Timing of Deduction for Start-Up Expenses

Section 195 of the tax code generally requires taxpayers to capitalize start-up expenditures. Fortunately, the first $5,000 of such expenditures can be expensed in the year in which an active trade or business begins, if the total such expenditures don't exceed $50,000. Expenditures in excess of $5,000 (or where the $5,000 allowance is phased out because of the $50,000 cap) can be amortized over not less than 180 months (15 years). The rule shouldn't be ignored. If a proper election to expense the expenditures isn't made, all the expenditures must be capitalized.

What are start-up costs? Start-up costs can include investigatory expenses such as conducting market surveys, analysis of locations, product sources, etc., amounts paid to evaluate several businesses and to determine whether to enter the business and which business to acquire, and preliminary due diligence to assist in a potential acquisition. However, once the business has been identified, additional due diligence such as a review of the acquisition's books and records by an accounting firm and or law firm don't qualify. Other items that qualify include expenses such as pre-opening advertising, hiring initial employees, training, salaries, travel expenses, etc.

    Example--Sue Flood incorporates Madison Dresses, Inc. in April 2009. On May 1 she signs a lease for the store and hires Ann to help her stock the racks, decorate, etc. In addition, Madison is paying $1,000 for rent. Madison opens its doors for business on July 1, 2009. From May 1 through July 1 Madison paid $8,000 in salaries, rent, etc. as pre-opening expenses. On Madison's return for 2009, Sue can deduct $5,000 of the total pre-opening costs. The remaining $3,000 must be amortized over 180 months, beginning in the month business began.

    Tax Tip--Clearly, it makes sense to keep the pre-opening expenses as low as possible. One way is to make sure you have all your resources ready before beginning. In the example above it would have made no sense for Sue to hire Ann on May 1 if the racks, dresses, etc. weren't going to be delivered for two months. A second way may be to begin business before the everything is in place. For example, you're opening a bar and grill in a resort area. The bar portion will be ready quickly, but the inspections and permits for food service will take three months. Open the bar now and the additional costs associated with the food service may be expensed as expansion costs. Caution. Check with your tax adviser on this approach.

Organization expenses fall under a different Code Sections, but the rules are similar. They include the costs of incorporating a corporation (Sec. 248) or of setting up a partnership (Sec. 709). Such expenses include setting up the books of the entity, legal fees in incorporating or organizing the partnerships, etc. (Caution. Not all organization expenses qualify.) Expenditures up to $5,000 can be expensed, if the total such expenses don't exceed $50,000. Expenses in excess of $5,000 must be capitalized and amortized over no less than 180 months.

The next issue to deal with is, when does the business begin? This is a factual issue and it's not often clear. Before looking at the nuances, the first question is, do you need a license or permit? If you haven't got the permit from the town, county, etc., you're most likely not in business. If you need a liquor license to sell wines and spirits, you're not in business until you get that license. Same for a restaurant; you'll need a license. On the other hand, if you had the restaurant but not a liquor license you could open for business and serve food only. There can be exceptions, but make sure you're on firm ground. But just because you have a license doesn't mean you're in business. If you don't need a license, business usually begins when your doors are open to customers. Generally that's also the same time you make your first sale, but not always. If there's any question (e.g., you don't have a fixed establishment, but sell over the phone) try to document the time.

Expansion versus new business. If you're just expanding an existing business, pre-opening expenses shouldn't have to be capitalized. For example, you already operate four restaurants in the local area. You decide to open a fifth. The expenses should be deductible as ordinary business expenses. On the other hand, it you set up a new corporation, LLC, etc. to own and operate the additional restaurant, you'll probably have to treat the costs as start-up expenditures. As always, there are exceptions. Check with your tax advisor.

In a recent case (Thomas J. Woody (T.C. Memo. 2009-93)) in February 2004 the taxpayer started investigating the real estate market so he could acquire real estate for investment or rental. Throughout 2004 the taxpayer looked at many properties he was interested in buying for this real estate investment and rental business. He made multiple offers to purchase properties but was out-bid on most of his offers. In May 2004 he entered into a contract to purchase a property on Bradley Avenue in Camden, New Jersey. However, after a home inspection revealed many defects in the property, he canceled the contract because the seller was not willing to make the needed repairs.

The taxpayer did not purchase any investment or rental property until he purchased the property on Randolph Street in Camden, New Jersey, on December 30, 2004, i.e., the next to last day of the year at issue. At that time, there was no tenant in the property, and he did not secure a tenant until sometime after 2004. Furthermore, there was nothing in the record to indicate that he held the property out for rent in 2004.

Throughout 2004 the taxpayer performed many other tasks in conjunction with his alleged business. He created a name for his endeavor -- Value Property Investments -- and began marketing his services via business cards, flyers, and word of mouth. In May 2004 he completed a business outline with "buying, remodeling, and renting property" being the stated purpose of Value Property Investments. On October 17, 2004, he paid $21,490 to the Wealth Intelligence Academy for certain training classes, which he subsequently attended to acquire real estate investment skills. After he took the Wealth Intelligence Academy courses, his business plan shifted from merely buying, remodeling, and renting to also include what the taxpayer referred to as "flipping" or "wholesaling" However, he never consummated this type of transaction during 2004.

In November 2004 the taxpayer applied, and was approved, for a loan from the U.S. Small Business Administration, and he obtained an employer identification number from the IRS. In December 2004 he obtained a credit card in the name of "Thomas J. Woody Value Property Invest" and opened a checking account in the name of "Mr. Thomas J. Woody D/B/A Value Property Investments".

Despite all of the foregoing activity, he did not purchase any investment property until December 30, 2004, and he did not buy or sell any other property, rent out any property, or hold any property out for rent, nor did he engage in "flipping" or "wholesaling" during tax year 2004.

The IRS disallowed the taxpayer's Schedule C expenses for 2004 because it determined that the taxpayer was not engaged in the active conduct of a real estate investment business as alleged. The taxpayer contended he commenced his real estate investment and rental business on May 1, 2004 when he entered into a contract of sale on the Bradley Avenue property. Thus, he contended that all his expenses associated with his business incurred after that date should be deductible business expenses. The IRS asserted that the taxpayer was not actively engaged in the real estate investment and rental business at any time during 2004, because he did not become actively engaged in business, i.e., by buying, selling, renting, or offering to rent property, until he held the Randolph Street property out for rent some time after 2004.

The Court noted that whether a taxpayer is engaged in a trade or business is determined using a facts and circumstances test under which courts have focused on the following three factors that indicate the existence of a trade or business: (1) whether the taxpayer undertook the activity intending to earn a profit; (2) whether the taxpayer is regularly and actively involved in the activity; and (3) whether the taxpayer's activity has actually commenced.

The Court held the taxpayer's activities did not rise to the level of a trade or business until, at the earliest, the time he purchased the Randolph Street property on December 30 of the year in suit. More likely, his activities did not rise to the level of a trade or business until he held the Randolph Street property out for rent sometime after the close of the year in suit, but the Court did not have to decide that issue.

Opening a new business is a major undertaking and the pre-opening costs can be substantial. To maximize your tax deductions and your cash flow, plan carefully and get good advice both tax and business.

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 from 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.

Business Expense Documentation and Tax Deductions

We've often mentioned the importance of adequate documentation to substantiate a business deduction. Ideally you should have a canceled check and an invoice marked paid with the serial number of the item purchased. While that may be viable for certain big-ticket assets, realistically, that's not often the case for most expenses. And the IRS knows that. There are many other ways to document expenses that are acceptable. However, you should be able to show that payment was made (e.g., a canceled check) and the nature of the item purchased (e.g., an invoice with a description of the item).

Travel and entertainment, auto expenses and charitable contributions. There are separate rules for these items, and they're very strict. We won't deal with them here. They'll be detailed in an upcoming report.

Canceled check. The check should have the payee and should show the cancellation on the back. Why the cancellation? In the case of large or unusual purchases, the IRS may check that the payee actually cashed the check.

Checks not returned. Many businesses (and individuals) no longer have their checks returned. The IRS will accept images of the check. In order to be accepted as proof of payment, the statement must exhibit a high degree of legibility and readability. If your bank doesn't send you hard copies of the images, you should be able to download PDF copies of the checks. Don't rely on the bank to save statements and check images. After a certain period of time you may not be able to retrieve them without cost. Download statements and images each month. (That's good advice for other statements where you may no longer receive hard copies such as telephone bills, etc.) You may also be able to show proof of payment by providing:

    an invoice marked "paid",
    a check register or carbon copy of the check,
    and an account statement that shows the check number, date, and amount.

An account statement prepared by a financial institution showing check clearance will be accepted as proof of payment if the statement shows:

    the check number,
    the amount of the check,
    the date the check amount was posted to the account by the financial institution,
    and the name of the payee.

Credit/debit cards. If payment is made using a credit card, the IRS requires that you have an account statement that shows the amount of the charge, the date of the charge (i.e., transaction date), and the name of the payee. If payment is made using a credit card, the IRS requires that you have an account statement that shows the amount of the charge, the date of the charge (i.e., transaction date), and the name of the payee. Most likely your credit card company is already mailing you these statements monthly. Cards specifically designed for business like American Express business credit cards will also provide year-end summaries. Note, this will only provide proof of payment.

Electronic funds transfer. If you transfer funds electronically, the IRS will accept an account statement prepared by a financial institution showing an electronic funds transfer as proof of payment if the statement shows:

    the amount of the transfer,
    the date the transfer was posted to the account by the financial institution,
    and the name of the payee.

Invoice. You must have an invoice or other documentation showing what you purchased. A canceled check without an invoice or some other document showing the item purchase could be a problem. Statements from a supplier may be substituted, but only if they show the item. Fortunately, since most businesses are computerized, a supplier could generate a duplicate invoice if an agent insisted on seeing one. But it's best not to rely on that. When paying invoices, write the check number and amount paid on the invoice and the invoice number on the check so that you can cross reference them later if necessary.

Save all invoices. Don't assume the IRS will accept a check written to the telephone company without an invoice. The check could have been for payment of your personal line.

What about independent contractors? Even for small jobs, ask for an invoice. In addition, make sure you give the party a Form 1099, if applicable. No 1099? You could lose the deduction or be subject to penalties. What about those cash payments to some contractors? No invoice and no record of payment probably could mean no deduction.

Cash register tapes. You go to the local hardware store to purchase some fasteners for the business and get only a cash register tape with no details of the items purchased. Will it fly? If the total is relatively small and it's not a common occurrence, and agent should accept it. Write a description of the items on the slip--1 gallon paint for repainting wall; bolts for shelving. Fortunately, most stores now print the detail on the tape.

Caution on tapes. Many businesses, including major big box retailers, use heat sensitive tape to print receipts. The life can vary widely from less than 1 month under poor conditions (the glove box of your truck) to several years under good conditions. Don't take a chance. Make photocopies of the tapes.

Reasons for purchase. The business purpose of most of your purchases may be obvious. An agent is unlikely to question a laser printer cartridge, a computer, a book on how to use a computer program, etc. But be prepared for questions if the invoice or tape shows the purchase of items that normally wouldn't be business related or could be personal as well as business. For example, the purchase of a book with no clear business relationship, power tools by a computer consulting business, etc. Don't take a chance on remembering the reason several years later when you're audited. Write the business reason on the receipt or attach a description to the receipt.

Avoid personal purchases through the business. It's convenient to use a company check or credit card to purchase personal items. Resist the urge. Your accountant may spend time making the entries to adjust your expenses. If he doesn't or misses some that an agent catches, the agent might increase his scrutiny of all your expenses. You could be liable not only for additional taxes and interest but also an accuracy-related penalty. In flagrant cases the IRS may claim fraud, particularly if other indications are present.

Checks made to cash. While you should try to avoid them at all cost, that's nearly impossible. The larger the amount, the more careful you should be. Be sure to indicate on the check what the purchase was for. This is one time when an invoice can be critical. An invoice marked paid in full would certainly help your position.

Cash expenses. Some expenses will be so small that an invoice or even a cash register tape is impractical. You may also be paying in cash rather than by using a check or credit card. Keep a diary showing the date, place, amount, and description of the item purchased or service obtained. For example, "11/20/12, Madison Hardware, $6.25, nuts and bolts for shelving".

Business standards for documentation. Any invoice, contract, etc. should be up to industry standards. For example, a receipt from a local deli for sandwich platters for the office party may be scribbled on an invoice without a number (it should, of course, be dated). But an invoice for a collision repair on the company truck should contain detailed parts and labor, since the shop normally does that for insurance purposes.

Other documentation. You should also retain other documentation that might be used in addition to or in place of an invoice. For example, a contract for services, lease on equipment or office space, warranties on equipment, service contracts, etc.

Petty cash. If you keep a petty cash fund, slips showing expense reimbursements should be sufficient to document the expenses. That's assuming the expenses are small, as one would expect. Make sure that the nature of the expense is clear from the slip. Employees should check that and, if not, write on the slip the type of expenses and the vendor.

Expense reports. We're not talking travel and entertainment here. It's not unusual for an employee to purchase office supplies, small equipment, shop supplies, maybe even items to be used on the manufacturing floor that may be critical. Officers and especially officer/shareholders often pay company expenses out of their own pocket. While it's best to avoid such situations, that's not always possible. The correct procedure is to have the employee file an expense report and attach the documentation. The company should then cut the employee a check for the amount documented. For example, you need a color printer for a rush job. An employee buys an inkjet printer with his own credit card. He should file an expense report and attach the credit card slip and any other documentation from the store.

This can be especially critical when it comes to an employee/owner/shareholder. Without the expense report the company can't take the deduction because it didn't pay for the item; the employee/owner can't take the deduction because it's not a valid deduction. Special rules apply to partnerships and there's an exception if the business has a policy of not reimbursing. Talk to your tax advisor.

Cohan rule. The last resort. It's called the Cohan rule because it evolved from a court case where the taxpayer was George M. Cohan. Cohan claimed travel and entertainment expenses for which he had no receipts. The court allowed him a deduction based upon the fact he was able to convince the court he incurred expenses but did not have proof of payment or the actual amount. Ironically, this rule cannot be applied to travel and entertainment expenses any longer. Now if required, no receipt, no deduction, no exception for those expenses.

How does the Cohan rule work today? If you can show you definitely incurred the expenses and are entitled to a deduction but don't have the receipts or proof of payment, the court may allow a deduction based on an estimate. But there has to be some basis on which the court can make the estimate. For example, you have no receipts to prove your fuel oil expense for 2012 because you inadvertently destroyed the bills. In addition, the company went out of business. Clearly you incurred some charges to heat your building. The court may estimate the expense based on an average of fuel bills for several years.

This is a last resort for a number of reasons. First, you may have to go to court to get the deduction. Second, the court is almost assuredly going to try and underestimate the amount of your deduction. Third, the rule will probably not be applied if you have access to the documentation but don't produce it (e.g., you could ask a vendor to produce the necessary statements, even if it cost you). Fourth, you'll still have to convince the court you incurred the expenses. It may believe your testimony; it may not. You'll be on safer ground if you have some corroborating evidence.

Finally, the court is under no obligation to assist you. Even if your records are destroyed through no fault of your own (e.g., a fire), the court can require you to reconstruct. You'll fare better if you can show the lack of records either isn't your fault or, if it is, there are extenuating circumstances. For example, you normally have excellent documentation but telephone and utility bills for one year were inadvertently discarded.

Corroborating witnesses. Sometimes you can convince the IRS or the court you incurred the expenses by producing witnesses. That may work, but if the witnesses aren't convincing or the court believes the testimony may be biased (they're employees or relatives), it doesn't have to accept their testimony. And that happens in a high percentage of cases. Again, not an approach to rely on.

Too much paper? In many cases you don't have to save paper copies. Electronic versions of statements received from vendors or others will normally suffice, but they must be readable. You can also scan documents and save them as electronic copies. If the documents are signed (e.g. a lease), you might want to retain an original copy. And consider retaining hard copies of important asset purchases. Talk to your tax advisor.

Retention time. You may have heard hold canceled checks and other documents for 3 years, but it's more complicated than that. Technically it's three years from the date you filed the return. But if the IRS suspects you underreported your income, it can go back 6 years. If it believes fraud is present, there is no limit. For assets such as autos, equipment, etc. you should retain all documentation for at least 3 years after the asset is disposed of. And longer retention periods can apply to employment records. If you need a single rule of thumb, use a 7-year holding period for most records. But the best approach is to check with your tax adviser.

Documentation vital. Based on an informal analysis, it appears that more taxpayers lose in Tax Court because they can't substantiate their expenditures than for any other reason. While the IRS sometimes does show some flexibility, it's generally a stickler for records and can disallow the smallest expenditure for lack of them.

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 from 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.

Social Security Taxable Wage Cap Increasing To $113,700 In 2013

The Social Security Administration has announced an increase in the Social Security taxable wage base in 2013 from $110,100 to $113,700. The $3,600 increase is slightly more than the $3,300 increase from 2011 to 2012. The cap was just $106,800 from 2009 to 2011, as inflation ground to a halt during the economic downturn.

The wage cap is the maximum amount of compensation subject to tax under the Federal Insurance Contributions Act (FICA) for old age, survivors and disability insurance (OASDI) — typically called Social Security tax. FICA imposes both Medicare tax and Social Security tax on compensation received for services at matching employer and employee rates (with self-employed taxpayers effectively paying both shares on self-employment income). Although the Social Security tax is capped, the Medicare portion of FICA tax applies to total earnings, with no limit on the amount.

The Social Security tax rate is generally 6.2% for both employers and employees, but under a special temporary provision it is only 4.2% for individuals in 2012. The rate is scheduled to revert to 6.2% in 2013 without legislative action. The maximum total individual share of Social Security tax is capped at $4,624.20 in 2012 but is scheduled to jump to $7,049.40 in 2013, with a return to the 6.2% rate and the higher wage cap.

S-corporation shareholders should see their tax advisor to understand how this may impact their compensation package.

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 from 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.

Barnes & Noble Customer Credit Card Data Stolen

According to CNNMoney.com. a data breach at various Barnes & Noble stores may have compromised credit card information of customers.

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 from 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.​​

Watching Out for the Cliff

Ordinarily, we use these posts to discuss fun items related to taxes and finances. We know that you can read the usual boring articles about the usual boring tax topics pretty much anywhere else. And most of you are happy to let us worry about "the details."

Every so often, though, we need to discuss more serious issues, even if it's just to let you know that we're on top of them. That's the case today with the so-called "fiscal cliff" -- Federal Reserve Chairman Ben Bernanke's clever term for what happens on January 1, when a bunch of current tax rules expire, and some new rules take effect. Here's a quick rundown of what to expect:

• The Bush tax cuts expire. That means the top rates on ordinary income goes from 35% to 39.6%; the top rate on capital gains goes from 15% to 20%; and the top rate on qualified dividends jumps from 15% to 39.6%. Much of the debate over tax rates focuses on income at the top. But the expiration of the Bush tax cuts affects all of us. The lowest 10% rate will disappear entirely, and everyone who actually pays income tax will pay more.
• The 2011-2012 payroll tax cuts expire. That means Social Security and self-employment taxes go up by 2% on all earned income up to $113,700. Two percent may not sound like a lot -- but it means higher taxes for about 163 million working Americans.
• New taxes imposed by the 2010 "Obamacare" legislation take effect. The Medicare portion of Social Security and self-employment taxes goes up from 2.9% to 3.8% on earned income topping $200,000 ($250,000 for joint filers). And there's a new 3.8% "Unearned Income Medicare Contribution" (which sounds so much better than "tax') on "net investment income" (interest, dividends, capital gains, rents, royalties, and annuities) over those same amounts.
• The Alternative Minimum Tax exemptions revert back to where they stood in 2000. Under current law, those exemptions aren't adjusted for inflation. So, every couple of years, Congress "patches" the system by temporarily raising the exemptions to where they would be if they were indexed for inflation. The AMT currently hits about 4½ million Americans -- but without the "patch," that number explodes to 33 million.
• Oh, and don't think dying solves your tax problem. That's because estate taxes, which currently start at 45% on estates over $5 million, will jump to 55% on estates over just $1 million.

So, January 1 is our fiscal cliff, and we're hurtling towards it like Thelma and Louise. What can we do? Well, plenty of legislators have proposed extending part or all of the Bush tax cuts, extending the payroll tax cuts, patching the AMT, and raising the estate tax exemption. But actually passing anything will be a challenge -- Congress has passed just 132 bills this year, and 20% of those were to name post offices!

The partisan gridlock has many observers convinced that we'll actually go over that fiscal cliff. (Maybe it'll be like those old Road Runner cartoons, where the coyote runs off a cliff and keeps right on going, just fine, until he looks down. That's when he realizes he's standing in thin air, then plummets 1,000 feet to the bottom of the canyon.) If that winds up being the case, we may see Washington wait for the election results and pass something noncontroversial like the AMT patch before the end of the year. Then in 2013 they'll pass legislation extending at least part of the Bush tax cuts and make it retroactive to January 1.

We're not writing today to take sides on any of these issues, or tell you where taxes should go. But we want you to know that we're watching everything closely to help you make the most of your opportunities and avoid land mines where possible. And remember, we're here for your family, friend, and colleagues, too!

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 from 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.​​

Intuit Quickbooks Syncing Sensitive Client Data To Their Servers

​I was alerted by Michelle Long, CPA, MBA from Long For Success, LLC, that Intuit Quickbooks may be accessing sensitive client data without first telling the program users. Seems we've seen this before with other companies.

From Michelle's blog:

    Intuit Sync Manager may be syncing QuickBooks data (indexing sensitive financial data like Social Security numbers and customer credit card information) to Intuit servers without your knowledge. 

    This may be a security concern for QuickBooks users who do not want to sync sensitive financial information with Intuit Servers. It should be a bigger concern for CPAs, Chartered Accountants and other accounting professionals. We are usually required to keep client information confidential and secure according to the AlCPA, state laws or other regulations. If client data will be shared with third parties (ie. Intuit's servers), we should have consent from the client in an engagement letter or privacy notice.

I urge you to read the blog post, then check your Quickbook program to ensure that you are not sharing your sensitive client data with Intuit.

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 from 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.

Duh!

Today's wired world has most of us drowning in information. Twenty-four-hour cable news networks, instantaneous online updates, Facebook, and Twitter are constantly assaulting our senses. Much of what passes for "news" is really just noise -- the latest statistical fluctuations in the presidential polls, for example, or the comings and goings of your favorite Kardashian sister. But every so often, we learn something so surprising that it rocks us to the core and causes us to re-evaluate everything we thought we knew.

Three professors have just revealed that sort of earth-shattering information in the newest issue of Accounting Review. They analyzed data from 5,000 corporations over 17 years from 1992-2008 to answer an age-old question: "Do IRS Audits Deter Corporate Tax Avoidance?" And here's their startling conclusion -- make sure you're sitting down to read it: when audit rates go up, so do taxes!

"We extend research on the determinants of corporate tax avoidance to include the role of Internal Revenue Service (IRS) monitoring. Our evidence from large samples implies that U.S. public firms undertake less aggressive tax positions when tax enforcement is stricter. Reflecting its first-order economic impact on firms, our coefficient estimates imply that raising the probability of an IRS audit from 19 percent (the 25th percentile in our data) to 37 percent (the 75th percentile) increases their cash effective tax rates, on average, by nearly 2 percentage points, which amounts to a 7 percent increase in cash effective tax rates. These results are robust to controlling for firm size and time, which determine our primary proxy for IRS enforcement, in different ways; specifying several alternative dependent and test variables; and confronting potential endogeneity with instrumental variables and panel data estimations, among other techniques."

Shocking, isn't it? (Just FYI, "endogeneity" is a statistical condition that occurs when there's a correlation between a parameter or variable and an "error term." It can arise as a result of measurement error, or a few other things that require looking up, including autoregression with autocorrelated errors, simultaneity, omitted variables, or sample selection errors.)

Let's give the authors a little credit here -- they do say it's not really surprising that more audits equal more taxes. But they say it was hardly obvious before they started their study. What if they found that corporations were just so confident they could outmaneuver the IRS that audit rates didn't matter?

The professors also argue that shareholders benefit from IRS audits -- especially when corporate governance is weak. Co-author Jeffrey Hoopes of the University of Michigan reports that "strict tax enforcement promotes good financial reporting and tends to check managers' proclivities to divert corporate resources for their personal use under the guise of saving taxes." They cite Tyco as an example, where top executives minimized taxes by relocating profits to low-tax foreign countries, then diverted millions of dollars for their own personal use. (Remember CEO Dennis Kozlowski, who spent $15,000 of shareholder money on an umbrella stand? Yeah, that guy . . . he's in jail now.)

What does all this mean for you? Well, audit rates for personal returns average just over one percent. That's a tiny fraction of the 30% or so that the biggest group of companies in the Accounting Review study faced. But we file every return as if we expect it to be audited. Yes, we work and plan to minimize your taxes. But the strategies we use are all court-tested and IRS-approved. That way, you save money and sleep well at night!

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 from 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.​​

IRS Considering Reporting Tax Debt to Credit Bureaus

Congress is considering allowing the Internal Revenue Service to report on taxpayers’ tax debts to consumer credit bureaus such as Equifax, TransUnion and Experian.

The Government Accountability Office provided a report Wednesday to Senate Finance Committee chairman Max Baucus, D-Mont., and Senate Judiciary Committee ranking member Charles Grassley, R-Iowa., on the factors for considering a congressional proposal to report tax debts to credit bureaus. The report noted that millions of individual and business taxpayers owe billions of dollars in unpaid federal tax debts—$373 billion as of the end of fiscal year 2011, including $258 billion in individual debt and $115 billion in business debt—and the IRS expends substantial resources trying to collect these debts.

Unlike many other debts owed to the federal government, tax debts are not directly reported to the credit bureaus that collect and sell information about the credit history of individuals and businesses. The IRS is not allowed to directly report tax debt information to credit bureaus because long-standing federal law protects the privacy of any personally identifiable information reported to or developed by the IRS. The IRS is, however, allowed to file tax liens on some tax debts. Tax liens become part of the public record, which can be picked up by credit bureaus and included in the credit history information they compile

Among the potential reasons for directly reporting tax debt information to credit bureaus are the possibility that it could increase revenue by encouraging tax debtors to pay off their debts and the possibility that it could give the users of credit bureau information a more complete picture of the indebtedness of tax debtors. A proposal could conceivably encompass all tax debts or specify types of tax debts for such reporting.

How much of this debt would be suitable to report to credit bureaus could depend on the purpose of the reporting proposal, such as to collect more debts or simply to inform other potential creditors of the existence of tax debts, the GAO noted. Most debts are relatively small in size. Well over half of individuals and businesses with tax debts owed less than $5,000.

However, much of the aggregate debt is concentrated among those owing relatively large amounts. Debts over $25,000 add up to a total of $310 billion.

However, the National Taxpayer Advocate cautioned that such reporting could cause some taxpayers to choose not to file or file inaccurately if they know they owe money to the IRS.

Now is the time to contact your congress critters to let them know how you feel.​

Do you have unfiled back taxes or owe the IRS money, contact me ASAP to get this resolved.​

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 from 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.​​

ObamaCare Business Overview

The Patient Protection and Affordable Care Act (PPACA) has several provisions that will affect you as an employer. While some of the law's provisions have already taken effect, many of the provisions will begin taking effect in 2013, 2014, and later years. Below is a summary of some of the more significant provisions that may be of interest to you.

FSA Limitation

Beginning in 2013, for a health flexible spending arrangement (FSA) to be a qualified benefit under a cafeteria plan, the maximum amount available for reimbursement of incurred medical expenses of an employee, the employee's dependents, and any other eligible beneficiaries with respect to the employee, for a plan year (or other 12-month coverage period) is $2,500.

Employer Mandate

Under PPACA, an "applicable large employer" is subject to certain "shared responsibility" requirements. Under those requirements, an applicable large employer that (1) does not offer coverage for all its full-time employees, (2) offers minimum essential coverage that is unaffordable, or (3) offers minimum essential coverage that consists of a plan under which the plan's share of the total allowed cost of benefits is less than 60 percent, must pay a penalty if any full-time employee is certified to the employer as having purchased health insurance through a state exchange with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee.

An employer is an applicable large employer for any calendar year if it employed an average of at least 50 full-time employees during the preceding calendar year. An employer is not treated as employing more than 50 full-time employees if the employer's workforce exceeds 50 full-time employees for 120 days or fewer during the calendar year and the employees that cause the employer's workforce to exceed 50 full-time employees are seasonal workers. A seasonal worker is a worker who performs labor or services on a seasonal basis, including retail workers employed exclusively during the holiday season and workers whose employment is, ordinarily, the kind exclusively performed at certain seasons or periods of the year and which, from its nature, may not be continuous or carried on throughout the year.

The penalty for any month is an excise tax equal to the number of full-time employees over a 30-employee threshold during the applicable month multiplied by one-twelfth of $2,000. In the case of persons treated as a single employer under the provision, the 30-employee reduction in full-time employees is made from the total number of full-time employees (i.e., only one 30-person reduction is permitted per controlled group of employers) and is allocated among such persons in relation to the number of full-time employees employed by each such person.

For example, say that in 2014, you fail to offer minimum essential coverage and have 100 full-time employees, 10 of whom receive a tax credit for the year for enrolling in a state exchange-offered plan. For each employee over the 30-employee threshold, you would owe $2,000, for a total penalty of $140,000 ($2,000 multiplied by 70 ((100-30)). This penalty is assessed on a monthly basis. Thus, the monthly penalty would be one-twelfth of $140,000. For calendar years after 2014, the $2,000 dollar amount is increased by the percentage (if any) by which the average per capita premium for health insurance coverage in the United States for the preceding calendar year exceeds the average per capita premium for 2013.

Small Business Tax Credit

PPACA provides a tax credit for a qualified small employer for nonelective contributions to purchase health insurance for its employees. Although the credit took effect in 2011, the amount of the credit increases from 35 percent (25 percent for tax-exempt organizations) of eligible premium payments to 50 percent (35 percent for tax-exempt organizations) in 2014.

Excise Tax on High-Cost Employer-Sponsored Health Coverage

Beginning after December 31, 2017, PPACA imposes an excise tax on certain health insurance providers for any excess benefit provided by an employer to an employee with respect to employer-sponsored health coverage. The excise tax is imposed pro rata on the issuers of the insurance. In the case of a self-insured group health plan, a health FSA or a health reimbursement arrangement (HRA), the excise tax is paid by the entity that administers benefits under the plan or arrangement. Where the employer acts as plan administrator to a self-insured group health plan, a health FSA or an HRA, the excise tax is paid by the employer. Where an employer contributes to a health savings account (HSA) or an Archer MSA, the employer is responsible for payment of the excise tax, as the insurer.

Please call me at your convenience if you wish to discuss these provisions or any other issue regarding employee health insurance.

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 from 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.​​​

ObamaCare Expanded Medicare Contribution Tax

Beginning in 2013, as part of the Patient Protection and Affordable Care Act (PPACA), an additional tax is imposed on income over a certain level in the case of an individual, estate, or trust. This tax is referred to as the "unearned income Medicare contribution tax." Others have referred to it as a tax on investment income, although it can apply to individuals, estates, and trusts that do not have investment income.

For an individual, the tax is 3.8 percent of the lesser of net investment income or the excess of modified adjusted gross income over a threshold amount. The threshold amount is $250,000 in the case of taxpayers filing a joint return or a surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case.

Modified adjusted gross income is adjusted gross income increased by any amount excluded from income as foreign earned income (net of the deductions and exclusions disallowed with respect to the foreign earned income).

The tax is subject to the individual estimated tax provisions and is not deductible in computing any income tax. Thus, for example, there is no deduction allowed for this tax when calculating the self-employment tax.

For purposes of the unearned income Medicare contribution tax, net investment income is investment income reduced by the deductions properly allocable to such income. Investment income is the sum of:

(1) gross income from interest, dividends, annuities, royalties, and rents (other than income derived in the ordinary course of any trade or business to which the tax does not apply);

(2) other gross income derived from any trade or business to which the tax applies; and

(3) net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business to which the tax does not apply.

Investment income does not include distributions from a qualified retirement plan or amounts subject to self-employment tax.

In the case of a trade or business, the tax applies if the trade or business is a passive activity with respect to the taxpayer, or the trade or business consists of trading financial instruments or commodities. The tax does not apply to other trades or businesses. Income, gain, or loss on working capital is not treated as derived from a trade or business.

Net investment income DOES NOT INCLUDE items that are excludible from gross income under the tax rules, such as interest on tax-exempt bonds, veterans' benefits, and any gain excludible from income when you sell a principal residence.

This law could affect you if you dispose of a partnership interest or stock in an S corporation. In such cases, gain or loss is taken into account to the extent gain or loss would be taken into account by a partner or shareholder if the entity had sold all its properties for fair market value immediately before the disposition.

In the case of an estate or trust, the tax is 3.8 percent of the lesser of undistributed net investment income or the excess of adjusted gross income over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins.

The unearned income Medicare contribution tax does not apply to a nonresident alien; a trust, all the unexpired interests in which are devoted to charitable purposes; a trust that is exempt from tax under Code Sec. 501; or a charitable remainder trust exempt from tax.

If you believe you may owe this tax, we will need to prepare estimated taxes in order to avoid a penalty. Please call me at your convenience if you wish to discuss this further or have any other questions regarding health insurance.

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 from 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.​​

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.