The Affordable Care Act and Individual Taxes

Preface: Compliance with the Affordable Care Act is easier with an understanding of the options. Here what you need know if you’d like an option for compliance beside health insurance.

Credits: Jake Dietz, CPA

The Affordable Care Act and Individual Taxes

It is tax time again. You may be wondering how the Affordable Care Act (ACA) affects your tax return. The ACA generally mandates taxpayers to have what the IRS calls “minimum essential coverage” for health insurance for every month of the year, claim an exemption from health coverage mandate, or pay a Shared Responsibility Payment or tax.

If you and everyone else on your tax return, such as a spouse and children, had minimum essential health coverage for the full year, then you can check the box on Line 61 of the 2016 Form 1040 stating that you had coverage. Do not check the box if you had other coverage, such as through a church, that was not insurance.

If you did not have minimum essential coverage, you may be able to claim an exemption on Form 8965. The IRS lists various exemptions in their instructions to Form 8965. Several of these exemptions will be covered in this article.

The IRS allows an exemption for “members of certain religious sects.” The IRS instructions define these religious sects as a “sect in existence since December 31, 1950, that is recognized by the Social Security Administration as conscientiously opposed to accepting any insurance benefits, including Medicare and social security.” Essentially, this exemption can be granted to church members whose church is approved for members to have Form 4029 Social Security exemptions. The member can still get the ACA exemption, however, even if they do not have a Form 4029 exemption. The taxpayer should probably not apply for this exemption if they hope to apply for Medicare later in life.

To claim the religious sect exemption, the taxpayer must apply to the Marketplace for an Exemption Certificate Number (ECN.) This application for exemption can be found at the website of the Health Insurance Marketplace. You may also be able to get a copy from a deacon or other church leader, and you could always ask your accountant for a copy.

Another exemption listed in the IRS instructions is for American citizens living outside the U.S. for at least 330 days in a timeframe of 12 consecutive months. For example, suppose that you were an American missionary living in Paraguay for 2016, except for a 3-week furlough in the United States. In this scenario, you would qualify for an exemption to the ACA health coverage mandate because you were living outside the U.S. for at least 330 days. This exemption can be claimed on the tax return without filing for an ECN.

Another exemption that can be claimed on your tax return is for members of a qualified health care sharing ministry (HCSM.) Not all ministries that share medical expenses, however, qualify for this exemption. If you belong to a sharing ministry and are unsure if it qualifies, please ask leaders of the ministry if it qualifies before you file your taxes. This exemption can be claimed on the tax return without filing for an ECN.


Generally, the ACA requires you to have a compliant coverage plan, qualify for an exemption, or pay a tax. If you are wondering if you qualify for any of the other exemptions not mentioned in this article, contact your CPA.

Form 4797 – Sale Of Business Property

Preface: Form 4797 easily could sound like a part of the national export strategy compliance reporting from the Department of Commerce or Customs and Borders Protection. It is an IRS workpaper for sales of business assets. Business property is typically either Section 1231, 1245 or 1250 property and the sale is listed on a 4797.

Form 4797 – Sale of Business Property

When your business sells a company vehicle, or a customer list, how does your tax accountant report the gain? Answer: On Form 4797 “Sale of Business Property.” The IRS tax code requires the reporting of a sale of business property in a different section of the tax code than ordinary revenues, from say a sale of inventory (Section 471.) The most common gain and loss code sections for business property are Section 1231, Section 1245 and Section 1250.

Section 1231 gains and losses can be taxed as either ordinary income or loss, or capital gain, depending on the characteristics of the transaction. Section 1231 assets are the exchanges of 1) real property, e.g. leasehold improvements; or 2) depreciable property used in a business and held for more than a year, [typically property that is held for rental or royalties income] or 3) Section 197 intangibles such as goodwill, customer lists or copyrights. Note: the origin of the Section 197 intangible is a key factor in the tax attributes of the transaction, e.g. self-created intangibles are always ordinary income. Other section 1231 property include sales or exchanges of livestock, unharvest crops, or timber. To determine if your asset sale is ordinary or capital you must net all section 1231 gains and losses for the year. If you have a net section 1231 loss, it is an ordinary loss. If you have a net section 1231 gain, it is ordinary to the extent of non-recaptured section 1231 losses from prior years. Non-recaptured section 1231 losses are the net section 1231 losses from the previous five years. Therefore, if your business had a section 1231 loss in any of the five preceding tax years, the section 1231 gain is an ordinary gain to the extent of the non-recaptured losses.

To detail, if your business sold leasehold improvements four years ago with a loss of $15,000 and a customer list (a section 197 intangible) for a $10,000 gain in the prior tax year, a current year section 1231 gain of $20,000 would be netted with the prior five year section 1231 gains and losses ($15,000 loss from leasehold improvement+ $10,000 gain from customer list = $5,000 loss, the non-recaptured section 1231 loss). Therefore, $5,000 of the $20,000 current year gain would be treated as ordinary income, and $15,000 as a capital gain. Hotchpot complexities, such as this, are why you pay a tax accountant.

Section 1245 property is property that is  1) Personal – tangible or intangible 2) Tangible property for manufacturing, production, transportation, etc. Most business equipment, e.g. machinery, furniture, is classified as section 1245 property. Gains treated as ordinary income on the sale of section 1245 property include the lesser of depreciation and amortization on the asset, or the gain realized on the disposition. An example would detail the sale of a $75,000 backhoe with $40,000 of depreciation. The cost basis in the asset, net the depreciation allowance of $40,000 is a $35,000 book basis. Market value is most often different than book basis, e.g. gain or loss on disposition. If the asset is sold for $50,000, the gain is $15,000 ($50,000 sale price – $35,000 book basis = $15,000 gain.) The entire gain is ordinary since it does not exceed the depreciation of $40,000. If the asset was sold for $85,000, the gain would be $50,000 ($85,000 sale price – $35,000 book basis = $50,000 gain). $40,000 of gain, the depreciation recapture, would be ordinary income, and $10,000 in excess of cost basis would be a capital gain. Sales of section 1245 assets are listed on Part III of the form 4797. Section 1245 assets can also be sold in bulk and aggregated on the form 4797.

Section 1250 property includes real estate as business property or real property that is depreciated and has never been section 1245 property. Recapture income on section 1250 property is ordinary income and un-recaptured income (income in excess of cost basis) is taxed at a maximum 25% capital gains rate (lower capital gain rates in some instances.) If you own real estate in your business, such as an office building, the asset is section 1250 property. You should always talk with your tax advisor before buying real estate in your business, to plan proper entity structuring, and optimize future tax attributes.

Section 1231, 1245 and 1250 assets in your business should always be listed on a fixed asset report. You should have a fixed asset report for federal tax, state tax and AMT, (and if you have accountant prepared financials, such as a reviewed financial statement, a financial asset report.) Your tax accountant should periodically discuss the reports with you to determine the accuracy of cost basis and accumulated depreciation that is relevant to gain and loss reporting on asset dispositions.

Before you transact any sale of major assets in your business, speak with your tax advisor for proper calibration of the tax attributes.

Vendor Management And Negotiation

Preface: Optimizing vendor costs, or purchases, is an opportunity to increase profits for any business. Astute negotiating with vendors can often lead to an increase in gross profit and net income percentages. Consider yourself a good negotiator? Is that D10T the better deal in a box? Let’s say it practical.

Vendor Management and Negotiation

What would your business do without good vendors? Maintaining supportive affinity with vendors is vital to a successful business; albeit a top priority. Vendor terms, discounts and payment negotiations, can reduce your cost of goods sold and increase net income with a little extra effort; the greater your cost of goods sold, the more value your business can obtain from optimal vendor negotiations. For instance, if your cost of goods sold is $870,000, a savings of 2% on vendor terms is $17,400. If cost of goods sold is 60% of sales on $1,450,000, for either the month or the year, then your net income increases 1.2% from good cash management using vendor discounts. If cost of goods sold are say $2,500,000, a 2% cost reduction is $50,000. It’s easy to see, negotiating vendor terms can be as important as advertising to increase revenue.

Vendors are people, just like your customers. You should learn the names of those in the accounting department who send invoices and process payments. Who has key decision making authority at the vendors to negotiate discounts? Treat your vendors the same way you want your customers to treat you. If cash is restricted, tell your vendors, be proactive in communicating late payments; a good vendor will have stringent terms on payment, but most often understand if you communicate honestly the situation. Yet, if you can pay something towards the balance, it is always advisable to do so.

Before you begin negotiating vendor terms, research thoroughly the company and acquaint yourself with the products the vendor supplies. You may be aware that the vendor supplies stroopwafels, but do you know what other products they merchandise. One discipline, to manage vendor costs, is to research the vendor website and any marketing documents to gain an increased knowledge of their target market. Will your business be .05% of their yearly revenue or 5%?  Review competitor’s prices and payment policies to obtain industry options. If you want a line of stroopwafels for inventory, it may be more convenient to purchase from a distributor who can negotiate volume discounts than from the stroopwafel boutique. Yet, price is not always the key factor. If you are purchasing circuit boards, your due diligence is significantly more important. Price may be one component, but supply channel bandwidth, lag times, and quality, with an optimal in-the-field success rate may be more important. If you are purchasing commodities such as 2×8 lumber or propane fuels, vendor discounts can be valuable, significantly valuable. Don’t over negotiate, but put in the effort to get good deals.

Negotiating must include incentives. If you have your research in hand, you will know what incentive you can offer. Negotiating options include: (I) Referring new business, if you have contacts that you can refer to the vendor you have value to leverage, (II) Volume guarantees, if you can guarantee you will order $150,000 a year, a vendor may consider a valuable discount opportunity in entirety, (III) ACH or credit payment access, if the vendor has the comfort of having access directly to your checking account, and payment is certain, you add value to the relationship. Avoid being abrasive or negotiating vendor terms without an incentive plan in place; but combine new business referrals, volume guarantees, credit payment access, and additional values, and you gain stellar negotiating strength that can increase your revenue profitability.

Amortization Of A Businesses Intangible Assets

Preface: Amortization of intangible assets is similar yet different than depreciation. It is governed by a different Section of the IRC and methods are unique to the intangible asset based on the IRC code section relevant to various intangible. This blog is provide an explanation of amortization and namely IRC Code Section 197 relevant to the majority of small business intangible assets.

Amortization of a Businesses Intangible Assets

Amortization is the expensing of intangible asset costs ratably over the intangible assets life. Amortization is governed with Internal Revenue Code (IRC); including section 197 and 195. Section 197 assets have a three factor test 1. They must be listed in Section 197 descriptions, 2. They must have been purchased, 3. They must be held in connection with the conduct of trade of business or investment activity. Factor 1 assets in Code Section 197 include: goodwill, workforce in place, patents, copyrights, formulas, processes, designs, patterns, market share, customer lists, licenses, permits, governmental rights, covenants not to compete, franchise fees, trademarks, trade names, contracts for use of acquired intangibles, and information bases in a business. This is not a comprehensive list of Section 197 assets, but the majority of the typical Section 197 intangibles.

Intangibles in Section 197 are expenses ratably over 15 years, beginning with the month of the acquisition. In businesses where intangibles are purchases along with other business assets, the intangible assets are determined by subtracting the cost of Class 1, Class 2 and Class 3 assets from the purchase price. This information is listed on IRS Form 8594 Asset Acquisition Statement.  For example, if a business is purchases $150,000 of intangible assets, including goodwill and patents in a acquisition, the intangible costs would be expensed at say $10,000 for 15 years, and not depreciated at standard MACRS methods of say 7 years at say a 200% declining balance.

Other assets are also amortized that are not in IRC Section 197. These include interests in partnerships, corporations, trusts, and estates, interests in land, computer software, and professional fees incurred in corporate organizations or reorganizations, accounts receivable, and interest in a lease of tangible property, etc.

Start-up expenses can be amortized with IRC Section 195. Code Section 195 expenses require that the expense must be for investigating the creation or acquisition of an active trade or business; for creating an active trade or business, activities engaged in for profit and for production of income before the day business begins, the taxpayer must elect to amortize the start-up expense.

Amortization rules have a few nuances, including amortization of intangible drilling and development expenses of oil or gas wells over a sixty month period under IRC Section 59; IRC Section 171(a) (2) permits the amortization of bond premiums, and disallowed amortizations such as the elections to amortize expenses paid or incurred in creating or acquiring musical compositions or copyrights to compositions is no longer a permissible tax feature in tax years beginning after 2010. Amortization of lease fees can be amortized for the lifespan of the lease too, and not a set amortization span.

Summarized: Amortization expenses differ from depreciation, in the fact that they are in intangible assets vs. tangible assets. Intangible is key here. Typically amortization is on the straight-line expensing method and not MACRS methods applicable to tangible property. When amortizing assets, talk with your CPA for appropriate handling of the intangible.