Moving Out of State? Learn All the Tax Implications First

With so many people working remotely these days, thinking about moving to another state has become common — perhaps for better weather or to be closer to family. Business owners might contemplate selling their business as part of an out-of-state move. Many retirees also look at moving to a state with a lower cost of living to stretch their retirement savings. If you’ve found yourself harboring such notions, be sure to consider taxes before packing up your things.

View from outside a house in a suburb

What Taxes Apply?

It may seem like a no-brainer to simply move to a state with no personal income tax, but you must consider all taxes that can potentially apply to state residents. In addition to income taxes, these may include property taxes, sales taxes, and estate or inheritance taxes.

If the states you’re considering have an income tax, look at what types of income they tax. Some states, for example, don’t tax wages but do tax interest and dividends. And some states offer tax breaks for pension payments, retirement plan distributions and Social Security payments.

What Are the Domicile Requirements?

If you make a permanent move to a new state and want to escape taxes in the state you came from, it’s important to establish legal domicile in the new location. Generally, your domicile is a fixed and permanent home location where you plan to return, even after periods of residing elsewhere.

Each state has its own rules regarding domicile. You don’t want to wind up in a worst-case scenario: Two states could claim you owe state income taxes if you established domicile in the new state but didn’t successfully terminate domicile in the old one. Additionally, if you die without clearly establishing domicile in just one state, both the old and new states may claim that your estate owes income taxes and any state estate tax due.

The first step to establishing domicile is to buy or lease a home in the new state and, generally, to sell your previous home (or rent it out at market rates to an unrelated party). Then, change your mailing address on bank and investment accounts, insurance policies and other important documents. Getting a driver’s license in the new state and registering your vehicle there also helps. So does registering to vote there and becoming involved with local organizations and activities. Be sure to take these and other steps as soon as possible after moving.

Keep in mind that there may be rules about the number of days spent in the state. So, you may have to do more than take the steps above to show that you’re domiciled in the new state.

How Might State Taxes Affect a Business Sale?

Business owners tend to focus on the federal tax implications of a sale, while they may ignore state taxes. Now that federal tax rates are lower than they’ve been in the past, state taxes may take on added significance. If you’re contemplating relocating or retiring to another state, it may make sense to consider moving before you sell the business — especially if the new state has low, or even no, income tax.

To successfully negotiate the sale of a business, it’s critical to understand all the tax implications. Armed with this knowledge, you can assess the impact that moving to another state would have on your net proceeds from the sale and whether it would be better to sell the business before or after you move.

Need Help?

When looking into whether the grass is greener in another state, do some research and contact the office for help avoiding unpleasant tax surprises.

San Jose: (408) 252-1800
Watsonville: (831) 726-8500

The Ins and Outs of the Home Office Deduction

The pandemic changed the landscape of work for a lot of people, including the numerous business owners who began running their businesses from their homes. Many are still working from their home offices, whether full-time or on a hybrid basis. If you’re self-employed and run your business from home, or perform certain functions there, you might be able to claim deductions for home office expenses against your business income.

How to Qualify

In general, self-employed taxpayers qualify for home office deductions if part of their home is used “ regularly and exclusively” as the principal place of business.

If your home isn’t your principal place of business, you may still be able to deduct home office expenses if:

  1. You physically meet with patients, clients or customers on your premises, or
  2. You use a storage area in your home (or a separate free-standing structure, such as a garage) exclusively and regularly for business.

Keep in mind the requirement that the space be used exclusively for business. For example, if your home office is also a guest bedroom, you can’t deduct the entire space as a home office expense. But if you use the desk area of the room exclusively for business, you can deduct that portion of the room, as long as you otherwise qualify.

Expenses You Can Deduct

Many eligible taxpayers deduct actual expenses when they claim home office deductions. Deductible home office expenses may include:

  • Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,
  • A proportionate share of indirect expenses, including mortgage interest, rent, property taxes, utilities, repairs and insurance, and
  • Depreciation.

But keeping track of actual expenses can take time, and it requires organized recordkeeping.

The Simpler Method

Fortunately, there’s a simplified method: You can deduct $5 for each square foot of home office space, up to $1,500.The cap can make the simplified method less valuable for larger home office spaces. Even for small spaces, taxpayers may qualify for bigger deductions using the actual expense method. So tracking your actual expenses can be worth it.

When claiming home office deductions, you’re not stuck with a particular method. For instance, you might have chosen the actual expense method when you filed your 2022 return, but then use the simplified method when you file your 2023 return next year, and the following year switch back to the actual expense method. The choice is yours.

More Considerations

The amount of your deductions is subject to limitations based on the income attributable to your use of the office. Other rules and limitations may apply. But eligible home office expenses that can’t be deducted because of these limitations can be carried forward and may be able to be deducted in later years.

Also be aware that, if you sell a home on which you claimed home office deductions, there may be tax implications. Contact us for more information.

A Valuable Deduction

You might be wondering why only business owners and the self-employed have been addressed here. Unfortunately, the Tax Cuts and Jobs Act suspended home office deductions from 2018 through 2025 for employees, even if you’re currently working from home because your employer doesn’t provide office space.

But the home office deduction can be valuable to those who’re eligible for it. We can help you determine if you’re eligible and the best method for claiming the deduction in your situation.

San Jose: (408) 252-1800
Watsonville: (831) 726-8500

August 2023 Wheeler Collaborative Day

On August 10th, the Wheeler team took a day off before the busy tax season to gather as a company for a Collaborative Day. This is a day in which most employees come in to the office and re-connect with co-workers in person. Those that work remotely in other states or a city farther away from the firm were able to join online. While some staff faced the camera for our revamped website (coming soon!), others met to discuss various topics about the firm.

We started off the day by getting our carbs in with donuts and bagels and then we broke off by management levels. Each management level (staff, supervisors, managers, and partners) had their own meetings to discuss workflow, deadlines, and firm logistics. We then had our first Partner Panel Session moderated by our two Tax Supervisors, Yesica Morales and Kevin Huang.

During the panel, three of our partners, Dahleet Dittmer, CPA, Vanessa Mun, CPA, and Matt Wheeler, CPA, openly discussed their journey to becoming Partners, the responsibilities as Partners, and even addressed any and all questions from our Wheeler team. This fun and informative session gave us all a small glimpse of life as a Partner at Wheeler.

We ended our day with Departmental meetings to discuss goals, concerns, and upcoming events for each department.

Collaboration is a key aspect of running an accounting firm, and although we put the tax deadline on hold for just one day, we know days like this will help our firm maximize productivity going forward.

Overall, it was a productive day and we cannot wait until our next Collaborative Day in December. For now, we are back to our desks tackling the tax deadlines!

Tax Season Is Ending, but Tax Scams Are Thriving

The IRS is warning taxpayers about emails and text messages that promise refunds and credits, but that actually result in identity theft. Many current schemes involve the third Economic Impact Payment (originally made in 2021). Messages may also reference the Employee Retention Credit, assert that the taxpayer is owed a refund or say there’s problem with a return that must be fixed. They encourage recipients to click links that download malware.

The fake messages usually contain misspellings and typos and come from a suspicious-looking email address. If you receive one like this, don’t click on anything! Report it to phishing@irs.gov.

What Certain IRS Notices Mean

What does it mean if a business receives a Notice CP2100 or CP2100A from the IRS? These notices tell recipients that the Form 1099 information returns they’ve submitted contain missing or incorrect Taxpayer Identification Numbers, names or both.

To respond, payers need to compare accounts listed on the notice with their own records and make corrections, if necessary. They may also need to amend backup withholding for payments made to payees. Typically, the IRS sends these notices twice a year, in April and in either September or October. As always, you should promptly respond to any IRS communication. Contact the office with questions.

San Jose: (408) 252-1800
Watsonville: (831) 726-8500

IRS Provides Guidance on SECURE 2.0 Catch-Up Contribution Changes

In Notice 2023-62, the IRS addressed a technical error in the SECURE 2.0 Act that wouldn’t have allowed catch-up contributions to 401(k)s and similar plans after 2023.

Generally, taxpayers who’re age 50 or older are allowed to make additional “catch-up” contributions to employer-sponsored retirement plans such as 401(k)s. When Congress included a requirement in SECURE 2.0, signed into law at the end of 2022, that certain higher-income taxpayers make catch-up contributions only to Roth accounts, it inadvertently left out language needed to allow any catch-up contributions to employer-sponsored plans, whether pre-tax or Roth and regardless of income. The notice clarifies that catch-up contributions can be made after 2023.

The notice also pushes out the requirement that taxpayers who earned more than $145,000 (indexed for inflation) in Social Security wages the previous year be made on a Roth (after-tax) basis. The new rule was to go into effect in 2024, but plan administrators requested additional time to modify systems to implement the change. The IRS has extended the effective date to 2026.

Contact us with any questions:

San Jose: (408) 252-1800
Watsonville: (831) 726-8500

Tax Implications to Be Aware of After a Job Loss

Despite the generally robust job market, some people are still losing their jobs. If you’re laid off or terminated from employment, taxes are probably the last thing on your mind. However, you may face tax implications due to your changed personal and professional circumstances. Depending on your situation, these can be complex and require you to make decisions that may affect your tax picture, both this year and in the future.

Unemployment and Severance Pay

Unemployment compensation is taxable for federal tax purposes, as are payments for any accumulated vacation or sick time. Although severance pay is also taxable and subject to federal income tax withholding, some elements of a severance package may be specially treated. For example:

  • If you sell stock acquired by way of an incentive stock option, part or all of your gain may be taxed at lower long-term capital gains 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 complex rules. In addition, the excess parachute payment also is 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.

Health Insurance

Under the COBRA rules, employers that offer group health coverage typically must provide continuation coverage to most terminated employees and their families. While the cost of COBRA coverage may be expensive, the cost of any premium you pay for insurance that covers medical care is a medical expense, which is deductible if you itemize deductions and to the extent that your total medical expenses exceed 7.5 percent of your adjusted gross income.

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

Retirement Plans

Employees whose employment is terminated may also need tax planning help to determine the best option for amounts they’ve accumulated in retirement plans sponsored by their former employers. For most employees, a tax-free rollover to an IRA is the best move, if the terms of the plan allow a pre-retirement payout.

If the 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.

If you’re under the age of 59½ and must make withdrawals from your company plan or IRA to supplement your income, there may be an additional 10% penalty tax (on top of an ordinary income tax due), unless you qualify for an exception.

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

Next Steps

While taxes aren’t the most critical concern after a job loss, they are still important to consider. Contact the office for help charting the best tax course for you during this transition period.

© 2023

San Jose: (408) 252-1800
Watsonville: (831) 726-8500

An “Innocent Spouse” May Be Able to Escape Tax Liability

When a married couple files a joint tax return, each spouse is “jointly and severally” liable for the full amount of tax on the couple’s combined income. That means the IRS can pursue either spouse to collect the entire tax, not just the part that’s attributed to one spouse or the other. This includes any tax deficiency that the IRS assesses after an audit, as well as any penalties and interest. In some cases, however, one spouse may be eligible for “innocent spouse relief.” This generally occurs when one spouse was unaware of a tax understatement that was attributable to the other spouse.

Qualifying for Relief

To qualify for innocent spouse relief, you must show not only that you didn’t know about the understatement, but also that there was nothing that should have made you suspicious. In addition, the circumstances must make it inequitable to hold you liable for the tax. Innocent spouse relief is available even if you’re still married and living with your spouse. In addition, if you’re widowed, divorced, legally separated or have lived apart for at least one year, you may be able to limit liability for any tax deficiency on a joint return.

Election to Limit Liability

If you make the innocent spouse relief election, the tax items that gave rise to the deficiency will be allocated between you and your spouse as if you’d filed separate returns. For example, you’d generally be liable for the tax on any unreported wage income only to the extent that you earned the wages.

The election won’t provide relief from your spouse’s tax items if the IRS proves that you knew about the items or had reason to know when you signed the return, unless you can show that you signed the return under duress. Also, the limitation on your liability is increased by the value of any assets that your spouse transferred to you in order to avoid the tax.

An “Injured” Spouse

In addition to innocent spouse relief, there’s also relief for “injured” spouses. What’s the difference? An injured spouse claim asks the IRS to allocate part of a joint refund to one spouse.

In these cases, an injured spouse has had all or part of a refund from a joint return applied against past-due federal tax, state tax, child or spousal support, or a federal nontax debt (such as a student loan) owed by the other spouse. If you’re an injured spouse, you may be entitled to recoup your share of the refund.

Moving On

Whether, and to what extent, you can take advantage of the above relief depends on the facts of your situation. If you’re interested in trying to obtain relief, there’s paperwork that must be filed and deadlines that must be met. Even if you’re not in need of any such relief now, as you file tax returns in the future, be mindful of “joint and several liability.” Generally filing a joint tax return results in lower taxes for a married couple. But if you want to ensure that you’re responsible only for your own tax, filing separate returns might be a better choice for you, even if your marriage is intact.

© 2023

Contact the office with any questions:

San Jose: (408) 252-1800
Watsonville: (831) 726-8500

Buy-Sell agreements Require Careful Planning

Does your business have multiple owners? If so, you need a buy-sell agreement. This type of binding contract determines how (and at what price) ownership shares of a privately held business will change hands should an owner depart. There are also potential tax consequences to consider.

Unique Challenges

Unlike public companies, private ones have no ready or established market on which to sell ownership shares. This can create difficult circumstances for businesses when something unexpected happens. Say an owner suddenly dies. The owner’s shares may pass on to heirs, but how much are those shares worth and to whom can the heirs sell them? A buy-sell agreement will remove uncertainty by stipulating that remaining owners will buy the ownership interest at a price determined by the stated valuation method. Plus, the agreement will help to prevent an unfamiliar and perhaps unwanted owner from suddenly joining the business.

Setting Parameters

A buy-sell agreement sets up parameters for the transfer of ownership interests following any of a number of “triggering events,” such as an owner’s:

  • Death,
  • Long-term disability,
  • Loss of professional license,
  • Retirement,
  • Bankruptcy, or
  • Divorce.

The agreement will also specify a valuation method for appraising the departing owner’s interest at the appropriate time. In choosing a method, you and your fellow owners should carefully define buyout terms and specify the financial data to be used in the agreement. For example, a sound buy-sell agreement will spell out a required end-date for the financial statements that must be used to appraise business interests following a triggering event. Some also mandate a particular level of assurance (compilation, review or audit) regarding those financial statements.

Different Approaches

In most cases business owners don’t have the cash readily available to buy out a departing owner. So most buy-sell agreements include insurance policies to fund the agreement. This is where different types of agreements come into play. Under a cross-purchase agreement, each owner buys life or disability insurance (or both) on each of the other owners. Should one owner die or become incapacitated, the other owners collect on their policies and use the proceeds to buy the deceased or incapacitated owner’s shares.

Another type is a redemption agreement. Here, the company (not each owner) buys the insurance policies and acquires the deceased or incapacitated owner’s shares. This approach can help businesses with a lot of owners, because fewer policies are needed. In some cases, a company will create a hybrid buy-sell agreement that combines aspects of the cross-purchase and redemption approaches. These agreements may stipulate that the business gets the first opportunity to redeem ownership shares. And, if the company is unable to buy the shares, the remaining owners are then responsible for buying the departing owner’s interests. Alternatively, the owners may have the first opportunity to redeem the shares.

Tax Consequences

The life insurance used to fund buy-sell agreement can also have undesirable tax consequences without proper planning. Life insurance proceeds generally are excluded from the beneficiary’s taxable income, whether the beneficiary is a corporation, another shareholder or a separate entity. An exception is the transfer-for-value rule, under which proceeds will be taxable if an existing policy was acquired for value by someone other than the insured or a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is an officer or shareholder.

This issue often arises when structuring or changing a buy-sell agreement using existing insurance policies. It’s important to structure the agreement so that the transfer-for-value rule won’t have an impact; otherwise, the amount of after-tax insurance proceeds will be reduced.

If your business is structured as a C corporation and has a redemption agreement funded by life insurance, you’ll need to watch out for another possible adverse tax consequence: When the departing shareholder’s shares are redeemed, the value of the remaining owners’ shares will probably rise without increasing their basis. This, in turn, could drive up their tax liability in the event they sell their interests.

You may be able to manage this problem by revising your buy-sell as a cross-purchase agreement. Under this approach, owners will buy additional shares themselves, increasing their basis. But there are downsides. If owners are required to buy a departing owner’s shares but the company redeems the shares instead, the IRS may characterize the purchase as a taxable dividend. Your business may be able to mitigate this risk by crafting a hybrid agreement that names the corporation as a party to the transaction and allows the remaining owners to buy back the stock without requiring them to do so.

Complex but Important

Buy-sell agreements can help closely held businesses ensure a smooth transition when an owner leaves the business. But they also require careful planning to be effective, including properly addressing potential tax issues.

© 2023

Contact us:

San Jose: (408) 252-1800
Watsonville: (831) 726-8500

Tips on the Tax Treatment of Gifts

Gift tax returns generally do not need to be filed unless you give someone, other than your spouse (if he or she is a U.S. citizen), money or property worth more than the gift tax annual exclusion for that year. Here are four more tips regarding the tax treatment of gifts:

1. The annual exclusion amount for 2023 is $17,000. You and your spouse can make a gift of up to $34,000 to a third party without making a taxable gift.

2. You do not have to file a gift tax return to report gifts to political organizations or qualified charities or for gifts made by paying someone’s tuition or medical expenses, as long as the payment is made directly to the institution.

3. Making a gift does not ordinarily affect your federal income tax. You cannot deduct the value of gifts you make (other than deductible charitable contributions).

4. Generally, the person who receives your gift will not have to pay any federal gift tax because of it. Also, that person will not have to pay income tax on the value of the gift received.

If you have any questions about the gift tax, please contact the office for assistance.

San Jose: (408) 252-1800
Watsonville: (831) 726-8500