Corporate Entity Disregarded

If you want to claim the benefits of a corporation, you've got to actually use the corporation for business, not just pass funds through the corporate bank account. In one case the Tax Court disregarded the taxpayer's corporation, finding it to be a sham.

The corporation observed none of the formalities of a corporate entity such as shareholder meetings, issuing stock certificates, invoices were not made out in the corporate name, etc. The Tax Court attributed all the income to the taxpayer. There can be nontax consequences too. 

K.R. Hoffman & Co., LLC, helps Entrepreneurs, Professionals and Select Individuals in taking control of their taxes and understand their financial affairs. Discover how we can help you with your business and tax challenges. For more inforamtion or to become a client, call me at (954) 591-8290 or drop me a note.

I Received a Notice From the IRS - What Do I Do Now?

The first thing to do is to take a deep breath and relax. Then call me immediately at 954.591.8290 for a FREE no cost obligation consultation, or use my contact form.

You only have a short time to respond to the IRS before the situation escalates. Call us immediately so that we can put you at ease.

The financial press is abuzz with all the latest announcements from IRS about calls for increased enforcement of the nation's tax laws.

IRS recently announced they have reviewed or audited nearly a third of all tax returns that reported income of $10 million or more in the past year. One may recall in the September 2010 issue of For the Record, IRS introduced the Global High Wealth Industry Group in 2009 - a specialized team within IRS to pursue a more unified approach to audits of wealthy individuals. With that context in mind, this is a good time to review the most common types of letters and notices that IRS sends taxpayers.

It is important to note that very few audits actually require a face-to-face meeting with an IRS agent. There are many issues that IRS can examine or question on a taxpayer's return via correspondence. Often, having a good understanding of what positions in a return are being examined as well as responding in a timely fashion to IRS inquiries can result in a quick resolution of the audit or examination. Here's a brief overview of the more common types of notices:

• Notice CP 30 Estimated Tax Penalty: This form is used to notify a taxpayer all or part of an overpayment has been applied to an estimated tax payment penalty. It will also advise a taxpayer that all or some of required estimated tax payments were not timely. It is important to double check your records to determine whether the payments were made on time. It is recommended that payments be made through the electronic deposit program, or alternatively, mailed in via certified mail.

• Notice CP 2000 Notice of Proposed Adjustment for Underpayment/Overpayment (aka the Matching Notice): Receipt of this notice is fairly common and is mainly due to the increased Form 1099 e-filing requirements for financial institutions. The notice will typically list out proposed adjustments to a tax return and indicate the total increase in tax based on the changes. Although it may look like a demand for payment, it is not really a final determination of changes to a tax return. IRS uses this notice to request additional documentation from the taxpayer to verify the income, credits and deductions reported on your tax return because they're different from the information received from other sources. This letter often includes a detailed description of the adjustments and the basis for IRS' position, which is presented in an Explanation of Items (Form 886-A). A typical Form 886-A will contain the issue, the facts, the IRS' legal position and the IRS' understanding of the taxpayer's position. Good recordkeeping is of the utmost importance when preparing a response to this type of notice. If the taxpayer can substantiate the rationale for the position taken, as well as provide adequate third-party documentation for the amounts in question, the taxpayer has a greater likelihood of obtaining a speedy and favorable resolution.

• Letter 525 General 30 Day Letter: Per IRS: "This letter accompanies a report giving you a computation of the proposed adjustments to your tax return. It informs you of the courses of action to take if you do not agree with the proposed adjustments." Basically, the letter outlines what to do if a taxpayer wants to appeal the findings within IRS. The taxpayer should submit a request for appeal/protest to the office/individual that sent the letter. The protest should be filed within 30 days from the date of the letter in order to appeal the proposed adjustments with the Office of Appeals.

• Letter 531 Notice of Deficiency: This is the letter advising a taxpayer of their last chance to appeal. Per IRS: "The Internal Revenue Code authorizes the Commissioner to send this notice. The letter explains how to dispute the adjustments in the notice of deficiency if you do not agree. To dispute the adjustments without payment, you file a petition with the Tax Court within 90 days from the notice date." If a taxpayer neglects to address this letter, the collection process can officially begin.

• CP 504 IRS Intent to Levy: This is a final notice of a balance that is due on the taxpayer's account. This is usually the fourth notice that is sent, and will inform the taxpayer that a levy will be issued against their state tax refund. It may also include details stating that IRS plans to search for other assets on which a levy can be placed. Additionally, a Federal Tax Lien may also be filed if payment is not made at once.

This article can only provide a sample of the more common types of IRS notices. It cannot be overemphasized that responding timely to IRS is critically important. IRS has many tools at their disposal that can quickly escalate the severity of the penalties that can be imposed for willful neglect or noncompliance. However, it is important to note that many IRS notices, especially matching and late payment notices, are erroneous or have a simple explanation.

K.R. Hoffman & Co., LLC, counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how we can help you overcome your tax and business challenges. For more information or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

I truly value your business and I appreciate your referrals. Refer your family, friends, acquaintances, and business colleagues to KR Hoffman & Co., LLC. If your referral retains our services, we will send you a $25 gift card and your referral will receive a $25 discount on their first invoice.

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Something to Scream About

It's one of the most recognizable images in all of art. It's Norwegian artist Edvard Munch's iconic vision The Scream: an agonized figure --little more than a garbed skull and hands -- set against a background of blood-colored sky. And last month, it sold for a record-setting price. But could it have been inspired, at least in part, by his tax return?

Munch grew up in Oslo, son of a dour priest. At 16, he enrolled in college to become an engineer. He did well, but he quickly dropped out, disappointing his father, to study painting, which he saw as an attempt "to explain life and its meaning" to himself. At 18, he enrolled at the Royal School of Art and Design of Christiana, where he began painting portraits. His personal style addressed psychological themes and incorporated elements of naturalism, impressionism, and symbolism. He wound up studying in Paris and exhibiting in Berlin before painting the first of four versions of The Scream in 1893.

In 1908, Munch suffered a brief breakdown, followed by a recovery. That recovery brightened Munch's art as well as his life, as his later work becoming more colorful and less pessimistic. He finally gained the public approval he had sought for so long; he was made a Knight of the Royal Order of St. Olav; and he hosted his first American exhibit. Munch spent the last years of his life painting quietly and alone on a farm just outside Oslo. Today, he appears on Norway's 1,000 kroner note, set against a background inspired by his work.

We remember Munch now for his art, not his life. But that life included some frustrating run-ins with the tax man. Apparently, Munch wasn't any happier keeping timely and accurate records than the rest of us. Here's part of a letter that his biographer, Sue Prideaux, quotes him as writing, in her book Edvard Munch: Behind the Scream:

"This tax problem has made a bookkeeper of me too. I'm really not supposed to paint, I guess. Instead, I'm supposed to sit here and scribble figures in a book. If the figures don't balance I'll be put in prison. I don't care about money. All I want to do with the limited time I have left is to use it to paint a few pictures in peace and quiet. By now, I've learned a good deal about painting and ought to be able to contribute my best. The country might benefit from giving me time to paint. But does anyone care?"

Even without that tortured face in The Scream, most of us can still probably relate to his frustration!

Last month, Sotheby's auction house in New York sold a pastel-on-board version of The Scream that Munch painted in 1895 for $119.9 million -- a new record for art sold at auction. The seller was Norwegian billionaire Petter Olsen; the buyer remains unknown. If the seller had been American, there could have been quite a tax to pay. "Capital gains" from the sale of appreciated property held more than 12 months are ordinarily capped at 15%. (Republican presidential candidate Mitt Romney has proposed eliminating tax on capital gains for taxpayers earning under $200,000; while President Obama has proposed raising them to 20% for taxpayers earning over $250,000.) But paintings like The Scream are classed as "collectibles" and subject to a top tax of 28%. (You would be disappointed if we didn't say that's enough to make a collector scream!)

Are you holding precious artwork or antiques that are just taking up space in your house? Call us before you call the auctioneer. We'll make sure you keep as much of your record-setting price as possible. And remember, we're here for your family, friends, and colleagues, too!

K.R. Hoffman & Co., LLC, helps individuals and businesses take control of their taxes. Discover how we can help you with your business and tax challenges; call me at (954) 591-8290 or drop me a note.

Report Card Time

Memorial Day has come and gone, and the school year is quickly winding down, if it isn't already over. Kids are getting excited for summer vacay, and there's just one hurdle left -- the dreaded report card. (If your kids are getting nervous and antsy around mail time, you might want to pay attention!)

 Kids in school aren't the only ones who have to sweat report-card time. That's right, the IRS gets a report-card time, too. In fact, they get two. By law, National Taxpayer Advocate Nina Olson has to submit two reports to Congress each year: the "Objectives Report," which outlines goals and activities planned for the coming year, and the "Annual Report," which summarizes the 20 most serious problems encountered by taxpayers, recommendations for solving those problems, and other IRS efforts to improve "customer" service and reduce taxpayer burden.

 And how do you think our friends at the IRS are doing? Well, this year's Annual Report listed twenty-two problems, not 20. Their biggest conclusion is that the IRS is simply "not adequately funded to serve taxpayers and collect taxes." It identifies "the combination of the IRS's expanding workload and declining resources as the most serious problem facing taxpayers."

 Granted, the IRS faces an especially tough challenge. "There were approximately 4,430 changes to the tax code from 2001 through 2010, an average of more than one a day, including an estimated 579 changes in 2010 alone. The IRS must explain each new provision to taxpayers, write computer code so it can process returns affected by the provision, and train its auditors to identify improper claims."

 And there were more specific problems, too. The IRS has to rely on computers to do most of their work, and computers don't always get things right. The IRS adjusts about 15 million returns per year -- but treats only 10% of those as "audits," so taxpayers don't always get traditional audit protections. And sometimes the IRS is just too busy to respond: they answer just 70% of taxpayer phone calls, and just 53% of written correspondence gets answered in 45 days. It's hard to ace your report card when you're missing that much of your homework!

 What can the IRS do about their report card? Well, they can't just make up their missing credit in summer school. But the Taxpayer Advocate does have two main recommendations. First, she urges Congress to "develop new budget procedures designed to fund the IRS at a level that will enable it to meet taxpayer needs and maximize tax compliance." And second, she suggests codifying a "Taxpayer Bill of Rights" to clearly outline and explain taxpayer protections and and responsibilities.

 Fortunately, the news isn't all bad -- the IRS has joined the social media revolution! There's a smartphone app to help track your refund, a YouTube channel with helpful videos in English, American Sign Language, and various foreign languages, and podcasts you can download from the iTunes store. You can even follow them on Facebook and Twitter!

 Our "Plan A," of course, is to give you the concepts and strategies to help you pay the least amount of tax legally possible -- then help prepare returns that avoid IRS scrutiny. But just in case that scrutiny finds you, we're always ready with "Plan B" -- to help deal with the IRS on your behalf, and make sure you don't become another Annual Report statistic!

 If you have any questions about this topic, tax law changes, have questions about your business, or want to become a client, please call us at 954-591-8290 or use our Contact form.

Proper Recordkeeping and Tax Deductions Go Hand in Hand

Recordkeeping is critical to securing a deduction. In Gabriel S. Garcia et ux. (T.C. Memo. 2012-139) the taxpayer operated two businesses that provided services to other entities.

The taxpayer paid various workers wages or contract labor expenses. Some of the payments were made by check and some of the payments were in cash. The taxpayer did not maintain complete books and records of the wages or contract labor payments he made during 2007 or 2008. Some, but not all, of the payments were reported to the IRS and to the workers as wages, and some were reported as nonemployee compensation.

Some, but not all, of the workers reported the income received from the taxpayer on their tax returns. Some of the workers provided to the taxpayer incorrect or illegible Social Security numbers. For 2007, the taxpayers reported on their tax return $356,581 as wage and contract labor expenses. The taxpayer was able to substantiate wage and contract labor expenses of only $230,291.

The IRS allowed a deduction $230,291 for 2007. For 2008, the taxpayers reported on their tax return $283,613 as wage and contract labor expenses but could substantiate expenses of only $157,190. The IRS allowed a deduction $157,190 for 2008.

The taxpayers' returns were prepared by his brother, who was not an accountant. The returns claimed erroneous, overstated or unsubstantiated deductions other than the ones for wages or contract labor. While the taxpayer testified he paid the amounts claimed, his testimony was not corroborated by any witnesses and he could not explain how he derived the amounts deducted on his tax returns in the absence of records, and his brother, who prepared the returns, did not testify.

The Court noted the taxpayer did not have any time records or other evidence from which we could estimate the amounts that he paid without substantiating documents. He did not identify any sources for cash payments to workers. The Court noted that it could have made an estimate of the expenses, but noted it could do so only when the taxpayer provides evidence sufficient to establish a rational basis upon which the estimate can be made. Without such evidence, the Court would not make an estimate. It allowed no more than the IRS allowed.

If you have any questions about this topic, tax law changes, have questions about your business, or want to become a client, please call us at 954-591-8290 or use our Contact form.

De-Friending Uncle Sam

Last week, Facebook's initial public offering hit the market like tickets to the season's hottest concert. Shares opened at $38, unlocking billions in new wealth for founders and early investors. While shares have actually fallen below that IPO level, investors will probably "like" Facebook for quite some time!

Taxes played a lead role in Facebook's IPO. The company went public largely so founder Mark Zuckerberg could pay $2 billion in taxes to exercise options on 120 millionshares. And six insiders, including Zuckerberg, have set up annuity trusts most likely intended to minimize gift and estate taxes on transfers to future heirs. (In Zuckerberg's case, those future heirs haven't even been born -- how'sthat for advance planning!) But one Facebook founder has taken an even more drastic step to avoid tax -- he's actuallyrenounced his American citizenship!

Eduardo Saverin was born in Brazil in 1982. His wealthy father moved the family to Miami in 1993 to avoid kidnapping threats, and Saverin became a U.S. citizen in 1998. He met Zuckerberg while the two were students at Harvard and, using his family's wealth, became Facebook's first investor. But Saverin was squeezed out shortly thereafter, reportedly at the urging of more experienced backers. He sued Zuckerberg, and settled out of court for what appears to be something between 2% and 4% of the company -- worth as much as $4 billion at last week's market close. 

Now, Americans like Saverin who give up their citizenship do pay an "exit tax" on the value of appreciated assets as of the time they leave. That means, essentially, you're taxed as if you sold everything the day before you surrender your U.S. passport. You'll file Form 8854 to calculate and report your tax. If you can't afford to pay on the spot, you can even "finance" it as long as you post adequate security. 

In Saverin's case, that means he pays based on the pre-IPO value when he left in September -- but he avoids tax on any appreciation after that date. This could spell hundreds of millions in savings. And where has Saverin settled? Singapore, where he has lived since 2009, and where the tax on capital gains is zero. Zip. Zilch. Nada. The Wall Street Journal reports that Saverin has become a Kardashian-like figure in his new home: "Mr. Saverin is regularly spotted lounging with models and wealthy friends at local night clubs, racking up tens of thousands of dollars in bar tabs by ordering bottles of Cristal Champagne and Belvedere vodka, according to people present on these occasions. He drives a Bentley, his friends say, wears expensive jackets and lives in one of Singapore's priciest penthouse apartments." 

Saverin is hardly the first American to to de-friend Uncle Sam. The IRS publishes a quarterly list of Americans who leave, one that totaled 1,781 in 2011. And, while Saverin denies he left to avoid taxes, outrage has grown over his move. Senators Chuck Schumer (D-NY) and Bob Casey (D-PA) have even introduced legislation that would punish future Saverins -- their so-called "Ex-Patriot Act" ("Expatriation Prevention by Abolishing Tax-Related Incentives for Offshore Tenancy") would impose a 30% tax on future expatriates' gains after they leave our shores. 

Are you working to create the next Facebook? There are lots of ways to pay less tax when you eventually sell, and they don't require you to give up your citizenship! So call us when you're ready for your IPO -- and remember, we're here for the rest of your social network, too!

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

When Your Business Hits Hard Times

In order for companies to be successful, business owners must understand the value of staying calm during a crisis situation. When an economic or public relations crisis hits your company, your first reaction may be to panic. But when you have the right kind of support system in place via planning, a great staff, and insurance you can withstand any crisis regardless of how difficult it may seem.

There are five things every business owner or executive should know when it comes to keeping your cool in a crisis. It helps to have a stress ball on your desk to squeeze when things start to go wrong. But for a real solution, nothing beats being prepared.

Business Planning. Small business owners often forget to put together a business plan when they are starting out. A business plan is a the comprehensive blueprint you use to run, grow and finance your company. Just like any good plan, a business plan also has a section that is dedicated to reacting to a crisis.

A business crisis is something that takes up your company resources. You should never use resources unless it fits the business plan. When you create your business plan, put together sections on options during a crisis. When a crisis occurs, you have a head start on getting yourself out of it.

Surround Yourself. The first thing a good business owner should do in times of crisis is surround himself with good people. It is important to avoid surrounding yourself with "yes" men or women that will only tell you want you want to hear. That will do nothing to help you come up with good answers. You need people you can trust that will give you good advice.

You should also surround yourself with the right kind of professional assistance. If your company is having economic problems, then hire an accountant. If it is a public relations issue, then hire a public relations firm. Contract the people who have the know-how to help.

Hit it Head On. The most common response to troubled times is to hide from it and hope it goes away. That is the wrong approach. When a crisis hits your company, then you need to meet it head on and address it immediately. Create a written evaluation of the situation and see where the problem originated. This will help you to solve the problem more quickly, or at least allocate the proper resources to get the issue resolved.

Restrict Access. If your company is having financial problems, then lock down your books and access to all financial tools such as credit cards and your bank account. Some people tend to take advantage of a crisis situation, which can only make it worse. Restrict access to the important elements of a crisis and make sure that only you know what comes in and what goes out.

Business as Usual. It is important that you maintain business as usual during a crisis. Of course, you may run into some situations that would make that difficult. For example, a financial problem may mean that your vendors are not extending you the credit that you need to get materials. In that case, you will need to find alternatives.

Maintaining business as usual gives you something else to think about to help get your mind off the crisis from time to time. It also helps you keep your company afloat and make sure that you are still in business when the crisis is over.

Troubled times require precise responses. When your company hits a rough patch, be sure you are prepared and can handle the problem efficiently.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

Crowd Funding Tax Questions

If you've been looking for funding for your business, you've probably heard of it. The concept is simple. Go to a web site that facilitates a matchup between you and potential investors. Investors may contribute small amounts (e.g., $50) or make a more substantial contributions (e.g., $2,000).

A bill defining the legal limits for investors was recently signed by President Obama, The Jobs Act & Investment CrowdFunding Act But the IRS has yet to weigh in on the craze.

Will the contributions be a "gift" and not income to the business? If the business provides a service or product in return will the contribution be "income"? If the contribution is significant, it couldn't be classified as a gift and probably not income, but then is it a loan or equity capital? If it's equity, does that mean the investor is now a partner or shareholder?

If you're doing business as a partnership, LLC, or S corporation and the contribution is equity capital, you may have to send the individual a K-1 each year. You may consider the tax issues a minor problem if you're getting several large (e.g., $10,000) contributions, but not if you receive 100 small contributions and have to treat them as equity interests. Talk to your tax adviser before making a commitment.

Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday between 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

If you found this article helpful, I invite you to leave a commit and  please share it on twitter, facebook or your favorite social media site and  with your friends, family and colleagues. Thank you.

Tax Choices for Startups

Choosing which entity to operate your business involves two fundamental choices: 1) will you remain personally liable for business debts; 2) how will you and your business pay tax? There’s no “pat” answer, and in many cases you’ll want more than one entity. Consider these options as starting points:

• Proprietorship: This is a business you operate yourself, in your own name or trade name, with no partners or formal entity. You remain personally liable for business debts. You report income and expenses on your personal return and pay income and self-employment tax on your profits. These are best for startups and small businesses with no employees in industries with little legal liability.
• Partnership: This is an association of two or more partners. General partners (“GPs”) run the business and remain liable for partnership debts. Limited partners (“LPs”) invest capital, but don’t actively manage the business and aren’t liable for debts. The partnership files an informational return and passes income and expenses to partners. GP distributions are taxed as ordinary income and subject to self-employment tax; LP distributions are taxed as passive income.
• “C” Corporation: This is a separate legal person organized under state law. Your liability for business debts is generally limited to your investment in the corporation. The corporation files its own return, pays tax on profits, and chooses whether or not to pay dividends. Your salary is subject to income and employment tax; dividends are taxed at preferential rates. These are best for owners who need limited liability and want the broadest range of benefits.
• “S” Corporation: This is a corporation that elects not to pay tax itself. Instead, it files an informational return and passes income and losses through to shareholders according to their ownership. Your salary is subject to income and employment tax; pass-through profits are subject to ordinary income but not employment tax. These are best for businesses whose owners are active in the business and don’t need to accumulate capital for day-to-day operations.
• Limited Liability Company (“LLC”): This is an association of one or more “members” organized under state law. Your liability for business debts is limited to your investment in the company, and LLCs may offer the strongest asset protection of any entity. Single-member LLCs are taxed as proprietors, unless you elect to be taxed as a corporation. Multi-member LLCs choose to be taxed as partnerships or corporations. This flexibility and asset-protection strength makes LLCs the entity of choice for many new businesses.

If you expect your business to lose money at first, consider a proprietorship, LLC, or “S” corporation. Losses from these entities (up to your basis in the business) offset outside income from salaries, investments, and other businesses. If losses exceed that income, they generate net operating losses (“NOLs”) that you can carry back two years or forward 20.

Filing Guide

Proprietors and single-member LLCs file Schedule C then carry profits or losses to Form 1040. Partnerships and LLCs taxed as partnerships file Form 1065, then report partners’ income and expenses on Form K1 “C” corporations file Form 1120 or 1120-A. “S” corporations file Form 1120S, then report shareholder income and expenses on Form K1.

IRS Publication 334:
Tax Guide for Small Business
 
IRS Publication 535:
Business Expenses
 
IRS Publication 536:
Net Operating Losses
 
IRS Publication 583:
Starting a Business and Keeping Records

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

Document Those Receipts

If your only income is through salary, dividends, interest, etc. you probably will have few worries about the IRS asserting you have unreported income. But if you or your spouse have a business, you've got to be able to document amounts received that are not business income.

For example, your spouse has a consulting business. You're taking a trip to a Germany and agree to purchase six cuckoo clocks for a friend for a total of $4,000. You use your credit card and upon returning your friend reimburses you the $4,000. You're later audited and the IRS claims the $4,000 you deposited in your personal bank account was unreported income from your business.

The first question is will you even remember what the $4,000 was for? If you pass that test, can you prove it? There are many income sources that may be difficult to prove; some are easy. A loan from relatives for your business. The repayment of a loan you made to your neighbor to start a business. The proceeds of a yard sale. The sale of an inherited art work.

At a bare minimum make some sort of diary entry to describe the source of the income. Copy the check before depositing the money. Retain any documentation such as a note that substantiates a loan, a bill of sale for an item, etc.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.