Resolve to Get the Most Out of Your Tax Return Preparer in 2012 Part I

2011 is drawing to a close and taxpayers will soon begin to receive 2011 W-2s, 1099s, 1098s and other tax forms in the mail.  In order to get the most out of your tax return preparer in 2012, ask yourself the following questions:

• Am I using the right tax professional?
• How will I know I have all the 2011 information required to prepare my return?
• Why is providing complete tax 2011 return information important?
• How should I organize my 2011 tax return information?
• Why is organizing my 2011 tax return information important?
• When should I give my preparer my 2011 tax return information?

This blog post will help you answer the first three questions.  My next blog post will help you answer the last three questions.

Are you using the right tax professional?
First, be sure you’re using the right tax professional.  Among other reasons, as tax returns have gotten more complex, the number of incorrectly prepared returns has sky-rocketed.  Last year, the GAO released a study of S corporation returns prepared by paid preparers, which found 71% to be “non-compliant.”  Remember, you are legally responsible for what’s on your tax return no matter who prepares it, so consider the following when considering a tax professional:

• A paid preparer is required by law to sign the return.
• Avoid preparers who claim they can get you a larger refund.  If your return is prepared correctly, every preparer should derive similar numbers.
• Beware of preparers who base fees on a percentage of the refund.  The IRS prohibits charging a contingent fee for preparing an original tax return.
• Reputable preparers will ask you questions about and request support for income, exemptions, deductions credits and payments.  Doing so helps you avoid penalties, interest or additional taxes that could result from an IRS examination.
• Choose a preparer you will communicate and work with you throughout the year, and not just during tax season.  Ask who will actually prepare the return and who will review it before engaging services.  You should know exactly who works with your tax matters at all times and how to contact him or her.  Determine if the preparer is exporting your return to a foreign country for preparation.  Believe it or not, many firms—even CPA firms—have been doing that for years.  Foreign countries do not have the same security and privacy laws as the United States nor is there any recourse should your information be compromised as a result of lax or nonexistent privacy procedures.
• Check the preparer’s record at the Better Business Bureau.
• If the preparer is a CPA, check his or her status and record at the state’s board of accountancy.  There are tax preparers who call themselves CPAs falsely.
• Use a tax preparer who is a CPA, attorney or Enrolled Agent (EA).  Regulation of tax return preparers is lax, and virtually anyone can charge a fee to prepare a tax return.  Until recently, California and Oregon were the only states to regulate tax preparers, and the IRS only had jurisdiction over the person who signed the return.  CPAs, attorneys and EAs are regulated by the IRS, and are the only preparers who may represent you before the IRS in the event of an audit.  CPAs and attorneys are also regulated by the states and their professional organizations.
• Find out if the preparer is affiliated with a professional organization, such as the American Institute of Certified Public Accountants, American Bar Association, or National Association of Enrolled Agents, that requires its members to pursue continuing education and holds them accountable to professional and ethical standards.
• Be very skeptical of preparer who offer “refund anticipation loans,” “audit insurance,” “tax shelters” or other ancillary products.  The conflict of interest in these cases is obvious, but many people overlook this.
• Check IRS.gov for information regarding abusive shelters and other tax schemes and scams.  Remember, if it sounds too good to be true, chances are it is.

How will you know you have all the 2011 information required to prepare your return?
Next, start compiling the tax information your tax return preparer will need to prepare your 2011 return.  If you haven’t done so already, make sure anyone who may mail you 2011 tax documents has your current address.  Open all your mail promptly—Routine looking envelopes from banks, brokerage houses or other sources may contain important 2011 tax documents.  If you receive bank, brokerage or other statements electronically, now is the time to start checking your accounts for electronic versions of 2011 tax forms.  Don’t forget to check your spam folder.

How will you know when you have all of the 2011 tax information your tax return preparer will need to prepare your return?  Most tax professionals mail each of their individual income tax clients a tax “organizer” based on the prior year return.  The organizer will categorize your income, exemption, deduction, credit and payment amounts from 2010.  If nothing has changed, significantly from last year your 2011 items and amounts should be similar.  If something has changed, make sure your tax return preparer knows the details.

If you don’t receive an organizer, ask your tax return preparer for one.  If you are a new client, your tax return preparer can enter your 2010 return into his or her tax preparation application and print an organizer for you.  If all else fails, you can use your 2010 tax return as a guide.

As soon as you think you have all the information required to prepare your tax return, organize it (see below) and send it to your tax return preparer.  Your preparer should compare your current year information to the information you provided the prior year and question any significant differences.  Between the two of you, you should be able to ensure the information is complete.

Stay tuned!  My next blog post will discuss why it’s important to provide all your tax return information at once, if possible.  I’ll also discuss organizing your tax return information and why doing so is important, and why it is important to get your tax return information to your tax return preparer as early as possible.

-Dante

Goodbye to 2011 – We Won’t Miss You (we hope!)

As we come to the end of 2011, most of our clients are of the opinion that this particular year can’t end too soon.  Though there are some “signs of life” in a number of sectors of the economy, and some of our clients are beginning to see at least some return of economic growth, the year has produced wide variations in month to month activity, demand is still uncertain, and the overall economic climate remains extremely tenuous.  It’s true that 2011 was, for most clients, better than 2010, but that’s definitely a low hurdle to compare with.  In fact, I think the old saying that fits best here is, “…damning with faint praise.”  Faint indeed.

The real question, however, is whether or not businesses in the industries we serve can expect 2012 to be much better.  Unfortunately, no one really knows the answer.  It is true that recent economic activity reports seem to be improving, there has been a slight down-tick in the unemployment rate (at least nationally) and there does not seem to be much inflation on the horizon.  However, business and consumer confidence indicators continue to be shaky, at best.  In the long run, when it comes to economic activity, perception has a tendency to become reality.  If people don’t think things are getting better, they will make choices that will result in things not getting better.  And right now, we don’t see a whole lot of reason to be positive, based on that.

In a recent report, Wells Fargo cited three major concerns regarding how quickly we can expect the recovery to really kick in:

• First, the recession exposed the credit dependency of many U.S. households, which, after a rapid decline in wealth caused by the crash in housing values, have realized the need to adjust current consumption more in line with current income.
• Second, housing, one of the major drivers in the economy for half a century, cannot be counted upon to drive economic growth the same way it has in previous cycles; demand has fallen because there is a downside risk to wealth from unstable housing prices, and mortgage lending has become much more difficult to obtain.
• Third, the slower pace of economic growth seen in this recovery will limit state and local government revenues and make it difficult to cover the spending promises of prior generations.

These all affect the willingness of consumers to begin spending again, even if they are employed.  But what about the unemployed?  We think this may be at least as big a problem as those above, and will likely slow down any recovery for some time.  The fact is that for many people currently out of work, they have not received the training or the education to compete successfully for jobs in the economy of today.  Simply ask most hiring managers how easy it has been to fill job openings in the past six months.  Our clients are constantly telling us that in spite of high rates of unemployment, finding qualified applicants is a real challenge.  And the continued high unemployment rate is just another drag on our economy.

What does all of this mean for our clients in the business community?  I believe that the following are all important considerations for any owner or manager for the next few years.

• First, avoid being overly pessimistic or optimistic.  The truth is that though overall the economy has problems, individual companies will thrive even during these times.  And even those companies that may not thrive all the time will find opportunities that they need to be prepared to take advantage of.  This means staying very close to your markets and engaged with your customers more intensely than ever before.  It doesn’t matter what the economists or the politicians say about the economy; what matters is what your customers are saying.  Listen to them and make sure all of your employees are doing the same.
• It’s always good advice to avoid unnecessary borrowings, but now more than ever, companies should be extremely careful about incurring additional debt.  While intelligent borrowing can be a real benefit to any company, it’s important to carefully examine each and every assumption that any new loans are based on.  For instance, borrowing in order to expand capacity has to be critically reviewed in terms of whether or not there will be real demand for the new capacity.  The days of “if you build it, they (the customers) will come” are long gone…if they ever actually existed to begin with.
• Develop and have available for rapid implementation “contingency plans” to allow your business to deal with a sudden downturn in the economy.  We’ve seen already what can happen to companies that don’t do this.  When the economy moves, the companies that will do the best are the ones that are most prepared.  Don’t wait until the storm hits to buy rain gear!
• Be prepared to accept the fact, no matter how unpleasant it may be, that when the economy is not strong, prices suffer.  You have to be able to accept the prices the market is willing to pay for your product or services, not bemoan the fact that your costs tell you that those prices are too low.  When the market cost for your product is lower than your costs, you can’t change the market, but you can at least consider changing your costs.  Focus on what you can change, not what you can’t.
• Finally, focus on the real inner strengths of your business.  Even in the worst of times, companies that focus on the things they do best will experience demand for their products or services.  Understand what your real strengths are, and be ready to play to those strengths.

Of course, 2012 may be a breakout year for the economy, but at this point, betting on that could be dangerous.  We recommend that you prepare for more of what we’ve had over the past 12 to 18 months for at least another year.  We have no doubt that the US economy will come back strong as ever.  The trick is to be able to take advantage of it when it does.

-Gerry

Don’t Look This Gift Horse in the Mouth

Joel Henley’s November 9 blog post—”How to give it away, without really giving it away?”—introduced the unified credit against estate and gift tax, which excludes up to $5 million of the taxpayers estate and lifetime gifts from tax in 2011 and 2012, and the opportunity it presents.  This post looks a little more closely at the $5 million exclusion and the unfortunately named “claw back” concept, which may scare some people away this fleeting opportunity.

The “claw-back” question is:
If the tax law reverts back to the predecessor law and/or reduces the exclusions below $5 million, will the system “claw back” (retrieve and tax) lifetime gifts made in 2011 and 2012 and charge tax on those gifts upon death?

Some commentators say yes, some no.  Whatever is said is speculative.  Congress and/or the IRS will have to resolve the issue one way or the other.  Either way, claw back is a worst case scenario that is not that bad.  If its name reflected its tax consequences—“freezing” $5 million of a taxpayer’s estate and deferring tax until his or her death—we would still see it as a great estate planning opportunity.  “Freeze and defer” may not be as good as permanently excluding $5 million from both gift and estate tax, but it sounds much nicer than “claw back” and is still significantly better than the status quo before 2011.

Claw back is possible because the tax code has used “adjusted taxable gifts” to compute the Federal estate tax since 1976.  Adjusted taxable gifts—the sum of post-1976 taxable gifts—is added to the taxable estate, the estate tax is computed on the total, and then the gift tax previously paid is subtracted.  Unfortunately, after 2012 the exemption for lifetime gifts may be greater than the exemption for estate tax purposes for the first time since 1976. That creates the possibility of subjecting 2011 and 2012 tax exempt gifts to estate tax in a subsequent year.

For example, if a taxpayer who made no previous taxable gifts makes $5 million of taxable gifts in 2012, no gift tax will be due.  He or she will simply have used up the gift tax exemption.  However, assume that the taxpayer dies in 2020 with a $10 million taxable estate, that the unified exemption has decreased to $3.5 million and that the tax rate has increased to 45%. What happens to the difference between the $5 million of exempted 2012 gifts and the $3.5 million unified exemption in 2020?  The answer depends on how line 7 (total gift tax paid or payable) of the estate tax return is calculated.  Specifically, it depends on whether the date of the gift or the date of death is used to calculate the total gift tax paid or payable.

Under the assumptions above the gift tax paid or payable that is subtracted from the tax will be $400,000 greater, and the tax will be $400,000 lower, if we calculate the total gift tax paid or payable on the date of death.  If we calculate the total gift tax paid or payable on the date of the gift, $400,000 in tax will be “clawed back”.  However, the taxpayer still effectively “froze” $5 million of his or her estate and deferred any tax consequences of the gift until his or her death in 2020.  That may not be as good as the alternative, but it is still much better than the result he or she could have achieved before 2011 without the $5 million exclusion.

Could estate tax equal or exceed assets at death?  Our crystal ball does not think this probable.

You should consider the benefit of tax-free or tax-deferred gifting under the temporary $5 million exclusion, if your situation warrants it.

Don’t let “claw back” scare you out of considering the $5 million exclusion.

-Dante

A Holiday Surprise from the IRS

We hate to spoil the holidays, but for many firms there may be a lump of coal in their holiday stocking, courtesy of the IRS.  You may want to take a moment to be sure that your business is not one of them.  This isn’t because of any change in the tax code, or expiration of some tax provision that was extended during the past few years.  It’s because the US tax code is based on the assumption that the economy will, for the most part, be in a permanently expanding mode (occasional recessions being no more than “periodic adjustments”).   For the past nearly 8 decades, this assumption has been pretty accurate, but the continued slowdown in the US economy seems to be upsetting that belief.

The tax code rewards businesses that invest in maintaining or even helping to create  growth, through the inclusion of numerous provisions that accelerate deductions, on the assumption that company’s higher after-tax profits in the short run will be re-invested in growth in the long run.  Most people see this is good economic policy, and most businesses enjoy the benefits of this approach, most notably through the use of accelerated depreciation or write-off of major investments.  Essentially, the tax code allows businesses that invest in new equipment to write off that investment over a shorter period of time, with the write-off equaling 100% of the cost of the investment, regardless of the depreciation that is used for financial statement purposes.  Often, this results in profits on a tax return being lower than the profits shown on the company’s financial statements.  Accountants call this a “timing difference,” but usually it’s more than that because the entire investment is written off, even though the financial statements may not write off the entire amount invested.

Sounds great, right?  You get to reduce your income on your tax return, but you still are able to demonstrate reasonable financial statement profits to your lenders, investors, and others.  But there’s a catch.  And here’s where that growth assumption I mentioned earlier becomes an issue.  Because this write-off is really just a “timing difference.”, ou get bigger write-offs now, in exchange for fewer write-offs later.  The previous expectation was that since the economy was in a constantly growing mode, and businesses would always be making investments in equipment, etc. to support that growth, “later” never came.  New investments with more accelerated tax write-offs were always going to be available to offset the lower write-offs from older investments.  But when the economy basically stopped growing, excess capacity in many businesses meant that very little new equipment investments were likely to occur.  With the current state of the economy, that may be a very real situation for a number of years.

What can happen is startling, and is best illustrated by a very good client of ours, a printer that has experienced both great financial success and occasional financial challenges over the past ten years.  They keep their books on Generally Accepted Accounting Principles, as required by their lenders, and were making reasonable investments in equipment as they grew.  However, when the economy started to weaken, they postponed equipment investments starting in late 2007, and have made none until this year, as the economy continued to struggle.

In 2009, they were showing a small loss on their books, after having reduced a number of expenses in response to a drop of around 15% in sales.  Because they felt that professional fees were an expense they could minimize, especially tax planning, given the fact that they were showing losses, they cancelled the normal quarterly tax planning update they had done in previous years.  With losses showing, they didn’t think they needed to worry about tax deposits.  That’s when the coal slipped into their Christmas stocking.

Primarily, as a result of accelerated equipment write-offs for tax purposes (but not for book) in previous years, even though they were showing a loss on their financial books, they in fact had significant “taxable income”.  The clientended up with significant income taxes due, as well as penalties and interest on the amount of tax due for failing to estimate and pay on a quarterly basis their taxes, as is required by the IRS.  Even though they ended the year with a loss for book purposes, they still ended up having to pay a large tax bill.  Simply put, their “timing advantages” of just a few years earlier turned into an unpleasant surprise when their needs no longer required continued investment in new equipment.

Many firms are likely so see similar results in their 2010 tax returns, though possibly not as severe as was the case I mention.  Remember, in most cases, tax “benefits” eventually do reverse.  Constant monitoring of your company’s potential tax liability, regardless of what your book income may be, is worth doing.

-Gerry

Research and Development Credit

Like most successful businesses, yours probably works hard to develop new or improved products or services and internal processes and techniques in order to stay competitive.  Whether you know it or not, some of those efforts probably constitute “qualified research expenses,” a portion of which can be claimed as an R&D tax credit on your tax returns.  This is true even if you don’t have a formal “research” department or think of yourself as a “high-tech” company.  You may be missing substantial tax savings compared to simply deducting your R&D expenses as a result.

History of the R&D Credit
The R&D credit was enacted as temporary legislation in 1981 to attract foreign capital and make U.S. businesses more competitive by promoting technological innovation.  Since then, it has expired eight times and been extended thirteen times, most recently through December 31, 2011.

Effective January 1, 2007, Congress enacted “alternative simplified credit” rules, to make it even easier for U.S. businesses to claim the credit because many U.S. businesses were outsourcing R&D to countries with more generous R&D tax benefits.  Ironically the IRS designated the R&D credit a “Tier 1 issue”—flagging it for heightened scrutiny—the same year.   Fortunately, court cases and other guidance have subsequently clarified prerequisites for claiming the credit.

What is a “Qualified” Research Expense?
Qualified research expenses are those paid or incurred in your trade or business for supplies or other personal property, qualified services, wages paid for such services or contract research.  To qualify for the credit, research expenditures generally must satisfy four tests:

1. Permitted Purpose: The research must be intended to be useful in the development of a new or improved “business component” (generally, any product, process, computer software, technique, formula or invention).
2. Technological in Nature: The research must rely on the principles of the physical or biological sciences, engineering or computer science.  Research activities relating to style, taste, cosmetic or seasonal design factors are not qualified.
3. Process of Experimentation: Substantially all (≥80%) of the research activities must constitute a process designed to evaluate one or more alternatives to achieve a result where the capability or method of achieving that result, or the appropriate design of that result, is uncertain.  The process must be evaluative and should be capable of evaluating more than one alternative.  However, there is no requirement that the process actually evaluate more than one alternative.
4. Elimination of Uncertainty: The research must involve the identification of uncertainty concerning the development or improvement of a business component.

Certain investments in internal and external software may also qualify.

Do Your Activities Qualify?
Our firm has a library of R&D examples available to help you determine if your activities qualify.  When determining if your activities qualify, the following questions are helpful:

• Did you develop new technology or apply existing technology in a new way?
• Did you use new materials in an existing product on process?
• Did you add new equipment intended to serve a new market?
• Did you develop a new product?
• Did you develop or improve production/manufacturing processes?
• Did you develop software?
• Did you automate internal process?
• Did you build or test new prototypes or models?
• Did you solve complex requirements?
• Did you develop and test new concepts?

Successful businesses innovate and much of what they do relates to these questions.  We can help you take a hard look at your operation to see if your activities qualify for the R&D credit.

R&D Credit Benefits
The tax benefits of the R&D credit can be substantial.  The credit replaces part of the tax deduction for R&D expenses.  However, unlike a deduction, a credit is an actual dollar-for-dollar reduction in tax, and the R&D credit is typically 5 to 8% of qualified research expenses.  Moreover, any unused R&D may be carried back three years and then carried forward for up to twenty.  Finally, many states also offer a similar—but often even more generous—R&D credit.

R&D Credit Costs and Risks
As mentioned previously, the IRS has identified the R&D credit as a “Tier I” issue.  That means it is subject to heightened IRS scrutiny, so returns claiming the credit are more likely to be audited.  The R&D credit claims must be well supported and thoroughly documented, or it may be reduced or disallowed on audit.  Claiming a state R&D credits may likewise increase state audit risk, so such claims should also be well supported and thoroughly documented.

In the event of an audit, the IRS typically attacks the “nexus” or relationship between qualified research expenses and a business component (as defined above) and the supporting documentation.  Project accounting systems often substantiate qualified research expenditures and their relationship to business components.  Unfortunately, most other accounting systems do not.  As a result, taxpayers typically must use a combination of project and cost center methods based on the available records to support the credit. Frequently, the manner in which the information is compiled does not support the relationship between the accounting records and the qualified research expenditures and business components to the IRS’s satisfaction.

Our Approach
Carlson Advisors understands our clients’ businesses, their industries and the relevant tax law.  Our knowledge and experience give us a uniquely ability to help you determine if claiming the R&D credit is worthwhile.  If it is, we can help you claim, substantiate, and—if necessary—defend the credit.  Our process is as follows:

Assessment – Our professionals perform an initial review of your company’s business—particularly its R&D activities as they relate to business components.  Next, we will review the process with your team and develop a work plan to review R&D within your organization.

Information Gathering/Documentation – After the initial assessment, we gather the required information and document the technical qualities of your activities.

Reporting/Tax Preparation – Next, we prepare a summary to support the R&D claims and prepare or amend your tax returns to claim the credit.

Systems – Lastly, for the future, we help you develop systems for identifying and recording information about R&D activities as they relate to business components.

Please contact Carlson Advisors to learn more about the R&D credit.  We offer a free presentation that provides more information about the R&D credit, and would be happy to meet with you to discuss the feasibility of a complete R&D credit study.

- Dante

How do you give it away, without really giving it away?

(Also a basic discussion regarding gifting and estate tax laws)

As a person ages, it is inevitable that one contemplates the consequences of death.  Some contemplate more than others.  For someone with any amount of wealth, the consequences merit thought and planning.  When someone dies without this thought and planning, the assets are split under state law (intestate) using some basic principles that some ancient legislator devised.  These have formulas and protocols for people with and without spouses and children.

There are three obvious reasons for the planning:

• Ensure you are provided a comfortable living during your lifetime.
• Basic good sense in providing for an orderly and efficient transfer, in the manner you best intend.
• Reduction of gift and estate taxes.

Our firm works with people in developing the plans.  We do not prepare wills or trusts, nor work in the probate courts.  However, we do often have a good understanding of your financial affairs and understand the tax laws. Thus, we can work with your attorneys in the process.

In developing the plan, the first point (basic good sense) can involve gifts during your life and your spouse’s life and gifts at death.  With the way the economy has performed recently, many people simply worry that that they will have enough to carry them through the duration of their lives and choose not to gift much.  But there is reason to reconsider a bit.

People with wealth worry about estate taxes, sometimes called death taxes.  There has been mayhem in the gift and estate tax area of recent history.  As it stands now, our federal statutes allow a unified $5 million lifetime exclusion to individuals from lifetime gifts and estate taxes; this is boosted to $10 million for married couples.  The exclusion includes lifetime gifts made in excess of stipulated amounts ($13,000 per person, $26,000 per married couple in 2011).  However, this exclusion changes dramatically in the near future.

In an unprecedented “horse trade” in late 2010, in which President Obama swapped health care reform forever for tax cuts for two years, the Republicans only bargained out a two year increase (to $5 million per person) from the previous statute’s $1 million per person exemption ($2 million per married couple).

So, only in 2011 and 2012, under federal gift and estate tax law, you can exclude $5 million per person or $10 million from a married person’s estate.  On January 1, 2013, you can only exclude $1 million per person or $2 million for a married couple from estate tax.  Federal estate taxes are assessed at a maximum of 35% under the current law and up to 55% in the 2013 reversion.

I should note here that the states’ gift and estate tax statutes do not necessarily mirror the federal tax statutes.  For example,Minnesotahas retained a $1 million exemption throughout the federal mayhem.

One little quirk in Minnesota law is that that Minnesota does not tax gifts; Minnesota only potentially taxes your heirs when you die.  Thus, it makes sense to gift sometimes, versus die with the money in Minnesota, just to save Minnesota estate tax.

If you are a married couple with somewhere in between $2 million and $10 million, or think that your assets might be that much at death, what do you do?  Spending it is an option.  Doing nothing is always an option, but can be the most costly for your heirs in the long run.

My crystal ball has been a bit cloudy lately and I am having difficulty seeing through the primary and general elections in 2012 to predict a subsequent tax bill.  Most estate planners are having similar difficulty.  Some (mostly Republicans) are saying the estate tax should be eliminated; others (mostly Democrats) are quietly thinking the reversion may not be so bad.  Moderates in each party might contemplate a “happy medium”, like a $3 million unified exemption, might occur, but there is not much “happy medium” talk lately inWashington.

I have some clients at that time in age when they are somewhat satisfied they have enough, but aren’t sure.  They wish to use their $5 million exemption, but are reluctant to give the assets away.  Can you give the assets away to utilize the exemption, but recoup them if you need them?  That is always the question.  What can be done?

There are a few people that are quietly gifting some money away, to their children and or grandchildren.  There might be an implied agreement that the money will be invested, not spent.  But mom and dad can retain no ownership and there can be no binding legal agreement to get it back.  There is usually a non-documented thought process that might infer that if there is an unforeseen issue for mom or dad, the kids will gift back to mom or dad, if necessary.  That concept takes a lot of trust.

At a certain time in one’s life, one’s children are what they are, at say age 50 or 60.  Some can handle gifts prudently; some not.  It is not unusual that one must treat children differently, even as adults.  What this means is that some might get gifts paid to them directly; some might have the funds put in trust or paid to them in small increments.  These are hard decisions.

The creation of a trust for your children or grandchildren that will hold the gifted assets until mom and dad’s death, or some term certain might give mom and dad some comfort that all or some of their money will not be wasted during their lifetime.  But mom and dad can retain no ownership and there can be no binding legal agreement to get it back.   The gifts can, however, be held and invested.   There might still be some implied agreement like that referred earlier.

One of my clients has suggested a small twist on this.  It is called a reverse Grantor Retained Annuity Trust “reverse GRAT”.  This is a bit fancy, but it simply involves mom and dad putting some amount in trust (with some potential intermediate steps) and retaining an annuity from the trust, which is clearly defined.  There are some uncertain tax issues with this arrangement, although some are very clear.  You might look at this link to a relevant article by Deborah Dunn.

There are several ways to put different creative twists into this sort of planning.  My gut feeling on this is that the $5 million amounts will be reduced, but my crystal ball isn’t sure.  If you are considering a gift, and particularly, if you are one of those that feels estate and gift taxes are only going to get higher, please feel free to discuss with us or your attorney.  First make sure you remember the obvious reasons for planning I mentioned above.

Signing off,

Joel

Firms That Not Only Survive, They Thrive

After spending three days with leaders of major printing firms on the West Coast, at the California Print Management Conference, it’s clear that the industry is undergoing change like never before.  Change, however, is nothing new to this industry.  The firms that survive and even thrive share some characteristics that most of the attendees at the conference recognized as critical to their futures:

• These firms are market oriented, not technology driven.  They make decisions based on their understanding of the needs of their markets and their customers, and how technology can address those, not based on the “gee whiz” factor in new equipment.

• These firms understand that pricing is a function of customer perceived value, and not of their operating costs.  The real challenge for firms in the industry is to make the value they add to a customer greater than their cost to add it.

• They understand that the days of being successful simply by putting ink on paper, if not already gone, soon will be.  The various media available to their customers to communicate their messages to their markets dictates that print be seen as just a part of an overall communications strategy.  Smart printers are looking to be suppliers of a wider range of such “message delivery,” whether in web design, mobile messaging, direct mail, or any of the myriad of services successful firms are getting into.

• These firms understand that adopting changes such as those demanded are risky, but not nearly as risky as doing nothing, or waiting for clear trends to develop.  Things are moving too quickly today to do nothing, but anything you do is risky.

Michael Makin, president of PIA and a key speaker over the entire three days, pointed out that though the number of printers in the US continues to drop, with as many as 1700 estimated to go away in 2011 alone, the printing industry remains a huge piece of the manufacturing sector, with over 150 Billion Dollars in revenues, which have now begun to slowly climb.  Great opportunities continue to exist, and great companies can do more then just survive, they can flourish.  “Embracing change” is no longer just a cute phrase; for printers and graphic arts firms in the later stages of 2011, it’s the key to success in the future.

-Gerry

More Tax Reform, But For Whom?

There’s been a lot of talk about deficit reduction and tax reform lately, so let’s take a look at some recent proposals.

Living Within our Means and Investing In the Future: The President’s Plan for Economic Growth and Deficit Reduction

On September 19, 2011, the President released Living Within our Means and Investing In the Future: The President’s Plan for Economic Growth and Deficit Reduction.  The President’s plan includes tax provisions in the American Jobs Act of 2011, which was presented to Congress earlier on September 13, 2011.

Stimulus

The stimulus measures in American Jobs Act include cutting the employer and employee portion of the Social Security tax in half (from 6.2% to 3.1%), a temporary tax credit equal to the social security tax on any increase in wages over the corresponding period in the prior year; and tax credits for hiring veterans and the long-term unemployed.  The tax cuts are good news for both employers and employees.

Mandatory Savings

The mandatory savings provisions of the President’s plan calls for a “Crack down on tax cheats and delinquents through investments in the Internal Revenue Service (IRS) tax enforcement and compliance.”  The plan calls for $350 million in new compliance and enforcement initiatives on top of the inflationary costs of maintaining current IRS enforcement activities through 2021.  The Congressional Budget Office estimates this proposal will reduce the deficit by $3.2 billion over the next 10 years, and the Office of Management and Budget believes it will save even more.  However, the only thing that is certain is that IRS enforcement activities (e.g., audits) will increase significantly if this provision of the President’s plan is enacted.  We don’t expect those activities to be efficient or focused on the right taxpayers.   Even without these new proposals, the volume of IRS notices has increased 670 percent since 2001, and we know from experience that many IRS notices are erroneous.  To make matters worse, an October 15, 2010 report of the Inspector General for Tax Administrations says:

Of the approximately 100,000 employees, including 9,100 managers that the IRS employs, more than half have reached age 50 and can retire within 10 years.  In addition, 39 percent of IRS executives are already eligible for retirement. Replacing these employees represents a significant challenge…

Even if the new initiatives are not enacted, we will be spending more of our time representing clients before the IRS and providing on the job training to inexperienced IRS Agents.

Tax Reform

The tax reform provisions of the American Jobs Act and the President’s plan are based on the following “principles for tax reform”:

1. Lower tax rates. The tax system should be simplified and work for all Americans with lower individual and corporate tax rates and fewer brackets.
2. Cut Inefficient and Unfair Tax Breaks. Cut tax breaks that are inefficient, unfair, or both so that the American people and businesses spend less time and less money each year filing taxes and cannot avoid their responsibility by gaming the system.
3. Cut the deficit. Cut the deficit by $1.5 trillion over the next decade through tax reform, including the expiration of tax cuts for single taxpayers making over $200,000 and married couples making over $250,000.
4. Increase job creation and growth in the United States. Make America stronger at home and more competitive globally by increasing the incentive to work and invest in the United States.
5. Observe the Buffett Rule. No household making over $1 million annually should pay a smaller share of its income in taxes than middle-class families pay. As Warren Buffett has pointed out, his effective tax rate is lower than his secretary’s. No house ­hold making over $1 million annually should pay a smaller share of its income in taxes than middle-class families pay. This rule will be achieved as part of an overall reform that increases the progressive nature of the tax code.

Here are the tax reform proposals in the President’s plan that are most relevant to our clients:

“Allow the 2001 and 2003 high-income tax cuts to expire and return the estate tax to 2009 parameters”—at least for those with household income above $250,000.  The Administration has previously pledged to keep the 10%, 15%, and 25% brackets in place. If the President gets his way, the 28% bracket would likely be expanded to accommodate taxpayers with household income of $250,000 or less.  However, taxpayers with household income above $250,000 would be subject to the 36% and 39.6% top rates that existed before the 2001 and 2003 tax cuts.  Adding the 3.8% Medicare surtax on high income taxpayers enacted by the Patient Protection and Affordable Care Act means the top rate could be 43.4% or more.  The expiration of the 2001 and 2003 tax cuts will also undo marriage penalty reform unless Congress and the President act to preserve it, increase capital gains tax rates to 18% (for assets held more than 5 years) and 20%, and subject qualified dividends to tax at ordinary rates.  Taken together, these changes would substantially increase the tax burden of many of our clients.

“Reduce the value of itemized deductions and other tax preferences to 28 percent for families with incomes over $250,000.”  When combined with the expiration of the 2001 and 2003 tax cuts, this proposal would further increase the tax burden of many of our clients.  Taxpayers in the top bracket, this would lose 11.6% of the benefit of their itemized deductions.

“Repeal last-in, first-out (LIFO) method of accounting for inventories” after December 31, 2012.  Obviously, this proposal, if enacted, would increase the tax burden of any taxpayer using this method of accounting for inventories.

“Repeal lower-of-cost-or-market inventory accounting method” after December 31, 2012.  Again, this proposal, if enacted, would increase the tax burden of any taxpayer using this accounting method.

“Make unemployment insurance (UI) surtax permanent.”  The 0.2% surtax expired on June 30, 2011.  The President’s proposal would restore it retroactively.  That would increase the federal UI insurance rate from .06% to .08%.

“Increase certainty with respect to worker classification.”  This proposal would permit the IRS to issue guidance about the proper classification of workers and require reclassification of workers.  This provision is expected to reduce the deficit by $8 billion over 10 years—presumably by reclassifying more workers as employees.

RECENT CORPORATE TAX REFORM PROPOSALS

The Joint Select Committee on Deficit Reduction (“Super committee”) created by the Budget Control Act of 2011 is also considering corporate tax reform, arguing that our 35% the top corporate income tax rate is too high, but that some large corporations pay little or no tax because by exploiting tax preferences (exemptions, credits and deductions) in the tax Code.  The President, Treasury Secretary Geithner and the Supercommittee appear to favor lowering corporate tax rates in exchange for eliminating tax preferences without similar reforms for 93% of American businesses organized as S corporations, LLCs and partnerships (which by some estimates employ 54% of the U.S. private sector workforce and pay 43% of all taxes collected by the federal government).  Chief of Staff Bill Daley reaffirmed the President’s commitment to corporate only tax reform, warning that some small businesses might face a tax increase.  Fortunately, prominent members of the House Ways and Means Committee and Senate Finance Committee understand the impact of corporate-only tax reform on the economy in general and small business community in particular and oppose it.

CONCLUSION

In the context of recent corporate tax reform proposals, the tax provisions of the American Jobs Act and the President’s plan should be of grave concern owners of S corporations, LLCs or partnerships Those owners pay individual income tax rates—not corporate tax rates—on their share of their business’s income, whether they receive it or not.  Moreover, that business income will count toward the “high income” threshold in the American Jobs Act and the President’s plan.  The proposed tax reforms, if enacted, would deprive owners of S corporations, LLCs and partnerships the tax preferences they currently enjoy.  However, unlike C corporations, they would not receive the quid pro quo of lower tax rates.  Instead, their tax rates would be significantly higher—up to 43.4%.  Ironically, the President’s plan would lower tax rates for Fortune 500 Corporations while increasing tax rates on the owners of over seven million S corporations, LLCs and partnerships.

-Dante

Looking for Bargains? Careful – You Get What You Pay For.

For the past year or so, we’ve seen a number of our clients acquire smaller competitors, or in some cases, firms that provide access to new markets.  In many cases, these acquisitions have really been more what we would term “tuck-ins,” which is an acquisition in which only a few selected employees, and either no or very few of the assets of another business, are acquired, generally on some type of contingent price.  No liabilities are assumed, at least not “officially.”  At first, such transactions appear to be “no-brainers” because there is no apparent risk to the buyer, but there’s the possibility of benefit if things go well.  In fact, these sometimes appear too good to be true.  Tuck-ins have always been around, but there is a reason for the increase in such transactions recently.

For a number of companies, the challenges of the financial and economic downturn over the past few years have just been too great to survive.  Now, even with the economy is beginning to improve, these firms, in many cases, find themselves in a hole so deep that they can’t find a way out.  When this happens, the owners sometimes look for a way to save the customer base and customer relationships, and also to find an income for themselves and possibly a group of key employees.  If these can be put together in a way that buyer’s are willing to accept, a tuck-in is often the result.  The owners of the former firm essentially walk away from it, and the customers, or at least a sizable proportion of them, transfer to an acquiring firm.

One of the reasons that these transactions have gained popularity recently is the apparently “low-risk” nature they appear to offer, especially if the price is contingent on future benefits to the buyer, as is often the case.  But there is still risk for buyers, risks which are often overlooked or even if seen, unappreciated by buyers.  And these risks can result in such “low-cost” acquisitions being the most costly of all!  There are a number of reasons for this, some of which are as follow:

• Companies that fail often have poor customer relationships, and the ability to actually transition those relationships may not be great, but when this occurs, the former owners sometimes blame the acquiring company for not handling their former customers well.
• Pricing at a profitable level to customers of the “tucked-in” firm may be an issue, as many firms that are struggling will reduce prices to levels that are not sustainable.  These prices are what the customers expect from a new firm that acquires the former business.
• Even if only a few staff are acquired, there can be HR issues that create both retention problems and possibly even claims against an acquiring firm based on prior employment with the former company.
• In many states, great care must be taken to avoid an allegation by a creditor of the former company that the acquirer is responsible for prior debts of the company that closes down, under a “continuity of business interest” doctrine.  This can lead to very serious problems.

One of the presumed benefits of tuck-ins is that they are simple to do, and therefore inexpensive.  However, as the above examples indicate, tuck-ins are not low risk.  In some cases, are just the opposite, since in nearly all such transactions there will be employees, creditors, and others that feel they were left holding the bag by the sellers.  So what should a firm considering such a transaction do?

• First, discuss any transaction, including a tuck-in, with your advisors, especially your attorney and CPA.
• Second, don’t accept verbal representations on the customer base.  Insist on meeting with key customers before closing.  If that’s a deal breaker for the seller, that should be a working.  Walk away.
• Third, review the work and the pricing to customers that you are acquiring very carefully.  Remember, not all new business is good new business.
• Finally, make sure that the people joining your firm, no matter how few, are a good fit culturally and that they feel a part of the deal.  They can be crucial to long-term success…that’s the reason they’re called “key employees.”

-Gerry

IRS Audit via Facebook?

Post by Joel D. Henley

An interesting article from an anonymous source.   Some names and facts changed, to protect the innocent.

Windward Leeward, a tax expert on our staff, sent me the following story from his journal.

I was recently in a squall caused by our dear friends at the Internal Revenue Service (IRS) relating to something I would describe as an audit through the U.S. Postal Service.

Some great individual clients, Port & Starboard Beam, received a Proposed Adjustment from the IRS in their mail, denying all of their mortgage interest.   The Beams had deducted interest on a home mortgage, as they had unfortunately bought a big house in San Diego at the peak of the market. They paid a lot of interest. The mortgage company had provided the IRS and to Port a Form 1098, carefully stipulating, in proper format, the interest the Beams had paid. The IRS asked nevertheless for some additional information.  Fair enough.

The Beams were on vacation, circumnavigating, when the inquiry came.   Because the taxpayers couldn’t respond within thirty days of the Proposed Adjustment, their housekeeper shipped the notice to me, the tax preparer.  As the taxpayer’s representative to the IRS, Windward requested, by fax and by mail, additional time of thirty days to respond.  This additional time to respond request was granted.

Windward filed a timely sixty five page response, giving IRS full mortgage documents and amortization schedules, with all the attachments and copies of bank wire transfer information.  Unfortunately, this information was lost somewhere within the administrative structure of the IRS “by mail” audit department.  Windward’s administrative crew has good evidence to prove the mailing and faxing.

Windward followed up on the letter by telephone inquiry, as he received no response to his letter, and found that the sixty five page response was not received or lost.  Another copy of the response was sent.

Simultaneously, another letter was received by the Beams indicating that the mortgage interest was disallowed entirely, denying any right to any form of due process other than the United States Tax Court.   The Beams considered circumnavigating their 54 footer elsewhere on the globe.  Doing nothing was always an option, which would cause the adjusted amount to be assessed by the collections people at the IRS.  There are then separate procedures to appeal the assessment itself Windward was contemplating.

Windward called the IRS again, to no avail.  The representatives could not move the issue to resolution on the telephone.  They said it was too late.

Like any good skipper, fast in a pinch, dear Windward filed a preemptive request for a due process hearing with the collection division to forestall the taking of this taxpayer’s assets by the collection machine at our U.S. Treasury. Windward also filed an administrative appeal with the IRS, asserting that the taxpayer was not given appropriate due process under the examination protocols required by the various Taxpayer Bill of Rights Statutes.

Windward has some deep concerns regarding this IRS audit process through the U.S. Postal Service. He wonders whether it will evolve to audit by email or audit via Facebook, MySpace or Google?

If a taxpayer doesn’t respond timely, in short order, will he be assessed, whether he is physically present, virtually present, or not present, and whether he is right or not?  In the present case, the taxpayer’s mortgage interest is clearly deductible.  It has been reported electronically to the IRS by a major mortgage company. This is not enough to sustain the deduction upon examination.  A lack of an immediate response apparently gives our dear government the fairly quick right to assess a wrongful tax, even a tax that violates the basic law.

A Facebook inquiry might have been more effective, because the Beams have a wireless satellite connection on their boat. But, could we be required by law to check our Facebook?  And do we have to “friend” the IRS?

Admittedly, the Beams responded a few days late.

Windward fears our rights to due process may be capsizing.

Post Script from Windward.

In response to the request for a due process hearing, the IRS assessment was settled two months later—through the mails.  The due process hearing request pushed it through expeditiously.

The Beam’s rights to due process prevailed, the IRS determined the proper tax, and following winds brought the Beams home!

Cheers!

Windward