Payroll taxes: Once is enough

The recent news about a local payroll tax provider falling behind on remitting client payroll taxes should be a wake-up call to businesses that outsource their payrolls. The good news is that the payroll service's attorney says that all taxes entrusted by the clients for transmission to the government will get to the government, eventually. 

Cases in other states have not had such a happy ending. In 2006, for example, clients of a New York payroll service learned that $3 million of payroll taxes sent to the service had not been remitted, and the money was gone. The firm's clients had to pay their payroll taxes a second time -- first to a thief, and then again to the government. That can be a ruinous expense.

Outsourcing payroll administration is common for good reasons, but most taxpayers don't realize how much risk they are taking when they make that decision. That's why even when you outsource your payroll taxes, you should still monitor the provider. 

Fortunately, you can do so. Taxpayers enrolled in the Electronic Federal Tax Payment System (EFTPS) can go online and check that their payroll taxes are being remitted by the third-party payroll service. It looks like this (details obscured for obvious reasons):


















Is it a hassle? A little, but not compared to paying payroll taxes a second time. And if your payroll service provider says the way they do business doesn't let you check your deposits on EFTPS, you need to ask whether you are taking a risk that you can't afford.

-Joe Kristan


What is this "Fiscal Cliff," and why are we in this handbasket?

20121001iabizThe financial press says we are heading to the edge of a fiscal cliff at year-end. Is there any way to keep from going over it, and if not, is there any way to soften the landing?

The "Fiscal Cliff" is the potential expiration of a series of federal tax breaks that will occur absent new legislation on January 1, 2013, combined with the Obamacare tax increases that take effect then. There are dozens of tax rules affected; the biggest include:

- An increase in the top rate on ordinary income -- the rate on most income passing through on shareholder and partner K-1s -- from 35% to 39.6%.  For "passive" investors, the top rate will be 43.4%.

- An increase in the top rate on most capital gains from 15% to 23.8%. 

- An increase in the top rate on dividends from 15% to 43.4% -- nearly tripling the second tax on C corporation earnings.

- A reduction in the lifetime estate and gift tax exemption from $5 million to $1 million, combined with an increase in the top estate tax rate from 35% to 55%. 

There will also be a new .9% tax on single W-2 income over $200,000 or joint W-2 income over $250,000, as well as a 3.8% tax on "passive" or "investment" income (this tax is included in the top rates listed above). 

What to do?  Everybody's situation is different. It's unwise to take action ahead of the fiscal cliff without talking to your tax advisor. Here are some of the ideas that advisors will be discussing with their clients in the coming months:

  • Pre-emptive dividends. Some taxpayers may consider paying dividends out of their corporations by December 31 to take advantage of the current 15% federal rate. Some of these taxpayers will be S corporations purging old C corporation earnings.
  • Close out some capital gains. If you are going to be selling an asset soon anyway, selling this year may save some some money.
  • Make large family gifts.  For taxpayers with enough assets to make where the diffence between a $5 million, this is an obvious thing to look at. Not everybody can or should make gifts that big, but if you are ever going to do so, this is a good time to do it.
  • Accelerate income and defer expenses. This reverses the usual strategy of deferring income and accelerating expenses, but if rates go up, it makes sense. It's silly to defer income just to see it taxed at a higher rate, and deductible expenses are worth more as deductions when rates are higher.

Of course, all of this is contingent on politics. In general terms, an Obama victory makes a trip over the fiscal falls much more likely, while a Romney victory increases the chances of an extension of the current tax rates. Of course, the composition of Congress also matters. The politicians may extend some provisions while letting others expire.  Whatever happens, it makes sense to stay flexible pending the election outcome, but to start to prepare for a big tax increase. 

-Joe Kristan


A step away from the fiscal cliff?

Journal of Accountacy Tax and fiscal cliff resources

Timing is everything: capital investments for the last quarter of 2012

20120916iabizYear-end capital investment could make more of a difference than usual this year.  Two important tax provisions favorable to capital investments expire at the end of 2012.  That means it can make a big difference in your tax bill whether you get those assets in place by the end of this year.

Bonus depreciation is scheduled to go away after this year.  The tax law normally requires businesses to deduct the cost of capital expenditures -- equipment, software, etc. -- over a period of years.  "Bonus" depreciation allows taxpayers to deduct some or all of those costs in the year the capital asset is placed in service.  For 2012 taxpayers can deduct 50% of the cost of "new" assets (though not most buildings) in the first year; the remaining 50% of the cost is recovered over the asset's normal tax life. 

Secition 179 is even more important to most entrepreneurs than bonus depreciation.  Qualifying investments can be fully deducted under Section 179 in the year they are placed in service.  Section 179 has two important advantages to Iowa taxpayers.  First, it can be used on purchases of used equipment, unlike bonus depreciation.  Second, Iowa recognizes Section 179, but not bonus depreciation, so it provides a state tax break that bonus depreciation doesn't. 

Taxpayers can deduct the cost of assets under up to $125,000 for tax years beginning in 2012.  That number is scheduled to decline to $25,000 in 2013. 

Section 179 is subject to some important limits.  The abiity to take the Section 179 deduction phases out dollar for dollar in 2012 as fixed asset purchases for the year exceed $500,000.  Also, unlike with bonus depreciation, you cannot create a loss with a Section 179 deduction, so you can't use it to generate a loss carryback to recover prior-year taxes.

To claim either a Section 179 deduction or bonus depreciation for an asset, a calendar-year taxpayer has to have the asset "placed in service" by December 31.  That doesn't mean ordered by year end, or sitting in a box on the loading dock when you close for New Years.  It means hooked up and ready to run.

Year-end planning this year is even more fraught with uncertainty than usual.  Top federal tax rates are scheduled to increase from 35% to 39.6% after this year -- and to 43.4% for "passive" investors in business.  Depending on the outcome of the elections, that increase may or may not happen.  If the tax increase happens, many taxpayers will be better off not taking bonus depreciation or 179; they may even want to delay placing assets in service. 

It's unwise to buy an asset you don't really need just for the tax break.  For assets you will need for your business anyway, it's best to have the flexibility to place the asset in service this year.  Depending on politics and your business needs, you can decide whether you want to plug in that new asset, and qualify for bonus depreciation and Section 179, closer to year end.  You can also wait until you file you return to decide whether to opt out of bonus depreciation and Section 179, in case you want to use the deductions in years with higher tax rates.

With so much uncertainty, it's more important than ever to consult your tax advisor on these decisions.  So do that.

Wisconsin trucker skids into "self-rental" rule

It’s common for taxpayers to rent things to their businesses. Owners of C corporations often find rentals a tax-efficient way to pull cash out of a business and get a rent deduction, instead of paying non-deductible dividends. Sometimes an owner of a multi-owner business will also provide the real estate via rental. It usually works fine, but a Wisconsin trucking operator last week learned in Tax Court of a tax trap that sometimes lurks in self-rental.

Iabiz20120816The taxpayer ran his Wisconsin trucking business as a C corporation -- a corporation that pays its own taxes. If a C corporation pays dividends, they are taxable to the owner and non-deductible to the corporation -- so corporate income is taxed both when it is earned and when it is distributed.

The trucking company owned no trucks. Instead it leased them from an S corporation owned by the taxpayer, and also from the taxpayer personally. An S corporation pays no taxes; its income is instead taxed directly on the shareholder’s returns, and distributions of taxable income are not taxed again. In short, the rental income showed up on the owner's 1040, and the C corporation took a deduction while getting cash to its owner.

So far, so good. Unfortunately the "passive loss" rules add another wrinkle. The passive loss rules were enacted largely to shut down the leasing tax shelters of the 1980s. They say that rental losses are normally "passive," deductible only to the extent of "passive" income. The taxwriters of the day feared that business owners would get around these rules by renting items to their own business to artificially create passive income that would allow them to continue to deduct passive losses. Their response was the "self-leasing" rule.

The self-leasing rule says that if you have income from leasing an "item" to a non-passive business that you own, that income is non-passive -- but self-rental losses are still passive. That means self-leasing income doesn't help you deduct passive losses.

The Wisconsin taxpayer had taxable income on the trucks he leased through his S corporation, but losses on the trucks leased personally. The IRS examined his return and told him he couldn't deduct the self-rental loss against the self-rental income. The Tax Court last week upheld the IRS. They also told the taxpayer that he was lucky the IRS didn't make things even worse:

we conclude that each individual tractor and each trailer was a separate “item of property” within the meaning of section 1.469-2(f)(6), Income Tax Regs. However, because respondent has not contested petitioners’ netting of gains and losses within TRI [the S corporation], only TRI’s net income is recharacterized as nonpassive income.

In other words, the court said the IRS could require the taxpayer to break out the income tractor-by-tractor and disallow the losses on each lease generating a tax loss.

The case gives us two important lessons:

1. Rental income from items rented to your non-passive business doesn't help you deduct other "passive" losses.

2. If you rent multiple items to your business, you should make sure each item generates taxable income.  This could affect how you structure your leases and what depreciation decisions -- like bonus depreciation -- you take.

These rules are complex, so be sure to get your tax advisor involved early.

-Joe Kristan

Big charitable contribution, no deduction?

20120701iabizIt may be better to give than to receive, but it's sure easier to give when it cuts your tax bill. That's why gifts of appreciated long-term capital gain property are in every tax planner's toolkit. You can get a deduction for the full value of the property without ever paying tax on the property's appreciation. Even cash contributions can fail as tax deductions without the right paperwork. 

Any good tax tool can be abused, so Congress has enacted a long list of formal requirements that property contributions have to meet. If you fail to get the paperwork right, your deduction goes to zero, no matter how valuable your contribution is. While the rules can be complex, here are some that come up often:

  • Any gift more than $250 -- cash or property -- requires a written receipt from the charity stating the amount, if any, of value received by the donor (other than intangible or religious value). That means if you get 50-yard line seats for your donation to good-old Alma Mater U., they have to tell you how much of your donation was for the seats; you can't deduct that part. No receipt, no deduction -- even if you have a cancelled check.
  • Any gift of property more than $500 must be reported on IRS Form 8283 with your tax return. This can subject your return to greater scrutiny. If you aren't sure your dropoff at Salvation Army was really worth more than $500, that's something to think about.

This rule can wreck your dedection even in instances where you have strong evidence of the value without an appraisal. For example, if you donate a parcel of land to charity and the charity sells it right away, you still need an appraisal. You can't just rely on the actual sales price, as reasonable as it may seem. No appraisal, no deduction. You even need an appraisal for a deduction of more than $5,000 even if you paid more for the donated property than the deduction you are taking.

While these are some of the commonly-encountered rules, there are some more obscure ones. For example, there are special rules limiting the deduction for "qualified taxidermy property," because hunters were "paying" for their safaris by donating their stuffed trophies to museums. 

The bottom line? If you want to deduct a property donation, get your tax advisor involved early. The money you save on professional fees can turn out to be a bad bargain indeed.

-Joe Kristan

Will your 1040 help pay for your vacation home?

English: Sunburst Lake with Sunburst Ranger Ca...English: Sunburst Lake with Sunburst Ranger Cabin in Mount Assiniboine Provincial Park, British Columbia, Canada (Photo credit: Wikipedia)

People who buy a vacation home often need an excuse to help overcome their better judgment. Sometimes the idea that they will get some deductions out of that lake cabin is enough to push them over the edge. But is it so?

Yes, there are tax breaks for second homes. The biggest one is the home mortgage interest deduction, available for up to two homes, to a maximum of $1.1 million in debt. You can also deduct property taxes, at least if you aren't subject to alternative minimum taxes. But what about the home itself, and your out-of-pocket costs? Can you claim the cabin as a rental property, deduct depreciation, insurance, and maintenance, and move your property taxes to an "above-the-line" schedule E deduction? Probably not.

To get beyond home-mortgage and property-tax deductions, you need to claim rental losses. Under the "passive loss" rules, rental real-estate deductions are normally "passive." Short-term rentals can avoid this rule, but then you have to show "material participation" in the short-term rental activity. Unless you are on-site, that's hard to do, and probably impossible if you have an agent helping you with the rentals.

More problems arise if you actually use your vacation home. The tax law has a rule that limits "business" deductions from a rental property when you use the house personally for the greater of 14 days or 10% of the days the property is used or rented.  

There is one break that can be easily available. If you rent the vacation unit for less than 15 days, you get to exclude the rent from taxable income. But two weeks rent won't do much to make the monthly payments on the cabin.

The Moral? If you buy that north-country cabin, don't look for a lot of help from the IRS to help pay for it. If you really need the deduction to make it work, talk to your tax advisor before you commit.

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What the tax changes in Obamacare mean for entrepreneurs in 2013

20120629-1While the political future of the Affordable Care Act is unknowable, it has survived its courtroom challenge. That means many entrepreneurs will need to deal with important new tax provisions starting next year.

There are two important new ACA taxes taking effect in 2013:

  • A new .9% payroll tax on single taxpayers with salaries exceeding $200,000, or joint filers with combined salaries exceeding $250,000.
  • A new 3.8% tax on "unearned" income (a despicable description, by the way). It applies to income earned as interest, dividends, rents and capital gains. It also applies to income that is "passive" under the "passive loss" rules received on K-1s from S corproations, partnerships and trusts.

These taxes apply without regards to the insurance plans or coverage of either the employer or the employee; they are just taxes.

The payroll tax will require additional withholding on income that exceeds these numbers, but because the employer won't know an employee's spouse's salary, it will also require a new schedule on Form 1040. 

These taxes will motivate more taxpayers to operate as S corporations with salaries below the thresholds covered by this tax. They will take more of their income as distributions of K-1 income rather than salary, because S corporation K-1 income isn't subject to this tax.

The .9% surtax will make some taxpayers operating in LLCs taxable as partnerships consider the S corporation format. Generally entrepreneurs who are active in an LLC pay self-employment tax on all of their earnings from their LLC K-1s.  This will include the .9% surtax if their income is high enough, as well as the current 2.9% Medicare tax. By switching to the S corporation format and taking out a salary under the $200,000/$250,000 limits, they could save both the Medicare tax and the surtax.

The IRS may not take this sort of thing lying down. They recently forced an Iowa accountant to increase his reported wage income from $24,000 to over $90,000 annually to make him pay more medicare tax on his S corporation earnings. Still, there is a wide range of salaries that can be considered "reasonable" for this purpose, and the IRS has yet to show that they can force taxpayers to the $200,000 salary level.

The tax on "passive" income also makes it important for taxpayers, especially part-timers, to document how much time they spend working in the business in 2013.  The most common test for whether a taxpayer is "passive" is whether they spend 500 hours working in the business. Taxpayers may want to get in the habid of keeping a time diary if their participation might be otherwise hard to document.

It's time for entrepreneurs to start pondering these issues for next year. Involvement of a qualified tax professional is important.

-Joe Kristan

To deduct business expenses, start with a business

20120601iabiz"I don't use that corporation, but I keep it around so I can use more deductions."

"Everybody should have a schedule C to deduct more things."

These statements illustrate one of the most persistent 19th hole tax folk myths. People actually think that simply filing a corporation return, or having a purported business on a 1040 Schedule C, transforms the tax lead of nondeductible personal expenses to the gold of business deductions. This myth may be one of the pillars of the multi-level marketing industry. It really is a myth, as one tax practitioner learned in Tax Court last month.

The practitioner sold his tax businesses, but kept around a C corporation "management company." That corporation paid and deducted expenses for an airplane, for "rental" of an office in the practitioners home, and for other travel and meal expenses. Unfortunately, it didn't appear that the corporation "managed" anything but his tax liability. That meant there was no "trade or business," which the tax law for some reason says you need to have to deduct "trade or business expenses." 

Unfortunately for the taxpayer, using a C corporation caused him another problem: The funds spent on personal items were treated as "constructive dividends" to the taxpayer, taxable on his personal return. That meant he lost twice -- no corporate deduction, but taxable income on his 1040.

The Moral: Filing a business tax return doesn't turn a personal expense into a deduction.

-Joe Kristan

You negotiated a debt workout? The IRS may be glad to hear that.

The best-laid business plans can go awry. When that happens, everyone may be better off renegotiating the debt. If you do that, remember that the tax man has a seat at the table.

20120516iabizThe default rule under the tax law is that debt forgiveness generates taxable income. Fortunately for distressed debtors, there are some important exceptions. The most important:

-A reduction in purchase-money debt for an asset can be treated as a reduction in your purchase price, rather than debt forgiveness income.

-Debts forgiven under the terms of a bankruptcy decree are tax-exempt.

- Debt forgiveness income is taxable to the extent a taxpayer is insolvent.

A taxpayer is "insolvent" to the extent the value of assets are less than the taxpayer's liabilities. If a taxpayer has a negative net worth of $100,000 and has debt of $110,000 forgiven, the $10,000 difference is taxable income.

There are also debt forgiveness exclusions when home mortgage debt is forgiven, for business real property acquisition debt forgiveness, and for farm indebtedness.

If a taxpayer has debt forgiven that is tax-exempt,, it's not usually a free lunch. If the taxpayer has unused loss carryforwards or tax credits, they may be reduced or eliminated by the debt cancellation income. Alternatively, you may find yourself with a lower basis in some of your property, increasing your gain or reducing your loss on an eventual sale.

Sometimes what seems like debt forgiveness isn't taxed that way. For example, if your debt is settled by foreclosure, you have a taxable sale of the secured property to the extent of its value. Only the debt forgiven in excess of the value of the surrendered collateral is debt forgiveness income that may eligible for an exclusion.  

If property is foreclosed in settlement of non-recourse debt -- debt for which the creditor has no right to pursue the debtor beyond what is recovered in foreclosure -- the entire amount of the debt is considered to be the sale price of the property sold. This can be an expensive problem if the taxpayer has depreciated the property and has a low basis, triggering a big taxable gain on the foreclosure.

Taxation of debt forgiveness can be fiendishly complex. If you are negotiating a workoout, keep your tax advisor involved; after all, the IRS already is.

Image via Wikipedia

-Joe Kristan

Death and income taxes

IMG_1675The untimely death of Business Record managing editor Jim Pollock is a sad reminder of how little control we have of our destiny, no matter how carefully we plan. He struck me as a wise and kind man. I'll miss him and his Business Record work.

Unfortunately, the tax law doesn't think death is much of an excuse for not filing tax returns for the departed.  Here are some tax basics for survivors:

  • Death ends the tax year.  A surviving spouse can include the portion of the year up to the spouse's date of death on a joint return. 
  • Single or separate filers file a final 1040 for the tax year ending on the date of death.  The decedent's final return is due on the normal April 15 due date.
  • Normally the decedant's estate will report after-death income on a Form 1041.  An estate can choose to end its taxable year at any month end up to a year following the death.  If the estate makes distributions, the income is also distributed to the beneficiaries.  Income retained in the estate is taxed there under the trust rate schedules.
  • The way assets are held determines how after-death income is reported.  Jointly-held assets automatically are the property of the surviving spouse after death.  Assets held directly by the decedent go into the estate. If the dededent owned assets in a living trust, the assets and their income are disbursed under the terms of the trust.
  • Large estates may need to file Form 706, the federal estate tax return.  If the decedent was married, even smaller estates may want to file Form 706 to preserve for the surviving spouse whatever portion of the decedent's $5 million lifetime exclusion was left unused. Form 706 is due nine months after the date of death.  If it is not filed, any unused exemption is lost. The executor of a tiny estate would sure feel silly if the widow won the Powerball and suddenly had enough assets to use that extra $5 million exemption.

IRS Publication 559 is an excellent guide for helping executors and family members deal with the tax requirements of decedent returns.

- Joe Kristan


Get over your 1040 already!

20111040logoThe deadline for filing your 2011 1040 is Tuesday. Unless you are extending, of course. For the most part, the game is over for 2011, and there's little to do but add up the score.

Any more, 2011 is dwelling on the past. It's time to move on. What lessons can we draw from this filing season while the pain is still vivid?


The hardest tax problems are those when people don't keep up on their taxes. It can happen when you reduce your withholding too much. It can also happen when you don't keep up with your estimated tax payment obligations. If you own an interest in a partnership or an S corporation, it can become a problem in a hurry, especially if you spend the nice distributions they give you without putting them away for your taxes.

The first quarter federal estimated tax payment is due tomorrow. If your tax preparer gave you a voucher, file it with your check as instructed. It won't get any easier next April if you don't.


Most people who come to their tax preparares in April looking for a miracle have already squandered most of their tax-saving opportunities. These are likely to be found at work. Take advantage of the easy stuff:

- Maximize your 401(k) contribution. If you aren't at least putting in enough to get the entire employer match, you are making an unforgivable financial blunder. More is better.

- Review your health plan opportunities. If your employer offers a Health Savings Account option, think not twice, but several times before rejecting it. Many employers offer generous breaks to switch to high deductible health insurance, and most of the time you'll be financially better off with an HSA. If there is no HSA at your job, make sure you take full advantage of the cafeteria plan.

- Start funding your 2012 IRA. The main benefit of these is tax-free buildup of earnings; if you fund it now instead of next April, your money is tax-sheltered an extra year.

- If you are saving for college, put a little money away in a Section 529 plan like College Savings Iowa every month.


One of the perplexing things about being a tax preparer is seeing somebody with a $500,000 W-2 unable to raise $30,000 to pay taxes in April. You should always have some amount of cash easily available. Some people advocate enough to pay six months of living expenses, but I think you can do with less - especially if you have some other investments, or if you have a house. If you are a homeowner, open a home-equity line of credit, and then don't use it except for emergencies - like a $30,000 tax bill.


The SEP plan: The last way to cut your 2011 tax bill?

20120401iabizThe 1040 is due April 17.  You can get an extension until October 15, but you should be pretty much paid in by then.  With Iowa's economy improving, that means many entrepreneurs will be writing a check to the government.  Many of them are wondering whether there is anything they still can do to lower the 2011 tax bill.

Most of the good tax planning opportunities for 2011 ended when the year did.  If you are a solo operator -- if you don't have employees -- a Simplified Employee Pension still might be a big moneysaver for you.  These plans allow solo owners to put up to 20% of their business income away for retirement and deduct the contribution.  It's a deduction for taking money out of one pocket and putting it in another -- though to be sure, it has to stay in the other pocket until retirement on pain of early withdrawal penalties.

SEPs are the easiest form of qualified plan to set up.  All you have to do is set up an IRA with your friendly community banker and sign (but not file) Form 5305-SEP by the tax deadline.  If you don't extend your return, you have to fund your contribution by the deadline, but if you extend, you can wait until October 17.

The drawback of a SEP is that all employees have to have the same percentage of income contributed.  As you add employees, that can be an expensive way to reduce your taxes.  That's why bigger businesses usually switch to traditional profit-sharing plans, which have more flexible vesting and more ability to discriminate among classes of employees.  But in this age of independents, the SEP can be a great mulligan for your 2011 tax planning.  Heck, if it's good enough for the President, maybe it's good enough for you!  Of course, consult your tax advisor first.

Day trading? Heads you lose, tails IRS wins, unless...

20120316iabizMany strong men have thrown away day jobs to spend their afternoons with Maria Bartiromo -- and with their computers and Ameritrade accounts.

They have become day traders.

While it looks easy on television, it isn't, and big capital losses often ensue. That's a bad thing when you do your tax returns, because you can only deduct capital losses to the extent of capital gains, plus $3,000.  There are day traders out there with loss carry-forwards that they will be still using at that rate when their grandchildren move into assisted living.

There is another way, if you are a truly serious trader: the "Section 475(f) election."  If you make this election, you can deduct unlimited capital losses, at least until you run out of money.  But it's not for sissies, and it's easy to miss.

If you make the Section 475(f) election:

- You have to mark all of your positions to market - gains and losses - at year end.  That means you have to compute your taxes on any open positions at year end as if you had sold them at the year-en closing price. 

- Your gains don't qualify for the reduced rate on capital gains.

- You have to be able to demonstrate to the IRS that your trading activity rises to the level of a "trade or business."  Unless you have trading on a daily or almost daily basis and look to it for your livelihood, you probably don't make the cut.

Most importantly, you have to make a Section 475(f) election by April 15 of the year for which you want it to be effective. That means if you have big 2011 daytrading losses, it's too late.

To make the election for 2012, you need to follow the steps set out in Revenue Procedure 99-17.  That procedure requires you to attach a statement making the election either to a timely-filed 2011 tax return by April 17, 2012 or to a timely-filed extension. 

The Section 475(f) election is a serious step, which you should only take in consultation with your tax adviser.  But if you a very serious trader, it might pay off big at tax time.

- Joe Kristan

Where is that blasted 1099?

I want my tax return done!  I need that 1099!  I need that K-1!  I'm supposed to have that all in January! Right?

20120301iabizWell, no.

This can be a frustrating time for taxpayers expecting tax refunds.  It's worse than usual this year, as many of the information returns -- W-2s, K-1s, 1099s -- are coming in later than usual.  What's the hangup, and when am I supposed to have them?

W-2s should be issued by the end of January. 
If you don't have them yet, it's time to be concerned. 

Most 1099 forms should be issued by the end of January. 
If you worked in 2011 as an independent contractor, you should have your 1099-MISC by now.  You should probably have 1099-INTs for interest from your bank in hand.  Less happily, if you settled a debt for less than face, you should have a 1099-C. 

This year it's different for 1099s from stockbrokers. 
A tax law change requires them to report cost information on stock sales starting this year.  That has required massive upgrades to the information systems at the brokerage houses, so their deadline was moved back to February 17.  Many brokers have received permission to issue 1099 forms as late as March 15

The delay for stockbrokers also delays returns that need 1099-Bs from the brokers.  Many trusts can't issue their K-1s until they have the 1099 information, for example.  Investment partnerships also need their 1099s before they can issue K-1s to their owners.  Even many S corporations with investment accounts are on hold until they get the 1099s.

K-1s -- information returns from partnerships, S corporations and trusts -- don't have a January 31 deadline.
These forms only are due when the underlying returns that generate them are due.  S corporation returns are due March 15, and trust and partnership returns are generally due April 17 -- and they all can be extended automatically to September 15. 

If your business has to issue K-1s, don't take the March and April deadlines lightly.
Even though they can be extended.  Irate owners and beneficiaries want their forms, of course.  And if you do have to extend, make sure you really extend.  You need to file Form 7004 to get the automatic extension.  If you don't extend and you file late, the IRS assesses a penalty of $195 per month or part-month for each K-1.  That means missing the March 15 extension deadline by one day for a 10-shareholder S corporation means a $1,950 penalty. 

Extensions can be filed electronically.  If you must file them on paper, be sure to use certified mail, return receipt requested, or an authorized private delivery service that delivers to the IRS service center street addresses.

- Joe Kristan

Nope, still no tax fairy

Taxes are hard. Even if you farm them out to your friendly neighborhood tax preparer, you still have to put together your W-2s and 1099s and comb through your checkbooks and credit cards for deductions. When you run a business, you face the everyday drudgery of depositing payroll taxes, sending in your quarterly payments, and dealing with notices that seem to come out of nowhere from states you've never seen. 

IAbiz20120216At the end of a day full of this stuff, you flip on the television and you see somebody telling you that you can settle your tax debts with the IRS for pennies on the dollar. When you see this, for one shining moment you feel like a chump for spending time and money getting your taxes right and paying them on time. Why bother when you can just do a pennies-on-the-dollar deal anyway?

Because there is STILL no Tax Fairy.

Two of the biggest players in the pennies-on-the-dollar tax settlement industry recently closed their doors. The first was Roni Deutch, the self-styled "Tax Lady." In the face of allegations that she took up-front payments from desparate taxpayers and failed to follow through, she surrendered her law license on her way to bankruptcy and contempt of court charges.

Now JK Harris has joined Roni Deutch in federal bankruptcy court. Like Ms. Deutch, JK Harris ended up in bankruptcy after battling state attorneys general over its business practices.  The ability to make tax debts go away would be an extremely valuable attribute. The bankruptcy of these outfits is strong evidence that such ability is a myth. As Nevada tax practitioner Russ Fox explains:

  • Only about 15% of Offers in Compromise successfully make it through the IRS;
  • It typically takes over one year for an OIC to make it through the IRS;
  • Most individuals will not qualify for an OIC; and
  • If you look at the fine print of the commercials, you will see, “Case not typical. Your results may vary.”

When the IRS does accept an offer-in-compromise, they usually do so because you are truly broke. That's not really a taxpayer victory.

As unpleasant as dealing with your taxes might be, the alternatives are much worse. If you get into tax trouble, there's no Tax Fairy -- or Tax Lady -- to make it all better.

There is no tax fairy

NEW YORK - OCTOBER 25:  Tinker Bell and United...Image by Getty Images via @daylife

It's okay to dislike taxes.  In fact, it's normal and healthy. But that doesn't make them go away. It would sure be nice if a Tax Fairy could wave her wand and make them disappear. 

It's not going to happen.

People will have been seeking the Tax Fairy as long as there has been an income tax.  That's fine, until you think you have found her. 

- The founder of sought the Tax Fairy in "OPIS," a tax shelter marketed by a national accounting firm designed to generate artificial losses.  The Tax Court ruled that there was no Tax Fairy, imposing $25.7 million in taxes and $10.7 million in penalties. 

- A defense industry consultant looked for the Tax Fairy in the "Millennium Plan," attempting to deduct contributions to a Section 419A(f)(6) welfare-benefit plan while earning tax-sheltered income and retaining access to the funds contributed.  The Tax Fairy never showed, and the Tax Court upheld $5.7 million in additional taxes and $870,000 in penalties.

- A group of medical professionals in North Platte, Nebraska, sought the Tax Fairy through a CPA from Bakersfield, California.  They attempted to hide their income and deduct personal expenses in "loan-out" corporations.  They were sentenced last week on federal tax charges, and the Tax Fairy never showed.

Tax professionals can do a lot.  They can make sure you pay no more than you need to; with the right facts they can delay your tax and sometimes get you nice refunds. They can guide you safely through the dangerous and byzantine byways of the tax law. 

But if you make a lot of money and you want to continue to control and use it, you will eventually have to pay taxes.  There is no special "de-tax" plan or double-secret pay-no-taxes-ever trust scheme that your preparer is just too lazy or ignorant to tell you about.

There is no Tax Fairy. 

- Joe Kristan

Image courtesy Wikipedia Commons.

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I want my tax forms right now!

Impatience can be a virtue for the entrepreneur.  You succeed because you move faster than the competition, because you don't wait for somebody else to take care of your customers.  That's one reason tax time can drive you crazy.

20120116iabiz-1When you were just starting out, you got your W-2, you filled out your forms, and you were done with your taxes in January, except maybe for waiting for your refund check.  Now, you almost certainly have to wait until well into February to have all of the information you need to file your returns.  For many entrepreneurs, the wait extends past the usual April 15 deadline.  What are the deadlines for issuing the forms needed to preparer 1040s?

W-2s are supposed to be issued by the end of January.  Wait for yours.  No reputable preparer will e-file your return in January off of your pay stub.  If it becomes clear that your employer won't be issuing one -- and that usually means waiting until February, at least -- you can file your return by attaching Form 4852 in place of your W-2.

1099 forms, reporting interest, dividends, independent contractor proceeds, among other things, normally are supposed to be sent to recipients by January 31.  Many financial institutions have received extensions as the information for these forms has gotten more complicated -- "qualified" dividends and basis of stock sold out of brokerage accounts, for example.  You might not have all of these until nearly March.

K-1 forms from partnerships and S corporations are not subject to a January 31 deadline.  The K-1s, which tell owners what items of their partnerships and corporations to report on their 1040s, can legally be issued as late as September 15 for calendar-year businesses.  These entities can be very complicated, and it can take a lot of time to prepare their returns.  Many of them have to wait on their own K-1s from other partnerships before they can issue yours. So there is no good alternative to patience.

But I'm in a hurry for my refund!  Shouldn't I just file anyway with what I have? 

Probably not. Unless you are waiting on an enormous refund, one that can save your business, it pays to stifle your impatience and delay filing until you have all of your tax information.  It's better to extend than amend:

  • Extended returns are not an audit flag.  Incorrect returns are.  The goverrnment continues to get better at matching K-1s and 1099s with returns, and chances are they'll come asking if they are different.
  • If you have to amend your return later because you didn't wait on a K-1, you get to pay the preparer twice. 
  • Every amended return or IRS matching notice is one more chance for the tax authorities to botch your account.

Patience is hard.  But sometimes, when it comes to filing your taxes, it's smart.

Related: Reading your K-1: partnership debt basis

Taxes: What's new for 2012

20120101iabizHappy New Year! So what does the tax law have in store for you in 2012? 

For entrepreneurs, the biggest change in the tax law might be the new rules for fixed assets.  Congress has not re-enacted the rules allowing "100% bonus depreciation" for new fixed assets. Instead, "50% bonus depreciation" applies.  For qualifying property, taxpayers will be allowed to deduct half of the cost of fixed assets placed in service in 2012; the remaining half of the cost will be depreciated over a period of years under the "MACRS" rules.  For example, a taxpayer buying a $10,000 computer system would get to deduct $6,000 this year: $5,000 "bonus" depreciation and 20% of the remaining $5,000 cost ($1,000) under the usual rules for five-year property.

The "Section 179" deduction limitation for fixed assets has also changed this year.  Section 179 allows businesses to deduct the cost of fixed assets -- new or used -- that would otherwise have to be capitalized and depreciated over a period of years.  For 2011, up to $500,000 in assets qualified for Section 179 treatment.  That goes down to $139,000 in 2012.

A few other tax numbers for 2012:

Have a great 2012!

- Joe Kristan

Flickr image courtesy prettyinprint under Creative Commons license.


It's time for joy, family... and to make deductible payments for related parties!

The holidays are a time for families to gather, eat, and share memories.  And, it seems, to scheme to reduce taxes.  At least that seems to be what the tax code assumes, with its rules restricting deductions for payments to relatives.

20111216iabizYes, you can usually deduct payments to relatives...but only in the year the relatives include them in income. 

Accrual-method taxpayers can deduct payments owed to unrelated employees if they are made within 2 1/2 months of year-end.  Many non-wage payments to unrelated taxpayers accrued at year-end can be deducted if paid as long as 8 1/2 months after year end.

But Code Section 267 only allows a deduction to a related party "as of the day as of which such amount is includible in the gross income of the person to whom the payment is made." That's no problem if the "related party" is on the accrual method, because they will be accruing the income at the same time you accrue the expense. But if the related party is a cash-basis taxpayer, you have to pay up to get that deduction.

Who is "related?" It's a wide net. Most problems arise with closely-held accrual-method businesses and their cash basis owners. If you have a C corporation, only owners of more than 50% of the stock, and their families (siblings, spouses, ancestors and descendants) are related. For pass-through entities -- partnerships and S corporations -- any owner is a related party, along with members of owners families and anybody related to the family members.  Commonly-owned businesses are also considered related.

The broad definition of related parties for pass-throughs means that if a calendar year accrual-method S corporation accrues a bonus for a 2011 shareholder's nephew payable in January 2012, the deduction gets deferred until 2012. The same thing applies to interest expense, rental expense, or any other expense owed to a cash-basis related party.

So enjoy the holiday turkeys, roasts, hams and bowl games.  Just make sure you take the time to cut the checks to any relatives to whom you owe deductible expenses, if you want that deduction this year. Check with your tax pro to make sure you get it right.

- Joe Kristan

Flickr image courtesy snowpea&bokchoi under Creative Commons license.

Prison - the reason you shouldn't "borrow" your payroll taxes

20111201iabizEvery entrepreneur struggling to stave off hungry creditors has probably taken a wistful look at that pot of cash set aside from employee paychecks to send to the IRS as withholdings and payroll taxes.  Some go so far as to "borrow" that money to pay other creditors, leaving the IRS hanging.

Don't do it.  It's very expensive money. 

  • If the business goes under before you pay the IRS, the liability doesn't go away.  "Responsible persons" who fail to remit withheld taxes for their business can be held personally liable for the unpaid amount, even if the business is run in an LLC or corporation that otherwise shields the owner from liability.  

The former owner and president of two businesses in Brookings, South Dakota, who collected taxes from his employees and then failed to account for and pay those federal income and FICA taxes, was sentenced November 15, 2010, to 21 months in federal prison.

Michael D. Hoppe, age 60, from Watertown, South Dakota, received the prison term after a May 27, 2010, guilty plea in federal court in Sioux Falls. Hoppe was convicted of one count of failing to account for and pay taxes.

While paying payroll taxes may make it hard to run your business, prison walls make it much harder. 

- Joe Kristan

Flickr image courtesy Dan4th under Creative Commons license.

IRS offers $10,000 prize for filing new form!

Well, that's one way of putting it.  More accurately, the IRS will take $10,000 hard-earned dollars out of your pocket if you are don't file some forms related to international taxes.

Iabiz20111116You say "I'm in Des Moines, I don't have to worry about international tax forms!" Don't be so sure.  It's surprisingly easy to find yourself needing to file a form out of the IRS international tax series. Some common situations:

- You have a foreign financial account, or you have signature authority over one you don't own.

- You have loaned money to an offshore borrower.

- You have invested in an offshore venture. Many Iowans, for example, have been investing in Brazilian farm ventures.

The standard IRS fine for failing to file these forms is $10,000, and they assert the $10,000 penalty automatically.  The most common forms Iowans have encountered up to now include:

  • Form 5471, reporting investments in non-US corporations;
  • Form 8865, reporting investments in non-US partnerships;
  • Form 3520, reporting interests in non-US trusts or cross-border gifts, and
  • Form TD F 90.22-1, reporting interests in offshore financial accounts.

Now there is a new Form reporting broader classes of offshore financial instruments.  New Form 8938 requires you to report many offshore financial assets missed by other forms.  Unless the interest is held in a securities account, interests in partnerships, closely-held corporations and even public companies will have to be reported on 1040s filed for 2011.

Even if the interest is already reported on one of the old forms, the IRS is requiring a Form 8938 filing, if only to refer to the other form.  Examples we've seen of assets that would need to be reported are the Brazilian farm partnerships and shares of Canadian insurer Sun Life received as demutualization proceeds.  Single taxpayers will need to file if their holdings of foreign financial assets are $50,000 at the end of 2011 or $100,000 during the year; the thresholds are $100,000 and $200,000 for joint filers.

Except for Form TD F 90.22-1, these forms are all filed with your tax return.  Be sure you let your tax professional know about any Non-United States investments you have.  Unless you are happy to spare the $10,000, of course.

- Joe Kristan

Two months left to control your 2011 tax destiny

By now most of us have a pretty good idea how 2011 is going to come out for our businesses. That means now is the time to get serious about our tax planning. By the time you are gathering your information for your tax returns next year, most of the best tax-planning opportunities are behind us.  Now is the time to take charge of your 2011 year-end planning.

20111101iabizFirst, make sure you have a good idea of how your income is shaping up. Wrap up your October financials and make an estimate of how the last two months will go. Then get out a crystal ball and take a shot at estimating your 2012 income.

Then get together with your tax advisor to see how that translates to taxable income.  Many items have different tax treatment than financial statement treatment.  Once you have a good idea of where your taxable income is headed, ponder your options.

Your options might include:

  • Planning your cash-basis deductions:  If you are a cash-basis taxpayer, you can move many deductions between years just by choosing which year you write the check.
  • Take a close look at related party expenses:  When you are an accrual-basis taxpayer, you still are on a cash basis with expenses paid to cash-basis related parties.
  • Ponder fixed asset purchases:  If you are going to be purchasing fixed assets anyway, 2011 may be the year to buy them.  New business property is eligible for "100% bonus" depreciation in 2011, allowing you to deduct the entire cost in the year of purchase.  Usually fixed asset costs are capitalized and deducted as depreciation over a period of years.  Even if you are buying used equipment, you may be eligible to take a Section 179 deduction for up to $500,000 of business asset purchases.
  • Consider retirement plans:   If you have been looking to add a profit/sharing or 401(k) plan to your employee compensation package, you need it in place by year-end if you want to deduct contributions for 2011.

Last but not least,

  • Consider your tax payments:  It often is good to make your tax payments for the tax year during the tax year.  This helps you match your deductions for taxes paid to your income, and it may help you avoid Alternative Minimum Tax.  This is especially helpful when your income fluctuates from year to year.

The tax planning game is pretty much over at year-end.  After that, it's mostly just adding up the score.

- Joe Kristan

Flickr image by Baaker2009 under Creative Commons license.

To C or not to C

While most entrepreneurs set up their businesses as "pass-through entities" taxable on their personal returns, the traditional corporation retains fans.  "C" corporations pay their own tax, unlike "S corporations," which "pass through" their income to their owners returns.   Economist Martin Sullivan ponders why this old format still hangs on: 

20111001iabiz Graduated corporate rates, the low rate on corporate dividends, and an exemption from payroll taxes combine to make subchapter C the most advantageous choice for a lot of small business profits. If a business owner can afford to leave profits inside the corporation, the resulting deferral of individual tax only makes subchapter C more attractive.

While the top tax rate for individuals and corporations is 35%, C corporation rates are as low as 15% for the first $50,000 of taxable income.  This can be attractive to a top bracket individual. Some tax-free fringe benefits are also available to owners only in C corporations.

In venture capital deals, sometimes C corporations are required because they are funded by tax-exempt entities.  If business income passes through to tax-exempts, they may have to pay "Unrelated Business Income Tax."  They prefer dividends and capital gains from C corporations, which they can receive tax-free.

Still, there are good reasons for the popularity of pass-throughs. 

  • The 15% bracket can only be used in one corporation with the same owners.
  • "Personal service corporations," including law, medical, accounting and consulting practices, don't get the lower brackets.
  • Appreciated assets inside a C corporation can be trapped there because a distribution is taxed to the corporation as a sale and to the recipient as a dividend at fair-market value.  This can get very expensive when it comes time to sell.

You should consult with your tax professional when it's time to choose a tax structure for your business.  You might also want to ponder these words from the standard treatise on corporation taxes:

Decisions to embrace the corporate form of organization should be carefully considered, since a corporation is like a lobster pot: easy to enter, difficult to live in, and painful to get out of.

Though, a C corporation is still likely to have a better ending than the lobster.

- Joe Kristan

Image by Hartmut Inerle via Wikipedia under Creative Commons Attribution-Share Alike 3.0 Unported license.


When two S corporations are one too many

Entrepreneurs often set up a new corporation for each new business. It makes sense; if one has a catstrophe, the others are shielded from the damage. But if you aren't careful, multiple corporations can cause a tax catastrophe. It caused a $16 million problem in Tax Court this month for a Michigan couple.

S-walnut Owners of "S corporations" may be eligible to deduct the corporations business losses against other income on their personal tax returns. There are a number of limits on such losses, starting with the owners' "basis" in their S corporation stock.  Basis starts with their investment in the company; it is increased for earnings of the business and additional investments, and reduced for losses and distributions from the business.  Owners may also get basis for losses from personal loans to the S corporation.

If you have two corporations, one might be profitable, but the other might be losing money -- and short on basis.  Owners may be caught with non-deductible losses at year-end if they can't figure out how to get the basis where it needs to be.  That's what happened to the Michigan couple.

The easiest way to deal with this problem might be an "S corporation holding company."  If you have two S corporations with identical ownership, you can contribute all of their stock to a new corporation (it has to be all of the stock).  The new corporation makes a timely S corporation election on Form 2553, and the now-subsidiary corporations file timely "Q-Sub" elections. 

The tax law treats the new corporate group as a single corporation for basis purposes, eliminating the need to try to shuffle basis between them at year end.  The lawyers are happy because the liabilities of the businesses are still in separate corporations under state law.

Of course, don't try this at home.  Check with your tax and legal advisors before messing with your corporate equity structure.

- Joe Kristan

Don't flush that home office deduction

20110901iabiz With the rise of the Internet and the wonderful business computer tools now available, more entrepreneurs make do without fancy rental office than ever before. But not everyone who works at home qualifies for a home office deduction. A Florida accountant learned that the hard way in Tax Court recently.

The accountant worked out of a home office. When you take a home office deduction, you get to deduct some otherwise non-deductible home expenses attributable to your business space.  The catch: the space has to be used "exclusively" for your business. And they mean it.  From the Tax Court:

Petitioner argued that he also used the hallway and the bathroom adjacent to this bedroom exclusively for his accounting business. Petitioner testified, however, that his children and other personal guests occasionally used the bathroom. Accordingly, the hallway and the bathroom were not used exclusively for business purposes.

Jean Murray explains what you need to know about your home office deduction:

  • The space you deduct must be used (1) regularly AND (2) exclusively for business. A bedroom or part of bedroom that you don't use for anything else might be deductible, but not a bathroom that's also used for personal reasons. (I'm still trying to figure out how a home bathroom could have a business purpose.)
  • You can deduct the percentage of the space compared to your home's total living space.
  • You can deduct direct expenses related to the home office, like a separate phone line.
  • You can also deduct indirect expenses, like roof repairs, using the percentage.

If you are a Schedule C entrepreneur, you compute the deduction on Form 8829.  If you are an employee, it gets more complicated, so check with your tax advisor or IRS Publication 587.

- Joe Kristan

Flickr image by dfwcre8tive2009 under Creative Commons license.

What should I do about my capital losses?

Maria Bartiromo has been the bearer of grim tidings for many of us in recent days. If your net worth has taken a hit, can you get some of it back from the IRS at tax time?

20110816iabiz The tax law is not very friendly to stock market losses.  Most of us can only deduct our capital losses to the extent of our capital gains, plus $3,000.  Capital losses carry forward as long as you live, usable to the extent of future capital gains; if you have none, you at least get the $3,000. Long-term gains can offset short-term losses, and vice-versa.

The $3,000 allowance can be cold comfort. At $3,000 per year, some of us will have to outlive Methuselah to use up our carryfowards.  Still, there may be some tax moves available to ease your pain.

If you already have capital gains that you have cashed out for the year, sell enough losers to generate capital losses to offset them.  Remember, this only works in taxable accounts.  Selling a stock for a loss in an IRA or 401(k) does nothing for you, and losses in taxable accounts of course do not offset income from IRAs or retirement plans.

If you already have loss carryforwards, you can rearrange your portfolio without paying taxes.  If you have some gain stocks that it's time to unload, you can do so.

Be sure you know what your loss really is.  If you inherited a stock, your "basis" -- the amount you compare to your sale price to determine gain or loss -- is normally the date-of-death value.  If you were gifted shares, you step into the basis of the giver.  And if the stock has split or came from a merger of another company, you may have to pick your way through old transactions to learn your basis.

Beware the "Wash Sale" rules.  If you sell shares at a loss, purchasing the same shares in the 30 days before or after the loss sale will disqualify the loss on your tax return.

If you are a very active trader, there is an election to have all of your capital gains and losses treated as ordinary income -- not so great when you're making money, but a blessing when you've lost a bundle.  Unfortunately, it's too late to make that election for this year, as the deadline for the election is April 15 of the year you want the election to be effective.  It might be useful for 2012, though. 

If you need more information, Kelly Phillips Erb has a great general discussion of capital losses at her Forbes blog.

- Joe Kristan

Flickr image courtesy donjd2 under Creative Commons license.


If it's really a vacation, the IRS doesn't want to pay for it

It's high vacation season in Iowa.  As your inbox fills with "Out of Office" auto-replies, you might be wondering whether there's a spot on your return to deduct a nice trip to somewhere cool.  Didn't you overhear somebody's doctor bragging about how his tax preparer let him write off his vacation to California because there might be sick people there?

20110731iabiz It's not so easy. 

Yes, there are preparers who will let you deduct a vacation for even the most strained connection to your business.  The tax law itself, however, has a stricter standard, as the clients of an Iowa preparer have been learning. 

According to a U.S. District Court opinion, the preparer encouraged clients to employ relatives as distributors, or to sell to them, to make family vacations deductible:

You want to go visit your mother for Thanksgiving . . . . If you’re self-employed and you  sponsor your mom into your business, now you’re going to meet with your distributor. All of a sudden, that trip for Thanksgiving is a deductible business trip.

Sorry, Mom.  The tax law has a much stricter standard for these things.  Your trip has to be "primarily" for business reasons.  Good luck convincing an IRS agent that you really visited Mom for four days on Thanksgiving weekend to sell her vitamins. 

IRS Publication 463 explains what the rules really are:

If your trip was primarily for personal reasons, such as a vacation, the entire cost of the trip is a nondeductible personal expense. However, you can deduct any expenses you have while at your destination that are directly related to your business.

A trip to a resort or on a cruise ship may be a vacation even if the promoter advertises that it is primarily for business. The scheduling of incidental business activities during a trip, such as viewing videotapes or attending lectures dealing with general subjects, will not change what is really a vacation into a business trip.

The IRS isn't required to take your explanation of your travel costs on your word.  In fact, it's up to the taxpayer to document the amount, dates and times and business purpose of any travel expenses.  If you are in the real estate business and you happen to go to Arizona during Bowl Season, you have to do more than just say you are going to check out the great values in Tempe real estate.  Unless you can show you went there primarily to check out real estate, with dates, names, documentation and proof you are serious about it, don't even try to write off the trip. They aren't going to buy it.

And the preparers that say you can write off your vacations?  There is one less now.  Last month a federal judge permanently barred that preparer from the tax prep business.  That preparer's clients have been getting special attention from the IRS.

If your corporation has sold out, the IRS may be after your "incorporated pocketbook"

Every entrepreneur daydreams of cashing out someday. Sure, there will be taxes on the sale, but then we can just invest in safe stocks and bonds and pay tax on the interest at the nice low 15 percent corporation tax rate, right?

20110716iabiz Be careful. A depression-era relic in the tax law could bite you.

The Personal Holding Company Tax arose during the Depression to get corporations to disgorge their accumulated cash to goose a staggering economy (sound familiar?). Over time, the justification shifted from stimulating the economy to preventing the shifting of income to an "incorporated pocketbook." The PHC tax hits "personal holding company taxable income" with a 15 percent tax, on top of the regular corporate tax.

The corporation sitting on cash after a successful asset sale is the classic candidate for a personal holding company tax. It can apply if "bad" income -- primarily investment income -- is at least 60 percent of business income, and more than half of the corporation's stock is held by five or fewer shareholders. Related shareholders count as one shareholder. Special rules allow banks and some other financial businesses to avoid the tax.

The PHC tax can crop up in more-surprising ways. For example, a subsidiary that is sitting on investment assets can end up paying PHC tax, even if the rest of the companies in the consolidated tax return have plenty of "good" active business income. A cash-rich corporation might run into this tax. So may a C corporation that loans money to related businesses.

S corporations don't pay Personal Holding Company tax, but those that are former C corporations face a similar tax. The S corporation version, the "Section 1375 tax," can result in the loss of S corporation status after three years. 

The surest way to avoid the PHC tax is to liquidate the personal holding company.  That can be painful, triggering both corporation and personal tax, but with capital gain rates at a historically low 15 percent rate, it may be time to bite that bullet.  If you think that PHC tax might apply to you, it's certainly time to talk to your tax advisor.

Flickr image courtesy SheriW under Creative Commons license.

Legislature allows new 2010 deductions

The Iowa legislature passed a big business tax break just before April 15, after many Iowa businesses had already filed their 2010 returns. Just before ending their session yesterday, the legislature passed a bill that allows taxpayers to take that late-passed break on 2011 returns, instead of filing amended 2010 returns. 

20110701biz The "Section 179 deduction" allows taxpayers to deduct the cost of qualifying fixed assets in the year of purchase, rather than through depreciation deductions over a period of years.  Until the Governor signed off on SF 512 on April 11, the Iowa "Section 179 deduction" limit for 2010 was $134,000. SF 512 increased it to $500,000, the amount allowed on federal returns, for 2010

So what about an Iowa business that had already filed returns, taking a Section 179 deduction of, say, $150,000 on its federal return, but only the $134,000 maximum deduction for Iowa? The usual answer is to file an amended Iowa return. But what if the business is a partnership or S corporation with, say, 10 or 15 owners? That amended return would trigger 10 or 15 amended 1040s for the owners to use the deduction. That's a lot of work, and maybe a lot of tax prep expense.

SF 533, passed late Wednesday this week, allows taxpayers to choose to take any additional 2010 Iowa Section 179 deduction on 2011 returns -- avoiding the time and expense of filing amended returns. This is only an option; they may still file amended returns if they prefer.

SF 533 allows taxpayers to claim two other deductions passed in SF 512 on their 2011 returns, rather than amending 2010: The $250 maximum "Educator Expense" deduction and the above-the-line college tuition deduction.

The legislature dropped the ball by passing major 2010 tax legislation so late, but at least now they've cleaned up some of their mess.

It's your return, no matter how much you pay your preparer

Why you shouldn't leave $3.4 million of income off your 1040

It's easy to accidentally leave a bit of income off your 1040. It even happens to preparers, especially under deadline pressure. If you have a big pile of 1099s, it's frightening how easy it is to lose track of one. When the 1099 is for $3.4 million, it can be a problem.

20110616iabiz For too many taxpayers, tax return preparation is a mystery box. The W-2s, 1099s and receipts go in to your preparer, a tax return comes out. Many people have no idea what the income should be; all that matters is the refund. That apparently even goes for fancy-pants fund managers.

Unfortunately, the taxpayer still is responsible for the numbers on the return, preparer or no preparer, as Mr. Fund Manager learned this week in Tax Court. His 2006 Form 1040 had some big numbers on it, and when he picked it up from his preparer on Oct. 15, 2007 -- the last day of his six-month filing extension -- it showed adjusted gross income of $29.2 million. That would seem to be enough, but the IRS computers caught the $3.4 million on the 1099 that the preparer had, but missed somehow. The IRS assessed about $500,000 in additional tax and a penalty of about $100,000.

Mr. Fund Manager went to Tax Court to get out of the penalty, arguing that because he gave the preparer the 1099, he made a reasonable attempt to report the correct income. The Tax Court took a hard line:

...when his own receiving of income was in question, Mr. [Fund Manager] was evidently alert and careful. But when he was signing his tax return and reporting his tax liability, his routine was so casual that a half million-dollar understatement of that liability could slip between the cracks. We cannot hold that this understatement was attributable to reasonable cause and good faith.

Mr. Fund Manager's problems provide lessons for the rest of us:

  • It's your return. When you sign it, you own it, even if you paid someone good money to prepare it.
  • Try to understand what's on the return.  If you don't, ask the preparer what's going on. If you prepare your own return and don't understand it, that's a big red flag.
  • Don't wait until the last second to pick up or review your return. If you don't have time to look things over before the April 15 deadline, get an extension. If you are up against the Oct. 15 extended deadline, look over the return carefully as soon as you can and amend right away if something is wrong.

Oh, and if you get a 1099 for $3.4 million, make sure it shows up on that return somewhere.

- Joe Kristan

Tax traumas of the traveling employee

Even little businesses send employees on the road to other states. They may be unwittingly causing those employees to be subject to income tax in the neighboring states.

20110601iabiz States started to take more of an interest in taxing short-term visitors when athletic salaries got very high. As a result, many states say as little as one day of in-state work subjects you to income tax. These rules may be ignored by many businesses, but they pose increasing risk as states improve their data-mining techniques while they scrounge for scarce cash.

Congress is considering a bill to limit the ability of states to tax brief employee stays. Tax Analysts reports ($link):

H.R. 1864, the Mobile Workforce State Income Tax Simplification Act, would allow a state to impose income taxes on an out-of-state employee's wages only if the individual spends more than 30 days working in that state during a calendar year. The threshold would not apply to professional athletes, entertainers and other high-profile individuals.

The 30-day rule would be a big improvement over current law, but the exception for "professional athletes, entertainers and other high-profile individuals" is misplaced. They want to pick LeBron James' pockets every time he shows up to play the Knicks, but there are plenty of athletes and entertainers who aren't LeBron James. Every traveling musician or minor-league hockey player would have the same reporting liability as LeBron, without the zillion-dollar income to pay compliance costs. 

In the meantime, every road warrior in sales and internal audit has potentially the same tax return filing requirements as the big athletes. That also means the employers have potential withholding liability in those states. It's important for employers to talk these situations over with their tax advisors to avoid unpleasant out-of-state surprises.

Link: HR 1864

Flickr image courtesy eric__I_E under Creative Commons license

The tax law wants you to buy a behemoth

A tax provision designed to encourage businesses to buy new machinery to fight the recession spur the recovery has a peculiar, and perhaps unintended, side effect: it makes 2011 a great time to buy a new giant SUV for your business. The Wall Street Journal reports:

The bottom line: This year Congress is running a large "bonus depreciation" special on cars weighing more than 6,000 pounds, such as the Cadillac Escalade and Nissan Armada. Taxpayers may deduct 100% of the car's cost in the first year—subject to the personal use disallowance, of course.

20110516-1IABIZThe new "100% Bonus" depreciation allows taxpayers to deduct the full cost of qualifying new machinery and equipment in the year it is placed in service. These costs are normally capitalized and deducted over a period of several years, rather than all at once. The 100 percent bonus depreciation differs from the similar "Section 179" deduction in that it only applies to new equipment, but it can generate a loss carryback.

The Wall Street Journal reports that BMW, General Motors, Ford, Jeep, Mercedes Benz, Porsche, Honda, Nissan, Toyota and Volkswagen all produce the big vehicles qualifying for the break. A list of such vehicles is posted here.

If you want to take deductions for business use of a vehicle, there are some things to keep in mind:

- The tax law requires you to document your business use. You need to keep a log or calendar documenting your business mileage, including the business purpose and distance for your trips. Commuting doesn't count.

- You can only deduct your depreciation to the extent you use your vehicle for business purposes. If your business use declines below 50 percent any year, you may have to "recapture" prior depreciation as non-cash taxable income.

- Don't buy something just for the deduction. Even after the tax savings, you are still out of pocket for most of the cost of the vehicle.

The TaxProf has more. You can read more about vehicle bonus depreciation here.

Flickr image courtesy Highway Patrol Images under Creative Commons License

Is it time to amend?

Iowa State Capitol in Des Moines, Iowa, after ...Image via Wikipedia

Iowa's legislature saw fit to change the rules of the 2010 tax game last month, after most Iowans had probably already tallied their scorecards.

So should we amend our Iowa 2010 returns right away?

Let's review what the legislature has done:

 - It has "coupled" with all federal tax legislation for 2010 except for "bonus" depreciation. That means, among other things:

- Taxpayers can take $500,000 of "Section 179" deduction on Iowa returns, just like on the federal returns. Until the change was made, the Iowa limit was $134,000.

- Iowa follows federal rules now for charitable contributions from IRAs in 2010. For 2009, IRA qualified distributions to charities for those more than 70 1/2 were excluded from federal income; they were included in Iowa income and a charitable deduction was taken on Iowa schedule A.

 - A bunch of smaller deduction that were not available on 2009 Iowa returns are now available on 2010 returns. These include the $250 educator expense deduction, the deduction for college tuition and fees, and the optional sales tax deduction for those not deducting income taxes. 

 - Taxpayers who took the new employee health care tax credit had to add the credit back to federal taxable income. That add-back now also is required for Iowa returns.

Go here for a complete list of changes.

No doubt many Iowa returns were filed before the legislature and the governor did that.  Should you amend your returns right away if you qualify for these benefits or have to pay more?

I understand that the Iowa Department of Revenue is working on a legislative proposal that would enable taxpayers to take some of the new deductions on 2011 returns, rather than amending their 2010 returns. The department isn't really staffed to handle a flood of amended returns and many taxpayers would rather not pay to have an amended 2010 return prepared if they can use their new 2010 deductions in 2011.

If you can take your Iowa 2010 $250 educator expense in 2011, it's hardly worth filing an amended return to claim a $17 refund. Even a big additional Section 179 deduction might be worth waiting for if it is coming out of an S corporation or partnership on a batch of K-1s, where each individual owner would also have to file an amended return.

Iowa may also come out with a streamlined amended return process for 2010 refunds. So it may well be worth waiting a few weeks to see what the legislature and the Department of Revenue come up with before filing your refund claims. But if you now have an additional $366,000 Section 179 deduction for 2010, you probably don't want to wait very long to claim it.

Sadly, if you owe, they will likely catch up to you eventually by electronically comparing your Iowa filings to your federal returns. In that case, you might as well amend and stop the interest. 

The tax deadline isn't the time to cheap out

Maybe you spent hundreds of dollars to have a preparer do your the 1040 that reports your business income. Or maybe you spent the 32 hours the 1040 instructions say is the average estimated time it takes to do a business 1040. Either way, you've made a substantial investment in time or money.

But you still have to get it to the IRS. The best way is to file electronically. You get an electronic receipt to prove you filed on time, and any refunds come back much more quickly.

20110416iabiz If you aren't filing electronically, now isn't the time to cheap out. You ought to spring for the extra $5.10 to file your return "certified mail, return receipt requested." It's well worth the time and trouble of going to the post office to get that postmarked receipt. The tax law is full of sad stories of taxpayers who lost thousands of dollars because they didn't have a postmark to document that they filed on time. Don't let it happen to you!

If there's no post office open or handy -- or you don't finish your return until after the post office closes -- you can also use a mailing receipt from one of the designated private delivery services authorized by IRS for timely return shipment. As private delivery services don't deliver to post office boxes, you'll want to refer to this list of service center street addresses. But be sure the delivery service will get the date right, and that the shipment date on their records is the one you want.

Or you could just take your chances with a late-night post office.  Good luck with that.

And don't procrastinate, because Jiffy Express isn't a designated private delivery service.

Can I deduct my K-1 loss?

Losing money in your business is no fun, but that dark cloud can have a silver lining at tax time. Many small businesses are "pass-throughs" taxed as S corporations or partnerships (often in the form of "limited liability companies," or LLCs). As the income of these businesses is taxed on the owners' 1040s, the owners get to deduct the business losses reported on the business Schedule K-1 -- right?


It depends.  There are three hurdles that a K-1 recipient has to clear to deduct K-1 losses. 

The first hurdle is basis. Your basis starts with your investment in the K-1 business; it is increased by income and cash contributions and decreased by losses and distributions. In partnerships  -- but not S corporations -- an owner's basis may include a portion of the company's borrowings from third parties.

Unfortunately, the K-1s do a poor job of tracking owner basis.  You, or your tax preparer, may need to keep a separate schedule of your basis to determine whether you might deduct K-1 losses.

The next hurdle is whether your basis is "at-risk." The "at-risk" rules are an obscure leftover of tax shelter battles of the 1970s, but they still apply.They can be very complex, but their gist is that if your basis is attributable to borrowings that are "non-recourse" -- that you aren't personally liable for -- it is not "at risk," and losses attributable to that basis must be deferred. You may also not be considered "at risk" for related-party borrowing, especially if you borrow from your business or from a business associate to fund your ownership in the K-1 issuer.

Partnership K-1s provide some useful information in determining whether you have an "at-risk" issue. If you have losses in excess of your cash investment, and your share of debt on the K-1 part K is on the "nonrecourse" line, you are likely to have an at-risk problem. You will have to go to IRS Form 6198 to figure out whether you have to defer losses under the at-risk rules.

The "passive loss rules" are the final hurdle for deducting K-1 losses. These rules were enacted in 1986 to shut down that era's tax shelters. If you have "passive" losses in excess of "passive" income, you have to defer the losses until you have passive income in a future year, or until you dispose of the "passive activity" in a taxable transaction.

A loss is "passive" if you don't "materially participate" in the business. There are a number of tests that you can use to determine whether you materially participate, but the most common is working at least 500 hours in the business in a year. 

Real estate rental is passive by law, unless you are a "qualifying real property professional."  Special rules keep you from generating "passive" income to allow you to deduct passive losses. For example, land rent and most investment income is not considered "passive" under these rules. The passive loss limitation is computed on Form 8582.

These rules are complicated, even for tax pros. If you aren't sure where you stand, and the losses are significant to you, get in touch with a tax pro who works with small businesses.

Flickr image by naotakem under Creative Commons license.

Should you be sending some of your rent to the IRS?

The author of a best-selling book said "The World is Flat."  Though the world may never be as flat as that author's prose, Iowans find themselves dealing with foreign businesses more and more. Sadly, perfectly innocent transactions with foreigners can have tax land mines.

IABIZ 20110316 Pretend that a foreign company buys the Des Moines Building. Now pretend that you rent some prime space there for your business and pay $100,000 in lease payments this year to the landlord. The foreign company takes your money, but neglects to file a U.S. tax return. Would you be happy to then write a $30,000 check to the IRS? Happy or not, you might have to.

The tax law requires U.S. taxpayers to withhold 30 percent of rents paid to foreign taxpayers. If you didn't get the paperwork in order before taking that prime Des Moines Building space, the IRS could come after you for that 30 percent. So how do you protect yourself?

First, you get a Form W-9 from the landlord (you should be doing that anyway to find out whether you have to issue a Form 1099 for the rent). The W-9 includes a statement certifying that the signor is a U.S. person. As long as you don't know otherwise, the W-9 protects you. Even a foreign-owned corporation incorporated in the U.S. is a "U.S. person" -- but an LLC wholly-owned by a foreign person normally is not.

If you find out the taxpayer isn't a U.S. person, you might still be able to avoid the withholding. If the foreign taxpayer treats the rent as "effectively connected" with a U.S. trade or business, they can give you a Form W-8 ECI -- letting you off the hook for withholding. Alternatively, they may provide a Form W-8 BEN, allowing you to withhold at a reduced rate under the provisions of the tax treaty with the landlord's home country.

If your foreign taxpayer can't give you a W-8 ECI, then you have to withhold. The withholding has to be deposited based on a schedule available on the IRS website; you have three days to deposit withholding of $2,000 or more. You have to report the withholdings on Form 1042, due on March 15 the following year.

The Moral?  Foreign landlords can lead to unhappy tax surprises.  Fortunately, you can protect yourself by getting a W-9, and by taking the proper precautions if it turns out you do have a foreign landlord.

In a hurry? Maybe you shouldn't be.

Iowa State Capitol in Des Moines, Iowa, after ...Image via Wikipedia

No business owner enjoys doing taxes. Even at its best, it's a distraction from what you'd rather be doing. When the law changes every year and your preparer always seems to want the tax information sliced just a little differently, it can be a headache. So you want to just get the stupid thing filed and done with.

If you do business in Iowa, this probably isn't the year to hurry.

Congress enacted two big changes in how fixed assets were depreciated for 2010:

  • It increased the maximum "Section 179 deduction" to $500,000. Section 179 allows taxpayers to take a current deduction for asset purchases that would otherwise have to be capitalized and written off over a period of years through depreciation. 
  • It enacted "100 percent bonus depreciation" for most new assets placed in service after Sept. 8, 2010. That means qualifying assets -- most "new" assets (not used) with a life of up to 20 years -- can be written off in the year of purchase without regards to the limits that apply to Section 179 deductions.  For example, bonus depreciation can create an operating loss that can be carried back to get prior year taxes refunded; Section 179 does not. New assets placed in service before Sept. 9, 2010 qualify for "50 percent bonus depreciation," where half of the cost is immediately deductible and the rest of the asset cost is depreciated over a period of years.

Iowa has not "coupled" with increases in Section 179 limits or bonus depreciation in recent years. The current Iowa House of Representatives voted to adopt both the increased Section 179 deduction and the federal bonus depreciation rules effective for 2010. The Iowa Senate is considering similar legislation, but its future is uncertain.

As a result, your tax preparer doesn't know what Iowa's depreciation rules will be for 2010.  If the legislation fails to pass, no bonus depreciation will be available for 2010 Iowa tax returns, and the maximum Section 179 deduction on an Iowa return will be $134,000. 

That's why you might want to wait and see what the Iowa General Assembly ends up doing. If you file and guess wrong, you may have to amend your Iowa returns. If you have a pass-through entity - an S corporation or a partnership -- the wrong guess could require amending all of the owners' personal Iowa 1040s.

Amending returns costs money. So though you naturally want to be done with your taxes, this probably is the year to be patient on getting your Iowa business taxes done.  Meanwhile, follow the Business Record and to see which way the Iowa General Assembly comes down on this.

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Come out with your hands up

The IRS has just launched a new "amnesty" program for taxpayers with offshore bank accounts. The tax law has strict rules for reporting offshore financial accounts with balances rising over $10,000 and severe financial penalties for non-compliance. Of course, the penalties can be much worse than financial when tax fraud is involved. 

Unfortunately, many otherwise innocent taxpayers have offshore accounts that have not Treas_logo been reported on Form TD F 90-22.1, the "FBAR" form. A business may have an account overseas to make it easier to pay vendors or accept export payments, or an individual posted overseas may have inadvertently triggered an FBAR filing requirement just by having a personal bank account.  The IRS has been taking a "shoot the jaywalkers" approach to minor technical violations, making it an expensive nightmare for such taxpayers to come into compliance. This program offers such taxpayers an opportunity to get in compliance at a small cost, or in some cases, no cost.

Taxpayers who have been avoiding tax, whether inadvertently or purposefully, can also come in from the cold by paying their back taxes and a penalty of up to 25 percent of the highest offshore account balance. That might seem like a high price to pay, but it may be a good deal, as Janet Novack explains at

Under the initiative, a taxpayer who put $1 million in a foreign account in 2003 and earned $50,000 of interest income on it each year, none of it reported to the IRS, would owe $518,000 in back taxes and penalties. If that taxpayer doesn’t participate and is found out, he could be assessed a stunning $4.5 million in back taxes and FBAR and tax fraud penalties. And, of course, he could be criminally prosecuted and go to jail.

Foreign bank account secrecy is rapidly becoming a memory. With the IRS securing thousands of names of Swiss account holders, and with other names becoming public via Wikileaks, there is no assurance that a secret offshore account can stay that way. If you have such an account, the time to contact your lawyer about the program is now.  The program requires filing amended returns to report all offshore income by its Aug. 31, 2011, deadline. Aug. 29 will be too late to start.

How to protect yourself from payroll tax disaster

A busy entrepreneur needs to know when to delegate.  As your business grows, you have to trust vendors and employees to do more.  But as a man once said, "trust, but verify."  The "verify" part is especially important in dealing with your payroll taxes.

EFTPS A Des Moines businessman has learned this lesson the hard way.  Somehow -- perhaps as a result of an employee dropping the ball, but it's not certain -- his distribution company got behind on its payroll taxes.  The federal courts found that he paid other vendors before he got the payroll tax debt straightened out.  When a "responsible person" does so "willfully," he becomes personally liable for the payroll taxes, even if the business is incorporated.  The court ruled that the businessman was on the hook:

"The term willfully does not connote a bad or evil motive, but rather means a voluntary, conscious, and intentional act, such as the payment of other creditors in preference to the United States." Willfulness is generally a question of fact, but if a responsible person knew of payments to other creditors after he was aware of the failure to pay over withholding taxes to the government, his actions are willful as a matter of law."

So can you wash your hands of the problem by outsourcing the payroll function?  No.  If you provide cash to the payroll service and they fail to remit it -- maybe because they steal it -- the IRS will come looking for the money.  They don't count stolen tax deposits as payment of withheld payroll taxes. 

As we said, the entrepreneur can't do everything.  You have to trust, but you can verify your payroll taxes.  If your business is enrolled in the Electronic Federal Tax Payment System (EFTPS), you can go online to make sure your payroll taxes are being deposited.  Whether you outsource your payroll or do it in-house, it only takes a minute to check your payments. 

Getting behind on payroll taxes can be enough to sink a business.  That's why you entrepeneurs should bookmark the EFTPS website, know your password, learn how to access your account, and at least once in a while, verify.

You may have already messed up your payroll

20110116-1bizCongress changed the payroll tax rules for 2011 less than two weeks before the start of the year, so it's hardly surprising that some of the millions of employers out there haven't got the message.  Are you one of them?

The new law reduced the employee share of the FICA tax from 6.2 percent to 4.2 percent, for 2011 only. The employer tax remains 6.2 percent, on wages up to the $106,800 FICA base. That means many employees who have already received 2011 paychecks have been overwithheld.

If you have overwithheld on your employees, what should you do?  The IRS says you should make it up by under withholding the same amount overwithheld sometime before March 31. 

The FICA change isn't the only one that applies for 2011 payrolls. The income tax withholding tables have been adjusted to reflect the end of the "Making Work Pay" tax credit. You can find IRS guidance on all of these 2011 changes in their Notice 1036.

Flickr image courtesy Marcin Wichary under Creative Commons license.

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