and ask them to help you investigate. The team must be objective, so it might be wise to include a forensic accountant or other consultant.
- Ensure confidentiality. The team should share only necessary information. Unwarranted disclosure can seriously damage the investigation. Keep in mind that if the reputation of an innocent person is tarnished, you may be exposed to a lawsuit.
- Be discreet. Financial, payroll, and personnel records should be discreetly reviewed. Your findings can quickly show whether your suspicions are right or wrong.
- Document the entire process. Put everything in writing, including the act or acts being investigated, how the investigation is being conducted, and an estimate of the projected losses.
- Secure evidence. Any potential evidence should be placed in a secure place. Team members should not attempt to examine evidence on their own. Doing so may inadvertently alter the evidence. There is one exception to this rule: if the person you suspect is in the process of destroying electronic evidence, you need to take immediate steps. There is no guarantee IT experts will be able to recover deleted data.
- Consult a lawyer. If the investigation shows a fraud has been committed, consult an employment lawyer to ensure that the rights of the suspected employee are protected. Otherwise, you might leave yourself open to a lawsuit.
- Identify witnesses. Make a list of potential witnesses. Remember that confidentiality is key, so interviews should be conducted individually.
- Restrict access. Don’t fire the suspected employee while the investigation is ongoing. Instead, restrict his or her access to company data and bank accounts.
After you have identified the fraud, take the following actions:
- Assess and repair damage. Evaluate the potential damage to the company’s reputation, both internally and with customers. Then, work with your public relations and human resources teams for a plan to rebuild your brand.
- Report the crime. Report the crime to law enforcement and to your insurance company.
- Reward whistleblowers. If you discovered the fraud through a tip, make sure to reward the person who stepped forward, and let others know how much you value their morality.
- Review controls. Review the internal controls you have in place so you can identify what went wrong and make needed changes.
Taking these steps will put your company in a position to move forward. For guidance in ensuring your company’s future success following an incident of internal fraud, contact R&A. We have experts who can help.
What Is Tax-Efficient Investing?
Avoiding taxation should not be the only goal, or even the main goal, of your investment strategy. Still, you always have to keep taxes in mind to make sure you’re not unnecessarily sending too much of your money to the government.
Managing Your Taxes
Keep on top of your tax losses. No one likes to see their investments fail, but failures provide opportunities for hidden tax savings. Tax-harvesting strategies take advantage of losses for tax benefits when you rebalance your portfolio if you comply with IRS rules on the tax treatment of gains and losses. Note that losses can offset up to $3,000 in taxable income in realized investment gains annually. If losses exceed deduction limits in the year they occur, you may be able to carry them forward to offset gains in future years.
Also watch out for capital gains. Securities held for more than 12 months and sold at a profit are taxed as long-term gains, with a top federal rate of 23.8%. For short-term gains, the tax rate can hit 40.8%. Timing can be everything.
Consider tax-exempt securities. Municipal bonds typically are exempt from federal taxes and may receive preferential state tax treatment. However, choose carefully before jumping into them. If you have a low tax rate in retirement, for example, it may not be necessary or even wise to concentrate so heavily on avoiding taxes.
Managing Your Taxes
Sometimes it’s better to pay taxes later rather than now. For example, 401(k)s, 403(b)s, IRAs, and tax-deferred annuities let you postpone your taxes until you are retired and thus likely in a lower bracket. Contributions you make may reduce your taxable income if you meet income eligibility requirements, and typically, investment growth is tax-deferred.
On the other side of the coin are Roth IRAs, which don’t give you an immediate tax break, since you use after-tax dollars. But this can help you later. For example, you may be in a low tax bracket now, so you put money into a Roth IRA; investment gains are tax-deferred. When you withdraw the money, you don’t have to pay taxes at what could be a higher rate.
Reduce Taxes through Charity
If you itemize, you can deduct the value of your charitable gift from taxable income but be aware that limits apply. Consider contributing appreciated stock, which may help you avoid capital gains taxes. Also try a donor-advised fund in a high-income year. These funds let you make a donation, take an immediate deduction, and spread the giving over a period of time.
Of course, this is just an introduction to a complex topic — there are limits and exceptions to these strategies. Tax law is detailed, especially when it comes to investments, and a slight miscalculation on your end can lead to an unexpected tax bill down the line. The point is to recognize that taxes are a key part, but not the only part, of an investment strategy. R&A’s tax and financial professionals can work with you to make sure your strategies are aligned with your goals.