The State of the Estate Tax Reform

Many clients have been asking about the status of the estate tax.  Regrettably, there is nothing new to report on this issue for federal purposes.  Presently, there is no federal tax on the estates of individuals dying in 2010.  Although many believed that Congress would reinstate the tax on estates in 2010, that has not happened, and the more time that passes the less likely it is that it will happen.  Meanwhile, some states whose estate tax laws were tied to the federal law grew tired of waiting for Congress to act and have passed legislation establishing their own estate tax rules.

Under present law, the federal estate tax will return in 2011, but with only $1 million of the estate’s value exempted from tax (down from $3.5 million in 2009) and a top tax rate of 55% (up from 45% in 2009).  Thus, without Congressional action, there will be a substantial increase in the number of estates subject to tax and the amount of estate tax that will be collected by Uncle Sam.  However, everyone is expecting Congress to step in and increase the exemption for 2011 and later years.  There has been talk of setting the exemption amount at between $3.5 and $5 million and capping the estate tax rate at somewhere between 35% and 45%.

Congressional committee members have indicated that they are nearing a resolution, but are still looking for revenue offsets to abide by the pay-as-you-go rules.  Watch for further developments in this area.

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Tax Exempts Can Benefit from Health Insurance Credit

A part of the recently enacted health care legislation is the new Small Business Health Insurance Tax Credit for eligible small employers (ESEs) that provide non-elective health insurance to their employees.  A qualified small business is one that has 25 or fewer equivalent full-time employees with average annual full-time wages of $50,000 or less.   Generally, the credit will be at its maximum for employers with 10 equivalent full-time employees making average full-time wages of $25,000.  The credit phases out as the number of equivalent full-time employees increases above 10 and as the average full-time wages increases above $25,000.

The term “equivalent full-time employees” factors in part-time employees as well as regular full-time employees (based on 2,080 hours a year for full-time).
 
Normally, the credit is a general business credit, can be carried back for one year and carried forward for 20 years, and can offset alternative minimum tax.  However, for eligible non-profit employers who have no tax liability, the credit is used to reduce payroll taxes.

Thus, any organization described in section 501(c) which is exempt under section 501(a) that otherwise qualifies for the small business tax credit is eligible to receive the credit.  However, for tax-exempt organizations, the applicable percentage for the credit during the first phase of the credit (any taxable year beginning in 2010, 2011, 2012, or 2013) is limited to 25 percent, and the applicable percentage for the credit during the second phase (taxable years beginning in years after 2013) is limited to 35 percent.  

This small business tax credit is otherwise calculated in the same manner for tax-exempt organizations that are qualified small employers as it is for all other qualified small employers.  

Tax-exempt organizations are eligible to apply the tax credit against the organization’s liability as an employer for payroll taxes for the taxable year to the extent of: (1) the amount of income tax withheld from its employees under section 3401(a); (2) the amount of hospital insurance tax withheld from its employees under section 3101(b); (3) and the amount of the hospital tax imposed on the organization under section 3111(b).  However, the organization is not eligible for a credit in excess of the amount of these payroll taxes.

If you have questions about how your tax-exempt organization can benefit from this new credit, please give this office a call.

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Reasonable Compensation is Becoming a Hot Issue

Corporate officers will sometimes attempt to disguise what should be payment for services as distributions of cash, dividends, and loans as a means of avoiding payroll taxes on the income.  Because they are pass-through entities, Sub Chapter S corporations are especially prone to the misclassification of income attributable to a misunderstanding of the compensation rules or by deliberate attempts to reduce the payroll tax bite.  Hence, the IRS and Congress are placing an increased emphasis on “reasonable compensation” and the collection of additional payroll taxes from the business and additional withholding from the officer or owner.

The Internal Revenue Code establishes that any officer of a corporation, including S corporations, is an employee of the corporation for federal employment tax purposes.  S corporations should not attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages.

Who's an Employee of the Corporation? Generally, an officer of a corporation is an employee of the corporation. The fact that an officer is also a shareholder does not change the requirement that payments to the corporate officer be treated as wages.  Courts have consistently held that S corporation officers/shareholders who provide more than minor services to their corporations and receive or are entitled to receive payment are employees whose compensation is subject to federal employment taxes.

Treasury regulations provide an exception for an officer of a corporation who does not perform any services or who performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration. Such an officer would not be considered an employee.

What's a Reasonable Salary? The instructions for Form 1120S, U.S. Income Tax Return for an S Corporation, state that “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.”

The amount of compensation will never exceed the amount received by the shareholder either directly or indirectly.  However, if cash or property or the right to receive cash and property did go to the shareholder, then a salary amount must be determined and the level of salary must be reasonable and appropriate.

There are no specific guidelines for reasonable compensation in the Code or the Regulations.  The various courts that have ruled on this issue have based their determinations on the facts and circumstances of each case.

In IRS Fact Sheet 2008-25, the IRS warns S corporations not to attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages.

The following are some factors considered by the courts in determining reasonable compensation:

• Training and experience
• Duties and responsibilities
• Time and effort devoted to the business
• Dividend history
• Payments to non-shareholder employees
• Timing and manner of paying bonuses to key people
• What comparable businesses pay for similar services
• Compensation agreements
• The use of a formula to determine compensation

In a recent district court case (Watson v. U.S., (DC IA 05/27/2010)) in which the IRS claimed that a portion of the dividend distributions by an S corporation to its sole owner should be recharacterized as wages subject to employment taxes, the court sided with the IRS and rejected the corporation's assertion that the IRS could not compel the corporation to pay a higher salary to the owner.

The American Jobs, Closing Tax Loopholes and Preventing Outsourcing Act of 2010, which passed the House on May 28, 2010 (currently awaiting Senate action), contains a provision that would clamp down on certain service professionals who try to minimize Medicare and Social Security taxes by routing their self-employment income through S corporations and then paying themselves nominal salaries.

If you have questions about this hot-button topic, please give this office a call.   

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2010 is the Last Year for the Lean Burn Vehicle Credit

2010 is the final year during which taxpayers can purchase an advanced lean burn technology vehicle and claim a tax credit for the purchase.  Unlike the hybrid credit, the lean burn credit is available to vehicles with internal combustion engines that are designed to operate primarily using more air than is necessary for complete combustion of the fuel, incorporate direct injection, and achieve at least 125% of the 2002 model year city fuel economy rating.  The table below lists the vehicles currently certified by the IRS as qualifying for the advanced lean burn credit.

If a vehicle is used both for business and personal use, the credits are divided between personal and business use and can be used to offset both the regular and alternative minimum tax.  The personal portion is a non-refundable credit, and can only reduce your current year tax to zero; any excess is lost.  The business portion becomes part of the general business credit, and unused credits are carried back one year and forward twenty years.

The credit will be phased out starting in the quarter following the one in which the manufacturer records its 60,000th sale of hybrid and lean burn vehicles.  Volkswagen Group America (includes Audi vehicles) has already reached that limit; thus, the allowable credits (as shown in the table below) are reduced by 50% for Audi and Volkswagen vehicles purchased for the balance of 2010.



If you are contemplating purchasing a vehicle that qualifies for the advanced lean burn technology tax credit or one that qualifies for the hybrid tax credit, it may be appropriate for you to call this office in advance to see how the credits will or won’t benefit you.  This is especially true if you are basing your purchase decision on receiving the credit.  Keep in mind that the personal portion of the credit is not refundable and cannot be carried over to another year.  Therefore, you may not benefit as much from the credit as the car salesperson might lead you to believe.

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Hiring Family Members in a Family Business

In today’s tough job market, students seeking summer employment, young adults looking for full-time employment, and college graduates looking to begin their careers are finding it difficult to land a job.  The family business may be the only place for some family members to find work, even if only temporarily until another opportunity arises.  Financially, it makes more sense to keep the family employed rather than hiring strangers, provided of course, the family member is suitable for the job, and not all are.

So rather than helping to support them with your after-tax dollars, you can instead hire them in your business and pay them with tax-deductible dollars.  Of course the employment must be legitimate and the pay commensurate with the hours and the job worked.  The following are typical situations encountered when hiring family members.

Employing a Child – A reasonable salary paid to a child reduces the self-employment income and tax of the parents (business owners) by shifting income to the child.

When a child under the age of 19 or a student under the age of 24 is claimed as a dependent of the parents, the child is generally subject to the kiddie tax rules if their investment income is upwards of $1,900. Under these rules, the child’s investment income is taxed at the same rate as the parent’s top marginal rate using a lower $950 standard deduction.   However, earned income (income from working) is taxed at the child’s marginal rate, and the earned income is reduced by the lesser of the earned income plus $300 or the regular standard deduction for the year, which is $5,700 for 2010.  Assuming that a child has no other income, the child could be paid $5,700 and incur no income tax.  If paid more, the next $8,375 earned by the child is taxed at 10%.

Example: You are in the 25% tax bracket and own an unincorporated business.  You hire your child (who has no investment income) and pay the child $10,700 for the year.  You reduce your income by $10,700, which saves you $2,675 of income tax (25% of $10,700), and your child has a taxable income of $5,000 ($10,700 less the $5,700 standard deduction) on which the tax is $500 (10% of $5,000).

If the business is unincorporated and the wages are paid to a child under age 18, he or she will not be subject to FICA – Social Security and Hospital Insurance (aka Medicare or HI) – taxes since employment for FICA tax purposes doesn’t include services performed by a child under the age of 18 while employed by a parent. Thus, the child will not be required to pay the employee’s share of the FICA taxes and the business won’t have to pay its half either.  In addition, by paying the child, and thus reducing the business’s net income, the parent’s self-employment tax payable on net self-employment income is also reduced.

Use the same example from above. Assuming your business profits are $130,000, and by paying your child the $10,700, you not only reduce your self-employment income for income tax purposes, you also reduce your self-employment tax (HI portion) by $287 (2.9% of $10,700 times the SE factor of 92.35%). But if your net profits for the year were less than the maximum SE income ($106,800 for 2010) that is subject to Social Security tax, then the savings would include the 12.4% Social Security portion in addition to the 2.9% HI portion.

A similar but more liberal exemption applies for FUTA, which exempts from federal unemployment tax the earnings paid to a child under age 21 while employed by his or her parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting solely of his parents.  However, the exemptions do not apply to businesses that are incorporated or a partnership that includes non-parent partners. However, there's no extra cost to your business if you're paying a child for work that you would pay someone else to do anyway.

Retirement Plan Savings - Additional savings are possible if the child is paid more (or works part-time past the summer) and deposits the extra earnings into a traditional IRA. For 2010, the child can make a tax-deductible contribution of up to $5,000 to his or her own IRA. The business also may be able to provide the child with retirement plan benefits, depending on the type of plan it uses and its terms, the child's age, and the number of hours worked. By combining the standard deduction ($5,700) and the maximum deductible IRA contribution ($5,000) for 2010, a child could earn $10,700 of wages and pay no income tax.

However, referring back to our original example, the tax to be saved by making a traditional IRA contribution is only $500 and it might be appropriate to make a Roth IRA contribution instead, especially since the child has so many years before retirement and the future tax-free retirement benefits will far outweigh the current $500 savings.

Hiring Your Spouse - Reasonable wages paid to a spouse entitles the employer-spouse to a business deduction.  The wages are subject to FICA taxes, and the spouse may qualify for Social Security benefits to which he or she might not otherwise be entitled.  In addition, the spouse may also be eligible to receive coverage under the business’ qualified retirement plan, and the employer-spouse may obtain a business deduction for health insurance premium payments made on behalf of the employed spouse.  While maintaining the same family coverage, the business deductions could be increased by providing the spouse with family health insurance coverage as an employee.

If the spouse was unemployed (worked less than 40 hours) during the prior 60-day period, the employer will qualify for exemption from the employer’s 6.2% share of the Social Security payroll tax on the spouse’s wages for the remainder of 2010.  If the spouse continues to work for an uninterrupted period of 52 weeks, the business would also be entitled to a retention credit of up to $1,000 in 2011. (Unemployed relatives such as children, siblings or parents whom you may hire are not qualified employees for this credit.)

If you have questions about the information provided here and other possible tax benefits or issues related to hiring your spouse or child, please give this office a call.

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Big Break for Adoptive Parents

As part of the Health Care Legislation passed earlier this year, the credit for expenses of adopting a child was increased and made refundable.  Prior to this change, the credit was non-refundable and could only be used to reduce the adoptive parent’s tax to zero, with any unused portion of the credit carried over for up to five years and used against future years’ tax.

What this means is that taxpayers with unused adoption credit carryovers will be able to get the full benefit of those carryovers in 2010, and depending on the amounts of their tax and carryovers, reducing their tax to zero and a refund of any excess credit.  Those who qualify for the credit in 2010 and 2011 also benefit from the new refundable provision, and any excess credit not used to reduce their tax for the year will be refundable.

The maximum amount of the credit was scheduled to drop to pre-2002 levels after 2010, but the reversion to the old law has been postponed until 2012, giving those who wish to adopt one additional year to take advantage of this substantial benefit at the higher amount.

For 2010, adoptive parents may be able to claim a credit against their federal tax for up to $13,170 of “qualified adoption expenses” for each adopted child.  That's a dollar-for-dollar reduction of tax, the equivalent, for someone in the 25% marginal tax bracket, of a deduction of over $52,000.  Where an adoptive parent’s employer has an adoption assistance program, the adoptive parent may exclude from their gross income up to $13,170 of qualified adoption expenses paid by an employer.  Adoptive parents may claim both a credit and exclusion for expenses of adopting a child, but not the credit and exclusion for the same expense.

Qualified adoption expenses - Qualified adoption expenses include reasonable and necessary adoption fees, court costs, attorney fees, traveling expenses (including amounts spent for meals and lodging) while away from home, and other expenses directly related to the legal adoption of an “eligible child.”

Qualified adoption expenses don't include expenses connected with the adoption of a child of a taxpayer's spouse, expenses of carrying out a surrogate parenting arrangement, expenses that violate state or federal law, or expenses paid using funds received from a federal, state, or local program.

Expenses in connection with an unsuccessful attempt to adopt an eligible child before successfully finalizing the adoption of another child can qualify.  Expenses connected with a foreign adoption (i.e., one in which the child isn't a U.S. citizen or resident) qualify only if the child is actually adopted.

Eligible child – Generally, an eligible child is under the age of 18 at the time the qualified adoption expense is paid.  A child who turned 18 during the year is an eligible child for the part of the year he or she is under age 18.  A person who is physically or mentally incapable of caring for himself is also eligible, regardless of age.

Credit phased out for higher-income taxpayers - The credit for 2010 is ratably phased out for taxpayers with adjusted gross incomes (AGI) over $182,520 and is completely phased out at $222,520.

If you are contemplating an adoption or in the process of one, and have additional questions or would like to determine how this credit will apply to your specific situation, please give this office a call.  You may also be able to reduce your current withholding and/or estimated taxes based upon your credit carryover or 2010 credit.  

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Having a Bad Year? You May Qualify for the Earned Income Credit.

Many individuals find themselves earning less during these troubled economic times than in years past.  As a result, they may qualify for a credit that they previously were not entitled to because of income limitations.

The Earned Income Tax Credit (EITC) is for people who work, but have lower incomes. If you qualify, it could be worth up to $5,666 for 2010.  So, you could pay less federal tax or even be eligible for a refund.  The credit is a refundable credit, meaning you can receive the benefits of the credit even if you may not owe any taxes.  That’s money you can use to make a difference in your life and help to carry you through hard times.

The EITC is based on the amount of your earned income and whether or not there are qualifying children in your household.  If you have children, they must meet the relationship, age, and residency requirements.  While taxpayers without children may qualify for the EITC, the potential amount of the credit is significantly more for eligible taxpayers who have one or more qualifying children.  These taxpayers are also allowed to earn over 2½ times more income before the credit is phased out than workers without qualifying children.

If you were employed for at least part of 2010, you may be eligible for the EITC based on the general requirements included in this article.

The credit calculation is rather complicated and takes into account a taxpayer’s income from working, his or her total income (AGI), number of children, and tax filing status.  The best way to describe how this credit works is that it is zero if a taxpayer has no income from working (the credit is devised as an incentive for individuals to work) and increases as the income from working increases until the credit reaches the maximum allowed, at which point it becomes smaller as the income grows.  The table below shows (1) maximum credit and corresponding earned income and (2) the income at which the credit totally phases out.
                       
 
In addition, to qualify, a taxpayer must meet a few basic rules:

• The credit isn't available to individuals when their “disqualified income” (i.e., investment income such as interest and dividends) is more than $3,100.
  
  
• The taxpayer claiming the credit and any qualifying children must have a valid Social Security number.
  
  
• Have earned income from employment or from self-employment.
  
  
• Filing status cannot be married filing separately.
  
  
• The taxpayer must be a U.S. citizen or resident alien all year, or a nonresident alien married to a U.S. citizen or resident alien, and filing a joint return.
  
  
• The taxpayer cannot be a qualifying child of another person.
  
  
• A taxpayer without a qualifying child must:
  
  o Be age 25, but under 65 at the end of the year,
  o Live in the United States for more than half the year, and
  o Not be a qualifying child of another person.

• The taxpayer cannot file Form 2555 or 2555-EZ (related to foreign earned income).
  
  
• Members of the military can elect to include their nontaxable combat pay in earned income for the EITC.  If the election to do so is made, all nontaxable combat pay received must be included in earned income for purposes of figuring the EITC.

The rules related to the EITC are rather complicated, so, if you have any questions related to how the credit might apply to you, please give this office a call.

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Misclassifying Workers Can Be Costly!

With the current economy, and not always knowing what lies ahead, most business owners and executives tend to be financially conservative and preserve the cash of the business.  This conservative approach frequently carries over to hiring activities, with many employers choosing to hire independent contractors/freelancers as opposed to full-time employees.  In doing so, they eliminate the cost of company benefits such as vacation, sick pay, health insurance and retirement funding.  Another big benefit is eliminating the employer’s matching share of Social Security and Medicare payroll taxes, not to mention the savings on unemployment taxes and worker’s compensation insurance.

Eliminating all those costs associated with employees and hiring independent contractors may save a lot of money, but it can also be a mine field.  Just because you pay a worker like an independent contractor does not necessarily make them one.  And if you are subsequently challenged on that classification by the IRS or your state taxing authority, and lose, you will pay back all those savings plus penalties and interest. The company’s retirement plan could also be in jeopardy of losing its qualifying status if workers who should have been eligible to participate have been excluded from the plan. The line between independent contractor and employee is not always clear, but the following are some guidelines that can be used in making the determination.

The three primary characteristics the IRS uses to determine the relationship between businesses and workers are: Behavioral Control, Financial Control, and the Type of Relationship.

1. Behavioral Control - Covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.

2. Financial Control - Covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker's job.

3. Type of Relationship – This factor relates to how the workers and the business owner perceive their relationship.

If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees.  If you can direct or control only the result of the work done, and not the means and methods of accomplishing the result, then your workers are probably independent contractors.

Here are some additional factors to consider when making a determination:

• Sole Employer - An independent contractor is in business for him or herself and generally will have additional clients for whom services are provided.  If you are the only client and he or she is not actively pursuing work from others, then it becomes an indicator favoring employee status.
  
  
• Work Schedule - An independent contractor generally sets their own work schedule.  Requiring the worker to maintain regularly scheduled work hours is an indicator of employee status.
  
  
• Materials & Supplies - Independent contractors generally provide their own materials and equipment and invoice their clients for labor and materials.  If you provide all of the material and supplies, that is another indicator of employee status.
  
  
• Work Location – Another indicator of employee status is when a worker performs services only at your work location and does not maintain an office or facilities elsewhere.

If, after considering all the factors and issues, you feel you cannot reach a definitive determination, then you, as an employer, can request the IRS to make a determination on whether a specific individual is an independent contractor or an employee by filing a Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) with the IRS.  However, the IRS does not issue determinations for proposed or hypothetical situations.  A worker may also file Form SS-8 requesting an IRS determination.

One final word of caution: if a worker that you classified as an independent contractor is subsequently determined to be an employee, you will be open to a lawsuit for back benefits or even other demands related to the worker’s specific circumstances.

If you need more information about the critical determination of a worker’s status as an independent contractor or employee, please give this office a call.

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More Details – Health Insurance Coverage for a Child under Age 27

The Department of Health Services and the Treasury Department have recently released additional guidance and details related to the health insurance coverage for a child under the age of 27.  Before the passage of the Affordable Care Act into law, many health plans and issuers could remove adult children from their parents' policies because of their age, whether or not they were a student, or where they lived.  Under this new law, plans and issuers that offer dependent coverage will be required to make the coverage available until an adult child reaches the age of 26. 


Effective Dates - This new provision is effective for plan years beginning on or after September 23, 2010.  Therefore, for plans in existence before the September date, the mandatory coverage for children could be delayed until the next anniversary date for the policy.  With that said, there are a huge number (65 at publication date) of insurers that have agreed to an early implementation of this provision.  Check with your employer, insurer or plan administrator to see when the coverage will be available for your health policy.

Tax Benefits - Under a change in tax law included in the Affordable Care Act, the value of any employer-provided health coverage for an employee's child is excluded from the employee's income through the end of the taxable year in which the child turns 26.  This tax benefit applies regardless of whether the plan or the insurer is required by law to extend health care coverage to the adult child or the plan or insurer voluntarily extends the coverage.  The tax benefit is effective March 30, 2010.  Consequently, the exclusion applies to any coverage that is provided to an adult child from that date through the end of the taxable year in which the child turns 26.

Broad Eligibility - This expanded health care tax benefit applies to various workplace and retiree health plans.  It also applies to self-employed individuals who qualify for the self-employed health insurance deduction on their federal income tax return.  

Self-Employed Individuals Thus, self-employed individuals can include their child under the age of 27 in their self-employed plan and deduct the premium cost as part of their above-the-line, self-employed health insurance deduction.

Pre-Tax Coverage Through Employer’s Cafeteria Plan - In addition to the exclusion from income of any employer contribution towards qualifying adult child coverage, an employee may pay the employee’s portion of the health care coverage for an adult child on a pre-tax basis through the employer's cafeteria plan - a plan that allows employees to choose from a menu of tax-free benefit options and cash or taxable benefits.  The IRS provided in recent guidance that the cafeteria plan could be amended retroactively up until December 31, 2010 to permit these pre-tax salary reduction contributions.

Enrollment Notice - For plan or policy years beginning on or after the September 23, 2010 implementation date, plans and issuers must (see an exception below) give children who qualify, an opportunity to enroll that continues for at least 30 days regardless of whether the plan or coverage offers an open enrollment period.  This enrollment opportunity and a written notice must be provided no later than the first day of the first plan or policy year beginning on or after September 23, 2010.  The new policy does not otherwise change the enrollment period or start of the plan or policy year.

Exception - There is one exception for group plans in existence on March 23, 2010. Those group plans may exclude adult children who are eligible to enroll in an employer-sponsored health plan, unless it is the group health plan of their parent.  This exception is no longer applicable for plan years beginning on or after January 1, 2014.

Equal Benefits - Any qualified young adult must be offered all of the benefit packages available to similarly situated individuals who did not lose coverage because of cessation of dependent status.  The qualified individual cannot be required to pay more for coverage than those similarly situated individuals.  The new policy applies only to health insurance plans that offer dependent coverage in the first place; while most insurers and employer-sponsored plans offer dependent coverage, there is no requirement to do so.

If you have questions related to health care for children, please give this office a call. 

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Three New Information Reporting Tools Being Added By the IRS

The IRS has long used information reporting as a tool to enforce compliance with the tax laws.  This is done in a variety of ways.  Information reporting provides the IRS with the ability to perform vast numbers of compliance checks using their computer system.  For example, Bank A issues a Form 1099-INT to Customer X and the IRS that reports the $1,000 of interest it paid to Customer X during the year.  The IRS then checks X’s tax return to see if the $1,000 of income has been reported.  The most commonly encountered compliance checks include the following:

o  Wages (W-2)
o  Income as an Independent Contractor (1099-MISC)
o  State tax refunds and unemployment compensation (1099-G)
o  Certain gambling income (W-2G)
o  Interest and dividend income (1099-INT and 1099-DIV)
o  Pension income, IRA withdrawals, etc. (1099-R)
o  Social Security benefits/Medicare premiums (SSA-1099)
o  Dependent Exemptions (Match against all other returns filed)
o  Filing status (Match against other returns filed)
o  Alimony (Match recipient to payer)
o  Gross proceeds from the sales of stock and property (1099-B and 1099-S)
o  Home Mortgage Interest (1098)

There are more, but this gives you an idea of how information reporting can be used as a tool to uncover noncompliance, unreported or under-reported income, and underpayment of taxes.  Beginning in 2011 and 2012, the IRS has added three additional tools to their toolbox which will significantly increase their ability to uncover noncompliance by security investors and business entities.

Here is an overview of the forthcoming new information reporting tools:

• Payment Card and Third-Party Payment Transactions - The “Housing Assistance Tax Act of 2008” added Code Sec. 6050W which adds one of the new compliance tools for the IRS.  This new tool will affect businesses that accept credit or debit cards, or other electronic payments received during 2011.  Beginning in 2012, payment processors will have to make an annual information report (for the year 2011) to the merchant and the IRS, stating the gross amount paid to the merchant during the previous calendar year.
  
  This will allow the IRS to determine the business’s gross income from credit and debit card sales and make it easier to segregate the credit/debit card sales from cash sales.  The IRS will then be in a position to see if the credit card dollar figure reported on the tax return matches the bank's information return and will also allow them to see if a business’s other sales from cash and check payments makes sense in the context of the firm's overall business.
  
  We can probably expect IRS to develop statistics for various types of businesses related to the ratio of cash payments to credit payments as a means of imputing cash payments for merchants that do not report a reasonable amount of income over and above that reported by the payment processors.
  
  The new reporting form is Form 1099-K.  The draft version of this form includes a box for reporting the annual amount of merchant card/third party payments and also has a box for each month’s credit/debit card sales. 
  
  
• Basis Reporting – For years, the IRS has had the ability to identify the gross sales received by taxpayers from broker transactions including security (1099-B) and property sales (1099-S).  However, the profit or loss from those sales is the amount that is taxable, and the only way to determine the profit or loss is to know the basis in the property that was sold.  The profit or loss is the difference between gross sales price and the taxpayer’s basis in the property.  Without confirmation of the basis, which up to now is only obtainable from the taxpayer via an audit, the IRS has no way to verify the reported profit or loss from the sale, leaving the area open to abuse.
  
  That will be changing beginning in 2011, at least for security sales.  Under tax changes enacted as part of the Emergency Economic Stabilization Act of 2008, every broker that is required to file an information return reporting the gross proceeds of a covered security must include in the return the customer's adjusted basis in the security, and whether any gain or loss with respect to the security is short-term or long-term.  Generally, this will apply to corporation stocks acquired after 2010 (2011 for regulated investment companies and dividend reinvestment plans and 2012 for other securities to be determined by the IRS).
  
  The IRS estimates that more than one in three taxpayers who sold securities may have misreported capital gains and losses—in many cases because they misreported their basis—and expects the new basis reporting rules will go a long way towards correcting that problem.
  
  
• Payments to Corporations – For as long as most can remember, payments for services made by one business to an unincorporated business required the payee to report the payments on a 1099-MISC if the aggregate payments for the year to a single entity were $600 or more.  Payments for merchandise (unless made in connection with services that were purchased) have been excluded from 1099-MISC reporting.  As part of the Health Care Act passed in 2010, the exemption from reporting payments to incorporated businesses will end, as will the exclusion of payments for merchandise, beginning for transactions occurring in 2012.  Thus, all business-related aggregate payments for the year to a single entity of $600 or more, including payments for merchandise, will need to be reported by all business entities.
  
  This will place a significant burden on businesses not only to track and report payments but also to reconcile their income with their accounting method and their reporting year (if not a calendar year).
  
  To ease the burden this requirement may impose on businesses, the IRS has indicated it plans to use its administrative authority to exempt from this new requirement business transactions conducted using payment cards (such as credit and debit cards).  These transactions will already be covered by the new reporting requirements on payment card processors, so there will be no need for businesses to report them as well.

It is not too early to start thinking about the impact these new reporting requirements will have on your investment transactions or your business.  You need to be prepared when 2011 rolls around.  If you have questions, please give this office a call.

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Declare Your Independence From Security Worries: Use QuickBooks' Protection Tools

If there’s one application that you don’t want compromised by a security breach, it’s the one that contains all of your financial information. Recognizing that, Intuit has built a number of security features into QuickBooks that are designed safeguard your debits and credits.

Tip: QuickBooks integrates with Microsoft Internet Explorer for some of its work. We’ll discuss some of its safety tools, but you may want to check with your accounting professional to see if your larger system is well-protected against malware, viruses, etc.

Set Up Preferences

Fortunately, QuickBooks is open for integration with many outside applications that complement QuickBooks’ native capabilities and extend its usefulness. But you should make sure that your system is set up to accommodate the features that you want to use.

To do this, click Edit | Preferences | Integrated Applications. Then click on the tab labeled Company Preferences. Here you’ll be able to indicate that:

• no applications should be allowed access, and
• you should be notified if an application’s certificate has expired.

This window also displays a list of applications that are currently integrated with QuickBooks. Highlight one, then click Remove if you want to break the link. Click Properties, and you’ll see the window shown in Figure 1.
 


Figure 1: QuickBooks lets you specify who gets in, and what they can do.

Check the top box if this outside application should be allowed in, and make decisions about the other options here. If you have any questions, give us a call and we’ll make sure your choices suit your business.

Broaden Your Horizons

QuickBooks relies on the Internet for many of its functions, which makes the program much more versatile. You can use this Web connection to update your copy of QuickBooks, receive payroll updates, download financial institution transactions, and access myriad business resources.

If your copy of QuickBooks is not yet integrated with Internet Explorer, click on the Help menu, then Internet Connection Setup. Work through the wizard to specify the correct connection to use, as shown in Figure 2.



Figure 2: To make sure your QuickBooks/Internet Explorer integration is working securely, specify the correct Internet connection.

Click on Edit | Preferences again, then click Service Connection. Under the My Preferences tab, you’ll be asked to decide whether:

• data downloaded from your financial institution—or information previously downloaded—should be processed immediately or saved to a file, or
• Internet Explorer should remain open after you’ve completed a Web-based task (only applicable if QuickBooks has opened IE).

Check or uncheck the appropriate boxes.

Click the Company Preferences tab. Here, you’ll tell QuickBooks whether it should automatically connect to Web services (other than Payroll or Online Banking; these have their own passwords) or if a password will be required. You’ll also specify whether service updates from Intuit should be automatically downloaded, as shown in Figure 3.



Figure 3: In the window, you can specify your preferences for password requirements and background downloading of service updates.

To ensure that you’ll be able to see all QuickBooks-related content on the Web, open Internet Explorer. Click the Tools menu, then Internet Options. Click the Security tab, and make sure the level is set to Medium, as suggested by Intuit.

Internal Security

Of course, QuickBooks offers internal tools to prevent unauthorized employees from reaching sensitive information. To access these, click Company | Set Up Users and Passwords | Set Up Users. You must be the Administrator to enter this area.

The window that opens gives you several options. You can add, edit, delete, or view a user. Click the Add User button, and assign a user name and password on the next screen. Click Next, and in the next window, choose whether to give the individual access to all areas of QuickBooks, or just a subset (the External Accountant option lets your accounting professional enter most areas of the program).

Choose Selected areas of QuickBooks and click Next in the window shown in Figure 4.



Figure 4: QuickBooks lets you specify which areas and functions individual users can access.

On each page in this wizard, you can assign no, full, or selective access to tasks for each employee. Other functional areas include Payroll and Employees, Time Tracking, and Sensitive Accounting Activities. When you’re done, click Finish.

Keep It Safe

Remember, too, that Intuit employs high-level encryption that secures your sensitive financial information. And it of course recommends that you back up frequently to further protect your data. If this all seems like too much poking around in QuickBooks, give us a call and we’ll help you make the right choices.

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Exemption for a Child

Generally, the custodial parent is the one that is entitled to deduct the exemption for a child unless the custodial parent releases the exemption. The release (IRS provides form 8332 for this purpose) must be a written declaration, and it must be unconditional (no strings attached, such as requiring the non-custodial parent to meet support payment obligations). If both parents were to claim the children as dependents, the IRS's computer matching program is designed to flag both of the parent's returns, and send each a notice requiring substantiation for the claim. The IRS would assess additional tax, as well as penalties and interest, if the facts do not support the parent as the one entitled to the exemption.

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