September 2017

Are You Ready for the New IRS Partnership Audit Rules?

Posted on September 24, 2017July 23, 2024 by Debra Barcuch

Legislation enacted in 2015 established a new IRS audit regime for partnerships and limited liability companies (LLCs) that are treated as partnerships for tax purposes. Here’s a comparison between the old and new partnership audit rules, along with a summary of recently proposed guidance to help partners prepare for the changes that are effective starting with the 2018 tax year.

Important note: To keep things simple, we’ll refer to any LLC that’s treated as a partnership for tax purposes as a partnership and any LLC member that’s treated as a partner for tax purposes as a partner.

Relief to Partnerships that Missed the New Filing Deadlines

The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 changed the date by which a partnership must file its annual return. The changes went into effect for the 2016 tax year.

Specifically, for calendar-year partnerships, the due date for filing the annual return or request for an extension changed from April 15 to March 15 (excluding weekends and holidays). For calendar-year partnerships, the due date for filing a return after receiving an extension also changed from October 15 to September 15 (excluding weekends and holidays).

Many partnerships filed their returns or their extension requests for tax year 2016 by the old April deadline. If not for the Surface Transportation Act, these returns and requests for extension of time to file would have been on time. The IRS has decided to provide penalty abatement for these partnerships, provided they meet the following criteria:

The partnership filed tax returns with the IRS and furnished copies to the recipients (as appropriate) by the date that would have been timely under the old deadline, or
The partnership filed an extension by the date that would have been timely under the old deadline.

Old Rules

Under the old rules, the federal income tax treatment of partnership items of income, gain, deduction and credit is generally determined at the partnership level, even though these tax items are passed through to the partners and reported on their returns. After a partnership audit is completed and the resulting adjustments to partnership tax items are determined, the IRS generally recalculates the tax liability of each partner and sends out bills for additional taxes, interest and penalties to the partners.

This set-up was deemed to be inefficient, so Congress established a new audit regime for partnerships. However, the old rules will continue to apply to most partnerships for tax years beginning in 2017.

The Big Difference

The new partnership audit regime applies to partnerships with more than 100 partners at the partnership level. The big difference under the new rules is that, subject to certain exceptions, any resulting additions to tax and any related interest and penalties are generally determined, assessed and collected at the partnership level.

Specifically, the partnership — not the individual partners — will be required to pay an imputed tax underpayment amount, which is generally the net of all audit adjustments for the year multiplied by the highest individual or corporate federal income tax rate in effect for that year.

However, the partnership can pay a lower amount if it can show that the underpayment would be lower if it were based on certain partner-level information, such as:

Differing tax rates that may be applicable to specific types of partners (for example, individuals, corporations and tax-exempt organizations), and
The type of income subject to the adjustments (for example, ordinary income vs. capital gains or cancellation of debt income).

An alternative procedure, known as the “push-out election,” allows the partners to take the IRS-imposed adjustments to partnership tax items into account on their own returns. Or, if eligible, a partnership can elect out of the new rules altogether. (See below for more details on both elections.)

Partnership Representatives

The new partnership audit rules eliminate the tax matters partner role that applied under the old rules. Instead, partnerships will be required to designate a partnership representative. The partnership representative has the sole authority to act on behalf of the partnership in IRS audits and other federal income tax proceedings.

If the partnership doesn’t choose a representative, the IRS can select an individual or entity to fill that role. If the partnership representative is an entity (as opposed to an individual), the partnership must appoint a designated individual through whom the partnership representative will act.

Under the proposed regulations, the partnership representative has a great deal of authority, and no state law, partnership agreement, or other document or agreement can limit that authority. Specifically, the partnership representative has the sole authority to extend the statute of limitations for a partnership tax year, settle with the IRS or initiate a lawsuit. Any defense against an IRS action that isn’t raised by the partnership representative is waived.

With all this authority comes the associated risk, which may mean that some partnerships will have a hard time finding someone willing to act as the representative. Partnerships should consider indemnifying or compensating their partnership representatives accordingly.

According to the proposed regulations, partnerships must designate a partnership representative separately for each tax year. The designation is done on the partnership’s timely filed (including any extension) federal income tax return for that year.

Partnerships should amend their agreements to establish procedures for choosing, removing and replacing the partnership representative. In addition, the partnership agreement should carefully outline the duties of the partnership representative.

The Push-Out Election

As noted above, under the new rules, a partnership must pay the imputed underpayment amount (along with penalties and interest) resulting from an IRS audit — unless it makes the push-out election. Under the election, the partnership issues revised tax information returns (Schedules K-1) to affected partners and the partnership isn’t financially responsible for additional taxes, interest and penalties resulting from the audit.

As the name suggests, the push-out election allows the partnership to push the effects of audit adjustments out to the partners that were in place during the tax year in question. This effectively shifts the resulting liability away from the current partners to the partners that were in place during the tax year to which the adjustment applies. The push-out election must be filed within 45 days of the date that the IRS mails a final partnership adjustment to the partnership. This deadline can’t be extended. The proposed regulations specify the information that must be included in a push-out election. The partnership must also provide affected partners with a statement summarizing their shares of adjusted partnership tax items.

Partnership agreements should be updated to address whether the partnership representative is required to make the push-out election or the circumstances in which a push-out election will be made. When deciding whether to make the election, various factors should be considered, including:

The effect on partner self-employment tax liabilities,
The 3.8% net investment income tax,
State taxes, and
The incremental cost of issuing new Schedules K-1 to affected partners.

Partnerships may want to require their partnership representatives to analyze specified factors to determine whether a push-out election should be made.

Option to Elect Out of the New Rules

Eligible partnerships with 100 or fewer partners can elect out of the new audit rules for any tax year, in which case the IRS must separately audit each partner. However, the option to elect out of the new partnership audit regime is available only if all of the partners are:

Individuals,
C or S corporations,
Foreign entities that would be treated as C corporations if they were domestic entities,
Estates of deceased partners, or
Other persons or entities that may be identified in future IRS guidance.

The election out must be made annually and must include the name and taxpayer ID of each partner. The partnership must notify each partner of the election out within 30 days of making the election out.

Eligible partnerships may want to amend their partnership agreements to address whether electing out will be mandatory. In most situations, electing out will be preferable. However, partnerships looking to maintain flexibility in their partnership agreements should include provisions indicating how the decision to elect out will be made.

Partnerships choosing to elect out may want to amend their agreements to prohibit the transfer of partnership interests to partners that would cause the option to elect out to be unavailable. They also may want to limit the number of partners to 100 or fewer to preserve eligibility for electing out.

Important note: Many small partnerships may assume that they’re automatically eligible to elect out of the new partnership audit rules because they have 100 or fewer partners. That’s not necessarily true. For example, the option to elect out isn’t available if one or more of the partners are themselves a partnership (including an LLC that is treated as a partnership for tax purposes). Also, if there is an S corporation partner, each S corporation shareholder must be counted as a partner for purposes of the 100-partner limitation.

Coming Soon

Although the new partnership audit rules don’t take effect until next year, partnerships should start reviewing partnership agreements and amending them as necessary. At a minimum, partnerships that don’t expect to elect out of the new audit rules should appoint a partnership representative before filing their 2018 returns. Your tax advisor can help you get up to speed on the new partnership audit rules and recommend specific actions to ease the transition.

IRS Tax Audits: What Every Business Owner Should Know

Posted on September 23, 2017July 23, 2024 by Debra Barcuch

An IRS audit may not seem quite as big of a business risk as a natural disaster or an unstoppable competitor. But getting that fateful letter in the mail can still hurt morale, impede productivity and delay strategic objectives. This article talks about what can trigger an audit and discusses what business owners should be ready to do in response.

What every business owner should know

When thinking about risks to your company, you might picture a natural disaster or an unstoppable competitor. An IRS audit may not immediately come to mind. But getting that fateful letter in the mail can still hurt morale, impede productivity and delay the accomplishment of strategic objectives. Here’s what every business owner should know about the process.

Return-related risks

The IRS maintains that many business audits occur randomly. That said, a variety of tax-return-related items are likely to raise red flags with the IRS and may lead to an audit. For instance, if the agency notices significant inconsistencies between previous years’ filings and your most current filing, it could decide to pursue the matter.

Maybe you just had a really good year — or a really bad one. But if your company’s income seems substantially higher or lower than in previous years, you’ve got to be able to clearly show why. On a similar note, if your gross profit margin or expenses are markedly different from those of other businesses in your industry, it may trigger additional IRS scrutiny that, in turn, could lead to an audit.

Miscalculated or unusually high deductions also are a common audit trigger. Remember, to be deductible, business expenses must be “ordinary” and “necessary.” You can’t deduct personal expenses, such as clothing or the nonbusiness use of vehicles or computers. Other expenses, including certain meal and entertainment expenses, may be at least partially deductible. But you’ve got to follow the rules.

Bigger picture issues

Your company’s tax return is the most obvious place to look for foibles or inconsistencies that could lead to an audit. But there are other, “big picture” moves that ultimately lead the IRS to audit many businesses. Here are a couple of specific examples to watch out for:

“Unreasonable” compensation.

The agency may scrutinize any business owner who draws a salary that’s inordinately higher or lower than those in similar companies in his or her location. But corporations are in particular danger here.

In the case of C corporations, the IRS may consider a high salary as dividend income and deny deductions for any associated compensation expenses. For S corporations, the IRS may reclassify excessive distributions as wages, making the shareholders liable for additional payroll taxes on the amount.

Thus, if you’re incorporated, make sure you pay any shareholders who work for the company within the standards of “reasonable compensation.” What’s considered reasonable is subjective, but the basic rule is that shareholders should pay themselves what they would pay others to do their jobs.

Employee misclassification.

With the increasingly common use of independent contractors — also known as the “1099 economy” — businesses remain at high risk of running into an audit because of improper employee classification. The temptation is to classify workers as independent contractors to avoid payroll taxes (and benefits). But if the IRS reclassifies an independent contractor as a bona fide employee, you could end up paying back taxes, interest and other penalties.

The distinction between employee and independent contractor is determined by a variety of factors, including the amount of control a company has over how the person works and by the support given to that individual. To steer clear of IRS trouble, explain your desired results to the independent contractor and provide a deadline. But leave how, and, to the extent possible given the work in question, when and where the work is done to the contractor.

Response measures

If you’re selected for an audit, whether randomly or because of one of the issues mentioned (or another matter entirely), you’ll be notified by letter. Generally, the IRS won’t make initial contact by phone. But if there’s no response to the letter, the agency may follow up with a call.

The good news is that many audits simply request that you mail in documentation to support certain deductions you’ve taken. Others may ask you to take receipts and other documents to a local IRS office. Only the most severe version, the field audit, requires meeting with one or more IRS auditors at your office.

More good news: In no instance will the agency demand an immediate response. You’ll be informed of the discrepancies in question and given time to prepare. To do so, you’ll need to collect and organize all relevant income and expense records. If any records are missing, you’ll have to reconstruct the information as accurately as possible based on other documentation.

The best news of all is that no business owner has to go through an audit alone. We can help you:

Understand what the IRS is disputing (it’s not always crystal clear),
Gather the specific documents and information needed, and
Respond to the auditor’s inquiries in the most expedient and effective manner.

The weaker or more complex your case, the more value your accountant can provide. In addition, IRS agents are often more comfortable dealing with professionals who understand tax law.

The right approach

Don’t let an IRS audit ruin your year — be it this year, next year or whenever that letter shows up in the mail. By taking a meticulous, proactive approach to how you track, document and file your company’s tax-related information, you’ll make an audit much less painful and even decrease the chances that one happens in the first place.

Download the 2017 – 2018 Tax Planning Guide

CECL and Loan Portfolio Analysis

Posted on September 22, 2017July 22, 2024 by Debra Barcuch

Analysis Required

In a June 2016 report by Big Four accounting firm PwC, it stated that each entity’s “estimate of expected credit losses (ECL) should consider historical information, current information, and reasonable and supportable forecasts, including estimates of prepayments.”

The actual methodology used to calculate ECL is left up to each financial entity, so it may be that several models are tested and used in combination to assess loan portfolio risk. Again, the new methodology is an assessment of risk of future losses as opposed to calculation of actual incurred losses, so you will need to use reasonable judgments based on historic data and the nature of current contracts and customer profiles — even types of cars sold — to determine the ECL.

Let’s look at two methodologies commonly used by BHPH operators to determine portfolio value and discounts, and how these might be adjusted and work in tandem to support the new standard:

Vintage Analysis

Vintage analysis is based on loss curves that include expectations of losses at each point in the life of a financial asset. Under the CECL model, dealers would look at the remaining area under the loss curve rather than one point of time on the loss curve. Dealers can use vintage analysis to report expected credit losses on the remaining life of the assets in their portfolio. This calculation can then be measured against a baseline of portfolio performance.

Static Pool Analysis

A baseline of portfolio performance — that is, historic performance — must be established in order to forecast expected losses. Using a static pool concept, you collect data on common risk characteristics within existing segments or classes of loans. Using origination dates by same month, quarter or year will help you develop a pool that can be tracked for lifetime of loss. By looking back over several years of origination and collection data, you will develop a stronger baseline to support implementation of the CECL and recording a risk-focused ALLL on your financial statements.

Continue Reading: Other Considerations Relating to CECL

In light of this new federal accounting standard for monitoring and calculating expected credit losses, BHPH operators of all sizes will likely require additional professional support. A CPA knowledgeable in BHPH operations can help you determine the standard’s impact on your current accounting methods, monitoring and reporting. Talk to the audit group at Cornwell Jackson to start planning for internal and external finance changes in the next few years.

Mike Rizkal, CPA is the lead partner in Cornwell Jackson’s Audit and Attest Service Group. He provides advisory services, including financial audit and attest services, to privately held, middle-market businesses.

Contact him at mike.rizkal@cornwelljackson.com.

Business Owners: Understand the Trust Fund Recovery Penalty

Posted on September 22, 2017July 23, 2024 by Debra Barcuch

The IRS is strict about collecting payroll taxes and tough on “responsible persons” who don’t pay them.

Withheld federal income, Social Security, and Medicare taxes are known as “trust fund” taxes because they are held in trust until they’re paid. If they aren’t paid, the IRS can assess liability for 100% of the unpaid amount on responsible individuals. Once that move is taken, the tax agency can start collection action against an individual’s personal assets. It can file a federal tax lien or take levy or seizure action.

A recent court case shows that a person may not be able to escape the penalty even if someone else is primarily responsible for handling payroll taxes.

The case involved a 50% owner and CEO of a tool and die company. He signed the paychecks. The other 50% owner served as the COO and prepared the payroll tax deposit checks. Both men had authority to handle money for the company, to open and close bank accounts in its name and to sign checks.

Payroll Service Bails

The company used a third-party payroll service provider to process its paychecks. But in December 2003, the service ended the contract after the tool and die company wasn’t able to remit the full amount of its gross payroll, including taxes.

At the COO’s urging, the company began using an in-house software system to handle payroll. Both the CEO and the COO expected to be able to fix the tax shortfall early in 2004.

The CEO maintained that the COO was the sole person entrusted to ensure that the payroll taxes were paid. He says that he didn’t learn that the COO was routinely failing to do so until July 2004. At that time, the CEO arranged a meeting with IRS to discuss the shortfalls.

At some point, the CEO was going through the COO’s desk and discovered that although the man was regularly cutting payroll tax checks, he wasn’t paying the taxes. Up until that point, the CEO claimed that the regular cutting of the checks led him to believe the taxes were being paid.

“Just Signing Papers”

The company tried, but couldn’t stay current with the taxes, so the CEO met with the IRS again in October 2004. At that meeting, the CEO stated that he discovered that the COO hadn’t been keeping up with the taxes. The CEO acknowledged that he signed tax returns but claimed he was “just signing papers that had to be signed,” and that he didn’t review the returns or understand them.

In 2005, several significant incidents occurred:

In January, the company filed for Chapter 11 bankruptcy protection and reorganization.
In May, an IRS Revenue Officer interviewed the CEO, who admitted that he first became aware of the delinquent taxes in December 2003 and that while the delinquent taxes were increasing, he authorized the payment of certain of the company’s other financial obligations, including payroll, utilities, rent, supplies, operating expenses, loan payments and equipment leases.
In August, the CEO laid off the COO but continued to use him to handle payroll taxes.

Following an investigation, the IRS assessed the trust fund recovery penalty against the CEO. He filed suit in U.S. District Court for the Eastern District of Michigan.

The tax code allows the IRS to seek a trust fund recovery penalty from any person who is:

A “responsible person” — that is any person, or group of people, who has the duty to perform and the power to direct the collecting, accounting and paying of trust fund taxes, and
Willfully fails to collect or pay those taxes.

Broad Interpretations

The IRS has broad interpretations of these two requirements. For example, a responsible person could be an officer or employee of a corporation, a member of a partnership or a shareholder, among others on a long list of individuals who can be held liable for unpaid payroll taxes.

And a willful failure needn’t be intentional. The penalty can be applied in situations where a person knew, or should have known, that the payroll taxes weren’t paid. Having a bad motive isn’t necessarily required.

In the case described above, the court found the CEO met both requirements. He had the authority to pay the taxes (even though he had no responsibilities related to calculating or paying them). The district court cited Kinnie v. U.S., where the court found that a responsible person can be responsible for a corporation’s failure to pay its taxes, or more explicitly, can direct payment of creditors.

“Obvious Risk”

The CEO also disregarded an “obvious risk that the taxes weren’t being paid,” the court said. While he had become fully aware of the COO’s deception in July 2004, he tried to show that until the fourth quarter of that year he had no idea that the books were being cooked — and that he had no reason to exercise oversight of the COO.

The court noted that the CEO also had continued to rely on the COO for paying the payroll taxes even after he laid him off. The court cited Calderone v. U.S., where it was ruled that a reckless disregard of the facts and known risks that taxes weren’t being paid is sufficient to hold a party liable.

By repeatedly disregarding these red flags that the COO wasn’t paying the taxes, the CEO acted recklessly and willfully, the district court found. As a result, he failed to convince the district court that he shouldn’t be held liable. (Hartman, DC MI 7/26/2017, 120 AFTR 2d-5091)

Do Not Ignore

The issue of trust fund taxes is far too serious to ignore. It’s critical that a person who meets any of the financial responsibilities that can lead to a trust fund penalty be certain that the taxes are paid (see box below: Critical Questions). It’s extremely difficult to get the courts to show any mercy if the IRS assesses the penalty.

Critical Questions

The IRS interviews individuals it suspects of being responsible parties. Some of the common questions asked are:

Do you determine the financial policy for the business?
Do you direct or authorize payment of bills?
Did you open or close bank accounts for the business?
Did you guarantee or cosign any loans?
Do you sign or countersign checks?
Do you authorize or sign payroll checks?
Did you authorize or make federal payroll tax deposits?
Do you prepare, review, sign or transmit payroll tax returns?

The more “yes” answers to these questions, the greater the likelihood the trust fund recovery penalty will be imposed.

The Tax Ramifications of Business Travel

Posted on September 21, 2017July 23, 2024 by Debra Barcuch

Abstract: Although conference calls and Web meetings are increasingly prevalent, plenty of dedicated “road warriors” still engage in business-related travel. It’s important for the companies sending them into battle to know and understand the tax ramifications. This article examines concepts such as accountable plans, “business travel status” and how to define a “tax home.”

The tax ramifications of business travel

Business travel isn’t what it used to be. With conference calls and Web meetings increasingly prevalent, the sheer volume of corporate travelers has probably diminished. But there are still plenty of dedicated “road warriors” on the job. And if your company is sending some into battle, it’s important to understand the tax ramifications.

Accountable plans

Generally, for federal tax purposes, a company may deduct all ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. This includes travel expenses that aren’t deemed lavish or extravagant, which can qualify as a “working condition fringe benefit.”

Working condition fringe benefits are any property or service provided to an employee to the extent that, if he or she paid for the property or service him- or herself, it would be tax-deductible. Such benefits aren’t included in the employee’s gross income or subject to FICA taxes or income tax withholding.

Under the Internal Revenue Code, an advance or reimbursement for travel expenses made to an employee under an “accountable plan” is considered a working condition fringe benefit. In general, an advance or reimbursement is treated as made under an accountable plan if an employee:

Receives the advance or reimbursement for a deductible business expense paid or incurred while performing services for his or her employer,
Accounts for the expense to his employer within a reasonable period of time and in an adequate manner, and
Returns any excess reimbursement or allowance within a reasonable period of time.

By contrast, an advance or reimbursement made under a “nonaccountable plan” isn’t considered a working condition fringe benefit — it’s treated as compensation. Thus, the amount is fully taxable to the employee, and subject to FICA and income tax withholding for the employer.

Business travel status

Although business transportation — going from one place to another without an overnight stay — is deductible, attaining “business travel status” fully opens the door to additional tax benefits. Under business travel status, the entire cost of lodging and incidental expenses, and 50% of meal expenses, is generally deductible by the employer that pays the bill. What’s more, those amounts don’t equate to any taxable income for employees who, as mentioned, are reimbursed under an accountable plan.

So how does a business trip qualify for business travel status? It generally must involve:

Overnight travel,
An employee traveling away from his or her “tax home,” and
A temporary trip undertaken solely, or primarily, for ordinary and necessary business reasons.

Bear in mind that “overnight” travel doesn’t necessarily mean an employee must be away from dusk till dawn. Any trip that’s long enough to require sleep or rest to enable the taxpayer to continue working is considered “overnight.”

Home sweet tax home

One particular aspect of business travel tax treatment that many companies struggle with is the concept of a “tax home.” In a nutshell, the IRS allows deductions for meals and lodging on business trips because these expenses are duplicative of costs normally incurred at employees’ homes and employees are required to spend more money while traveling. Consequently, a taxpayer can’t claim deductions for meals and lodging unless he or she has a home for tax purposes and travels away from it overnight.

A “tax home” — that is, an employee’s home for purposes of the business-travel deduction rules — is located at either his or her:

Regular or principal (if more than one regular) place of business, or
Regular place of abode in a real and substantial sense, if he or she has no regular or principal place of business.

If an employee has two or more work locations, his or her “main” place of work will be considered the tax home. In determining which location is the main place of work, the IRS looks at factors such as total time spent at, degree of business activity in, and amount of income derived from, each business location.

There may be situations, however, in which an employee has no permanent residence. For example, an itinerant salesperson who moves from place to place is only “home” wherever he or she stays at each location. Because the taxpayer doesn’t have duplicative expenses, there’s likely no deduction for meals and lodging.

There is an exception under which local, “nonlavish” lodging expenses incurred while not away from home overnight on business may be deductible if all facts and circumstances so indicate. One factor specified in the regs is whether the employee incurs the expense because of a bona fide employment condition or requirement. An example is a business that’s hosting a conference at a local hotel, where it’s necessary for some employees to stay at the hotel to effectively run the conference.

Important rules

Even if your company has pumped the brakes on business trips of late, knowing the tax rules involved remains important. These rules can save your organization tax dollars and spare your employees aggravation and increased liability on their own returns. Contact us for help ensuring you’re handling travel expenses properly.

Download the 2017 – 2018 Tax Planning Guide

Recent Breach Highlights the Vulnerability of Your Personal Data

Posted on September 19, 2017July 23, 2024 by Debra Barcuch

Equifax, one of the nation’s three major credit reporting agencies, recently reported a massive data breach. Are you among the 143 million U.S. consumers whose personal information was hacked? Here’s how to find out — and how to help protect yourself against future breaches.

What Went Wrong?

On July 29, Equifax discovered that, starting in mid-May, criminals had exploited a vulnerability in a website application. Although management took immediate action to stop the attack, hackers had already gained unauthorized access to millions of consumers’ names, Social Security numbers, birth dates and addresses, along with thousands of credit card numbers and credit dispute documents that contained sensitive personal information. The attack affected individuals in the United States, Canada and the United Kingdom.

Equifax immediately launched a forensic investigation and began working with law enforcement officials to discover the source and scope of the breach. Equifax has also responded by offering a free year of identity theft protection and credit file monitoring to all U.S. consumers.

Has Your Personal Data Been Breached?

Go to Equifax’s website and click on the “Potential Impact” tab to find out if your personal information has been compromised. The website also allows you to sign up for free data protection and credit monitoring services — regardless of whether you were affected by this particular incident.

Important note: The link requires you to enter personal information. So, access it using only a secure computer and an encrypted network connection.

After you request to enroll in the free service, the website will provide you with an enrollment date. Write down the date and come back to the site and click “Enroll” on that date. You have until November 21, 2017, to enroll for the free services. In addition to the website, Equifax plans to send direct mail notices to consumers whose credit card numbers or dispute documents were breached.

“This is clearly a disappointing event for our company, and one that strikes at the heart of who we are and what we do. I apologize to consumers and our business customers for the concern and frustration this causes,” said Chairman and Chief Executive Officer, Richard F. Smith, in a recent statement. He added, “I’ve told our entire team that our goal can’t be simply to fix the problem and move on. Confronting cybersecurity risks is a daily fight. While we’ve made significant investments in data security, we recognize we must do more. And we will.”

What Should You Do If a Breach Occurs?

If you suspect a data breach, help protect your identity from thieves and minimize losses by taking these steps:

Call the relevant companies if you suspect that a breach has occurred. Ask for the fraud department and explain the incident. Then change log-ins, passwords and PINs to minimize your losses.

Consider freezing your credit. A credit freeze makes it harder for someone to open a new account in your name. Keep in mind that a credit freeze won’t prevent a thief from making charges to your existing accounts, however. Alternatively, consider placing a fraud alert to warn creditors that you may be a victim of ID theft. Fraud alerts are free from all three major credit reporting agencies and last for 90 days. After the 90-day window, you can renew a fraud alert, if necessary.

Obtain free annual credit reports from Equifax, Experian and TransUnion. Identity theft usually results in accounts or activity that you won’t recognize.

Ongoing Protection

ID theft often happens long after your personal information has been stolen, so don’t allow yourself to be lulled into a false sense of security after your initial response. Ongoing credit monitoring is essential. Proactive consumers continue to watch credit card and bank accounts closely for unusual activity. They also file their taxes as early as possible — before a scammer can.

If your personal data was exposed in the Equifax attack or it’s affected by another breach, contact your financial and legal advisors to guide you through the recovery process.

Designing a Tax-wise Bonus Plan

Posted on September 19, 2017July 23, 2024 by Debra Barcuch

Abstract: An annual bonus plan can help attract, retain and motivate employees. And if the plan is designed carefully, the taxpayer can deduct bonuses earned this year even if he or she doesn’t pay them until next year. This article explains certain rules, such as the 2½ month rule and the all-events test.

Designing a tax-wise bonus plan

An annual bonus plan can be a great way to attract, retain and motivate employees. And if the plan is designed carefully, you can deduct bonuses earned this year even if you don’t pay them until next year.

The 2½ month rule

Many employers are aware of the “2½ month rule” and assume they can deduct bonuses earned during a tax year so long as they pay them within 2½ months after the end of that year (by March 15 for a calendar-year company). But that’s not always the case.

For one thing, this tax treatment is available only to accrual-basis taxpayers — cash-basis taxpayers must deduct bonuses in the year they’re paid, regardless of when they’re earned. Even for accrual-basis taxpayers, however, this treatment isn’t automatic. Bonuses can be deducted in the year they’re earned only if the employer’s bonus liability is fixed by the end of the year.

The all-events test

For accrual-basis taxpayers, the IRS determines when a liability (such as a bonus) has been incurred — and, therefore, is deductible — by applying the “all-events test.” Under this test, a liability is deductible when:

All events have occurred that establish the taxpayer’s liability,
The amount of the liability can be determined with reasonable accuracy, and
Economic performance has occurred.

Generally, the third requirement isn’t an issue; it’s satisfied when an employee performs the services required to earn a bonus. But the first two requirements can delay your tax deduction until the year of payment, depending on how your bonus plan is designed.

For example, many bonus plans require an employee to remain in the company’s employ on the payment date as a condition of receiving the bonus. Even if the amount of the bonus is fixed at the end of the tax year, and employees who leave the company before the payment date forfeit their bonuses, the all-events test isn’t satisfied until the payment date. As discussed below, however, it’s possible to accelerate deductions with a carefully designed bonus pool arrangement.

Everyone into the pool

One solution to the problem described above is to establish a bonus pool. In a 2011 ruling, the IRS said that employers may deduct bonuses in the year they’re earned — even if there’s a risk of forfeiture — so long as any forfeited bonuses are reallocated among the remaining employees in the pool rather than retained by the employer.

Under such a plan, an employer satisfies the all-events test because the aggregate bonus amount is fixed at the end of the year, even though amounts allocated to specific employees aren’t determined until the payment date.

In reaching this result, the IRS has emphasized that the employer must:

Define the terms and conditions under which bonuses are paid,
Pay bonuses for services performed during the tax year,
Communicate the plan’s general terms to employees when they become eligible and when the plan is changed,
Determine the minimum aggregate bonus amount either through a formula fixed before year end, or based on a board resolution or other corporate action taken before year end, and
Reallocate forfeited bonuses among other eligible employees.

Item 4 above is significant: It indicates that a bonus plan satisfies the all-events test if the minimum aggregate bonus is determined according to a formula that’s fixed by year end. This allows employers to deduct performance-based bonuses tied to earnings or other financial benchmarks, even if the exact amount isn’t determined until after year end, when the company’s financial reports are prepared.

To ensure that bonuses are deductible this year, employers shouldn’t retain any discretion to modify or cancel bonuses before the payment date or condition bonuses on approval by the board or a compensation committee after the end of the year.

Plan carefully

Designing a bonus plan that allows you to accelerate deductions into this year for bonuses paid next year can reduce your tax bill and boost your cash flow. To enjoy these benefits, work with us to ensure you satisfy the all-events test.

Download the 2017 – 2018 Tax Planning Guide

Understanding Bitcoin

Posted on September 14, 2017July 23, 2024 by Debra Barcuch

If you watch much financial news, by now you’ve probably been exposed to the Bitcoin craze. Bitcoin has experienced an astounding increase in value in 2017 – from $967 to $4,627 at the time of writing – a rise of 378%. Worth just $358 at its 2016 low point, Bitcoin makes even the most unruly equity markets look relatively steady.

Invented in 2008 by an anonymous programmer and developed by an open-source team, Bitcoin is the largest of many cryptocurrencies that exist today, with a market cap of $160 billion. Unlike dollar bills that are printed and regulated by a Central Bank and Treasury Department, Bitcoin has no centralized control. It can be used on certain websites to make purchases and can be traded on online exchanges. Using Bitcoin ATMs installed across the US, it can be exchanged directly for cash.

Despite Bitcoin’s label and features, it has a long way to go to be considered a real currency.

Standard economic theory states that money has three functions: a medium of exchange, a store of value, and a unit of account. As a medium of exchange, while hundreds of online vendors accept Bitcoin, only three of the top 500 online retailers do. As a unit of account, businesspeople must be able to attribute a Bitcoin value to their good and services. With low adoption among retailers, they are not inclined to take on that risk. As a store of value, Bitcoin again fails, with average monthly price moves in excess of 10% in either direction. Given this knowledge, we consider Bitcoin more of a speculative asset than a real currency.

One questionable aspect of Bitcoin it that it is unregulated and anonymous, making it an attractive tool for money launderers. We cannot foresee the US or EU legitimizing cryptocurrencies with these protocols. In fact, a new EU Draft Law proposed in March seeks to end the anonymity of cryptocurrency users. Confronting the governance issue may cause the value of Bitcoin to decrease or stagnate. Of course, on the other side it may increase its notoriety, making it more attractive to users with that desire.

Another concern about Bitcoin is the threat of hacking. A cryptoexchange called Mt. Gox lost bitcoin worth nearly $500 million to thieves. The Hong Kong cryptoexchange Bitfinex lost bitcoin worth $72 million in 2016. While programmers learn from these mistakes, the risks are still great. Unlike a bank account where there is a paper trail, Bitcoin transactions are anonymous and irreversible, making it almost impossible to recover stolen funds.

Due to their volatility and speculative, get-rich-quick nature, we would not advise clients to bet the ranch on Bitcoin or other cryptocurrencies. In other words, don’t consider investing anything in Bitcoin that you cannot afford to lose.

That said, an aspect of Bitcoin that has real potential is blockchain, the underpinning technology that records and verifies secure transactions on a public ledger. With no need for central recordkeeping, blockchain presents a more efficient way of record keeping and decentralizing markets.

Blockchain technology has the potential to be useful across many industries and transform business operating models in the long term.

Using energy as an example, a Goldman Sachs report from 2016 says, “With the advent of rooftop solar and high-capacity battery technology, individuals can potentially act as distributed power providers. We think blockchain could be used to facilitate secure transactions of power between individuals on a distributed network who do not have an existing relationship.” Start-ups like TransActive Grid in Brooklyn and Grid Singularity in Austria are doing just that.

The secure, tamper-proof blockchain system also offers enhancements for administrators and their record-keeping. This efficiency boost could help in a variety of industries. SWIFT, the secure global financial messaging system, has started utilizing blockchain. Airbnb is exploring using it to manage digital credentials for guests and hosts. For technology as young as blockchain is, it is remarkable seeing how widely it is being applied.

What began as a small experiment is now a rapidly expanding ecosystem. We’re seeing people placing trust in systems and network protocols, as opposed to people and businesses. And that shouldn’t matter, as long as it’s cheaper, faster, more secure and more efficient.

Will Bitcoin become the ubiquitous currency of the future? It’s doubtful, at least under the current status quo. But we do believe the underlying technology is cementing itself as a future-builder. And we aren’t yanking your blockchain when we say that.

Learn more at: http://www.slaughterinvest.com/insight/market-and-economic-commentary/understanding-bitcoin

Current Expected Credit Loss Model (CECL) and Data Collection

Posted on September 12, 2017 by Debra Barcuch

BHPH dealers may need to consider data collection in ways they haven’t before, or ways of collecting data that weren’t required before, to develop forward-thinking estimates of credit loss.

For example, our clients will often review data on all the loans issued in a given month, and then analyze how those loans are performing as a gauge of how all loans are performing for the year (static pool analysis). They might see that 10 percent of loans defaulted in the first six months and another 10 percent defaulted in the next six months. Using that static pool of loans, the dealers will then calculate a discount rate before selling the portfolio to the RFC.

With the new standard, tracking average default rates for a short time period is not enough. Analysis will have to go deeper to determine “potential loss” over the life of loans. The final risk-based calculation will be reported in the dealer’s current earnings as an “Allowance for Loan and Lease Losses (ALLL)” on financial statements.

If the ALLL increases — as many think it will under this new standard — it will impact the net worth of a financial institution on its financial statements. That’s why it’s so important to collect the right data and make sure it is accurate. Incomplete or inaccurate historic data — such as data that has not historically been audited — will affect the accuracy of the final calculation

Operators may need to track data such as expected timing and extent of projected cash collections of the loan portfolio as well as projected losses and an estimate of future principal losses. In order to estimate future losses, it may also be helpful to track:

Actual cash value and type of vehicle sold
Customer risk assessments, including credit scores
Underwriters approving each contract
Collectors assigned to which loans
Loan performance data

The level of risk estimated also correlates to the amount of cash reserves an entity may be required to hold to support these expected losses over the life of the loan portfolio. Known as your entity’s “reserves for credit losses,” this amount may need to increase under the new accounting standard if you find that “expected credit losses” over the life of the loan portfolio are higher than the real incurred losses that previously guided reserves.

Continue Reading: CECL and Loan Portfolio Analysis

Inadequate Records Lead to Unfavorable Results for Taxpayers

Posted on September 11, 2017 by Debra Barcuch

Federal tax law allows deductions for many items, such as legitimate business expenses and charitable donations. But, if you claim deductions on your tax return, you also must maintain adequate records to support them. If your tax return is audited, missing or incomplete records could lead to additional taxes, interest and penalties, as these three recent U.S. Tax Court cases demonstrate.

How Long Should You Retain Tax Records?

In general, any written evidence that supports figures on your tax return, such as receipts, expense logs, bank notices and sales records, should generally be kept for at least a three-year period. That’s because the statute of limitations generally runs out three years from the due date of the return for the year in question or the date you filed, whichever is later. So in most cases the IRS can decide to audit your return anytime within that three-year window.

You can also file an amended return on Form 1040X during this time period if you missed a deduction, overlooked a credit or misreported income.

Important note: There are some cases when taxpayers get more than the usual three years to file an amended return. You have up to seven years to take deductions for bad debts or worthless securities, so don’t toss out records that could result in refund claims for those items.

So, does that mean you’re safe from an audit after three years? Not necessarily. There are some exceptions. For example, some records support figures affecting multiple years, such as carryovers of charitable deductions, net operating loss carrybacks or carryforwards, or casualty losses. The IRS recommends that you save these records until the deductions no longer have effect, plus seven years.

Alternately, if the IRS has reason to believe your income was understated by 25% or more, the statute of limitations for an audit increases to six years. Or, if there’s suspicion of fraud or you don’t file a tax return at all, there is no time limit for the IRS to launch an inquiry.

In addition, you should keep records related to real estate for as long as you own the property, plus three years after you dispose of it and report the transaction on your tax return. Throughout ownership, keep records of the purchase, as well as receipts for home improvements, relevant insurance claims and documents relating to refinancing. These help prove your adjusted basis in the home, which is needed to figure the taxable gain at the time of sale, or to support calculations for rental property or home office deductions.

Likewise, keep the records for securities for as long as you own the investments, plus the statute of limitations on the relevant tax returns. To accurately report taxable events involving stocks and bonds, maintain detailed records of purchases and sales. These records should include dates, quantities, prices, reinvestment of dividends, and investment expenses, such as broker fees.

If you have questions regarding record retention, contact your tax advisor.

1. Alan Brookes, et ux. v. Commissioner(TC Memo 2017-146)

In this decision, the taxpayers were a married couple who filed a joint tax return. They operated the husband’s financial services and consulting business, along with the wife’s art business, through an S corporation. The S corporation’s losses were passed through to the couple’s personal tax return.

The IRS audited the couple’s tax returns for the 2010 through 2012 tax years, and disallowed many of the business’s deductions, increasing the taxpayers’ taxable income for the three years in question. For example, deductions the taxpayers claimed for travel, meals, entertainment and auto expenses were disallowed because the taxpayers had failed to:

Keep contemporaneous records,
Categorize the expenses, and
Separate business expenses from personal expenses.

However, the IRS allowed partial deductions for advertising, rent, gallery fees and supplies related to the wife’s art business, because the taxpayers had kept receipts from one of the tax years that showed purchase dates and amounts paid. Other deductions were allowed based on the wife’s oral testimony in conjunction with some sketchy recordkeeping.

The IRS also allowed partial deductions for amounts paid for massage therapy to treat the wife’s severe scoliosis, because the S corporation operated a medical expense reimbursement plan. However, deductions the taxpayers claimed for other medical expenses were disallowed due to inadequate recordkeeping.

The Tax Court concluded that the IRS had acted properly when it disallowed many deductions and also agreed that the taxpayers owed the 20% penalty for negligence on the additional tax assessed. The court opined that the taxpayers had failed to produce adequate records to support the disallowed expenses or demonstrate reasonable cause or good faith in claiming the disallowed expenses. Ultimately, the Tax Court sided with the IRS, charging the taxpayers with additional federal income tax of roughly $122,000 and a 20% negligence penalty of more than $24,000.

2. Stephen Drah v. Commissioner(TC Memo 2017-149)

In another recent Tax Court case, the taxpayer worked as an independent contractor for FedEx. Specifically, the taxpayer’s wholly owned C corporation contracted to provide services to FedEx and then paid wages to the taxpayer. On his individual return, the taxpayer claimed deductions for contract labor expenses, as well as vehicle depreciation, repair and maintenance.

The IRS audited the taxpayer’s tax return for the 2011 tax year and determined that the taxpayer had generally failed to substantiate the amount and business purpose of many expense deductions. Other business expense deductions — including those related to a vehicle leased by the corporation — were properly deductible by the corporation (and presumably were) but not by the taxpayer on his personal return.

The Tax Court concluded that the taxpayer owed additional income tax of roughly $12,000, plus nearly $4,000 in penalties for failure to file his personal return on time, failure to pay personal federal income tax and failure to make estimated tax payments.

3. Mark R. Ohde v. Commissioner(TC Memo 2017-137)

Another recent Tax Court decision involved married taxpayers who claimed charitable contribution deductions totaling more than $146,000 on their joint 2011 federal income tax return for donations of clothing, media, furniture and other household items. The taxpayers claimed to have donated more than 20,000 items to Goodwill.

The IRS audited the couple’s tax return and disallowed $145,000 of the claimed charitable contribution deductions. Why? The taxpayers had failed to properly substantiate noncash contributions that were purportedly worth more than $250. The receipts supplied by Goodwill didn’t describe the specific items contributed or indicate the number of items of any particular type. Instead, they simply stated that the thousands of items delivered fell into the categories of clothing, shoes, media, furniture and household items. In addition, donations that were purportedly worth more than $5,000 weren’t supported by qualified appraisals.

The Tax Court concluded that the IRS had acted properly in disallowing $145,000 of charitable deductions and assessing the 20% negligence penalty (based on the taxpayers’ inadequate recordkeeping). The Tax Court noted, “The term ‘negligence’ includes any failure to make a reasonable attempt to comply with the tax laws, and ‘disregard’ includes any careless, reckless, or intentional disregard” of the tax laws. The court concluded that recordkeeping failures can amount to negligence.

Bad Records, Bad Outcome

These cases show that inadequate support for tax deductions — such as lack of receipts and other documentation, the use of confusing and inconsistent accounting techniques, and vague testimony — can have expensive tax consequences. In addition to owing additional tax, taxpayers who claim unsubstantiated deductions may also be assessed interest and penalties on their unpaid taxes.

The Internal Revenue Code, the IRS, and the courts don’t distinguish between completely bogus deductions and deductions for legitimate, but unsupported, expenses. In either case, you can get into the same amount of trouble. Will your recordkeeping practices survive IRS scrutiny? Contact your tax advisor to fortify your recordkeeping procedures and help support your valuable tax write-offs.

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Relief to Partnerships that Missed the New Filing Deadlines

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The Push-Out Election

Option to Elect Out of the New Rules

Coming Soon

What every business owner should know

Return-related risks

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“Unreasonable” compensation.

Employee misclassification.

Response measures

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Analysis Required

Vintage Analysis

Static Pool Analysis

Payroll Service Bails

“Just Signing Papers”

Broad Interpretations

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Do Not Ignore

Critical Questions

The tax ramifications of business travel

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Important rules

What Went Wrong?

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Ongoing Protection

Designing a tax-wise bonus plan

The 2½ month rule

The all-events test

Everyone into the pool

Plan carefully

How Long Should You Retain Tax Records?

1. Alan Brookes, et ux. v. Commissioner(TC Memo 2017-146)

2. Stephen Drah v. Commissioner(TC Memo 2017-149)

3. Mark R. Ohde v. Commissioner(TC Memo 2017-137)

Bad Records, Bad Outcome

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