Looking Ahead: 2021 Tax Planning for A Biden Administrations Tentative Tax Policy Revisions

Preface: With the baton of democracy peacefully transferred on January 20th, the Biden Administration now will be ideally positioned to introduce tax policy changes that should not be discounted nor unheeded with the deal making successes and cohesive union among current lawmakers. 

Looking Ahead: 2021 Tax Planning for A Biden Administrations Tentative Tax Policy Revisions

Credit: Donald J. Sauder, CPA | CVA

The good news on possible tax reforms? Any proposed sweeping tax legislation from the Biden Administration for tax reform likely will only be concerning for high-income taxpayers. The bad news? A curbing of high-income earner financial appetites will result in projected shifts to economic activity and require the government to have an increasingly crucial role in replacing recent decades’ economic stimulus measures from the marketplace.

What Biden’s Tax Plan Could Change?

With the House and Senate’s passage of the Tax Cut and Jobs Act of 2017, top tax rates were reduced. A new tax reform proposal from the Biden Administration may increase the maximum rate back to near 40%, with a lower threshold applicable to an adjusted gross income of $400,000 and above.

The 199A Qualified Business Income deduction of up to 20% could perhaps be eliminated with tax reform leading to immediate increases to tax costs for Main Street business owners. This would be in addition to any possible income tax rate changes and threshold adjustments outlined above. A business that qualified under the Tax Cut and Jobs Act of 2017 for the 199A tax deduction experienced more than ideal business tax conditions—introducing new tax reforms would somewhat likely phase-out this tax-saving attribute for Main Street business owners.

Of note, while present tax reform guidance is silent on the accelerated depreciation features from the Tax Cut and Jobs Act of 2017 that were almost too good to be true for business owners, including 100% bonus deductions on both new and used capital expenditures and a substantial increase in the long-standing Section 179 tax deduction. Any proposed tax reforms may change these features of accelerated deductions on capital expenditures, and therefore, lower permissible and beneficial tax deferments, leading to high immediate tax costs.

Current information on possible reform to itemized deductions, while unknown, the possibility is likely. This would be most applicable and focused on high-income earnings, say above the $400,00 adjusted gross income threshold.

Revisions to social security taxes are also under discussion, and current proposals apply only to high-income taxpayers above the $400,000 adjusted gross income threshold.

For estate planners and high-net-worth individuals, a Biden tax reform may propose an estate exemption reduction from $11.5M to say $3.5M, resulting in increased restrictions on wealth transfers among generations with a tax-free pass. Additionally, the step-up basis of inherited assets could be eliminated. This is a tax feature whereby the cost basis of appreciated assets is increased to the fair market value in an estate transfer that therefore reduces the amount of the investment subject to capital gain or ordinary taxes on the future sale of the asset(s).

Finally, capital gains on capital asset transactions are also subject to revisions with any proposed tax reforms. Firstly, an increase in long-term capital gains from 20% to an ordinary rate of 39.6% again for high-income earnings above, say $1.0M in adjusted gross income, or when harvesting such levels of gains. Secondly, 1031 tax exchanges may be eliminated with a Biden tax reform plan. This would disallow the deferment of tax gains on the sale of a property when proceeds are invested in like-kind property and a widely used tax defer tool for real estate investments.

For business budgeting, keep foremost in mind that the higher levels of cash flow required for amortized debt payments (debt is paid with after-tax cash-flows, leverages with higher tax rates and earnings threshold) will be subject to coverage of additional tax costs. Bottom-Line of these tax reform implications? Higher tax rates from possible tax reform will lead to reduced cash flow for debt payment. Management that planned debt-financed capital expenditure payments under the Tax Cut and Jobs Act of 2017 rates in recent years, aligned with tight payments margins on cash flow, should heed this caution immediately. Prudent planning could include appropriate cash flow management plan revisions and perhaps discussions with lenders.

Trump’s tax reform for businesses with the Tax Cut and Jobs Act of 2017 may be the lowest tax rates Main Street business may see for the next decade(s). We are advising clients to defer as little taxable income as possible and capitalized on the low tax rates for the 2020 year to build equity and balance sheet strength, pay down debts, and prepare for what may be likely reforms with tax planning that will require additional diligence in cash flow management.

With the baton of democracy successful transferred on January 20th, the Biden Administration now will be ideally positioned to introduce tax policy changes that should not be discounted nor unheeded with the deal making successes and miracles of the cohesive union among current lawmakers. Please begin to plan appropriately and discussing the tax and cash flow implications with your tax advisor.

Should I Extend my Tax Return?

Preface: A Wall Street Journal headline declared “Biden Tax-Increase Agenda Revived as Democrats Win Senate”. At the time of writing, we do not know exactly what tax increases will or will not come. 

Should I Extend my Tax Return?

 Tax Season

Time marches onward. Another year has ended, another year has begun. With the change of the calendar comes tax season.

Some taxpayers always file timely, some always file an extension. Which option is right for you? Read this article to consider the benefits of both timely filing and filing after an extension.

Benefits of Timely Filing

        • Clarity and Precision
        • Avoid Procrastination
        • Allow Partners to File Timely
        • Calculate Quarterly Estimates

A taxpayer might file timely to gain clarity and precision. Before the taxes are prepared for filing, the taxpayer likely does not know precisely how much the tax bill will be. Good tax planning, however, might give an idea of the amount. Think of tax planning as watching a deer walking through the field 250 yards away with the unaided eye. You can see it with the eye, but the clarity increases when the scope is placed between the eye and the deer. Likewise, preparing the tax return brings the tax bill into focus. A hunter catching sight of a big buck might shake with buck fever, and a taxpayer catching a glimpse of a huge tax liability might tremble as well.

Another reason to file timely is to avoid procrastination. The wise old saying attributed to Ben Franklin “Don’t put off until tomorrow what you can do today” might inspire some taxpayers to take care of their taxes quickly, even though they could delay if they chose to do so. Filing an extension causes a delay. It does not drive taxes away permanently.

One important reason for partnerships to consider timely filing is that the individual partners will need a K-1 from the partnership to file their personal tax returns. A partnership might therefore choose to file timely if some or all the partners want to file their personal tax returns timely.

A fourth reason to file timely is to calculate quarterly estimates for the next year. One factor in the safe harbor for tax estimates involves the income of the prior year. If a taxpayer wants to use that safe harbor, it helps to know the prior year income. If the taxpayer does not know it, then they may pay more estimates than necessary, or perhaps pay too little and miss the safe harbor.

Benefits of Extensions

So why would anyone ever extend a tax return? In some cases, the prudent taxpayer will file an extension. Here are some reasons.

        • Wait to See if the Next Year Looks Profitable
        • Save on Accounting Fees
        • Wait to See if Tax Rates Increase

Many tax returns are filed on an annual basis. Tax accountants file scores of returns after December 31 but before April 15. As you can imagine, that provides a buildup of work for tax accountants. If you normally file timely but do not care when you file, consider asking your accountant if you can go on extension to get a discount since you are leveling out their workload. The price savings may make it worth the wait. Good things take time. Sometimes the first buck trotting along the path is not the biggest buck.

From time to time throughout history, tax rates go up. Taxpayers could be entering such a time. A Wall Street Journal headline declared “Biden Tax-Increase Agenda Revived as Democrats Win Senate”. At the time of writing, we do not know exactly what tax increases will or will not come.

If taxes increase significantly, some taxpayers may prefer to defer depreciation until future years, when tax rates are higher, rather than accelerate depreciation on new purchases this year when rates are lower. Without knowing the tax rates, that decision is more difficult. Some taxpayers may benefit from extending to see how it ends up. Patience sometimes pays.

Another reason to extend is to assess how profitable next year will be. If a taxpayer files in February, they have a small idea of how the next year will be, and they might find it difficult to make tax decisions on tax elections, such as depreciation. Alternatively, a taxpayer filing in July would have a much longer timeframe to assess how well the next year is going.

If the next year appears to be going well, the taxpayer may save some depreciation to reduce income in that year. Alternatively, if the year past was great and the next year is challenging, the taxpayer may elect to accelerate depreciation into the high-income year. The additional months may reduce the guesswork

To Extend or not to Extend?

As you read the article, did any of the points resonate with you? Different taxpayers will make different decisions. Do not automatically file on time, and do not automatically file for an extension. Consider which path makes sense in your situation. Hopefully this article brings some clarity and perspective to you as you hunt for the answers.

This article is general in nature, and it does not contain legal advice. Contact your advisors to discuss your specific situation.


Why You Should Consider Converting Your Business to an LLC

Preface: Setting up a good legal structure for your business will minimize future risks, and can position you for the best legal protection and tax savings.

Why You Should Consider Converting Your Business to an LLC

By Nevin Beiler, Attorney

A large part of my law practice consists of forming and restructuring business entities for business owners. People often ask me what would be the best form of entity for their business. Although there are exceptions, in the vast majority of cases the answer to that question is a Limited Liability Company (“LLC”). If you have a business that is located in Pennsylvania and is structured as something other than an LLC, you may want to at least consider restructuring it. This is especially true if your business is a sole proprietorship or a general partnership.

In this article I will explain the main benefits of being structured as an LLC. But first, a quick story about some clients I assisted in restructuring their business from a general partnership to an LLC. As always, I have changed the names and some details in order to protect the confidentiality of my clients.

A father and his three sons came to my office one day to discuss restructuring their construction business. For the past 15 years they had been operating as a general partnership. At the time of the meeting, the father owned 90% of the business, his three sons owned 2% each, and two other workers owned 2% each.

In the past, the sons and two other workers had been listed as partners mainly to avoid payroll taxes. The father wanted to increase his son’s percentage of ownership and give them more management responsibilities. He was also considering putting the other two workers on payroll because he had heard that the strategy of having workers be low-percentage partners to avoid payroll taxes was causing some partnerships to incur fines and penalties in Pennsylvania Unemployment Tax audits (he was right about that).

The father had also heard somewhere that he should consider changing from being a general partnership to an LLC partnership, but he wasn’t totally sure why. I explained that one reason he should convert to an LLC partnership was to limit the personal liability of the partners for lawsuits against the business. He seemed to have a “lightbulb moment” when I said that, and said, “do you mean that if the business is sued all the money in my sons’ personal bank accounts would be at risk”? When I answered “yes” and also said that the personal assets of his other workers were also at risk, he become very concerned. His sons had worked hard for the business since their teen years, and had each developed sizable savings accounts. He was also uncomfortable with the thought that his workers, who functioned essentially like employees, were sharing in the risk of the business due to the fact that they were 2% general partners.

The realization that the way his business was structured was putting his sons’ savings and his employees at risk provided a substantial motivation for the father to change the general partnership to an LLC partnership. As part of that change, he put the other workers on payroll and increased his son’s percentages of ownership in the business. He also increased the liability insurance of the business. The good news for them was that converting a general partnership to an LLC partnership is fairly simply in Pennsylvania. The bad news was that the conversion and the limited liability it brought would only apply to the future. Any potential lawsuits for activities prior to the date of the conversion to an LLC would still put the partner’s personal assets at risk.

The Benefits of a Limited Liability Company

The above story illustrates one of the main benefits that an LLC has over sole proprietorships, general partnerships, and general partners in limited partnerships, which is that partners in an LLC (typically called “members”) do not have personal liability for lawsuits against the LLC. The members of an LLC also generally do not have personal liability for the debts or other liabilities of an LLC, unless they sign a personal guarantee for the liability. They are at risk of losing the value of their share of the business if an accident or lawsuit is not covered by the business’s insurance policy, but their personal assets would be protected.

On the other hand, the personal assets of all the partners in a general partnership (including a 1% partner) can be fully at risk for the liabilities of the partnership (including loans, audits assessments, lawsuits, etc.), regardless of which general partner of the partnership incurred the liability or caused the lawsuit. The same is true of sole proprietors, who are generally fully responsible for both their own actions, and the actions of their employees during the workday. Most businesses should and do carry liability insurance that will cover unexpected accidents and lawsuits. However, not everything can be covered by insurance, and sometimes insurance coverage limits are lower than a lawsuit amount, so having the extra protection of the LLC structure can be a big help in protecting the owners of the business when things go majorly wrong.

Another benefit of the LLC structure is its administrative and structural simplicity and flexibility. Unlike corporations (which were more common before LLCs became available), LLCs do not require many formalities like annual meetings, electing directors, director meetings, etc. An LLC can require certain formalities in its Operating Agreement, but very few formalities are required by law for LLCs.

Similar to a general partnership, an LLC can be structured as “member managed” (meaning it is managed by all its members) or “manager managed” (meaning the members elect one or more managers from among or outside the membership to manage the LLC). The provisions regarding voting, compensation, profit sharing, buy/sell agreements, etc., are all very flexible in an LLC and can be customized in the LLC’s Operating Agreement to suit the needs of the members.

LLC’s are also very flexible when it comes to how they are taxed. A single member LLC is normally taxed as a disregarded entity, meaning that the income and expenses of the LLC are reported on the appropriate schedule of the owner’s Form 1040 (e.g. on Schedule C). However, a single member LLC can elect to be taxed as an S Corp or C Corp if that would be advantageous to its owners (not common for those exempt from FICA taxes).

A partnership LLC (an LLC with more than one member), like a general partnership, is normally taxed as a pass-through entity, meaning that the partnership entity files an information tax return but all income taxes are paid by the individual members. However, the members can choose to have the partnership be taxed as an S Corp or C Corp if that would be advantageous to the members. The flexibility to choose between the full range of tax elections could become an advantage over corporations, which are limited to C Corp and S Corp tax options. With the Qualified Business Income Deduction (new for the 2018 tax year), more small corporations may want to consider whether changing their structure to an LLC would be advantageous. Doing so would allow them to be taxed as a disregarded entity (one owner) or partnership (multiple owners) and potentially maximize the QBI Deduction.

Another advantage, though perhaps smaller than the ones discussed above, is that registering a business as an LLC provides more protection for the registered business name than filing a fictitious name registration (as is required for sole proprietorships and general partnerships). Many business owners are surprised when I tell them this, but the reality is that filing a fictitious name registration does not result in exclusive use of that name in Pennsylvania (and probably many other states). If only a fictitious name registration is filed in Pennsylvania, another business owner could come along and register the same name as an LLC or Corporation (or other registered entity). But once a name is registered as an LLC (or other registered entity) in Pennsylvania, nobody can come along and register a business under that same name in Pennsylvania. (Businesses that want exclusive use of a name in multiple states may want to consider registering a Trademark for their name.)

Starting an LLC or Converting to an LLC

Starting an LLC in Pennsylvania is fairly simply. New LLCs in Pennsylvania do not require legal advertising (which is required for fictitious names and new corporations), so that helps to keep the cost down. Also, Pennsylvania has a conversion process by which a general partnership can convert to an LLC partnership without re-titling assets or getting a new EIN number. This greatly simplifies the administrative hassle of these conversions.

An existing sole proprietorship business will generally need a new EIN in order to change to a single member LLC. This means a little more administrative burden (usually involving a new bank account, new payroll accounts if there are employees, new PA Dept. of Revenue accounts, and transferring business assets to the new LLC), but it is very manageable for most businesses.

When starting a new business or changing your business structure, you should seek good legal advice and tax advice. Setting up a good structure for your business will minimize complications down the road, and can position you for the best legal protection and tax savings.

Nevin Beiler is an attorney licensed to practice law in Pennsylvania (no other states). He practices primarily in the areas of wills & trusts, settling estates, and business formations & agreements. Nevin and his wife Nancy are part of the conservative Mennonite community, and Nevin previously served as the in-house accountant for Anabaptist Financial before leaving to become an attorney. Nevin’s office is located at 105 S Hoover Ave, New Holland, PA 17557, and he can be contacted by email at info@beilerlegalservices.com or by phone at 717-287-1688. More information can be found at www.beilerlegalservices.com.

 Disclaimer: This article is general in nature and is not intended to provide specific legal or tax advice. Please contact Nevin or another attorney licensed in your state to discuss your specific legal questions. This article was initially published in the PCBE.


Gearing up for the New Year of 2021

Gearing up for the New Year of 2021

Credit: Donald J. Sauder, CPA | CVA

January 2020 began just like the Great Roaring ’20s. The decade of the 1920’s lifted all social classes on the winds and wings of a surging economy and profuse consumerism from sales of mass-produced goods that made lives more comfortable, including radio’s refrigerators, and washing machines. The social landscape was changing quickly from automobile travel’s increasing affordability and a Model T less than 400 dollars. Businesses began issuing consumer credit, it was a “Goldilocks” economy, and as they say, “The rest is history.”

Then, fast forward one century. Likely most of us would consider 2020 a year of tremendous challenge with the onset of the Covid-19 Pandemic and the rapid changes in social, business, and educational life. Time has never stood still, and here we are, welcoming the New Year of 2021.

Looking forward to 2021 and expecting life to return to pre-Covid-19 normalcy maybe a soupcon unrealistic. Yet predicting what’s ahead for 2021 is best deferred to the experts.

So to help us plan to thrive in 2021, no matter what the New Year 2021 may bring, a plan to bring hope to hardship, even if as simple as supporting your local entrepreneurs and therefore local families is a good start to the year ahead. Or perhaps helping to build your local community into a healthier and more sustainable place through say concerted organizational successes will likely be smart allocations of equity with your time and resources.

And foremost, investments of gratitude for these simple freedoms may never have been more critical to our individual and collective futures and why our community(s) can experience memorable enjoyments in each season and profusions from ae quality of life.

Now, we may perhaps find a helpful idea or two in the following article:

You Survived 2020. These 4 Ideas Will Help You Thrive In 2021

We wish you a Happy, Healthy and Safe New Year!



Passage of Second Covid-19 Relief Bill

Passage of Second Covid-19 Relief Bill 

President Trump has signed the second COVID-19 relief legislation coined the Consolidated Appropriations Act, 2021 (CAA2021) that is now effective.

The new legislation also brings notable relief for businesses with PPP loans that now legislates approved tax deductibility on qualifying expenses covered from round one of PPP loan proceeds. This is a Holiday Gift from Trump for businesses with PPP loan proceed tax planning. This legislation supersedes IRS Rev. Rul. 2020-27 whereby taxpayers could not deduct  expenses covered with PPP loan proceeds.

Key tax provisions in the second COVID-19 relief bill include:

  • A second round on taxpayer relief payments of $600 for individuals earning up to $75,000 per year and; $1,200 for married couples earning up to $150,000 per year; $600 additional payment for each dependent.
  • Small businesses relief with a Round Two of PPP business loans;
  • $300 per week unemployment aid for qualifying individuals until the middle of March 2021.

To support the restaurant industry, the new relief bill also allows a 100% business expense deduction for business meals provided from a restaurant. This legislation is only effective for expenses incurred after Dec. 31, 2020, until December 31, 2022.

The bill also modifies the above the line charitable deduction for 2020 from increasing from $300 to $600 for married filing jointly tax payers, and extends the charitable deduction to the 2021 tax year.

The new relief bill also provides a second round of PPP loans to both newly qualified applicants and, also for businesses that participated in the initial round of PPP loan proceeds. Prior PPP applicants can now apply for a second PPP loan with the following parameters. A) the business has 300 or fewer employees B) the business has extinguished or plan to extinguish all initial PPP proceeds; and C) the business demonstrates a 25% sales volume reduction in any 2020 quarter compared to that quarter in 2019. Second Round expenses include payroll, rent, mortgage interest, and utilities on PPP proceeds. As in round one of business PPP proceeds, qualifying loan applicants can obtain a round two PPP loan up to 2.5x average monthly payroll costs.

The bill simplifies forgiveness for all PPP loans of less than $150,000. Also relief is now available for expenses paid with PPP loans as tax-deductible, bringing a holiday benefit to businesses tax planning with 2020 PPP proceeds.

This is not to be construed as tax, or legal advice. Please contact your trusted advisor to discuss any specifics of this legislation or tax provisions for your business or individual tax planning, before making any decisions with regards to the provisions in this Covid-19 relief bill.

2020 Form 1099 Filings Revisions with Form 1099-NEC Reporting

2020 Form 1099 Filings Revisions with Form 1099-NEC Reporting

For the 2020 tax year, former IRS 1099-MISC filers will need to comply with new 1099 reporting rules. Form 1099-NEC, Non-Employee Compensation has been refurbished and brought back to the showroom floor and is intended to replace Form 1099-MISC for nonemployee compensation.

While Form 1099-MISC will still be part of the 1099 filing tradition for certain payments, for the 2020 tax year non-employee compensation payments for independent contractors and other business services from non-employees now 1099 reporting will be on the Form 1099-NEC.

The newly revised Form 1099-NEC payments include:

      • services performed (including parts and materials), as well as certain payments to an attorney,
      • cash payments for fish or other aquatic life or business of catching fish,
      • reporting includes oil and gas payments for a working interest (whether or not services are performed), and
      • include expenses incurred for the use of an entertainment facility that you treat as compensation to a nonemployee.

The IRS rules that trades or businesses need to issue a Form 1099-NEC if the following four conditions are met:

      • You made the payment to someone who is not your employee;
      • You made the payment for services in the course of your trade or business (including government agencies and nonprofit organizations);
      • You made the payment to an individual, partnership, estate, or, in some cases, a corporation;
      • You made qualifying payments to the payee of at least $600 during the year.

The Form-1099 NEC is being reintroduced to prevent room for tax fraud with EITC and ACTC refunds.

State 1099 Filings

In addition, the IRS has not coordinated the Form 1099-NEC with individual state revenue agencies. Hence for filing 1099s for recipients that reside in states that require submission of Form 1099 information, you should submit a separate state filing Form applicable as required.


The IRS also has made revisions to Form 1099-MISC and rearranged box numbers for certain payment reporting with the addition of Form 1099-NEC. Form 1099-MISC is required to be filed with the IRS by February 28 of the following calendar year, but it must be filed with the IRS by January 31 if nonemployee compensation is reported in box 7 for payments made before 2020.

The 2020 tax year changes to reporting on Form 1099-MISC include:

      • Payments made for direct sales of $5,000 or more (checkbox) in box 7,
      • Crop insurance proceeds are reported in box 9,
      • Payments to an attorney are reported in box 10,
      • Section 409A deferrals are reported in box 12,
      • Nonqualified deferred compensation income is reported in box 14, and
      • Boxes 15, 16, and 17 report state taxes withheld, state identification number, and amount of income earned in the state, respectively.

If you have any questions with regards to your 2020 1099 filings please contact us.

Merry Christmas & Happy New Year

Wishing you a Merry Christmas & Happy New Year

As the Holiday Season arrives, we find ourselves reflecting on the past year and the blessing to once again celebrate Christmas time. It’s been quite a year for us all. Now, as we approach the New Year, may God prosper your journey in the years ahead. 

Merry Christmas  & Happy New Year!

Sauder & Stoltzfus, LLC


Merry Christmas! A Holiday Gift for Our Blog Readers

A Christmas Gift for Our Blog Readers: Merry Christmas!

Today I’m excited to share a gift for you during this Holiday Season on behalf of a corporate sponsor that’s completely free to our blog readers. Our firm now has unlimited access to RightNow Media @ Work—a streaming library of leadership videos, and professional business development training! This extensive library has more than 20,000 videos from leaders like Patrick Lencioni, John Maxwell, and Liz Bohannon. And it’s available on all major streaming devices so you can access content anywhere, anytime.

In addition to, business, leadership and career development resources, RightNow Media @ Work has videos for everyone from Business Basics including the renowned Venture Academy series to a complete toolkit of business leadership training tools. As an organization, we’re always looking for ways to help you grow and develop your business. If you’re interested in an e-learning forum of video business training, the resources at Right Now Media @ Work are worth your attention.

To get your free holiday gift of business education, simply forward an email to accounting@saudercpa.com with the Subject: #Right Now Media @ Work.

Merry Christmas  & Happy New Year!

From Sauder & Stoltzfus and our Alliance Partners.


Why Your Last Will Might Not Accomplish What You Want

Why Your Last Will Might Not Accomplish What You Want

By Nevin Beiler, Attorney

A large part of my law practice is preparing Wills and sometimes Trusts for people of all ages. Young couples are often concerned about having a plan for guardianship of minor children, or that ownership of a business would pass to a surviving spouse if one spouse would die. Older people are usually more concerned about appointing executors and ensuring the fair and orderly distribution of their assets after they pass away. Whatever stage of life we are in, having a current Will is a good idea.

What many people don’t think about, however, is that Wills have limitations. People often think that whatever their Will says is what will happen to their stuff after they die. However, that is not always true.

I recently observed a situation (with which I was unable to assist because of the distance from my office) that illustrates how things can go wrong even when a person’s Will appears to say what the person wants to happen after they die. I have substantially changed some of the facts of the following story to protect confidentiality, but the illustration is true to life.

The Story

There was a middle-aged man who was an only child, and who was in charge of settling his father’s estate after the father died. The father owned a duplex property jointly with his younger sister (the son’s aunt). When they originally bought the duplex, the father thought that he’d like his sister to get the whole duplex if he and his wife died before the sister did.

The sister had never married, and she lived in half of the duplex. Some years later, after his wife had died, the father decided that he wanted his son to receive his share of the duplex when he died, so he wrote a will that directed that his share be given to his son, not his sister. He did not inform his sister of this. The trouble was, the deed for the duplex included the words “joint tenants, with right of survivorship.”

Also, the father wanted to leave a portion of his IRA account, which totaled a little over $200,000, to his sister, and the rest to his son. The father told this to his IRA custodian, who helped him sign a beneficiary designation that directed that when he died 25% of the IRA should go to his sister, and the rest to his son. The father also later told his attorney that he wanted $50,000 to go to his sister, with the intention that it come from his IRA account, so the attorney wrote in the father’s Will, “I give $50,000 to my sister. This amount may be withdrawn from my IRA account.” In addition to the duplex and the IRA account, the father died with about $90,000 in his checking account.

As far as the father was concerned, his plan was clear and exactly how he wanted it. The Will stated that the son would get half of the duplex, and both the IRA beneficiary designation and the Will indicated that the father’s sister would get $50,000, to be paid from the IRA account. The son would get everything else. But as we’ll soon see, things were not going to work out as the father had planned.

The Problems

What many people don’t realize, or perhaps just fail to think about, is that a Will does not necessarily direct what happens to everything that a person owns. Actually, there are many things that people commonly own that might not pass according to the direction of their Will when they die.

For example, a house that is jointly owned with a right of survivorship automatically passes to the surviving owner when one owner dies. This is what happened in our story, meaning that the sister automatically became the owner of the whole duplex, instead of the son getting half of it like the father’s Will stated. The duplex was simply not subject to the directions of the Will. Instead, it passed automatically based on the language in the deed.

Another example is an IRA account, and some other types of investment accounts. These often are transferred by a beneficiary designation that an account owner signs, rather than by the account holder’s Will. In our story, the father signed a beneficiary designation that left 25% of his IRA account to his sister. This was not necessarily a wrong thing to do. In fact, naming beneficiaries of an IRA account can sometimes be a good thing for tax purposes. However, the father also stated in his Will that his sister should get $50,000 from his estate, with only a suggestion that the funds could come from the IRA account. This was likely a mistake in drafting the Will.

The son thought, and I agreed with him, that the father probably meant to leave just a total of $50,000 to the sister, not 25% of the IRA account plus $50,000 through his Will. However, the way things were written, the sister appeared to be legally entitled to both 25% of the IRA and $50,000 from the Will.

To make matters worse, the Will contained a generic tax clause that stated that all inheritance taxes owed by the estate, including for transfers not affected by the Will, must be paid from the residue of the estate. This meant that all the tax due on half the value of the duplex, and all the money going to the sister, was to be paid from the portion of the estate that the son was supposed to receive.

Now for the math. The value of the duplex was $220,000, meaning that the taxable portion (50%) was $110,000. The $50,000 gift stated in the Will and 25% of the IRA account totaled about $100,000, meaning that the total value going to the sister was about $210,000. The inheritance tax rate for transfers to siblings in Pennsylvania is 12%. Multiplying $210,000 times 12% equals $25,200. Plus, the son needed to pay taxes on his $150,000 share of the inherited IRA account and his $40,000 share of the father’s checking account, which at the 4.5% rate for children, would be about $8,000. From the $90,000 in the father’s checking account, the estate was expected to pay $50,000 to the sister (to satisfy the gift written in the Will) and about $33,000 in taxes. After funeral costs and estate administration expenses, there wasn’t going to be anything left for the son other than his $150,000 share of the inherited IRA account, which would also be subject to income taxes if he chose to withdraw any of it.

In total, the father’s sister would be receiving value of about $210,000, while the son would be receiving value of about $150,000. But from all the evidence, it appears that the father’s intent was for his sister to receive $50,000, and for his son to receive the rest, which would have been assets worth about $321,000 for the son. The son was not too pleased when he discovered this. He shared with me about how his father had been determined to make things clear and simple for his heirs by writing a Will that expressed his final wishes. Unfortunately, the father’s goal would not be accomplished.

The son tried to explain the situation to his aunt and propose an alternate settlement arrangement, but their relationship was not very close, and was sometimes cold. She was on a limited income, and was very reluctant to give up anything that she thought she was technically entitled to receive. Plus, she had all along been expecting to receive the father’s half of the duplex if she lived longer than him, because of the right of survivorship in the deed. And even if she agreed to give half of the duplex to the son, the higher tax rate (12% instead of 4.5%) would still apply, as well as real estate transfer taxes.

The Lesson

There is a lesson you can learn from this story, even if the unique facts do not apply directly to you. Where the father (and his attorney) messed up was failing to coordinate his Will with the ownership and beneficiary designations of his assets. The father should have owned the duplex as “tenants in common” with his sister if he wanted to be able to pass on his half of the property to his son through his Will. Also, he should have listed the $50,000 gift to his sister in just his Will or just his IRA (not both the way he did). Or, he should have made it clear in his Will that if he left money to his sister in his IRA that the gift to her in the Will should be disregarded or reduced.

When you have your Will prepared, it is important to understand which assets will be directed by your Will, and which assets will be directed by another means, such as by right of survivorship or a beneficiary designation. When these issues are known, your overall estate plan can address them properly. For this reason, it is important that your estate planning attorney knows the following information:

  • How your real estate is titled. For example, whether you own property individually, jointly with your spouse, jointly with someone else, etc.
  • Whether you have any financial accounts that are owned jointly with any person other than your spouse.
  • Whether you have any financial accounts (such as IRAs or other investment accounts) that have beneficiary designations.

By paying attention to which assets pass according to the directions of your Will, and which assets are directed in other ways, you and your heirs can avoid the disappointment and confusion faced by the son in our story. Otherwise, your Last Will might not accomplish what you want.

Nevin Beiler is an attorney licensed to practice law in Pennsylvania (no other states). He practices primarily in the areas of wills & trusts, settling estates, and business formations & agreements. Nevin and his wife Nancy are part of the conservative Mennonite community, and Nevin previously served as the in-house accountant for Anabaptist Financial before leaving to become an attorney. Nevin’s office is located at 105 S Hoover Ave, New Holland, PA, and he can be contacted by email at info@beilerlegalservices.com or by phone at 717-287-1688. More information can be found at www.beilerlegalservices.com.

 Disclaimer: This article is general in nature and is not intended to provide specific legal or tax advice. Please contact Nevin or another attorney licensed in your state to discuss your specific legal questions.

To Group or not to Group

Preface: If you are starting a new business, and you already have an existing business, then consult with your tax accountant regarding whether the businesses should be grouped for improved tax attributes.

To Group or not to Group

By Jacob M. Dietz, CPA

Are you a business owner? If so, how many different enterprises do you own? Frequently the owner of a business owns or partially owns more than one business activity. The other business activity or activities may be large or small.

In some of these situations, the owner may want to group these activities together to avoid passive treatment. If you own multiple activities, have you considered grouping them?

Passive Activities

First, the IRS may consider a business activity to be passive if the taxpayer does not “materially participate.” The full complexities and the details of passive activities are beyond the scope of this article, but generally the IRS will not allow the deduction of passive losses unless there is offsetting passive income of an equal or greater amount, or the activity is entirely disposed. There could be exceptions, however.

For an example of how the passive activity rules could work, let us imagine John owns two businesses. Business A is a restaurant, and John works full-time in the restaurant. Business B is a bakery across the street from the restaurant, and the bakery provides the restaurant with food. John hired an able manager for the bakery named Charlie, so John hardly does any work in that business. If the bakery and the restaurant were treated as separate activities, then John would be active in the restaurant but may be passive in the bakery. If the restaurant made money and the bakery lost money, then John might not be able to deduct the bakery’s loss until future years if he had no other passive income.

Depending on John’s taxes for the year, he may end up writing a large tax check to pay for his restaurant business while he is also investing more personal funds into the bakery to keep the money-draining bakery afloat.   Such a scenario would not please John.

Grouping of Activities

The IRS, however, does allow grouping of activities that form an “appropriate economic unit.” If the bakery and the restaurant had been grouped into one, then John’s work in the restaurant would count as material participation for the entire activity, thereby making the bakery’s loss nonpassive and potentially offsetting that loss against the restaurant’s income.

What constitutes an “appropriate economic unit?” There is some discretion in making this determination, but below are some factors from IRS Reg. 1.469-4 detailing some of the considerations.

“(i) Similarities and differences in types of trades or businesses;

(ii) The extent of common control;

(iii) The extent of common ownership;

(iv) Geographical location; and

(v) Interdependencies between or among the activities….”


Do you think John’s bakery and restaurant form an appropriate economic unit? The answer may not be 100% clear and involves some discretion, but John could probably honestly answer “Yes.” First, they both involve the business of food for human consumption. Second, John exercises control of both businesses, although he delegated daily responsibilities of managing the bakery to the able manager Charlie. Third, both companies have 100% common ownership by John. Fourth, the businesses are very close geographically since they are across the street from each other. Fifth, the operations of the bakery and restaurant are interdependent because the restaurant purchases baked goods from the bakery. John should have a strong case for grouping.

If John and his accountant had appropriately grouped the restaurant and bakery, then John might write a smaller tax check because the bakery loss would help offset the restaurant income.

Why Group?

As demonstrated in the hypothetical example about John, some taxpayers will want to group to offset losses against income. An entrepreneur that runs multiple businesses may find it hard to prove material participation in each venture to avoid the passive loss rules limiting passive losses to passive income. That same entrepreneur might be able to prove material participation in one venture. If appropriately grouped, then the entrepreneur materially participated in the whole group.

An entrepreneur might also group to avoid Net Investment Income Tax (NIIT) on the income. The NIIT was enacted as part of the tax changes that came with the Affordable Care Act. It charges a 3.8% tax on investment income for certain taxpayers.

Passive activities are classified as net investment income. Therefore, passive income from a second business could be subject to the NIIT. Let us go back to John’s bakery and restaurant. Now, assume that John did not group the bakery and restaurant, and assume that both businesses are profitable. In this hypothetical scenario, John now owes NIIT on the bakery income, which could be classified as passive. John may wish that he had grouped with the bakery, in which he materially participates, to possibly avoid the NIIT.

Why Not Group?

These groupings are permanent per the IRS regulations unless “a taxpayer’s original grouping was clearly inappropriate or a material change in the facts and circumstances has occurred that makes the original grouping clearly inappropriate.” Taxpayers should therefore exercise thought when considering grouping. It cannot be lightly changed.

One reason a taxpayer may wish to avoid grouping is if they already have an enterprise generating passive losses, and they want passive income generation. Remember the hypothetical bakery and restaurant owned by John? Now let us assume that the bakery and restaurant have been in business for several years, and they are not grouped. The bakery is passive, the restaurant is active. The bakery generates losses, but it is slowly moving towards profitability. Suppose John starts a new business, a coffee shop, that generates profits. It is run by a manager named George with little time from John.

John could potentially choose, in that first year, to group the coffee shop with the restaurant to make the coffee shop income active. John might choose, however, to let the coffee shop remain passive so that the passive loss from the bakery can be netted against the passive income from the coffee shop.

Timing of the Grouping

If you are starting a new business, and you already have an existing business, then consult with your accountant regarding whether the businesses should be grouped. If you fail to group them now, and later try to group them, the IRS might disallow that grouping. There is an exception to the regrouping rule which allows taxpayers to regroup the first time the taxpayer is subject to the net investment income tax.

Although there can be exceptions available to group later, do not simply count on an exception being available for businesses to group when desired. No entrepreneur has perfect knowledge of the future. The unknowns could make the decision difficult to group or not to group, but the entrepreneur could benefit if they consider in the first year whether to group.

Disclosure of the Grouping

In Rev. Proc. 2010-13, the IRS lists disclosure requirements regarding tax groupings. If the original grouping was made before Rev. Proc. 2010-13 was effective, then no disclosure may be required until a change is made. New groupings or regroupings after that date must be disclosed. If there is no disclosure, the IRS can generally treat them as separate activities.

What if it is discovered that a grouping has not been disclosed? The IRS does have a method that might work to remedy the failure to disclose. Contact your accountant if you think you may have some undisclosed groupings on your tax return which should be disclosed.

Even when the disclosure has already been made, the taxpayer may want to continue to disclose that grouping in each tax return. If done correctly, this may help inform the taxpayer and future accountants that there is a grouping in effect.

Are your business activities grouped? Should they be grouped? If you do not know, consider calling your accountant to discuss. If this is the first year for a new activity and you already have an existing activity, then think especially hard on the grouping decision.

This article is general in nature, and it does not contain legal advice. Contact your advisors to discuss your specific situation.