Plan for the Unexpected

I received a call on Sept. 13 from a person asking that I call him back quickly as his matter was urgent.  He was worried about missing the Sept. 15 filing deadline as his CPA passed away and he had nothing to allow him to file tax returns.  The story goes on but the lessons are more important.  

1. Always have a back-up plan.  I am now in the process of crating a contingency plan in case my business ever goes down for an extended period of time. 
2. Keep electronic files of everything that you receive.  Paper copies are OK but electronic documents can be saved safely in secure cloud storage.  This guy had received some necessary documents but did not save them.  He thought that he could always call his CPA to get them.  

As they say on Big Brother, "Expect the Unexpected!" 

Top Small Business Concerns

Someone recently asked me “what, in my opinion, are the top two or three biggest concerns of a small business?”  I couldn’t reply immediately but then gave it some thought. 

• Act like a business!!!  Courts might pierce the corporate veil and impose personal liability if there is no real separation between the company and its owners.  If the owners fail to maintain a formal legal separation between their business and their personal financial affairs, a court could find that the corporation or LLC is really just a sham and that the owners are personally operating the business as if the corporation or LLC didn't exist. 

• S-Corps…Make sure that you pay “Reasonable Shareholder Compensation.”  The IRS requires that business owners that perform substantial services to their business be paid a salary according to several factors.  This is called reasonable compensation.  You can’t pay yourself below market and take a large amount in distributions. 

• S-Corps…Keep track of your basis in your business.  Two problems arise when shareholders do not have basis in their entity.

1. Current year losses are not allowed to be deducted on your personal tax return.
2. Distributions to shareholders who do not have basis in their entity are not tax free.  They are converted into long term capital gain and taxed at the capital gain tax rates. 

• There is a difference between an employee and a contractor.  There are many factors to determine this but, if you have control over what, when, where and how a person performs work for you, the that person is an employee. 
• Generally, you must withhold income taxes, withhold and pay Social Security and          Medicare taxes, and pay unemployment tax on wages paid to an employee.
• You do not generally have to withhold or pay any taxes on payments to independent contractors. 

• Which leads me into my last important issue.  Make sure that you obtain the proper documentation for both employees and contractors at the beginning of your relationship.  You will need it when you prepare their W-2 or 1099. 

 There are so many other important issues but, these are the ones that I run into most in my practice. 

S Corporations and Reasonable Compensation

I want to remind S Corporation shareholders of their responsibility to accurately determine and document Reasonable Compensation for services provided to your business.  Reasonable Compensation is the salary or wages that you, a shareholder-employee of an S Corp, pay yourself for the work you perform for your company.

The IRS requires that all shareholders of S Corps who perform services for their company pay themselves Reasonable Compensation, and it should be paid prior to taking any distributions.  You should be aware that under Rev. Rul. 74-44, the IRS will re-characterize distributions paid to shareholders as salary when such distributions are paid in lieu of reasonable compensation. 

There are two ways to think about Reasonable Compensation:

1.      Replacement Cost:  What would it cost your company to pay someone else to provide all the services you currently provide?

2.      Fair Market Value:  What would other businesses in your community pay you for the services you currently provide to your company?

The key to establishing reasonable compensation is determining what you do for your S Corporation.  In addition to direct generation of revenue, you should also compensate yourself for administrative work.  It is important that you research and document how you reach your Reasonable Compensation figure.

We are here to assist you with this issue and have tools available that can help you accurately determine your Reasonable Compensation figure.  Please contact us if you would like to discuss this issue further or to have me prepare a Reasonable Compensation Report for you.

A Reasonable Compensation Report is a detailed report that establishes your Reasonable Compensation using criteria outlined by the IRS.  To generate a Reasonable Compensation report we would complete a short interview (15-20 minutes).  When complete, we will go over the report and make any needed changes before locking in your Reasonable Compensation figure.

The best time to establish your Reasonable Compensation figure is now, before an IRS examination.  Reasonable Compensation has become an IRS hot button and we have been told to expect an increase in examinations of S Corps.  Completing a Reasonable Compensation Report is easy and provides a defensible position to an IRS challenge.

If you are currently taking a salary, it may be time to revisit it to determine that it is reasonable.  If you are not currently taking a salary from your S Corp. then it quite possibly may be time to start. 

If you are interested, please contact us so that we can discuss this issue further.

Lessons from H&R Block

OK…I’ve had it with all of the H&R Block ads telling everyone on TV to “Get Your Billions Back.”  If their clients are getting refunds of that size, then their tax planning is all wrong.  Block even have an anti- CPA YouTube video - https://www.youtube.com/watch?v=AJcBK1DCrbo

I have seen the following from H&R Block over the past year alone:

·         A corporate client had me review their Block prepared individual tax returns.  Block missed their real estate taxes, auto excise and self-employed health insurance deductions resulting in them overpaying their tax by $8,600.  When they had Block amend the returns (for a fee) the Block person actually had the audacity to say “I love it when we can save you tax dollars.”

·         A UK citizen but US resident has been living in the US since 2012 and has bank accounts back in the UK.  He had been using H&R Block from 2012 – 2014.  Well, the United States has this little filing called FBAR (Foreign Bank Account Reporting) where US tax filers need to report all foreign bank accounts with balances greater than $10,000.  The penalty for non-compliance is $10,000 for EACH account.  Thanks Block.  You left my new client with $30,000 worth of potential penalties by not knowing this rule.  It may be possible to fix this but the exposure is still there and it is going to cost my client $$$ to have me try. 

·         I met with a prospect that had used Block to prepare their S Corp. returns (huge mistake).  Block incorrectly recorded their balance sheet (not even needed on return) causing possible basis issues for the shareholders.  The return was just wrong! 

So Block, I'll answer the questions in your YouTube video:

• At my firm a CPA with 20+ years of experience will actually prepare your return. 
• You can sit with us at any time. 
• We don’t use paper.  We do everything electronically when possible.
• We have gone through numerous IRS and state audits and stand behind our work.  Of course, there are additional fees associated here.  When a Block employee represents you they are really there for the company CYA and not your benefit. 

Most Block employees have taken a 10-week tax class and are corporate franchisees.  Debi and I are both CPA’s, have degrees in accounting (I have a Master Degree in Taxation from Northeastern) and have been doing tax work for 20+ years. 

Oh, I have also seen Block’s pricing and most times, we are less expensive. 

Why pay more to have them file incorrect tax returns?

You make the call. 

Act like a Business

OK, so you have set up a corporation or LLC to limit your liability.  You want to protect your personal assets from business debts.  Now what?  There is more to running a LLC and corporation than just filing your annual report and corporate tax returns.  Sometimes courts will hold an LLC or corporation's owners, members, or shareholders personally liable for business debts.  When this happens it's called "piercing the corporate veil” and it is ugly.  Now your house, car and retirement fund are all exposed to your corporate debts. 

You have to act like a business!!!  Courts might pierce the corporate veil and impose personal liability if there is no real separation between the company and its owners.  If the owners fail to maintain a formal legal separation between their business and their personal financial affairs, a court could find that the corporation or LLC is really just a sham and that the owners are personally operating the business as if the corporation or LLC didn't exist.  For instance, if the owner pays personal bills from the business checking account.  So, if you are doing this, it’s time to stop.  Your corporate credit card and bank account should only be used for business expenditures!

So, what do I do? you ask.  To stay out of trouble it's important for small corporations and LLCs to comply with the rules governing formation and maintenance of a business entity, including:

•          holding annual meetings of directors and shareholders or members
•          keeping accurate, detailed records (called "minutes") of important decisions
•          adopting company bylaws and making sure that officers and agents abide by those bylaws.
•          DO NOT comingle assets.  Your entity should maintain its own bank account and you should never use the company account for personal use or deposit checks payable to the company in a personal account.
•       Make sure the world knows it is dealing with a corporation or LLC by conspicuously identifying the company status ("Inc.", “PC” or "LLC") on all forms of company communication.  When signing company documents, clearly state your representative capacity (such as, "Jane Doe, President, Acme LLC.")

And, just in case you don’t like keeping business records, a decision on veil-piercing was handed down in 2014 by the Massachusetts Appellate Division, in Kosanovich v. 80 Worcester Street Associates, LLC.  The court pierced the veil of a single-member LLC based on only one factor: the LLC’s failure to maintain business records.

Tax Lessons from U2

I was listening to an old U2 song while working and think that it is fitting for this time of year. It goes something like this. “October and the trees are stripped bare of all they wear. What do I care?” (U2, October, 1981)

I really think that this song is about taxes and believe me, U2 cares!!! In 2006 the Irish government decided to limit tax free earnings on artistic royalties to €250,000 ($338K US). This would have caused a huge tax bill for the band so they decided to move some of their business to the Netherlands which is considered to be one of the most tax favorable countries in the world.

According to Billboard, U2’s 2009-2011 tour grossed around $736 million. It is estimated that the total net worth of the band is over $800 million. So, you can imagine their tax savings by leaving Ireland and its 12.5% tax on royalties for the Dutch tax rate of 5%.

U2 has received a lot of bad press for this move since critics believe that it is totally hypocritical to their human rights activism. I’ll let the philosophers debate the ethical issues. I can say that what they did is perfectly legal and the band still pays close to half of their income in various taxes.

It is October…Do you care? What’s the moral of this story? Good tax planning saves money! It doesn’t need to be complicated and you won’t have to go to Holland. Sometimes simply taking a look at your situation before the year is over can save you money.

Now is a great time to plan for the end of the year. If you would like to discuss your tax planning please call me.

Getting a Hug

This has never happened to me before but last week I met with two different clients that I had not seen in a few months.  I held my hand out to shake theirs and both clients gave me a hug.  Those who know me well also know that I am not a publicly affectionate person.  But I must say that both of these hugs made me feel very nice.  It was almost as though they were acknowledging the service that I provide.  I really enjoy working with my small business clients and consider building relationships as important as the work itself.  It is very rewarding when I can see the passion that my clients have for their business and know that my services are helping them to succeed. 

Bad news for firms that reimburse workers tax free for health insurance

Employers could owe a $100 per day penalty according to the IRS. 

The IRS just issued guidance on the tax treatment of employers who give tax-free money to their employees to help pay for insurance purchased through health insurance exchanges like the Mass. Health Connector.  These employers will be in violation of the Affordable Care Act (ACA) and subject to tax penalties that could be as much as $100 a day or $36,500 a year, per employee. This ruling effectively prevents employers from shifting costs to the government by “dumping” employees into the new health exchanges rather than providing workers with health coverage, as mandated by the ACA.

This new ruling eliminates many arrangements that employers have made in the past with workers to reimburse them for health insurance premiums and out-of-pocket costs. According to the IRS, when an employer reimburses employees for premiums, the arrangement, known as an employer payment plan, is subjected to taxes.

Right now, the IRS has not indicated how strict it will be in levying the penalty.  If the premium reimbursement is done on an after-tax basis, that arrangement generally is not subject to the excise tax. 

The federal government has already postponed until 2015 enforcement of the employer mandate, which requires employers with 50 or more full-time employees to provide insurance for full-time employees until 2015. Failure to comply carries a penalty of up to $3,000 per employee. The $100-a-day tax is separate from that fee, and will be assessed on employers who fail to provide plans that meet ACA standards.

How to open new doors by closing your office

I am not looking to shed a rent payment.  I am hoping to never have one.

How to open new doors by closing your office

Reasonable Compensation

I know...you've heard this from me before. But it is such an important issue that I am going to keep reminding you.

The IRS repeatedly warns that S corp. owners must pay themselves “reasonable compensation”. Despite warnings, S corporation owners often neglect to put themselves on payroll…that is a regular payroll checks with tax payments for withholdings, filing W-2s, etc. Instead, many owners take out cash as a draw or distribution.

The IRS is on to this, is looking for it and you could be at-risk for an audit. The IRS will attempt to re-characterize all those draws as wages and subject them to all applicable payroll taxes. This re-characterization triggers back taxes, penalties and interest and have bankrupted other small businesses and owners.

So, you should pay yourself “reasonable compensation”. If you are unclear what that means, please call me. Together we can go through the steps needed to prevent an unwanted and painful IRS audit.

Bank loans to small business

Banks are often the accompanist to this common S corporation blunder: Banks often will loan money directly to your S corporation to buy equipment, building, etc. As odd as it sounds, have the bank loan you the money to you personally and then you loan the money to the S corp.  In order to take any losses of the S corporation, you must have at least that much basis (see e-mail sent last week) in your S corporation. But you only get basis from money you’ve personally invested in or personally loaned to the corporation. Bank loans made directly to the S corporation do not count. This S corporation tax mistake gets made all the time. S corporation owners have loans made to the S corporation but then can’t take any deductions because there is no basis! To add insult to injury, the S corporation loan may be personally guaranteed or dual titled (loan made to both S corporation and person) and still no deduction. If you have any questions about borrowing money from or lending money to your small business, please give me a call.

Basis and Distributions

I am often asked "What is basis"? Think of basis like a checking account. Investing in your business increase basis just like a bank deposit. A draw from your business decreases basis just like a bank withdrawal. Profits add to basis and losses decrease basis (similar to how interest earnings increase a bank balance and bank fees subtract from it). Just like a bank account, more basis cannot go out than comes in—basis can never go below zero.

So, if you are thinking about taking a distribution from your S-Corp. (or LLC taxed as an S-Corp.), please call me. We should calculate your basis first to make sure that a distribution will not create any unwanted tax problems. Remember…zero basis equals no tax free distribution!

S-Corp. distributions

 

You should know that your ability to use any losses that pass through from an S corporation to you personally depends on your basis in the S corporation's stock and debt. Basis is also important for other purposes such as determining the amount of gain or loss you recognize if you sell the stock. Your basis in the corporation is adjusted to reflect various events such as distributions from the corporation, contributions you make to the corporation, and the corporation's income or loss.

Calculating the S corporation shareholder’s basis correctly is important because it measures the amount the shareholder can withdraw or receive from the S corporation as a distribution without realizing income or gain.

Often, the task of tracking basis is neglected because, when a profitable company makes only minimal distributions, the number simply doesn’t matter—until a major change happens, such as a change in the shareholder’s ownership or the end of the company’s life.

If the company has losses, they are allowed as a deduction on the shareholder or partner’s tax returns to the extent the individual has basis. Without basis, those losses are suspended/carried over to offset future income or basis. If basis is unknown or incorrect, a shareholder might incorrectly deduct losses he or she is not entitled to deduct.

A constant struggle between CPAs and their clients lies in distributions—or “over-distributions”, to be more accurate. When a shareholder or partner takes all the basis out (and then some), the excess is a taxable capital gain—often an unwelcome surprise to shareholders accustomed to receiving distributions tax-free. Distributions are an important and common reason for good basis calculations and good basis discussions with clients ahead of time.

If you have taken distributions in 2012 (or a planning to) it’s imperative that you have enough basis in your S-Corp. so that they are not re-characterized as taxable capital gains. I will be happy to sit down and review your basis and go over other S-corporation planning techniques.

Please give me a call to set up an appointment.

S-Corp reasonable compensation

As the owner of an S corporation, it is important that you take a reasonable salary for the work that you do. A big concern of the IRS is the issue of whether or not an S corporation pays reasonable compensation to its shareholders. Often, shareholders avoid paying a salary to avoid paying employment taxes. Instead, they take money out of the corporation as distributions. Filing an S corporation return that reports income but no salary is a red flag for the IRS and can trigger an audit.

Often, in these cases, the IRS recharacterizes a portion of the S corporation's net income as wages. Courts have held that an officer of an S corporation who performs substantial services for the corporation and who receives remuneration in any form for those services is considered an employee, whose wages are subject to federal employment taxes. An S corporation cannot avoid federal employment taxes by characterizing compensation paid to its shareholders as distributions of the corporation's net income, rather than wages. In such cases, the S shareholders must be treated as an employees and the distributions will be recharacterized as wages.

In order to head off an IRS audit, it is important for us to determine what would be a fair salary for you to take from the corporation. By appropriately documenting the amount we arrive at, we can defend against any attempted increase in compensation by the IRS should you ever be audited.

Will there be an AMT “patch” for 2012?

Without a change in the law, millions of taxpayers will incur AMT in 2012.

A special deduction called the AMT exemption amount protects most low- and middle-income taxpayers from paying AMT, but this number has not been permanently indexed for inflation. Instead, every year or two, Congress makes a temporary fix that has become known as the AMT patch. The most recent one covered 2010 and 2011. Both political parties agree on the need to prevent the AMT exemption amount from reverting to a lower level, but disagreement over the manner of doing this has made it difficult to enact the necessary legislation.

It is unlikely that Congress will wait until 2013 to extend the AMT patch, unless political gridlock prevented more expedient action. It is also likely that nothing will be done before the election in November. 

Election year taxes

It's an election year and that means that taxes are up for discussion. We've already seen big changes with the Supreme Court's ruling on the Affordable Healthcare Act.

Many issues still remain unresolved. Will another "patch" be placed on the Alternative Minimum Tax so that millions of Americans are not liable for the dreaded AMT? Will the Bush tax cuts that expire on Dec. 31 be extended? What is the likelihood that bonus depreciation will be extended for 2012 and beyond? The list goes on.

The outcome to these questions (and many more) will likely be determined by who wins the presidency in November. If you have any questions regarding 2012 tax issues please contact me. As always, I am happy to speak with you about them.

Tax aspects of the new health care lax

The US Supreme Court declared a mandate requiring US citizens and legal residents to maintain minimum essential health insurance coverage, to be a permissible exercise of Congress's taxing powers under the Constitution.

There were only four votes to uphold the requirement as valid under the Commerce Clause.  The majority opinion by Justice Roberts emphasized that folks who don’t want to purchase health insurance can avoid doing so simply by paying the fee imposed by section 5000A of the tax code, whose collection is enforced by the IRS.  Chief Justice Roberts pointed out that the fee may cost considerably less than purchasing a health insurance policy and that the fee is not applicable to people whose income is so low that they are not required to file income tax returns.

Although the individual mandate's "shared responsibility payment" in US Internal Revenue Code Sec. 5000A is labeled a penalty, not a tax, the Court held it is a tax for purposes of determining its constitutionality, and ultimately upheld it as a valid exercise of Congress's power to tax.

The Court held that the individual mandate was within Congress's power under the Constitution's Taxing Clause. The Court concluded that the individual mandate is not a legal command to buy insurance, but rather a tax on the choice to forgo buying insurance.

Outlook for S-Corps.

Democrats want to make upper-incomer owners of S-Corps. pay self-employment tax on their share of profits if 75% (or more) of the corps. gross income is attributable to the services of 3 or fewer shareholders.  This won’t pass in 2012 but will certainly be looked at in 2013 and beyond. 

Tax law writers are willing to accept tax increases that are used to reduce tax rates.  Congress is rumbling about changing the rules related to S-Corps and partnerships with gross receipts > $50 million.
Any changes would only be made as part of a larger overhaul to help lower corporate tax rates. 
This is bad news to the owners of small S corporations.

Stay tuned!!!

Tax & hockey go together...watch out!

Winger Eugeni Artukhin rejected Tampa's last offer and has signed on for more money in his native Russia. The same goes for Russian defenceman Denis Grebeshkov and Finnish winger Sean Bergenheim of the Islanders.  All three will earn more money this season playing for Lokomotiv Yaroslavl.

"In Russia the taxes are 13 per cent, so it's relatively speaking tax-free," explained [Mark] Gandler, whose firm International Sports Advisors has some 25 NHL players, half of them Russian. "They also usually have bonuses on top of everything, a free apartment, a free car, basically perks."