ODR Not Following Their Own Instructions

Well, I survived another brutal tax season, and unfortunately I still have a ton of extended returns to get out in the next week, but the last thing I need is ODR wasting my time with incorrect notices to clients that force me to double and triple check OR PTE calculations.  I had to post this really quick in case there is anyone else out there with this scenario:

• Filed an OR 40P Part-Year Resident return for 2015?
• Was Schedule OR-PTE-PY included?

If both apply to you and you have received a letter from ODR with a proposed refund adjustment, then there is a good chance that their adjustment is incorrect – especially if they are proposing a lower tax amount that is equal to the tax on the OR-PTE-PY form, Section B, line 19a multiplied by your Oregon percentage from Form 40P, line 35.

The OR-PTE-PY is new this year, and the worksheet in Section B can be very confusing the first time through, but the most important thing is the the worksheet already multiplies the tax amounts by the Oregon percentage and the Oregon non-passive percentage, so by the time you get to line 19a, it is already pro-rated.  For this very reason, ODR lists specific instructions below line 19a “Don’t multiply the tax by the Oregon percentage as instructed on line 48 of the Form 40P.” .  However, on the notice I received, they have done just that in their proposed tax number – they have multiplied the amount on line 19a from OR-PTE-PY Section B by the Oregon percentage, which is incorrect.  We had even clearly marked box 47c on Form 40P as they requested, but they still made the error.

The thing that frustrated me is that the return was transmitted on 4/14/16 and they had a letter sent out on 4/22/16, which means a machine is likely kicking these out without any manual review and this could result in a large number of erroneous tax refunds.  This is a waste of everyone’s time and money, and coupled with the disastrous late release of OTTER 2016, I am starting to think Oregon needs to following Intel’s lead and clean house at ODR and OED.

 

 

Minimum Requirements for Accounting Solutions and Software

One of the highlights of my summer was going to the MLS All Star Game and getting to see FC Bayern Munich and many of the German World Cup winners. I enjoyed booing Clint Dempsey and other Seattle Sounders, witnessed “Pepgate”, and don’t forget the amazing assist by Deigo Valeri.

Much like the way FC Bayern Munich has dominated German and European football over the last few years, QuickBooks has long been the top accounting solution for small businesses. It is easy to learn, flexible, and it provides all the features needed for a complete accounting system that works for both the small business owner and their tax preparer. It is by no means a perfect small business accounting solution, as I have a lengthy list of suggestions & complaints for Intuit, but it is the best solution you are going to find for the price.

In recent years, some low-cost, online accounting solutions have emerged to challenge QuickBooks for the sole proprietorship market by offering more simplistic accounting and integration with other online services like Ebay, Etsy, and PayPal. While I am all for simplicity and keeping accounting work efficient, I am strongly against the use of some of these services, as many of them lack basic reporting features that should be part of even the most simplistic accounting system.   To help you avoid these inferior accounting solutions, below are the minimum requirements you should look for before committing to a specific solution.

Balance Sheet Report

If an accounting solution only provides a profit and loss report, you are missing out on crucial accounting information and an important tool that enables you to verify that your accounting records are accurate and complete. In fact, if a balance sheet report is not provided as a standard report, it should be an outright deal-breaker and “go-time” to find a different solution.

A balance sheet report provides the balances of your assets, liabilities and equity as of a specific date. This would include all your bank and credit card accounts, loans, fixed assets and accumulated depreciation accounts, payroll liabilities, and most importantly – your accumulated draws taken from the business. Even if you have a small sole proprietorship, you likely have a number of these accounts, as most business owners use credit cards and PayPal, but even if you only have one bank account and no debt, you still need to be able to generate a balance sheet so that you can see how much net profit you have withdrawn from the business. After all, one of the most difficult issues for a small business owner is determining how much cash needs to be left in the company and how much can be safely withdrawn.

In addition to providing you with account balances and your remaining equity in the company, the balance sheet report is also an important tool, and the document that most CPAs and tax preparers use to confirm that your accounting records are correct. If you have a quality tax preparer, they will take a balance sheet approach when doing the accounting work for your tax return, which means they will reconcile each balance sheet account to third party and other verifiable documents and reclassify any differences to profit and loss accounts. Once all the accounts on the balance sheet are reconciled and tied out, you can be confident the profit and loss is correct. Without the balance sheet, you would not know if changes were made to the prior year, if transactions were missing, or if there were duplications and other errors. Most CPAs and tax preparers require a balance sheet to prepare a tax return – even for sole proprietorships and small LLCS – so do not use a service that does not offer a balance sheet report.

Bank & Credit Card Account Reconciliation

I love technology and the fact that you can save hours of input work by importing transactions from banks right into accounting solutions. Even better, most accounting solutions remember expenses categories for vendors, so the input side of bookkeeping work is becoming easier. However, that doesn’t mean you can neglect basic accounting procedures like reconciling your bank and credit card accounts. It is still the best way to verify that the data in your accounting system matches the bank and that there are no duplications, stale checks, or other input and/or import errors, and your accounting solution should make the process a quick and painless.

Reconciling is the process of matching the individual transactions input and/or imported into the accounting system to a bank statement until the cleared balance in the accounting system matches the ending balance per the bank statement. The reconciliation report is important verification that your accounting records are complete and not missing any transactions, and most CPAs and tax preparers will want a copy when preparing your return, as the IRS’s most effective audit technique is their bank account analysis. Reconciliations also help identify old outstanding checks and duplications and errors that need to be voided. Without reconciliations, there is no guarantee that your accounting records are correct.

The overconfidence in imported data in an accounting system often leads to duplication errors and grossly misstated financial statements, which makes the reconciliation process even more important. Importing works great for straightforward expense transactions, but bank transfers and balance sheet transactions often create problems. Much care needs to be taken when you are reviewing and categorizing the imported transactions, and the accounting solution is not always correct in its categorization. Plus, always keep in mind that only cleared transactions are downloaded and imported – you still have to manually input any transactions that have not cleared the bank, as expenses are deductible when the check is written or charge is made, not when it clears the bank, so do not miss out on tax deductions by taking bookkeeping shortcuts. Take the time each month to reconcile all your bank and credit card accounts and review your outstanding transactions, and you will dramatically improve your accounting records and maximize your tax deductions.

All quality accounting solutions have a reconciliation feature where you can check off each deposit and check/charge as you match them to the bank statement. For example, QuickBooks, has a very easy to understand reconciliation feature that hides all transactions after the statement date, tracks the difference between the cleared balance and the bank statement balance, and allows you to click through to transactions if corrections need to be made. There are accounting solutions out there that do not offer such a feature in the name of “simplicity”, or they have a very limited reconciliation feature – please avoid these solutions at all cost. Reconciliation of bank and credit card accounts is a basic accounting function, and failure to reconcile your accounts each month results in accounting records that are simplistically inaccurate.

Statement of Cash Flows

Like the balance sheet, a statement of cash flows is an essential report that that is a minimum requirement for an accounting system. The report begins where the profit and loss report ends and shows you the inflows and outflows of cash unrelated to income and expenses, which often include loan payments, owner draws, equipment acquisitions, and loan proceeds. Even with a simple business, the statement of cash flows is just as important as the profit and loss report, so make sure an accounting solution offers a cash flow report before deciding on it.

Drill-Down Reporting and Transaction Attachments

The ability click on a transaction and quickly view the transaction is crucial for an accounting solution. As a decision maker reviewing financial statements, you are often looking for variances of concern, and you need to be able to quickly find the reasons for the differences without too many steps. You should also be able to go to the source transaction and related transactions quickly, and have the option to attach pdfs of receipts to the transactions. Make sure you use a sample company in an accounting solution before deciding on purchasing it, as minor issues with drill-down capability can cause major aggravation and waste time you could spend growing your business.

Reporting for All Entity Types

An accounting solution should have flexibility for future growth and not be limited to a specific business entity type like a sole proprietorship or simple LLC. Granted, a simplistic accounting solution may sound great for your small Schedule C business, but what about a few years later when you are looking to elect to be taxed as an S corporation? Are you going to wish you had just gone with QuickBooks so you do not have to deal with the hassle of a software migration? Businesses can grow quickly, and you need an accounting solution that is flexible enough to handle any changes. I spend much of my time assisting business owners with changes to their business structure – everything from adding new owners to converting to an LLC or S Corporation for tax savings purposes, and these changes are complex enough without having to worry about accounting software, so make sure you think long range before deciding on an accounting solution.

There you have it – my minimum requirements for an accounting solution. I am sure there are many more, so feel free to share. Also, if you have any bad experiences with particular solutions, please share with my readers. My parting advice (in case you missed my not so subtle hints)– steer clear of accounting solutions offered by web hosting companies. They are outright horrible.

Partnership Late Filing Penalty – Rev Proc 84-35 and TEFRA

I have written two prior posts on this issue, and there has been a lot of discussion and important contributions from readers, so I wanted to compile all the information in one post.

The Basics:

Partnerships and entities taxed as partnerships (LLC, LLP, etc) are required to file annual returns by 4/15.  A five month extension is available, making the final deadline 9/15.  Strict penalties are assessed by the IRS if you file late.

The penalty is currently $195 “per partner, per month” that the return is late.  This can add up really fast, and average late filing penalties result in several thousand dollars of non-deductible fees that the IRS is making more and more difficult to get removed.

It does not matter if your business taxed as a partnership did not make any money or never really took off – if you registered for an EIN# or have filed previous returns, you need to follow through and returns annually.  The IRS is not going to listen to they type of excuses.

Abatement Option #1 – Rev Proc 84-35

If the partners or LLC/LLP members filed their personal returns timely (4/15 or extended and filed by 10/15), then you may have a get out jail card that has been available for over a decade now and provides automatic penalty abatement.

Here is the complete list of factors:

• The partnership has to be a domestic partnership,
• have 10 or fewer partners (husband and wife and their estate are treated as one partner),
• all partners have to be natural persons (other than a nonresident alien) or an estate of a deceased partner,
• each partner’s share of each partnership item has to be the same as their share of every other item,
• all partners need to have timely filed their income tax returns, and
• all the partners need to have fully reported their share of the income, deductions, and credits of the partnership on their timely filed income tax returns.

If you meet all these requirements, your first response to a partnership late filing penalty letter from the IRS needs to look like this sample letter.

Now, it seems the IRS has grown tired of Rev Proc 84-35 abatement requests, as they have been trying to shift the discussion of penalty abatement to “reasonable cause”.  Do not let them do this!  Rev Proc 84-35 is available if you meet the criteria.  Even if you have claimed it several years, do not let them try to claim that they cannot abate the penalty or get you side-tracked with a reasonable cause argument – stick to citing Rev Proc 84-35 until you get your abatement.

Important!  This does not work for S corporations and LLCs taxed as S corporations.  A similar Rev Proc for automatic abatement was unfortunately never created for them.  For more information, read my post on S corp late filing abatement.

Abatement Option #2 – The TEFRA Complication

A few years ago, the IRS was looking to raise revenue (they have lavish parties in Disneyland to pay for) and employed a new tactic to reduce partnership late filing penalty abatements.  They found that if a partnership had filed a TEFRA election, that they would not be eligible to use Rev Proc 84-35 to request abatement.  Suddenly, many CPAs who submitted standard Rev Proc 84-35 abatement requests were receiving denials with the IRS claiming the client had filed a TEFRA election.

For all the background on this complication, read my penalty update blog post, but the short story is that the IRS would claim the election was filed clear back in 2002 or earlier, and the client had to dig up a copy of the tax return to prove the election was not made or put together a letter – signed by all partners/members – stating that a TEFRA election had never been filed.  Even then, it often took many letters back and forth or messages on the now defunct IRS eServices resolution service.

I have personally dealt with this issue several times and was able to get abatement in each case; however, I have not had to deal with it in over a year.  Fortunately, some PDXCPA blog readers have had some more current experience, and there was really good information shared in the comments section of the prior posts.  Specifically, Melissa F. Hill, CPA provided a sample abatement letter and backup documentation that became a popular request on this blog.  The documents she has been emailing to readers are available below:

• Sample abatement letter – TEFRA and Rev Proc 84-35
• TEFRA Election Memorandum
• Rev Proc 84-35 Memorandum

I like Melissa’s sample letter, as that is how you should frame you argument – cite Rev Proc 84-35 and then maintain that a TEFRA election was never filed and request they provide their proof of the election.  A letter signed by all partners maintaining that the election has never been filed helps as well.

Sometimes they will respond with a tax year that they claim the TEFRA election was made in, but then they will claim that it will take them awhile to get a copy from archives.  If you are organized and have a copy of the return, send them a copy and continue to maintain your assertion that the election was not filed and that Rev Proc 84-35 should apply.  You may have to be persistent and put up a strong fight for abatement, but keep trying and do not let them bring up reasonable cause.

Good luck!

Original post 1/5/09 – https://pdxcpa.wordpress.com/2009/01/05/partnership-late-filing-penalty-abatement/

Update post on TEFRA 10/1/12 – https://pdxcpa.wordpress.com/2012/10/01/partnership-late-filing-penalty-update/

S Corporation Shareholder Health Insurance – 2013 Update

I wrote about about the reporting of health insurance for more than 2% shareholders last November and provided an excerpt from my book on the subject, but for 2013, this issue is even more crucial because of several tax changes.  As a more than 2% S Corporation shareholder, your total health and dental insurance premiums for the year need to reimbursed (if not paid directly) by the corporation and included on your W-2.  If this is not done correctly, you are technically not allowed to claim the self-employed health insurance deduction on your individual tax return, and instead you have to claim the deduction on Schedule A.  This treatment has never been desirable because of limitations on Schedule A, but for 2013 the limitations have been increased.  First, the medical expenses floor has increased to 10% (up from 7.5%), which means you only get a deduction for the amount of expenses that exceed 10% of your adjusted gross income.  Secondly, the itemized deduction phase-out (Pease limitation) is back for 2013 for higher income taxpayers, so even if your medical expenses exceed the 10% floor, you could encounter further limitation.  Overall, the difference between a self-employed health insurance deduction and a very limited deduction on Schedule A can translate to thousands of dollars in taxes for a shareholder, and all because of a minor reporting error.

Here is what you need to do before year-end:

• Calculate total health and dental insurance premiums for the year for each >2% shareholder (including premiums that will be paid before year-end).
• Make sure the premiums have been paid or reimbursed by the S Corporation.
• If amounts were deducted from a >2% shareholder’s wages for a portion of their health or dental insurance, contact your CPA or tax preparer, as adjustments will need to be made.  These deductions should not have been made, so immediate modifications will need to be made to your payroll processing.
• Contact your payroll processor to have the total 2013 health/dental insurance amount added to your W-2 BEFORE the last pay date in the calendar year.  Also, have them coordinate with your CPA or tax preparer to make sure it is reported correctly.
• If you self-prepare payroll through QuickBooks, I recommend this resource for recording the insurance amount properly.

I strongly recommend putting this at the top of your to-do list for December, as it can be very costly to amend W-2s and federal and state payroll tax filings after their due dates.

If you are in the Portland metro area and need assistance with this issue, you can reach me at brian@pandgcpa.com or 503.244.8844.

The Minority Owner Report, Part 1- LLCs and Partnerships

I am by no means a “precog”, nor can always predict when minority ownership in a small business will result in disaster, but my 14 years of experience with small business clients has taught me a great deal about what not to do when structuring a business and offering ownership to employees.

If you are currently a minority owner (<50% interest) in an LLC taxed as a partnership or a traditional partnership, or you are being offered such ownership, you may want to consider running away from the ownership if certain warning signs are present.  Also, I highly recommend having your tax professional and/or lawyer look everything over before you sign anything.  Business ownership is a lot like marriage, so know what you are getting into.

Minority Ownership Warning Signs in LLCs and Partnerships

The entity does not increase guaranteed payments by 5% to cover self-employment tax

When an employee becomes a partner or LLC member, their tax burden increases substantially because of the self-employment tax.  Generally, an employee pays social security and Medicare tax of 7.65% on gross wages, and the employer pays another 7.65%.  However, an active partner or LLC member is considered self-employed and has to pay both the employee and employer portions of social security and Medicare tax, which total 15.3%.  Fortunately, the IRS allows a deduction for one half of the self-employment taxes paid (just like the deduction available to employers), which results in an approximate net rate of 12%.  This means that a employee who becomes a partner or LLC member will incur a tax increase of approximately 5%.

Most companies do the right thing and give an employee transitioning to ownership enough additional income to cover this 5% tax increase.  The most effective means of doing this is to provide the additional income to the new partner or LLC member in the form of an increase to their regular guaranteed payment.  Employees are accustomed to predictable cash flow and regular tax withholdings, so the transition to making quarterly estimated tax payments at a higher tax rate can be difficult.  Additional income that is guaranteed and paid on a regular basis is going to ease that transition and insure that there is a tangible benefit to ownership.

Unfortunately, a surprising number of partnerships and LLCs do not provide additional income to employees transitioning to minority ownership, and often it can result in ownership that is actually a detriment to them as a result of the additional tax.  Usually, future profits are promised when selling ownership to the employees, and in some businesses, this works very well when consistent profits easily eclipse the 5% tax burden.  However, taxable business profits can be very unpredictable due to current accelerated tax depreciation rules and other complications, and in order to distribute profits during the year when they are helpful to the owners, a business has to keep very accurate accounting records.  Owners have to pay estimated tax payments quarterly, so the unpredictability of having to rely on distributions of profits can create a lot of dissension among owners – especially during periods of low profits or losses.  The sad irony for these businesses who are unwilling to pay the additional 5% in income to partners/LLC members is that they often make ownership offers to employees for the sole purpose of keeping them at the company, and often the tax burden on the new owners does the exact opposite after several years of seeing no benefit to ownership.

The entity is providing capital interest ownership in exchange for services

Giving ownership to an employee in exchange for services can actually work very well if structured correctly and all parties are properly informed of the tax ramifications.  However, ideal situations like this rarely happen in the real world, and usually such an arrangement results in a surprise tax bill for the employee receiving ownership.  Avoiding such a disaster requires an understanding of the most common types of interests available in small business organized as LLCs.

Capital Interest – this is the default type of LLC interest, as it is a complete ownership that entitles the holder to a share of profits and losses as well as a share of the proceeds from the sale of the LLC’s assets if the LLC liquidates.  A capital interest is most commonly given to employees brought on for succession planning purposes.

Profits Interest – this interest is like the capital interest, except a profit interest holder does not receive liquidating distributions from the LLC.  In other words, it is only an interest in future profits of the LLC and there is no initial capital balance for the member.  A profits interest is often given to key employees much like stock options are given to employees of corporations.  It is often intended as a form of additional compensation and a method to retain key personnel.

If you receive a capital interest in exchange for services, it is treated as current compensation in an amount equal to the fair market value of the capital interest at the grant date.  The problem is that most small businesses owners organized as LLCs are not aware of this, and rarely do they tell their CPA about such transactions in advance, so it often becomes an ugly year-end or tax-time surprise for the recipient, as they have taxable income to recognize and no cash to pay the tax with.  To make matters worse, most small business owners have no idea what the fair market value of their LLC is, so the transaction becomes very complex can create many problems down the road if not done correctly.  As an employee being offered such an interest, I strongly recommend asking the LLC to involve their CPA and/or lawyer so that the compensation is determined ahead of time.  This will allow you plan accordingly and look into options like the 754 election that can minimize the tax impact.

If you are granted a profits interest in an LLC, no taxable income is recognized as long as the interest satisfies the Revenue Procedure 93-27 safe harbor rules.  Most LLCs that offer a profits interest have already had a CPA and/or lawyer setup it up so that the rules are met, so in most cases it is a good deal for the employee receiving the interest.  However, it is important to get some prior financial statements and/or tax returns so that you can know what to expect, as sometimes start-ups give profit interests and then go several years without any recognized profit.

The entity does not have a method of equalizing expenses

Single-owner businesses have it very easy in the area of expenses, as they can spend how they want without having to justify to other owners or worry about trying to keep things equal.  In multi-owner businesses, there is a constant problem with equalization, as business partners are usually wired differently when it comes to spending and often have different tastes.  One LLC member may be tech savvy with smart phones and tablets and another may still prefer a flip phone and a paper legal pad, so it is crucial for a minority owner that an LLC or partnership have an established method of expense equalization in place.

The most flexible method of expense equalization is to have the operating agreement specifically state that the LLC or partnership will not reimburse partners for certain expenses and that they are required to pay for these expenses.  As long as it is properly setup in this way, each partner or member can deduct their unreimbursed partnership expenses on their own 1040 tax return on Schedule E page 2.  This allows each partner or member to be as lavish or frugal as they want without having to worry about the expenses of the other owners.  Often, meals and entertainment, automobile, travel, and office expenses are treated in this fashion.

The second best method is devising a special allocation where certain expenses are allocated 100% to certain owners against their guaranteed payments.  This can be elaborate or just a simple calculation done with the tax return preparation, but either way – LLCs and partnerships are extremely flexible in this area.  Just make sure the allocation is decided on well in advance, as it is much more difficult to agree on after expenses have already been paid.

That’s it for LLCs and partnerships.  In Part 2, I will concentrate on minority ownership issues in S corporations.

The Pocket Small Business Owner’s Guide Series Expands

Last October, my book – The Pocket Small Business Owner’s Guide to Taxes – was published by AllWorth Press and became part of a series of books for business owners.  The Pocket Small Business Owner’s Guide books cover such topics as negotiating, buidling your business, and business plans, and today a new title has been added to the series: The Pocket Small Business Owner’s Guide to Starting Your Business on a Shoestring by Carol Tice.

Also known as the Shoestring Startup Guide, the book definitely looks like a great resource for anyone considering starting a new small business.  I meet with new business owners all the time, and unfortunately I see a lot of new businesses run into early cash flow problems or even fail, so there is a definite need for practical money-saving advice for small business owners.

If you buy the book in July, you get a free Shoestring Startup Guide workbook that provides checklists that can be used to brainstorm money-saving opportunities for your business.  Also, you can enter to win a copy of the book on Goodreads.

Manual Review: Oregon Department of Revenue’s Refund Delay Tactic?

If you have an overpayment of over $5,000 on your Oregon tax return, be forewarned – the Oregon Department of Revenue may sit on your refund for up to six months while they “manually review” your return.

In the last year, we have witnessed a sharp increase in the number of clients who had their refund delayed by ODR.  The only common factor we can find is that they all had large overpayments.  In each case, the return was selected for “manual review”, and after weeks and sometimes months of waiting, ODR asks for something as simple as copies of the W-2s (which they should already have since employers are now required to efile W-2s to Oregon).  Even after you supply them with copies of the W-2s, the manual review and refund can often take weeks to process.  Even worse, when you call them, they offer very little information into why the manual review was triggered in the first place and cite their “policies” without letting you speak to a manager.

If I had to venture a guess as to the reason for these delays, I would point to the embarrassing $2.1 million dollar refund error that ODR made last year.  In fact, soon after that error is when our clients started encountering these manual review delays.  Could overreaction be the cause of these delays, or are they simply a fumbling bureaucracy that cannot process refunds in a reasonable period of time?

You can draw your own conclusion, but what I do know is that I am changing my tactics when I have a client with a large Oregon overpayment.  From now on, I am applying the entire overpayment to the next year and then the client can just pay less in estimates during the year.  That way, ODR can take an entire year manually reviewing the return to their hearts content and it will not delay refunds for my clients.

If your 2012 return has been selected for manual review, I would love to hear from you.  There is little advice I can give you other than calling ODR every other day, but the more taxpayers voicing concern about this, the better.  This needs to be given proper attention, as ODR is wasting the time and money of honest Oregon taxpayers and small business owners.

Business Provisions of the American Taxpayer Relief Act

While a good majority of the tax changes in the 11th hour Fiscal Cliff bill (American Taxpayer Relief Act of 2012) concern individual taxes, there are a few changes for small business owners, which are mostly centered around the extension of and retroactive change to depreciation limits and rules.

Section 179 Depreciation Limit

In 2011, we had a $500k limit on the amount that could be taken as Section 179 depreciation expense (provided the business purchased less than $2 million in qualifying property in the year).  This limit was very generous and few small businesses had to worry about getting close to this limit.  However, in 2012 the limit was scheduled to be reduced to $139k (after inflation adjustments), and then even further reduction to $25k in 2013.  For small businesses that acquire a lot of equipment each year, such large limit reductions would have a big impact.

All of 2012, we were unsure if Congress would increase the Section 179 limit, and finally after the ball dropped in Times Square and many of us had resigned ourselves to the 139k limit, our bickering government representatives finally get it together and decided to make a retroactive change to the 2012 limit.  Now, it is as if the the treat of the $139k limit never existed, and we now have a $500k limit for 2012 and 2013.

Now, correct me if I am wrong, but I thought the purpose the Section 179 depreciation benefit was to encourage business owners to buy more business equipment and help spur economic growth?  How are we suppose buy equipment when our government does not decide on the depreciation limit until after the year is over?  I had several clients that typically buy more than $139k in equipment that were trying to make purchase decisions at year-end, and the delay caused by partisan politics in Washington on this limit was extremely frustrating.

Bonus Depreciation Kept Alive

Is bonus depreciation ever going to truly go away?  It seems it is always brought back by 11th hour legislation.  Unfortunately, this time around we only have 50% bonus depreciation that is extended through 2013.  While businesses with net taxable income will use Section 179 depreciation, bonus could be useful for those with losses.

In 2011, we were spoiled with 100% bonus depreciation, and we pretty much wrote off everything in the first year that qualified.  Now we are going to be a little more limited, but it is still a good benefit if you remember back to years before bonus was available.  At best, it provides a great first year deduction for those of you who purchased new vehicles weighing less than 6,000 GVW.  Even with 50% bonus depreciation, you are still going to get $11,160 in depreciation in the first year ($11,360 if a light van or truck) given that most new vehicles are well over $22,320 these days.  Remember, it has to be a brand new.  Certified new does not qualify.

Qualified Leasehold Improvement Retroactive Change

Even though this one will greatly benefit my calendar year filing businesses, it frustrates me to no end that Congress would make this change retroactive to 2012.  Not only did it make one paragraph from my book obsolete, but we are going to have to file several amendments for our fiscal year corporations that have already filed tax returns with qualified leasehold improvements put into use after 1/1/12.

To fully understand my frustration, you need the background history on this tax deduction:

• In 2011 (and several years prior) you could depreciate qualifying leasehold improvements over 15 years and then use Section 179 or bonus depreciation on the improvements.
• Before this rule, we had to depreciate them over 39 years, so this was a BIG benefit.
• Due to the patchwork of tax code in the last few years, the special treatment expired as of 1/1/12, and qualified leasehold improvements could no longer be depreciated over 15 years.
• Even worse, if you had any 179 carryover originating from qualified leasehold improvements at that point, you had to reclassify the amount (according to steps in Sec 179(f)(4)) and depreciate it under the 2012 rules over 39 years.  Reporting this adjustment was a bit complicated since the IRS did really anticipate the expiration of the tax rules, so not only was it a lost benefit, but it cost fiscal year small businesses more in tax prep fees.
• Fortunately, there was some saving grace in that the qualifying improvements still qualified for bonus depreciation (since the availability of bonus treatment was not based on the 15 year life), so we were able to take 50% bonus depreciation, but the rest went over 39 years.

Now, fast forward a few months after these fiscal year returns have been filed to when we are all enjoying New Years and watching football (or soccer in my case).  Our government officials, in all their wisdom, decide to retroactively change the 2012 rules and make the 15 year special treatment available again.  In addition, they extend it to 2013 as well, so it is as if the rules we used during 2012 for fiscal year filers never existed.

Again, if you are a calender year filer and you made or are looking to make some leasehold improvements that qualify for the 15 year treatment, this is very welcome news.  However, if you are a fiscal year filing corporation, your CPA may need to file amendments for you once the tax preparation software companies update their software for all the Fiscal Cliff bill changes.

By the way, if you bought my book and would like more information on this change, please feel free to email me at pdxcpa@gmx.com.  Again, it only changes one paragraph in the Fixed Assets chapter, but I would be happy to provide additional details on this change for my readers.

Other Extenders

In addition to the depreciation changes and the retroactive change that has me all riled up (much like the Cascadian supporter groups are at Don Garber), there were also some minor extensions that will benefit a select group of small businesses.  The Research and Work Opportunity Tax Credits were both extended through 2013.  The enhanced charitable deduction for contributions of food inventory is also extend through 2013, as is the special treatment of qualified small business stock.

All in all, there was not much change for businesses; however, we will likely see more substantial changes later in the year.  You may say I am a dreamer, but I am thinking we may actually see some comprehensive tax reform this year.

Avoid Fiscal Cliff Panic

As you can imagine, I have heard a lot of panic from clients since the election results came in last month.  Some panic is warranted, as most acknowledge that the 2% payroll tax reduction will not be extended, capital gains will likely be increased to 20% or 25% at most, and that tax rates will likely be increased for married couples with AGI over $250k.  However, when it comes to capital gains, panic can actually be very detrimental and cost you much more in taxes than you would think.

Naturally, you would assume accelerating a large capital gains to take advantage of the 15% rate would result in large tax savings, but unfortunately the alternative minimum tax erodes the tax savings if you are a high-income taxpayer.  In fact, most of the time it results in an overall tax rate between 20% and 25%.  Why this happens is very complex and even CPAs get frustrated in fully understanding the alternative minimum tax, but here is the best explanation I could find.  Basically, if a large amount of your income is long-term capital gain income and you are a high-income taxpayer, the AMT tax can kick in and erase the benefit of the 15% rate.  We witnessed this quite a bit back in 2010 when financial advisers worried about the expiration of the 15% rate and advised their clients to sell off their low basis stock.  It sounded like a great idea at the time, but when preparing the tax returns in 2011, many were surprised at how AMT tax erased much of the benefit.  Well, the same thing can happen for tax year 2012 if you give in to panic.

Before you make any big moves on capital gains before year-end, talk to your CPA and and have them run a projection to see what the true impact would be.  It may just be that there is no need to panic.

Reporting Health Insurance for S Corporation Shareholders

NEW! 2013 Update Post 

The following is an excerpt from my book, The Pocket Small Business Owner’s Guide to Taxes, and is important information for S corporation shareholders as 2012 is starting to wind-down.  This is especially important if you use a payroll processing company, as they will need to include your health & dental insurance on your last payroll run.  This is a time-sensitive matter, and failure to report your premiums correctly can be a very costly mistake.

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The reporting of health insurance premiums for a more than 2 percent S corporation shareholder can be a little confusing; however, it is crucial that it is reported correctly if you want to maximize your deduction. If you miss a few simple steps before the end of the year, you could end up limiting or losing your deduction all together.

The self-employed health insurance deduction allows self-employed individuals to deduct their health insurance premiums on the front of the 1040 as an adjustment against income. Even though an S corporation shareholder is not technically self-employed, the IRS requires a more than 2 percent S corporation shareholder to report the deduction as if they were self-employed and not on the S corporation return.

Simple Steps to Maximize Your Deduction

Below are the steps that have to be taken in order to get the self-employed health insurance deduction. Make sure you follow them closely as an error can result in the loss of substantial tax savings.

• An S corporation cannot deduct health, dental, and other medical premiums for a shareholder who owns more than 2 percent. Their premiums should be tracked separately in the accounting system throughout the year.
• If the corporation did not pay the premiums during the year, make sure the corporation reimburses them before the end of the year.
• Before the final payroll run of the year, calculate the total shareholder health, dental, and other medical insurance premiums paid or reimbursed by the corporation as this figure will be needed for the final payroll and the shareholder’s W-2.
• The amount of premiums for the year is paid to shareholder as payroll, but there is special payroll tax treatment for this payment. The amount is subject to Federal and State withholding, but it is not subject to social security or Medicare tax. If you use a payroll service, they will have a pay item for this specific payment.
• On the W-2, the amount of the premiums is recorded in box 1 wages, in the state wages, and in box 14 as “S/H Health Ins” or a similar description.
• Finally, on the shareholder’s individual tax return, make sure the amount of shareholder health insurance is deducted as self-employed health insurance on the front of Form 1040.

The end result is that the payroll payment for the premiums is deducted as a wage on the corporation return, the wage is taxed as income on the individual return, and the self-employed health insurance deduction is taken on the personal return, which all nets out to a deduction in the amount of the premiums. This may seem like a whole lot of unnecessary paperwork, but it is much better than the treatment that results if you do not follow these steps.

Tax Consequences of Incorrect Reporting

If a more than 2 percent shareholder fails to include their health insurance premiums on their W-2, technically the IRS will not allow the self-employed health insurance deduction on the individual return, and the shareholder would have to claim the premiums as a medical expense on Schedule A, which unfortunately is subject to a haircut of 7.5% of adjusted gross income (10% starting in 2013). This means that your deduction is reduced by an amount equal to 7.5% of your adjusted gross income, and if there is anything left then you get a deduction for the remaining amount. If you run the numbers, this is huge loss of deduction and a horrible penalty for not following the IRS rules.

Given the high cost of health insurance premiums these days, it is very important that you make sure and follow the steps listed above each year. Have your tax professional help you and do not wait until tax time as amended W-2s can be costly to prepare.

For more S corporation shareholder tax advice like this, refer to Chapter 9 in my book.