When teachers are setting up their classrooms for the new school year, it’s common for them to pay for a portion of their classroom supplies out of pocket. A special tax break allows these educators to deduct some of their expenses. This educator expense deduction is especially important now due to some changes under the Tax Cuts and Jobs Act (TCJA).

The old miscellaneous itemized deduction

Before 2018, employee expenses were potentially deductible if they were unreimbursed by the employer and ordinary and necessary to the “business” of being an employee. A teacher’s out-of-pocket classroom expenses could qualify.

But these expenses had to be claimed as a miscellaneous itemized deduction and were subject to a 2% of adjusted gross income (AGI) floor. This meant employees, including teachers, could enjoy a tax benefit only if they itemized deductions (rather than taking the standard deduction) and all their deductions subject to the floor, combined, exceeded 2% of their AGI.

Now, for 2018 through 2025, the TCJA has suspended miscellaneous itemized deductions subject to the 2% of AGI floor. Fortunately, qualifying educators can still deduct some of their unreimbursed out-of-pocket classroom costs under the educator expense deduction.

The above-the-line educator expense deduction

Back in 2002, Congress created the above-the-line educator expense deduction because, for many teachers, the 2% of AGI threshold for the miscellaneous itemized deduction was difficult to meet. An above-the-line deduction is one that’s subtracted from your gross income to determine your AGI.

You don’t have to itemize to claim an above-the-line deduction. This is especially significant with the TCJA’s near doubling of the standard deduction, which means fewer taxpayers will benefit from itemizing.

Qualifying elementary and secondary school teachers and other eligible educators (such as counselors and principals) can deduct up to $250 of qualified expenses. If you’re married filing jointly and both you and your spouse are educators, you can deduct up to $500 of unreimbursed expenses — but not more than $250 each.

Qualified expenses include amounts paid or incurred during the tax year for books, supplies, computer equipment (including related software and services), other equipment and supplementary materials that you use in the classroom. For courses in health and physical education, the costs of supplies are qualified expenses only if related to athletics.

Many rules, many changes

Some additional rules apply to the educator expense deduction. Contact us for more details or to discuss other tax deductions that may be available to you this year. The TCJA has made significant changes to many deductions for individuals.

If your small business doesn’t offer its employees a retirement plan, you may want to consider a SIMPLE IRA. Offering a retirement plan can provide your business with valuable tax deductions and help you attract and retain employees. For a variety of reasons, a SIMPLE IRA can be a particularly appealing option for small businesses. The deadline for setting one up for this year is October 1, 2018.

The basics

SIMPLE stands for “savings incentive match plan for employees.” As the name implies, these plans are simple to set up and administer. Unlike 401(k) plans, SIMPLE IRAs don’t require annual filings or discrimination testing.

SIMPLE IRAs are available to businesses with 100 or fewer employees. Employers must contribute and employees have the option to contribute. The contributions are pretax, and accounts can grow tax-deferred like a traditional IRA or 401(k) plan, with distributions taxed when taken in retirement.

As the employer, you can choose from two contribution options:

1. Make a “nonelective” contribution equal to 2% of compensation for all eligible employees. You must make the contribution regardless of whether the employee contributes. This applies to compensation up to the annual limit of $275,000 for 2018 (annually adjusted for inflation).

2. Match employee contributions up to 3% of compensation. Here, you contribute only if the employee contributes. This isn’t subject to the annual compensation limit.

Employees are immediately 100% vested in all SIMPLE IRA contributions.

Employee contribution limits

Any employee who has compensation of at least $5,000 in any prior two years, and is reasonably expected to earn $5,000 in the current year, can elect to have a percentage of compensation put into a SIMPLE IRA.

SIMPLE IRAs offer greater income deferral opportunities than ordinary IRAs, but lower limits than 401(k)s. An employee may contribute up to $12,500 to a SIMPLE IRA in 2018. Employees age 50 or older can also make a catch-up contribution of up to $3,000. This compares to $5,500 and $1,000, respectively, for ordinary IRAs, and to $18,500 and $6,000 for 401(k)s. (Some or all of these limits may increase for 2019 under annual cost-of-living adjustments.)

You’ve got options

A SIMPLE IRA might be a good choice for your small business, but it isn’t the only option. The more-complex 401(k) plan we’ve already mentioned is one alternative. Some others are a Simplified Employee Pension (SEP) and a defined-benefit pension plan. These two plans don’t allow employee contributions and have other pluses and minuses. Contact us to learn more about a SIMPLE IRA or to hear about other retirement plan alternatives for your business.

Late summer and early fall, when so many families have members returning to educational facilities of all shapes and sizes, is also a good time for businesses to creatively step up their business development efforts, whether it’s launching new marketing initiatives, developing future employees or simply generating goodwill in the community. Here are a few examples that might inspire you.

Becoming a sponsor

A real estate agency sponsors a local middle school’s parent-teacher organization (PTO). The sponsorship includes ads in the school’s weekly e-newsletter and in welcome packets for new PTO members. Individual agents in the group also conduct monthly gift card drawings for parents and teachers who follow them on Facebook.

The agency hopes parents and teachers will remember its agents’ names and faces when they’re ready to buy or sell their homes.

Planting the seeds of STEM

An engineering firm donates old computers and printers to an elementary school that serves economically disadvantaged students. The equipment will be used in the school district’s K-12 program to get kids interested in careers in science, technology, engineering and math (STEM) disciplines.

At back-to-school time, a firm rep gives presentations at the schools and hands out literature. Then, in the spring, the company will mentor a select group of high school seniors who are planning to pursue engineering degrees in college.

Participating in STEM programs fosters corporate charity and goodwill. It can also pay back over the long run: When the firm’s HR department is looking for skilled talent, kids who benefited from the firm’s STEM efforts may return as loyal, full-time employees.

Launching an apprenticeship program

The back-to-school season motivates a high-tech manufacturer to partner with a vocational program at the local community college to offer registered apprenticeships through a state apprenticeship agency. In exchange for working for the manufacturer, students will receive college credits, on-the-job training and weekly paychecks. Their hourly wages will increase as they demonstrate proficiency.

The company hopes to hire at least some of these apprentices to fill full-time positions in the coming year or two.

Finding the right fit

Whether schools near you are already in session or will open soon, it’s not too late to think about how your business can benefit. Sit down with your management team and brainstorm ways to leverage relationships with local schools to boost revenues, give back to your community and add long-term value. We can provide other ideas and help you assess return on investment.

Licensing your not-for-profit’s name to a for-profit company can provide a valuable new revenue source — but it can also be risky. If you’re considering a licensing arrangement, ensure that the partnership really will generate funds and, possibly more important, a positive impression of your brand.

Success . . . and controversy

When licensing arrangements work, both charities and companies can experience significant benefits. AARP and UnitedHealthcare, the ASPCA and Crum & Forster Pet Insurance Group, and Share Our Strength and American Express have all successfully executed profitable licensing arrangements.

But such arrangements can also cause controversy. In the 1990s, the Arthritis Foundation licensed its name to a line of Johnson & Johnson analgesics called Arthritis Foundation Pain Relievers in return for at least $1 million per year. But many groups complained that the arrangement compromised the charity’s objectivity.

Preventing unwelcome surprises

To ensure a license arrangement doesn’t become a public relations problem, thoroughly research any potential partner’s business and products and the backgrounds of its principals. Also confirm that your mission and values align. If you determine that a potential licensee’s products or services have the potential to undermine your brand, take a pass — no matter how high the promised royalties.

Work with your attorney to include certain provisions in any license agreement. Specify how the licensee can use your name and brand, mandate quality control standards and detail termination rights. And realize that signing the agreement doesn’t end your responsibility — you’ll need to actively monitor the licensee’s use of your name and intellectual property throughout the agreement period. If it sounds like all this will require additional staff time, you’re right.

In fact, the resource-intensive nature of licensing leads some nonprofits to outsource the work. Outsourcing allows your organization to focus on its mission, but you’ll probably pay upfront fees, a monthly retainer and a percentage of the royalties your consultant secures. So it’s important to crunch the numbers and make sure your license arrangement is worth this expense and effort.

Compliance matters

Nonprofits enjoy a royalty exclusion that generally exempts licensing revenues from unrelated business income taxes (UBIT). But certain arrangements can jeopardize this. You can’t receive compensation based on your licensee’s net sales — only on gross sales. And you must play a passive role, meaning you don’t actively provide services to the licensee. Contact us for more information.

The S corporation business structure offers many advantages, including limited liability for owners and no double taxation (at least at the federal level). But not all businesses are eligible – and, with the new 21% flat income tax rate that now applies to C corporations, S corps may not be quite as attractive as they once were.

Tax comparison

The primary reason for electing S status is the combination of the limited liability of a corporation and the ability to pass corporate income, losses, deductions and credits through to shareholders. In other words, S corps generally avoid double taxation of corporate income — once at the corporate level and again when distributed to the shareholder. Instead, S corp tax items pass through to the shareholders’ personal returns and the shareholders pay tax at their individual income tax rates.

But now that the C corp rate is only 21% and the top rate on qualified dividends remains at 20%, while the top individual rate is 37%, double taxation might be less of a concern. On the other hand, S corp owners may be able to take advantage of the new qualified business income (QBI) deduction, which can be equal to as much as 20% of QBI.

You have to run the numbers with your tax advisor, factoring in state taxes, too, to determine which structure will be the most tax efficient for you and your business.

S eligibility requirements

If S corp status makes tax sense for your business, you need to make sure you qualify – and stay qualified. To be eligible to elect to be an S corp or to convert to S status, your business must:

• Be a domestic corporation and have only one class of stock,
• Have no more than 100 shareholders, and
• Have only “allowable” shareholders, including individuals, certain trusts and estates. Shareholders can’t include partnerships, corporations and nonresident alien shareholders.

In addition, certain businesses are ineligible, such as insurance companies.

Reasonable compensation

Another important consideration when electing S status is shareholder compensation. The IRS is on the lookout for S corps that pay shareholder-employees an unreasonably low salary to avoid paying Social Security and Medicare taxes and then make distributions that aren’t subject to payroll taxes.

Compensation paid to a shareholder should be reasonable considering what a nonowner would be paid for a comparable position. If a shareholder’s compensation doesn’t reflect the fair market value of the services he or she provides, the IRS may reclassify a portion of distributions as unpaid wages. The company will then owe payroll taxes, interest and penalties on the reclassified wages.

Pros and cons

S corp status isn’t the best option for every business. To ensure that you’ve considered all the pros and cons, contact us. Assessing the tax differences can be tricky — especially with the tax law changes going into effect this year.