When a company assumes the role of payroll administrator, there are considerations to protect the assets of the company from risk related to various employment taxes.
“There are several circumstances that may cause a company to run the risk of becoming noncompliant or considered evasive of employment withholding tax obligations, requiring employers by law to withhold taxes from their employees, including federal income taxes and other taxes required by the Federal Insurance Contributions Act such as Social Security and Medicare taxes,” says Walter McGrail, senior manager, Cendrowski Corporate Advisors LLC.
Although not discussed here, these same requirements apply to other employer taxes such as FUTA and taxes required by any states.
Smart Business spoke with McGrail about employment tax risks and what companies can do to mitigate them.
What are employment tax risks, and are they a realistic issue?
Companies are required to withhold taxes and remit them to the Internal Revenue Service via an authorized financial institution, as established by the Federal Tax Deposit Requirements. When the taxes withheld are not remitted, or not remitted in a timely manner, the company may be liable for penalties, interest, or, in the case of proven evasion, prosecution. Noncompliance may result in penalties and interest, whereas evasion may subject the responsible parties to criminal and civil sanctions
According to the IRS, for fiscal years 2009 to 2011, it initiated approximately 500 investigations into employment tax evasion. Of these cases, more than 40 percent were investigated, recommended for prosecution, indicted and ultimately sentenced. Additionally, of those sentenced, 80 percent were incarcerated by means of either federal prison, halfway house, home detention, or some combination, lasting an average of nearly 24 months.
These penalties are most commonly levied against the responsible parties, including, but not limited to, corporate officers, shareholders, members and partners.
What are the most common methods, or schemes, related to employment tax evasion?
There are several common scenarios that could result in evasion or simply result in noncompliance when it comes to employment taxes. The most common, according to the IRS, involve pyramiding, utilizing unreliable intermediaries to remit the tax and misclassifying wages or salaries based on worker status or officers’ compensation treated as distributions. Due to the lengths someone may go to in order to evade employment taxes, there is even a listed transaction related to employment and the use of offshore employee leasing to evade these taxes.
If employment taxes are automatically withheld, how can companies be put at risk?
Companies are at risk when withheld taxes have not been paid in a timely manner, as prescribed by the IRS. Fraud can be an integral part of employment tax evasion.
Pyramiding is one of the more common practices. This involves the employer not remitting the taxes and using the monies to cover other liabilities or operating shortfalls. If the employer continuously uses this practice to continue the operation of the company, the amount can accrue over time (pyramid) to the point where business operations cannot recoup the funds utilized and the company is left with a tax liability and no cash. The frequent result is the business going under.
Unreliable payers can also be an issue. A payer can be either a third party or related (someone employed by the company). Both types of payers can be instrumental in causing the company to be at risk of noncompliance.
Third-party payers generally fall into one of two categories: Payroll Service Providers (PSP) and Professional Employer Organizations (PEO). PSPs typically assume the role of payroll administrator and the responsibility for making employment tax payments and filing the appropriate employment tax returns. PEOs effectively lease employees and assume the role of human resources, managing the administrative, personnel and payroll functions for the company. Tax issues can arise when either type of third-party payer is in control of employment taxes or the company dissolves. This can leave employment taxes unpaid.
If the company utilizes an internal department or employee to pay employment taxes, there are different ways the company can be exposed to risk. One way could be rooted in fraud. If the payer were to pay taxes but not properly credit them to the company’s tax account, the company would still have an employment tax liability and no funds to pay the taxes owed.
Much like other frauds that involve payables, funds can be paid or transferred to a taxing authority while being applied to a different account. The company believes its tax liabilities are being properly paid and may not become aware of an issue for months or years.
How can companies safeguard against employment tax evasion and noncompliance?
There are no guarantees, but one way to reduce possible exposure is to exercise due diligence when engaging a third-party or related payer.
Monitoring is essential to the process. The company can insist on paying all federal taxes electronically, utilizing the Electronic Federal Tax Payment System (EFTPS), which allows users to access tax payment history to ensure payments were made and applied to the appropriate tax account. Additionally, verifying and matching the amounts paid against the information reported on the Employer’s Quarterly Federal Tax Return (Form 941) can aid in reducing noncompliance and the possibility of employment tax evasion.
Additionally, ask your CPA to look at wages and related withholdings as part of the tax return preparation for your company.
Walter McGrail, CPA, is senior manager of Cendrowski Corporate Advisors LLC. Reach him at (866) 717-1607 or email@example.com.
Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC
It’s a common misconception that if you have income or assets offshore and it never touches U.S. soil, then you don’t have to report it. That belief is proved wrong with a new tax form, Form 8938, which seeks information on individuals’ foreign financial assets, with substantial penalties for failure to report. In future years, entities also will be required to fill out the form.
“This area is just ripe for people to misstep, and the penalties for noncompliance in this area are incredibly steep, starting at $10,000,” says Henry J. Grzes, CPA, director, international tax, at SS&G, Inc. “Many tax practitioners, as well as taxpayers, are unaware of these new rules.”
Smart Business spoke with Grzes about Form 8938, why it was created and some the challenges taxpayers may face in staying on the right side of the law.
What is tax Form 8938, Statement of Specified Foreign Financial Assets?
Form 8938 requires individuals — if they meet certain filing thresholds — to disclose the existence of foreign financial assets they have an ownership interest in, which can be individually or jointly owned. The form was first required to be filed with 2011 tax returns. The law that requires disclosure of assets is complex, so the IRS initially decided only individuals would be required to file, but once it finalizes regulations and provides additional guidance, corporations, trusts and partnerships will also have to comply.
Why did the IRS create Form 8938?
It was created to make sure taxpayers are properly reporting the existence of and any income from a bank account, ownership in a foreign corporation, whether public or private, and other offshore assets. The IRS has been focusing on taxpayers with offshore activities, especially if those activities aren’t being properly reported on their tax returns.
The recent U.S. pursuit of UBS, a global financial institution, brought the issue to the forefront. UBS employees allegedly attended high-profile events such as the Super Bowl and solicited people to invest money with them by saying they wouldn’t disclose the existence of the investment to other parties..
What are the penalties for failing to properly file Form 8938?
There’s an initial penalty of $10,000 for failure to file, which applies to both spouses if you file jointly, even if only one spouse has foreign financial assets. Failure to file or failure to disclose an asset will also extend the statute of limitations for a return. For example, if you don’t file Form 8938 for the 2011 return until tax year 2013, the statute may remain open for all or part of your income tax return until three years after the date in which the 2011 Form 8938 is filed. If there is unreported income from the assets included on the 2011 filing, the statute of limitations is extended even further.
What advice would you give individuals who aren’t sure if they qualify for Form 8938?
Seek qualified help and inquire whether your tax preparer has experience in international reporting. Some tax practitioners might not want to take on such a filing burden because they aren’t familiar with the area and could be liable for potential preparer penalties.
The form can be confusing because whether you have to file depends on whether you file separately or jointly and whether you live in the United States or abroad. In each circumstance, there is a different filing threshold. In addition, a specified foreign financial asset may not be what you think. For example, holding precious metals directly doesn’t need to be reported on Form 8938, but if you hold precious metals in an account in a foreign financial institution, the account must be reported. When in doubt, report it.
It’s also hard to determine the fair market value of some assets, such as ownership in a closely held business. The IRS requests that you use readily accessible information to determine the maximum value of the foreign asset. If you can’t determine the value, put it down on the form as a value of zero. This is often the case where a taxpayer is a beneficiary to a foreign estate and no distributions were received by the taxpayer in the reporting year.
If individuals have to file the Foreign Bank Account Report (FBAR), why do they need to fill out Form 8938?
The rules for filing the FBAR and Form 8938 are promulgated under different titles of the U.S. code. Form 8938 is part of the Income Tax Act, so only certain individuals can access the information without a subpoena or legal reason. FBAR is part of the Bank Secrecy Act and is a law enforcement tool used to detect money laundering or terrorism.
Filing and reporting requirements for the FBAR and Form 8938 requirements are different; if you file either Form 8938 or FBAR, it doesn’t mean you have to file the other, but you may have to file both.
What happens if someone failed to file the form for the 2011 tax year?
The IRS is playing hardball. There is a reasonable cause provision that allows a taxpayer to avoid any late filing penalties if the failure to file or to disclose an asset is due to reasonable cause and not due to willful neglect. If you have a reasonable argument to put forth, it’s still going to involve time and money. You may not end up having to pay any penalties that might be assessed, but to get to that point, you will have to affirmatively show to the IRS that the facts support a reasonable cause claim.
For taxpayers who determine they need to file this form and did not include it with their 2011 returns, it would be wise to address this failure as soon as possible. Such a voluntary admission of noncompliance and taking corrective action to immediately cure this filing deficiency will generally be to an individual’s benefit when attempting to negotiate any penalty abatements with the IRS as a way to demonstrate a good faith effort to be in compliance with these new filing obligations.
Henry J. Grzes, CPA, is a director, international tax, at SS&G, Inc. Reach him at (919) 651-1616 or HGrzes@SSandG.com.
Insights Accounting & Consulting is brought to you by SS&G
Not only is Texas a leading provider of crude oil and natural gas, but the state’s abundant sunlight and persistent winds offer businesses yet another opportunity to lead the nation, by tapping renewable energy sources to power manufacturing plants, distribution centers and office buildings.
But despite the fact that Texas companies can leverage more than 80 federal, state and local incentive programs to defray the cost of purchasing and installing renewable energy systems and energy conservation equipment, executives in the Lone Star state are still leaving money on the table.
“Renewable energy and conservation incentives and credits allow companies to demonstrate environmental stewardship, increase operating efficiencies and lower income taxes by defraying the cost of purchasing renewable energy and energy conservation equipment and systems,” says Laura Roman, CPA, CMAP, partner in tax and strategic business services at Weaver. “Unfortunately, the funds often go unused, and the programs won’t last forever.”
Smart Business spoke with Roman about the opportunities to lower taxes and operating expenses and positively impact the environment by taking advantage of underutilized conservation and renewable energy credits and incentives.
Why should companies consider switching to renewable energy or energy efficient building materials?
The benefits include the opportunity to lower energy consumption and utility bills by installing modern, energy-efficient manufacturing equipment, windows or HVAC systems, and the chance to promote a positive public image by launching green initiatives and supporting environmental stewardship. Plus, both tenants and building owners can utilize the incentive programs and reap the financial rewards. For example, the improvements help owners by boosting property values, while tenants benefit from increased energy efficiency, which ultimately reduces operating costs.
What types of incentives are available?
There are more than 54 federal and 28 state and local programs that can be used for equipment purchases or upgrades that reduce energy consumption or utilize solar, wind, ethanol and biodiesel energy. The programs include: tax deductions, credits and exemptions, loans and grants, rebates and performance-based incentives. For example, Texas businesses can qualify for commercial energy efficiency rebates, energy efficient incentive programs, green building corporate tax credits and sales tax exemptions for purchasing energy and water efficient products. While the U.S. Treasury Department offers renewable energy grants for projects involving: solar photovoltaics, landfill gas, wind, biomass, hydroelectric, geothermal, municipal solid waste, CHP/cogeneration, solar hybrid lighting, hydrokinetic, tidal/wave energy, and ocean and fuel cells using renewable fuels or micro turbines.
Best of all, executives don’t have to commandeer large amounts of cash to complete the projects because companies can tap different programs to train employees, purchase equipment or pay for installation contractors. So, companies can still invest in that much-needed marketing program or software upgrade if they utilize renewable energy incentives and credits to hire renewable energy specialists, replace inefficient manufacturing equipment or install a new HVAC system.
How do the incentives provide financial benefits?
Essentially there are five areas where companies benefit from renewable energy incentives and tax credits.
- Gross income exclusions. Companies can deduct the full amount of incentive payments or grant funds they receive for qualified renewable energy or energy conservation projects from gross income.
- Dollar-for-dollar deductions. There are no sliding scales or phased-out deductions. Companies can use every dollar they invest in qualified renewable energy and energy conservation projects to reduce their tax liability.
- Accelerated depreciation. Under IRS 179D, companies can depreciate the cost of purchasing new plant and energy equipment at a faster rate than typically allowed. So, instead of taking 39 years to recover the cost of a new lighting, HVAC system or building envelope, the owner of a 100,000-square-foot building can deduct up to $1.80 per square foot, or up to $180,000 in the first year.
- Ancillary funding and allowances. Funding is available to hire specialized workers or train current employees on the use of renewable energy equipment and processes.
- Multiple opportunities. Companies can tap multiple incentives for each project including loans, performance-based incentives, deductions, tax exemptions and grants, as well as property and sales tax rebates.
Should executives be aware of any special qualifications or rules?
The incentive plans and tax codes are fairly straightforward, but there’s no need to spend hours interpreting the criteria or deciphering nebulous clauses when a tax professional is intimately familiar with the nuances of each program. At the same time, he or she may help identify additional opportunities to complete the project without tapping cash reserves, and can often share tips and ideas from experience helping other companies navigate the process.
How can executives evaluate the ROI and choose the most advantageous projects?
Companies should discuss ideas and energy needs with architects, contractors and energy professionals so they can create a list of feasible projects and determine the material and labor cost for the various improvements. Review the list with an accountant, since he or she is familiar with the tax code and incentives and can provide an estimate of the cash outlay and ROI. Finally, act now. Remember, it costs virtually nothing to investigate these opportunities, and there’s no sense in waiting when the money to complete renewable energy or energy conservation projects is there for the taking.
Laura Roman, CPA, CMAP, is a partner in tax and strategic business services at Weaver. Reach her at Laura.Roman@weaverllp.com or (432) 570-3030.
Most business owners have a CPA and call that person to do their taxes, but don’t realize that their accountant can help them year-round. But working with your CPA at other critical junctures can ensure that your practices meet the IRS code and save you money in the long run, says David McClain, CPA, MBA, a manager in tax at SS&G.
“Many business owners want to get their tax returns filed and get it out of their minds for another year,” says McClain. “But there are a lot of options out there and a lot of ways that working with your CPA throughout the course of the year can save you money in the long run.”
Smart Business spoke with McClain about how creating an ongoing relationship with your accountant can benefit your business year-round.
How can a CPA assist a business in the implementation of employee benefits?
Employee benefits can be anything from tuition reimbursement to travel reimbursement, and it is very important to talk to a CPA about those programs before you implement them.
There are a lot of IRS rules surrounding employee benefits programs, and there may be some unintended tax consequences to your business if you don’t follow them.
Under IRS rules, there is often a maximum amount that is allowed to be reimbursed tax free to employees and certain rules under which a business can reimburse employees tax free.
If you set up your program without talking to a CPA, you may end up with a plan in which reimbursement becomes additional compensation, and therefore a taxable event to the employee. The result is that the employees will not get back the dollars that they initially thought they would.
A CPA can help you make sure that you are operating within the IRS code and that you are not unintentionally abusing the system.
How can a CPA impact a business’s banking relationships?
CPAs generally have relationships with several bankers, and they may be able to help negotiate better rates and terms with bankers they know, versus ones that you may be considering.
The other issue your CPA can help you with is understanding loan covenants and the potential audit requirements for loans.
When getting a loan from a bank, you may be required to meet certain covenants. A CPA can advise on whether it’s realistic to meet those covenants or whether you need to renegotiate.
The accountant may also be able to negotiate a requirement for a full-blown financial statement audit to a simpler financial statement and review, which is less work and costs the client less but gives the bank the reassurance it needs to offer that loan.
How can a CPA provide a benefit in the case of an IRS audit?
Any time you are facing an IRS audit, the No. 1 rule is never go into it alone. As soon as you get a notice saying that you’ve been selected for an audit, your first phone call should be to your CPA. That is important because when the CPA looks over the IRS audit request lists and talks to the agent for the first time, he or she is probably going to have a good understanding of exactly what the auditor is looking for.
The accountant is going to be able to navigate you though the audit rules and give the IRS the information it is looking for. If you can get the IRS the requested information and support the positions you’ve taken, you often get a ‘no change’ on the audit.
But if that doesn’t happen, you need a CPA to be there if it gets down to negotiations with the IRS or ends up in tax court. When dealing with the IRS, your CPA should always be your first stop.
Should a business owner wait until tax season to consult with a CPA on general business matters?
No. Too many business owners do that, and that is a mistake.
You really need to talk to your accountant in November or December. That’s a very important time. Even if you don’t think there is anything going on, that is the perfect time to sit down with your CPA and look at where you are for the year, what your business has done for the year and where you are in terms of income versus where you were last year.
Look at whether you need to adjust making estimated payments for the year and whether you are going to be covered on tax payments come April 15. This will give you an idea of what you owe so that you can plan your cash flow better.
You may be able to implement some ideas before the end of the year to save money.
Taxes are one of those tasks in life that people don’t want to deal with. They want to get their return filed and get it out of their minds for the year. But there are a lot of options out there, and calling your CPA when making business decisions can help you save money in the long run.
David McClain, CPA, MBA, is a manager in tax at SS&G. Reach him at (800) 869-1835 or DMcClain@SSandG.com.
The end of the year is fast approaching — which means it’s time to start thinking about year-end tax planning, both for your business and personal accounts. Planning early will help ensure maximum benefits.
“Many items within tax planning are time sensitive,” says Tim Schlotterer, CPA, director, tax and business advisory services at GBQ Partners LLC. “Tax planning is best done throughout the year. However, if you are interested in year-end tax planning, it’s best to start in November or early December.”
Smart Business spoke with Schlotterer regarding key items to look at when starting your year-end tax planning, as well as the risks and benefits associated with such matters.
Have there been any recent changes in taxes?
As of right now, there have not been any major tax changes in 2011. The current primary focus in Washington is related to providing assistance with unemployment and incentives for companies to hire unemployed workers.
President Obama has been pushing his $447 billion American Jobs Act package to Americans and Congress with minimal support. With next year being an election year, history shows that it is doubtful any major tax laws will be placed into law as we approach November 2012.
What are some key things business leaders need to understand about year-end tax planning?
Good financial information is the starting point for good tax planning. It’s important to understand the current financials to date and to be able to project what you think will occur toward the end of the year. Companies should plan on working with their trusted CPA in ensuring that financial information is complete and accurate. In addition to financial statements, business leaders should look at the important factors that drive growth for their business; this can help determine what type of incentives might be the best to explore.
Timing is also important. Look at income recognition and the expenses that will be incurred, and determine whether those items will be recognized before year end. It is important to work with a trusted tax advisor to assist with year-end tax planning. Book to tax differences lead many companies to a higher or lower projected taxable income.
Your trusted tax advisor should be able to assist in identifying these differences and providing proper planning in assisting with your tax situation.
What are some key items to consider when looking at year-end tax planning for your business?
One of the key areas to look at in 2011 is capital expenditures. Depending on the facts, companies have two options in 2011 available to them in expensing qualified purchases for tax purposes. The first option is under Internal Revenue Code Section 179. If a company has taxable income and capital purchases which are under $2 million, a taxpayer can write off the first $500,000 worth of qualified assets, either used or new. However, this does not include real property, so you have to be cognizant of the type of assets you’re buying to determine whether or not they qualify. If you have more than $2 million in purchases or want to maximize additional purchases, bonus depreciation is the second option available. You can deduct 100 percent of your qualified asset purchases in 2011. Please note that in order to claim the 100 percent bonus depreciation, the asset must be new and placed in service on or before December 31, 2011. The generous dollar ceilings that apply this year mean that many small and medium-sized businesses that make timely purchases will be able to deduct most, if not all of their outlays for machinery and equipment. The expensing deduction is not prorated for the time that the asset is in service during the year. This opens up significant year-end planning opportunities. These tax depreciation incentives allow you to accelerate a deduction you were already going to have. If you would have depreciated these assets over a five-, seven- or 15-year period, you’re able to take a deduction hopefully in year one.
What are some other unique tax credits or incentives that businesses can take advantage of this year?
Nail down the work opportunity tax credit (WOTC) by hiring qualifying workers. Under current law, the WOTC may not be available for workers hired after this year, unless extended. Qualifying individuals hired by a company can get up to a $9,000 tax credit. You have 28 days from the time the associate is hired to submit this information in order to qualify. It’s important to work with your tax adviser and human resources department to ensure that you qualify and receive the benefits. Qualifying workers include food stamp recipients, veterans, felons, families on assistance, individuals in empowerment zones and several other at-risk individuals.
Make qualified research expenses before the end of 2011 to claim a federal research and development (R&D) credit. This credit could give your company up to six-and-a-half cents for every dollar spent on qualified research expenditures and could be used as a credit to offset federal tax. Many states offer incentives as well on qualified research expenditures. For example, Ohio allows a research credit against the commercial activity tax.
Finally, while many companies have had to cut out benefits for their work force due to financial burdens, 401(k) matching is one area to consider keeping. Not only does it help with securing employment and ensuring job satisfaction, you can also get a tax deduction for making a matching contribution to a qualified plan.
Tim Schlotterer, CPA, is director, tax and business advisory services, at GBQ Partners LLC. Reach him at (614) 947-5296 or firstname.lastname@example.org.
If you own real estate, a cost segregation study is one of the best tools to help you reduce taxes and improve cash flow. Although a cost segregation study will not provide additional tax deductions, it will enable the taxpayer to accelerate a portion of the depreciation on the building, says David R. Walter, CPA, MBA, tax manager at Skoda Minotti.
“Cost segregation is the process of breaking out a portion of a building’s cost that can be depreciated quicker than the standard life of 39 years,” Walter says.
Smart Business spoke with Walter about the benefits of performing a cost segregation study and how doing so can help keep money in your business.
Where should a property owner start when considering a cost segregation study?
The purchase or construction of a building is the starting point for any cost segregation study. Any building is eligible, but the owner must determine if it is cost beneficial to perform a study. Any cost segregation study should start with a cost-free estimate to quantify the potential tax savings from doing the study. These estimates usually do not take a large investment of time, as only a few items of basic information are needed.
How can an owner determine if a cost segregation study is worth the investment?
Most firms that provide cost segregation studies provide a cost-free analysis of the potential tax savings. This analysis gives you a conservative estimate of how much could be saved, the net present value of those savings, and the fee for conducting the study. This allows you to compare the net present value of what you could save, versus what you’re going to pay for the study, allowing you to make an educated decision.
At worst, you’ve invested half an hour to pull together information to get an estimate and see whether it makes sense.
What is the minimum building value at which a study is worth the investment?
There is no true value that answers this question. It depends on the size and type of building. If you’re talking about a traditional warehouse, which is essentially just four walls, $500,000 would be a general rule of thumb. But if you have a specialized facility, that rule of thumb could drop down to $200,000 or $300,000. I tell clients that while these may be general guidelines, because an estimate is free, any building owner should get an estimate to determine if a cost segregation study makes sense.
When should a study be performed?
Ideally in your first year of ownership. The sooner you break down the costs and depreciate them over those shorter depreciation periods, the sooner that you’re going to reap those benefits.
However, it is still worth doing a study even if the building was purchased/constructed in a prior year. With a cost segregation study, you can go back and determine the amount of depreciation that should have been deducted if a study was done at the beginning, and compare that to what actually was deducted. The current IRS rules allow you to deduct, in the year of the study, the difference in depreciation up through that year, thus getting the taxpayer caught up all in one year.
The value of a study is based on the time value of money saved. If you buy a building today, the sooner you get the study completed, the more beneficial it will be.
Are there benefits of performing a study beyond accelerating depreciation?
There may be some potential benefit on the insurance side. With a cost segregation study, you’re detailing the cost basis of the building. With this detailed cost basis, the replacement cost of the property may be better determined, which could lower the insurance premiums on the building.
Is this something building owners can do on their own?
No. The IRS has stated that an engineering-based approach must be used to substantiate the cost breakdown. If the segregation of costs is not supported by an engineer’s report, it will not stand up under audit of the IRS. Although that means investing in a professional, the cost is typically worthwhile when compared to the savings you will realize.
Why should owners pay for a study when they still get those deductions over time without one?
It’s all about timing and the ability to push those deductions into earlier years. From a time value of money standpoint, the sooner a deduction can be taken, the more valuable it is.
If you look at a $1 million building, either way, you’re going to deduct that cost over 39 years, but by moving 25 percent of that million-dollar depreciation into earlier years, for example, you are decreasing your taxes in earlier years and getting that money back in your business sooner.
Everyone needs cash, and one of the best ways to get it is to reduce taxes in earlier years. Most tax planning strategies are based on the deferral of taxes, and that’s what you’re getting here. You’re deferring the taxes for a number of years and using that cash to grow the business.
What role should your CPA play in the process?
As much as this is an engineering approach, there is also a tax side. Your cost segregation study may produce a deduction, but you want to make sure you are working with a knowledgeable CPA to figure out how those tax deductions are going to play into your tax situation.
You don’t want to be in a position where you have paid for the study and then later find out that because of your situation, the deduction didn’t quite work out.
David R. Walter, CPA, MBA, is a tax manager at Skoda Minotti. Reach him at (440) 449-6800 or email@example.com
U.S. companies that export goods can significantly reduce their taxes through use of a federal tax incentive known as the “Interest Charge — Domestic International Sales Corporation” or “IC-DISC.”
IC-DISC provides an incentive to promote the exporting of U.S.-sourced products to customers outside of the United States, says Henry J. Grzes, CPA, director in tax at SS&G.
“Generally, it provides a tax benefit on export-related income,” says Grzes. “There can be two benefits associated with such an entity, one is a permanent tax savings in the sense that income earned by the IC-DISC can be potentially taxed at a lower federal rate than it would have been had it been earned by the operating company. Or, you can use this as a method to defer the payment of taxes, so you can accumulate income in this separate entity without having to immediately pay the taxes due on this particular income.”
Smart Business spoke with Grzes about how an IC-DISC can significantly reduce the amount of taxes your business pays on income earned from exported products.
What types of companies can create an IC-DISC?
The company has to be selling outside the U.S. It can be a manufacturer of goods in the U.S. that is selling overseas, or a distributor that acquires goods from a third party, then resells them to customers outside the U.S.
To qualify, more than 50 percent of the value of your product has to be from goods sourced to the U.S. For example, if a manufacturer’s product sells for $1,000 outside the U.S., and $300 of the cost is related to products imported from outside the U.S., this sale can qualify for IC-DISC benefits because it’s under the 50 percent threshold. This affords you the opportunity to make qualifying sales using some level of imported products.
However, if you are a U.S. distributor with a wholly owned subsidiary in China, you can’t buy items from that related company, then sell them in other countries and still qualify for IC-DISC treatment on these sales.
Also, if your U.S. company sells to an independent third party that uses your product in its products, which are then resold outside the U.S., you may be able to treat these sales as revenue eligible for IC-DISC benefits.
How does an IC-DISC work?
Ordinarily, there is an expense reported by the operating company that can take the form of a commission or a factoring charge on accounts receivable. That amount of expense is reported by the IC-DISC as revenue.
Say your company is taxed at the 35 percent federal corporate rate. If it generates $200,000 of net taxable income, its tax bill would be $70,000. Ordinarily, if this income is kept in that operating company and reported as income, you’d give up $70,000 in cash for taxes. But with the IC-DISC, you get the benefit of $70,000 in tax savings in the company by paying $200,000 in deductible commissions to the IC-DISC, thereby reducing taxable income to zero and completely eliminating the tax that would be due. Taxes don’t have to be paid on revenue earned by the IC-DISC until it is distributed to its owners. Depending on who owns the IC-DISC (often the same individuals who own the operating company), they may be able to take advantage of the 15 percent rate afforded to recipients of qualified dividend income. Even if the operating entity is in a lower tax bracket, individual owners would only owe taxes on distributions from the IC-DISC at a maximum federal rate of 15 percent. However, state taxes are assessed on this income when received by the IC-DISC as well as when the distributions are received by the owners of the IC-DISC.
So if the operating company owes $70,000 in tax on $200,000 of net taxable income, but that revenue goes into the IC-DISC and is distributed to the owners of the IC-DISC, that income would instead be reported on the individual’s tax return. And because it is qualified dividend income, it would be taxed at a maximum rate of 15 percent, or $30,000. You’ve achieved a $70,000 tax savings in the operating company and it has only cost $30,000 to do so, resulting in a net tax benefit of $40,000.
If you use it as a deferral mechanism and choose to leave profits to accumulate in the IC-DISC, you would compute an interest charge on what the tax would be on this revenue, as if the IC-DISC was a taxable entity.
Current IRS interest rates are very low (less than 1 percent per year), so a 1 percent interest rate on $70,000 would be $700 — a very inexpensive way to keep cash in the business.
You only have to pay the interest charge on profits that are not distributed to owners of the IC-DISC. If the profits are all distributed, you are not going to incur that interest charge.
How can a company establish an IC-DISC?
The owners of an IC-DISC must form a regular (Subchapter C) corporation and that entity must make an election to be treated as an IC-DISC on IRS form 4876-A. Next, set up a bank account with a minimum capitalization of $2,500 and issue stock. It is wise to form the corporation in a state with no state corporate income taxes (i.e., Nevada), to maximize tax savings. However, the corporation must be formed and the IC-DISC election must be made before benefits can begin to accrue in the IC-DISC. So unlike other tax benefits, this one is not retroactive to the beginning of the year the IC-DISC was formed. The benefits only start when the entity is in place and the proper paperwork has been filed.
What is the future of IC-DISCs?
With the current economy, IC-DISCs are an incentive for U.S. taxpayers to export products. Anything the U.S. can do to improve its balance of trade and the trade deficit is a positive result. Under the extension of the Bush tax cuts, the 15 percent rate on qualified dividends will last through 2012. No one knows what will happen with that rate after that, or whether IC-DISC dividends will still be considered qualified dividends.
Most experts think that IC-DISC distributions will continue to be treated as qualified dividend income, but the preferential rate may increase. But even with a reduced benefit, IC-DISC owners would still pay tax at lower than the 35 percent corporate rate.
Henry J. Grzes, CPA, is director in tax at SS&G. Reach him at (330) 668-9696 or HGrzes@SSandG.com.
Spending on unemployment compensation is at an all-time high, jumping from approximately $31 billion in 2008 to $120 billion in 2009, $160 billion in 2010 and a projected $120 billion for 2011. Numerous states, including Ohio, have depleted their unemployment compensation trust funds and have had to borrow from the federal government.
“Ohio employers have seen modest increases in their state unemployment taxes over the last few years as automatic triggers kicked in to try to keep the fund solvent. However, the increases just haven’t been enough to stay ahead of the benefits paid out,” says Anthonio C. Fiore, an attorney with Kegler, Brown, Hill & Ritter.
Eventually, the federal government will look to Ohio employers to replenish their fund through higher contributions or taxes. To keep the costs to employers from growing ever higher, Fiore says the state and its employers must work to reform the unemployment compensation system in Ohio and get people re-employed.
Smart Business spoke with Fiore about the tasks at hand.
What is the status of Ohio’s unemployment compensation (UC) trust fund?
Employers pay into both the state and federal unemployment compensation trust funds. Solvency of the state’s UC trust fund had been a growing concern for a number of years, but it finally moved into the red in January 2009. Ohio currently owes the federal government over $2.6 billion for loans from the Federal Unemployment Account (FUA) — commonly referred to as Title XII loans.
How does the situation in Ohio compare to that in other states?
Ohio is in the same boat as many other states. The highest unemployment in nearly three decades is spread across the U.S. and very few counties and states have been immune. State unemployment taxes increased as a percent of total wages on average by 34 percent from 2009 to 2010 and are expected to increase even more for 2011 and 2012.
As of Sept. 1, 2011, 27 states and the Virgin Islands have outstanding federal loans of over $36 billion. The United States Department of Labor (USDOL) projects a peak in 2013 of up to 40 states and $65.2 billion in outstanding loans. Interest on loans is charged at the rate of just over 4 percent for 2011. Approximately $1.7 billion will need to be paid from sources other than the state unemployment insurance (UI) tax — employers in 19 states (not including Ohio) will pay a special assessment to cover this cost. The first interest payment from states is due September 30, 2011, and interest will continue to accrue as long as loans are outstanding.
State and federal unemployment taxes will continue to increase over the next three years and remain at higher rates for at least 10 years on average. Average UI taxes will more than double with some employers experiencing much higher tax increases as a percentage of total wages. Increased taxes will increase the cost of hiring. Increased duration of unemployment compensation will continue to be a disincentive to individuals deciding whether to actively seek and accept work available in the labor market. Relief from automatic Title XII interest and Federal Unemployment Tax Act (FUTA) offset credit penalties is possible only if states, businesses and workers push for them. States with no debt may be less supportive of relief, arguing that they have already addressed solvency and did not get relief.
How long will it take Ohio to get its fund solvent once again?
The goal is not simply to pay back the $2.6 billion to the federal government. The goal is to replenish the fund to what is called ‘minimum safe level’ in order for it to weather future economic downturns. The minimum safe level is around $2.5 billion; therefore the state UI fund is approximately $5 billion away from where it needs to be in the future. It could take three to five years to get the fund back to this level.
How can Ohio get the fund back to solvency?
Obviously, the best case scenario is finding a way to get more individuals employed, so fewer individuals are collecting unemployment. That would help Ohio rebuild the fund the fastest, versus raising employer taxes. In terms of direct costs to companies, businesses can work with third-party claims administrators and/or an attorney to more aggressively manage their claims to eradicate fraudulent claims and overpayments. The state itself is taking numerous proactive efforts and is focusing on ways to reform Ohio’s unemployment compensation system, keep businesses in Ohio, attract new companies to Ohio, and get Ohioans re-employed.
How will developments at the federal level impact Ohio?
Pending legislation (H.R. 1745, also known as the Jobs Act) would reform aspects of the unemployment system. Ohio would benefit from some of the reforms that are being advocated by a broad coalition of national and state business associations. One of these is a requirement that would strengthen job search requirements for those receiving unemployment. In addition, President Obama recently released the ‘American JOBS Act’ with several provisions affecting unemployment compensation. While some provisions of the proposal have merit there is still uncertainty surrounding what price tag will be levied on those who fully fund the system — employers. The current system was developed in the 1930s and was not set up for the situation the country is currently in. Reforms would focus on getting people re-employed faster and into the jobs that are available.
ANTHONIO C. FIORE is an attorney with Kegler, Brown, Hill & Ritter. Reach him at (614) 462-5428 or firstname.lastname@example.org.
With the decline in U.S. real estate markets and challenging economy, a large number of taxpayers continue to negotiate loan modifications to help relieve them of unmanageable debt. The issue of how to correctly report forgiveness of debt for tax purposes will be of importance for the next several years, as the volume of loans modified or canceled by lenders remains historically high, says David Musser, a partner at Nichols Cauley & Associates LLC.
Smart Business spoke with Musser about how to report forgiveness of debt.
How is debt treated for tax purposes?
If debt for which an individual taxpayer is personally liable is canceled or reduced in a loan modification arrangement, it can result in ordinary taxable income. In general, debt for which a taxpayer is personally liable is called recourse debt, while all other debt is nonrecourse.
For instance, in a foreclosure, when a taxpayer owns the property securing a recourse debt, the amount realized by the taxpayer when the property is disposed includes the unpaid amount of the debt, not just the fair market value (FMV) of the collateral. The amount of forgiven debt in excess of the property’s FMV may result in ordinary income in addition to the capital gain or loss measured by the difference between the FMV of the property and its adjusted basis. If the taxpayer owned foreclosed property subject to nonrecourse debt in excess of the FMV, the foreclosure does not result in ordinary cancellation of debt income. Instead, the amount of nonrecourse debt forgiven is treated as an amount realized upon disposition, and the capital gain or loss is measured by the difference between total amount realized and the adjusted basis of the property.
How is taxable canceled debt reported?
When debt is reduced or canceled, the lender typically sends Form 1099–C to the borrower. This form reports the lender’s and borrower’s name, address and taxpayer ID number, the amount and type of debt forgiven, the date of forgiveness, whether the taxpayer is personally liable for repayment, the FMV of foreclosed property that may be involved, interest that may be included in the amount of canceled debt and whether the canceled debt results from bankruptcy. Any taxable canceled debt must be reported as ordinary income on Form 1040, line 21 ‘Other Income,’ if the debt is nonbusiness debt. In addition, nontaxable canceled debt and the resulting reduction of tax attributes must be reported on Form 982, ‘Reduction of Tax Attributes Due to Discharge of Indebtedness.’
Are there exceptions and exclusions?
Yes. For example, cancellation of debt resulting from a gift does not have to be included in taxable income, nor do student loans canceled or reduced as a result of complying with provisions in the loan agreement. Debt canceled in a Title 11 bankruptcy generally does not have to be included. Also excluded is canceled debt to the extent the taxpayer was insolvent. A taxpayer can also elect to exclude income realized from the forgiveness of real property business indebtedness. Qualified real property business indebtedness is debt incurred or assumed in connection with real property used in a trade or business and secured by that real property. The amount of canceled qualified real property business debt a taxpayer can exclude is limited to the amount of outstanding principal immediately before the cancellation that is in excess of the fair market value of the real property securing the debt. The excludable debt cannot be more than the total adjusted basis of depreciable real property held immediately before the cancellation. The calculation of the adjusted basis of the depreciable real property includes any reductions in basis required due to the exclusion of debt canceled under bankruptcy, insolvency, or farm indebtedness provisions.
What are the rules regarding home mortgage debt forgiveness?
With the Mortgage Forgiveness Debt Relief Act of 2007, a taxpayer can exclude income realized for the forgiveness of debt incurred to buy, build, or substantially improve a principal residence. This debt must be secured by the primary residence.
Debt used to refinance the home qualifies, but only to the extent that the principal balance of the old mortgage, immediately before the refinancing, would have qualified. This exclusion applies for qualified principal residence indebtedness forgiven in calendar years 2007 through 2012. The maximum amount that can be excluded is $2 million, or $1 million if married filing separately. The exclusion is claimed by checking box 1e of Form 982 and reporting the corresponding reduction of principal residence basis on Part II, line 10b. This exclusion applies only to forgiven debt realized in a disposition of principal residence, regardless of whether that disposition is the result of a foreclosure or short sale. It does not exclude any capital gain that may be realized. However, this capital gain may be excludable under I.R.C. Sec. 121 that allows a taxpayer to exclude up to $250,000 ($500,000 for joint filers) of capital gain from the sale or exchange of a home used as a principal residence for two of the preceding five years.
How do the rules impact state filings?
In most cases, Georgia conforms to the federal tax treatment of debt forgiveness. Therefore, any federal taxable income that includes or excludes debt cancellation income usually does not require an adjustment on the individual’s Georgia income tax return.
David Musser is a partner at Nichols Cauley & Associates LLC. Reach him at (404) 214-1301 or email@example.com.
Outsourcing accounting services is a proven, cost-effective solution for businesses of all sizes, even those that have dedicated accounting personnel.
It’s a popular trend in the current economy. When companies decide to streamline operations, staff reduction is an obvious consideration. Business owners may figure they can handle cutting checks, or they disperse various accounting responsibilities among managers. But these tasks can be time-consuming and take leaders away from their primary roles.
“In the past few years, companies have reduced their staffs,” says Karen Stern, member in charge of BSW Small Business Services LLC, an affiliate of Brown Smith Wallace LLC in St. Louis, Mo. “Often, they seek to downsize personnel who can only do one job, such as a bookkeeper, who only handles payroll.”
An outside firm can provide a valuable third-party perspective and the experienced, licensed and trained personnel to complete mission-critical tasks. You can outsource payroll, analysis and preparation of special documents such as property tax returns, or any other accounting function.
Smart Business spoke with Stern about what accounting services can be outsourced and how it saves valuable time and money.
What types of companies can benefit by outsourcing the accounting function?
Any company from a mom-and-pop shop to a Fortune 500 corporation can utilize outsourced accounting services. Depending on the size of the company and its accounting workload and demands, a business might decide to leverage a single task, such as payroll, to an accounting/tax services provider. A Fortune 500 company might hire a firm to manage all back office work. Another company might require a professional to analyze its property tax reports.
On the other hand, a business might want the firm to act as the bookkeeper and take on all accounting duties. Keep in mind, firms that provide a full range of accounting services have the ability to look at a company’s financials from a tax perspective, as well.
What types of services can be outsourced?
Any and all accounting services can be outsourced, whether it’s receivables, payables or payroll — anything that is considered a bookkeeping task. And delegating these duties to a professional accounting/tax services firm will not compromise your security. Payroll is password protected, and there is complete anonymity.
Accounts are never discussed outside of the company, nor are they discussed with those inside the company who are not directly involved in those accounting processes.
What are the benefits of outsourcing?
First, there is the time management benefit. For example, in a smaller company, perhaps the owner’s spouse is managing payroll and keeping the books when that person could instead be selling or analyzing financials — responsibilities that are important to the growth of the company. Larger companies can farm out aspects of accounting such as payroll and free up their staff accountants’ workloads.
Second, the outsourced firm performs more efficiently. When a business outsources accounting tasks, the firm taking on those responsibilities does not require benefits or vacation time. The firm won’t call in sick, and there aren’t phone calls to answer, meetings to attend or other distractions.
The ease of transitioning to an outsourced firm is surprising for many clients. A professional accounting/tax services firm can quickly drop in and analyze company financials, clean up books, set up processes and procedures, and train employees to read financial statements.
What is a typical delivery model?
Outsourced services can be provided electronically or in person. Some clients prefer to have professionals in the office physically writing checks and managing other accounting tasks. It’s important for them to have the personal contact. Other clients like the convenience of a professional who works remotely and performs accounting tasks electronically.
These days, it’s easy to outsource services by using cloud computing, where information can be shared in real time. Many clients rely on a combination of personal and electronic services to meet their accounting service needs.
How does outsourced accounting help decrease a company’s risk?
The main risk with accounting services is safeguarding one’s assets. A company is exposed to innumerable risks when there is a single bookkeeper or one back-office clerk who makes all the deposits, writes the checks, pays the bills and reconciles the bank accounts.
These risks can be alleviated by involving a third party, a professional accounting/tax services firm that brings separation of duties to the financial process at the company. Perhaps the payroll clerk still writes checks and makes deposits, and the outsourced firm reconciles bank accounts so there is another party reviewing the work. Or, the outsourced firm might take over the check writing and bank reconciliation, or any combination of duties.
The key is to split those duties so that all of a company’s financial information isn’t managed by one person. For this reason alone, it’s a good idea to include an outside professional in the company’s accounting practices — and the efficiencies and cost savings the company will realize are an added bonus.
Karen Stern, CPA, is member in charge of BSW Small Business Services LLC, an affiliate of Brown Smith Wallace LLC in St. Louis, Mo. Contact her at (314) 983-1204 or firstname.lastname@example.org.