November 21, 2012

Final Expiration Date?

by Kenneth Hoffman in Business Counsel, Tax Planning, Tax Counsel

The history of American business is littered with companies that crash and burn. Sometimes they fly so high they attract attention from antitrust regulators. That's what happened with John D. Rockefeller's Standard Oil, which grew so big that a federal judge ordered it broken into pieces. Sometimes poor management or fraud are the culprit, like when energy giant Enron imploded. And sometimes technology overtakes a company, like when Henry Ford put the buggy whip manufacturers out of business.

Last week, another corporate stalwart threw in the towel. You've heard the sad news. Hostess Brands -- maker of Wonder Bread, Ding Dongs, Ho Ho's, Sno Balls, and the pop-culture icon Twinkies -- filed for bankruptcy in January. But last week, citing a strike by members of the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union, the company announced they would wind down their operations and liquidate their assets. The move leaves over 18,000 Americans jobless just as holiday baking season moves into high gear.

Foodies and gourmets reacted immediately to the devastating news. Shoppers across the country are quickly emptying shelves of Hostess goodies. An enterprising class of baked-goods arbitrageurs have even taken to the internet, offering Twinkies on Ebay and Craigslist for $100 or more per box. (On the brighter side, dieters throughout the land are giving thanks this week that one more temptation is disappearing from their tables!)

But what about the IRS? How will the tax man make out in Hostess's bankruptcy? Will he enjoy a delicious creamy filling? Or will he have to settle for stale crumbs?

When debtors like Hostess go out of business, the bankruptcy court supervises liquidating the debtor's property and distributing the proceeds to creditors. Hostess has plenty to sell, including 40 bakeries, 400 retail locations, and thousands of trucks and trailers. Once those assets are liquidated, claims will be paid according to specific priority rules, starting with 1st-priority domestic support obligations, 2nd-priority administrative expenses, 4th-priority employee wages, and so forth.

Uncle Sam rarely loses income taxes in corporate bankruptcies. That makes sense because companies that can't pay their bills aren't likely to owe much income tax to start with. But even unprofitable companies like Hostess still make the tax man happy. Consider the property taxes they owe on those bakeries and retail locations the sales taxes they collect on every Ding Dong, and the payroll taxes they withhold on those 18,000 employees' wages. The bankruptcy rules acknowledge these debts by treating "pre-petition" taxes a debtor incurs before filing as an 8th-priority, and "post-petition" taxes a debtor incurs after filing as a 2nd-priority administrative expense.

The good news here, at least for those of us not watching our weight, is that Twinkies might not be quite past their final expiration date. Popular consumer brands are worth big money in today's crowded marketplace. Hostess should be able to sell the Twinkies name and recipe to a rival like Kellogg (owner of Sara Lee) or Mexico's Grupo Bimbo (owner of Entenmann's). So odds are strong that Twinkies will someday appear back on your grocer's shelf. (Rumour has it that Twinkies are pumped so full of preservatives that they have no expiration date, which makes them as likely to survive a nuclear holocaust as the cockroaches. We'd hate to see them taken down by a simple bit of financial trouble!)

Our job, of course, is to help you manage your business and your finances to avoid the same fate as Hostess. We understand that planning is the key to minimizing the tax man's share of your twinkie, and we're here to give you the plan that's right for you. But time is running out to plan for 2012, and many of the best tax breaks go stale on December 31. So don't wait to call us for your plan!

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November 19, 2012

Employers and the Patient Protection and Affordable Care Act

by Kenneth Hoffman in Business Counsel, Tax Planning, Tax Counsel

With the 2012 presidential election decided, we now know that Barack Obama will remain president for the next four years, and the Democrats will control the Senate for at least two more years.

The result means businesses and individuals should prepare for full implementation of the Patient Protection and Affordable Care Act of 2010 (ACA).

The ACA, also widely referred to as Obamacare, includes some significant tax-related provisions affecting employers and individuals that are scheduled to take effect in 2013 and 2014.

In this post, we will discuss what employers should expect as Obamacare is implemented and several related tax provisions: a tax on wages, self-employment and unearned income, flexible spending account contributions, and the pay or play provisions.

Wages and self-employment tax

Starting in 2013, individuals will face an extra 0.9 percent Medicare tax on wages and self-employment (SE) income in excess of $250,000 for married couples filing jointly and $200,000 for single taxpayers. This tax is in addition to the current Medicare tax on salary and/or SE income of 2.9 percent split between the employer and employee.

Employers must withhold the extra 0.9 percent in Medicare taxes, but are not required to match that extra payment. To avoid penalties, employers must do little more than arrange to withhold the additional amounts. Nonetheless, it’s a good idea to alert affected employees that, upon reaching the threshold amount, they will see a drop in their paychecks.

Tax on investment income

Also starting in 2013, a 3.8 percent Medicare tax on unearned income will be applied to individuals, trusts, and estates. The tax will be equal to 3.8 percent of the lesser of net investment income or the excess of Modified AGI in excess of $250,000 for married couples filing jointly and $200,000 for single filers.

Net investment income includes interest, dividends and rents, passive trade or business income (i.e., most income reported on Form K-1), and capital gains. It does not include qualified retirement plan distributions from an IRA or tax exempt income, such as interest from municipal bonds.

Flexible spending accounts contributions

Starting in 2013, the ACA applies a $2,500 limit to employee contributions in flexible spending accounts (FSA). According to the IRS, the $2,500 limit on pre-tax employee FSA contributions applies on a plan-year basis. Thus, non-calendar-year plans must comply with the plan year that starts in 2013.

Employers must amend their plans and summary plan descriptions to reflect the $2,500 limit (or a lower one if they wish) by Dec. 31, 2014, and institute measures to ensure that employees don’t elect contributions that exceed the limit. There will continue to be no limit on employer contributions to FSAs.

Shared responsibility provisions

Starting in 2014, a penalty tax will be levied on individuals who don’t purchase health insurance, with a penalty that will be no more than $285 per family or 1 percent of income, whichever is greater. In 2015, the cap rises to $975 or 2 percent of income. And by 2016, the penalty will go to $2,085 per family or 2.5 percent of income, whichever is greater.

Although the ACA does not require employers to provide health care coverage, employers will face a “shared responsibility” excise tax scheduled to take effect Jan. 1, 2014. These provisions levy stiff penalties if larger employers do not offer coverage or provide coverage that does not qualify as “affordable” or provide “minimum value.” These penalties are not deductible, so they are more expensive after tax than premium payments.

Employers with 50 or more full-time employees or equivalents (those working 30 hours or more per week) that don’t provide employees with health coverage will be assessed a penalty if just one of their workers receives a premium tax credit when buying insurance in a health insurance exchange. The annual penalty is $2,000 per full-time employee in excess of 30 workers. For example, if the employer has 53 full-time employees, the penalty would be $46,000 (53 – 30 = 23 x $2,000).

Penalties will also be triggered if the coverage provided does not encompass at least 60 percent of covered health care expenses for a “typical population,” or the premium for the coverage exceeds 9.5 percent of a worker’s income. In such cases, the worker can opt to obtain coverage in an exchange and qualify for a tax credit. For each worker receiving the credit, the employer must annually pay the lesser of $3,000 per employee for each employee receiving a premium credit or $2,000 for each full-time employee beyond the first 30 employees.

The amount of the penalties is indexed for inflation, but it is tied to increases in the costs of health care premiums. And with health insurance premiums expected to rise at a faster rate than wages, employers with no one in the “over 9.5 percent” group currently could find that trend reversed quickly in later years.

Next steps

From a business and individual planning standpoint, the time to act is now. We don’t know what additional tax changes the future will bring, especially with the fiscal cliff looming. However, we do know the changes the ACA will bring to employers and individuals.

Check back soon for a post that will go into greater detail on the mandates, expansion of coverage, and state insurance exchanges associated with the ACA.

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November 18, 2012

Eight Tips for Deducting Charitable Contributions

by Kenneth Hoffman in Church Counsel, Charitable Contributions, Tax Planning, Tax Counsel

Charitable contributions made to qualified organizations may help lower your tax bill. The IRS has put together the following eight tips to help ensure your contributions pay off on your tax return.

1. If your goal is a legitimate tax deduction, then you must be giving to a qualified organization. Also, you cannot deduct contributions made to specific individuals, political organizations and candidates. See IRS Publication 526, Charitable Contributions, for rules on what constitutes a qualified organization.

2. To deduct a charitable contribution, you must file Form 1040 and itemize deductions on Schedule A.

3. If you receive a benefit because of your contribution such as merchandise, tickets to a ball game or other goods and services, then you can deduct only the amount that exceeds the fair market value of the benefit received.

4. Donations of stock or other non-cash property are usually valued at the fair market value of the property. Clothing and household items must generally be in good used condition or better to be deductible. Special rules apply to vehicle donations.

5. Fair market value is generally the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts.

6. Regardless of the amount, to deduct a contribution of cash, check, or other monetary gift, you must maintain a bank record, payroll deduction records or a written communication from the organization containing the name of the organization, the date of the contribution and amount of the contribution. For text message donations, a telephone bill will meet the record-keeping requirement if it shows the name of the receiving organization, the date of the contribution, and the amount given.

7. To claim a deduction for contributions of cash or property equaling $250 or more you must have a bank record, payroll deduction records or a written acknowledgment from the qualified organization showing the amount of the cash and a description of any property contributed, and whether the organization provided any goods or services in exchange for the gift. One document may satisfy both the written communication requirement for monetary gifts and the written acknowledgement requirement for all contributions of $250 or more. If your total deduction for all noncash contributions for the year is over $500, you must complete and attach IRS Form 8283, Noncash Charitable Contributions, to your return.

8. Taxpayers donating an item or a group of similar items valued at more than $5,000 must also complete Section B of Form 8283, which generally requires an appraisal by a qualified appraiser.

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November 18, 2012

No Documentation No Tax Deduction

by Kenneth Hoffman in Tax Tips, Business Counsel, Tax Counsel

In Scott Chrush v. Commissioner, T.C. Memo 2012-299, October 25, 201, the Tax Court upheld the IRS’s disallowance of deductions for a real estate consultant. He wasn’t able to substantiate his deductions. He did provide copies of receipts, but had no books or records and didn’t adequately explain the business purpose for the expenses, and many of the receipts were illegible.

He also wasn’t able to substantiate his home office expenses.

This case illustrates the importance of keeping good records, although the result seems harsh considering he produced copies of receipts and a bookkeeper had helped him assemble his tax information.

The result might have been worse than it otherwise would have because the taxpayer represented himself instead of hiring a lawyer to represent him.

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November 18, 2012

Are Pastoral Accounts Income To Pastor?

by Kenneth Hoffman in Church Counsel, Church Issues, Charitable Contributions, Tax Counsel

A recent Tax Court case held that amounts deposited into a “pastoral account” maintained by husband-and-wife pastors in the name of their unincorporated church were not deductible as charitable contributions. Gunkle v. Commissioner, TC Memo 2012-305(11/1/12), involved tax deficiencies levied against Bruce and Sherilyn Gunkle, two Texas ministers who formed and operated the City of Refuge Christian Fellowship (“CRCF”).

Bruce was a graduate of the US Naval Academy with a masters degree in theology from Antioch University. He and his wife served as pastors and conducted religious services for CRCF during the taxable year in question. Some 17 years earlier, Bruce had formed, and for a number of years headed, a qualified section 501(c)(3) organization with a similar name.

Acting on the advice of promoters (the Gardners) who were subsequently enjoined by a federal court from participation in an abusive tax shelter program promising unwarranted tax benefits from the use of a device they called a “corporation sole,” Bruce terminated his tax-exempt charity and formed CRCF as a corporation sole. This action was taken to permit the new entity to operate without interference by the government and corporate directors. Bruce and his wife took vows of poverty and CRCF agreed to “provide for all their needs as Apostle and as pastors of the church.” Those needs were to be met through funds placed by CRCF in a bank account known as their pastoral account. Deposits to the account were made by church members and nonmembers, and Bruce’s Social Security checks were also deposited therein.

The Gunkles had full control over that account, and wrote all of the checks drawn on the account, many of which were for groceries, car payments and other personal expenses. On their 2007 income tax returns, they did not report any income from CRCF. They claimed a deduction of $13,917 for charitable contributions, of which $8,926 was claimed for contributions to CRCF. That tax return was prepared and signed by Frederick Gardner, who had apparently masterminded the corporation sole scheme for CRCF.

The arrangement didn’t work out as planned. IRS disallowed the claimed charitable deductions, and charged the Gunkles with $63,000+ in unreported income The Tax Court agreed. Amounts deposited in the pastoral account were held taxable to the Gunkles as income, and the charitable deductions were disallowed because they retained control of those funds and benefited from them. They claimed, but failed to show, that CRCF had characteristics of a religious order. On top of all that, the court upheld the imposition of a penalty of $3,252.40 under Code §6662(a).

The Court noted that in very similar circumstances it held that deposits made into the account of a purported church were includable in the taxpayers' gross income where the taxpayers were the owners of the bank accounts, exercised complete control over the funds in the accounts, and used those funds for personal expenditures.

Source: Charitable Gift Planning News, Issue 2012-17 (Nov. 3, 2012)

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

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November 14, 2012

Jedi Tax Planning

by Kenneth Hoffman in Business Counsel, Tax Planning, Tax Counsel

Filmmaker George Lucas has been a Hollywood success since 1973, when he spent just $775,000 to produce American Graffiti -- then watched it go on to gross over $200 million. Lucas has influenced a generation of filmmakers and films, as director (19 titles), producer (67 titles), writer (81 titles), and even an actor (he played an uncredited "Alien on TV Monitor" in the first Men in Black). Of course, he'll always be best known as creator of the Star Wars series, which popularized the "space opera" genre for a galaxy of fans.

Last month, Lucas announced that he's selling his production company, Lucasfilms, to The Walt Disney Company for $4.05 billion in cash and stock. And it should hardly come as a surprise ending that he found a way to beat the IRS that's almost as powerful as launching a proton torpedo down the Death Star's exhaust port.

How did he do it? Elaborate special effects? Computer-generated imaging? Nope. He did it just by selling now, in 2012.

We have no idea how the evil Empire collected taxes a long time ago, in a galaxy far, far away. (We suspect that R2D2 kept awesome records in case he was audited; Darth Vader hid his money on Endor, a forest moon bearing a striking resemblance to the Cayman Islands; and Chewbacca never bothered to file at all.) But here in the U.S., gains from the sale of a business are treated as capital gains and subject to tax up to 15%. Lucas is taking half of his proceeds in Disney stock, so that part escapes tax for now. (He'll pay if he sells those Disney shares sometime down the road.) But that still leaves up to $2 billion in fully taxable cash gains. And that means up to $300 million in tax for Uncle Sam.

At least, that's how it works this year. On January 1, the Empire strikes back, when those Bush-era rates expire. Unless Washington gives us a new hope, that capital gains rate jumps to 20%. President Obama has said he wants to extend the current rates for income under $200,000 ($250,000 for joint filers), and the Senate has passed a bill to do just that. But if the 20% Clinton capital gains rate returns, at least for guys in Lucas's bracket, selling in 2013 could have cost him up to $100 million more in immediate tax. That's at least enough to recondition a Millenium Falcon or two!

January 1 also marks the start of a new phantom menace, the "Unearned Income Medicare Contribution," on investment income, including capital gains, for those earning above that same $200,000 threshold. The new Medicare tax is "just" 3.8% -- but 3.8% of $2 billion is still a hefty $76 million.

The sale also represents smart estate planning for Lucas, who is 68. While generations of fans hope to see him shepherd the final three Star Wars films to the theatre, the sale will spare his heirs the challenge of managing his affairs at his death. Lucas has already announced plans to donate the bulk of his estate to educational charities, and the gifts he's already made, including $175 million to his alma mater University of Southern California, will surely ease the tax bite on that transfer.

Selling a business is one of the toughest productions any entrepreneur directs. Making the most of that opportunity takes bits of Luke Skywalker's drive, Han Solo's skill, and Obi-Wan Kenobi's wisdom. And keeping the most of your proceeds takes the right tax advice. That's why we're here -- to give you a plan to keep the most of your legacy. And remember, we're here for your family, friends, and colleagues, too. May the Force be with you!

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November 12, 2012

Income from Foreign Sources

by Kenneth Hoffman in Business Counsel, Tax Preparation, Tax Planning, Tax Counsel

Many U.S. citizens earn money from foreign sources. But unless it is exempt under federal law, taxpayers sometimes forget that they have to report all such income on their tax return.

As such, some U.S. taxpayers living abroad have failed to timely file U.S. federal income tax returns or Reports of Foreign Bank and Financial Accounts (FBARs). Some of these taxpayers have recently become aware of their filing requirements and want to comply with the law.

Effective September 1, 2012, taxpayers who are low compliance risks are able to get current with their tax requirements without facing penalties or additional enforcement action. These taxpayers generally have simple tax returns and owe $1,500 or less in tax for any of the covered years.

U.S. citizens are taxed on their income regardless of whether they live inside or outside the United States. The foreign income rule also applies regardless of whether the person receives a Form W-2, Wage and Tax Statement, or Form 1099.

Foreign source income includes earned and unearned income, such as:

Wages and tips
Interest
Dividends
Capital gains
Pensions
Rents
Royalties

But there is some good news. Citizens living outside the United States may be able to exclude up to $95,100 of their 2012 foreign source income if they meet certain requirements. This will increase to $97,600 in 2013.

If you're married and you and your spouse both work abroad and meet either the bona fide residence test or the physical presence test, each of you can choose the foreign earned income exclusion. Together, you can exclude as much as $190,200 for the 2012 tax year.

If you earn income from outside the country, please be sure to meet with me about it. I can advise you on how to address all of the tax implications of this situation.

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November 12, 2012

Tax Issues and the Home Office

by Kenneth Hoffman in Business Counsel, Tax Planning, Tax Counsel

With unemployment still near the highest rate in decades, it is not surprising to find many people working out of their homes. Now may be a good time to review the criteria for claiming a deduction for the business use of part of a person’s residence.

Your home office must be used in a trade or business activity. You cannot take a deduction if you use your home for a profit-seeking activity that is not a trade or business. For example, if you use part of your home to manage your personal investments, you cannot take a home office deduction.

The home office must be used regularly and exclusively for business. You must regularly use a room or other separately identifiable area of your home only for your business. You do not meet this requirement if you use the area for both business and personal purposes. For example, an attorney who writes legal briefs at the kitchen table cannot claim a home office deduction for the kitchen.

You do not have to meet the exclusive-use test if you use part of your home to store inventory or product samples or as a day care facility.

Your home office must be one of the following:

Your principal place of business. Your home office also will qualify as your principal place of business if you use it regularly for administrative activities and you have no other fixed location where you conduct substantial administrative activities; or
A place to meet with patients, clients or customers in the normal course of your business. Using your home for occasional meetings and telephone calls is insufficient; or
A separate structure not attached to the dwelling unit used for trade or business purposes. The structure does not have to be your principal place of business or a place where you meet patients, clients or customers. For example, John operates a floral shop in town. He grows plants in a greenhouse behind his home and sells them in his shop. He uses the greenhouse exclusively and regularly in his business. Even though it is not his principal place of business, because it is separate from his dwelling, he can deduct the expenses for its use.

If you are an employee, you must use your home office for the convenience of your employer. If the employer does not require the employee to work from home and provides an office or work space elsewhere, a home office is likely to be considered a matter of the employee’s convenience and therefore not deductible.

Even if the taxpayer’s home office meets the above rules, the deduction may be limited. Expenses attributable to business use that you could deduct even if the home were not used for business, such as home mortgage interest and real estate taxes, are fully deductible. Otherwise, home office expenses are deductible only to the extent of gross business income, reduced by other allowable business expenses unrelated to the home; any expenses that are not deductible due to the income limitation may be carried forward.

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November 9, 2012

IRS Targeting Small Businesses for Increased Audits

by Kenneth Hoffman in Business Counsel, Tax Counsel

Recently, the IRS said that small businesses are responsible for 84 percent of the $450 billion tax gap and the IRS believes that’s due in part to underreporting. In an effort to increase compliance, the IRS will focus on eight specific areas that could red flag a small business for an audit. If you own a small business that may be subject to any of the following issues, be proactive and address these areas now to prevent future problems.

Fringe benefits. The IRS has found that employers are not reporting personal use of company vehicles on Forms 1099 or W-2 and plan to investigate the use of all company cars – especially luxury autos – in its audits.
Total positive income. The IRS will focus on those small businesses who have a total positive income of more than $1 million (this includes all gross receipts and all sources of income before expenses and deductions) and file a Schedule C business return. Last year, 12.5 percent of all individuals with incomes of more than $1 million were audited.
Form 1099-K matching. The IRS has indicated it plans to pilot a business-matching program, starting with Form 1099-K, which they believe will address a large portion of small business noncompliance.
Small business employee health insurance credit. Eligibility requirements for small business employers and tax exempts for the small business employee health insurance credit under Section 45R will face scrutiny this year. The IRS will examine small business employers and tax exempts to make sure they meet all eligibility requirements. .
International transactions. The IRS will be looking to aggressively pursue taxpayers who hide assets overseas and focus on offshore transactions for both large and small businesses. This focus in an attempt to lessen the international tax gap.
Partnerships with unreported income. The IRS plans to target partnership who claim a loss, have unreported income, or present abusive transactions.
Compensation for S-Corporation officers. S-Corporations who report a loss in excess of basis on shareholder returns will be reviewed by the IRS to determine whether tax preparers and completing due diligence requirements. They will focus on S-Corporations with income, distributions, and little or no salary paid to officers.
Worker classification. The IRS believes a lot of small businesses report workers as independent contractors rather than employees and feels there is significant noncompliance in worker classification. This, obviously, creates employment tax issues and the IRS plans to continue to focus their field examination resources in this area.

November 9, 2012

Home Ownership by Unmarried Individuals

by Kenneth Hoffman in Tax Tips, Tax Preparation, Tax Planning, Tax Counsel

If you co-own a home with someone who is not your spouse, such as a significant other or sibling, special tax rules apply to you during the period of ownership as well as at the time of sale. Watch for dollar limitations and allocations of tax benefits.

Mortgage interest

Interest on acquisition debt to buy, build, or substantially improve a principal residence plus one other designated home cannot exceed $1 million. Interest on home equity debt is limited to borrowing up to $100,000. To qualify for either acquisition debt or home equity debt, the debt must be secured by the first or second home.

The same $1.1 million combined debt limit applies to joint filers and single individuals. However, unmarried co-owners with total mortgages exceeding $1.1 million on their first and/or second homes must allocate the limit between them and deduct only a proportionate share of the interest paid. The allocation can be based on any reasonable method, such as by:

The amount of mortgage payments during the year. For example, if one owner made all of the mortgage payments, that owner would be entitled to deduct 100% of the mortgage interest, up to the dollar limits.
The percentage of home ownership. For example, if the home is owned 50/50, then each owner could deduct half of the total mortgage payments, regardless of which one actually made the payments.

Real estate taxes

There is no limit on the amount of real estate taxes that can be deducted. Again, co-owners can allocate the deduction for property taxes in any reasonable manner. Again, this can be done according to the percentage of ownership or the actual real estate taxes paid in the year.

Recapture of the homebuyer credit

If co-owners claimed a first-time homebuyer credit for the purchase of principal residence several years ago, recapture of the credit to the extent required is allocated in the same way in which the credit was originally claims. For example, if two people bought a home in 2008 and claimed the $7,500 credit, $500 of that credit must be recaptured in 2012. The amount that each owner recaptures depends on how much of the credit each owner claimed. If they split the credit, then each recaptures $250 on his or her personal income return.

Home sale exclusion

Gain on the sale of a principal residence (other than gain allocated to nonqualified use of the home) can be excluded up to a set dollar limit as long as you used the home as your principal residence for at least 2 of the 5 years preceding the date of sale. The dollar limit for a single individual is $250,000 of gain.

When co-owners are unmarried, each can exclude his or her share of gain up to this dollar limit. The dollar limit does not have to be apportioned between the owners. For example, if a home that is co-owned equally by 2 unmarried individuals is sold for a gain of $550,000, one-half of the gain, or $275,000 is allocated to each owner. Each owner can exclude up to $250,000 of gain on their personal income tax returns.