Seven small business IRS audit areas to watch through 2013

Seven small business IRS audit areas to watch through 2013

The IRS continually analyzes compliance levels for entities, issues and industries by conducting hundreds of compliance projects and initiatives each year. Leading up to the start of the government’s fiscal year on Oct. 1, the IRS has announced emerging or significant areas that it will prioritize for the coming year. When it comes to compliance, the IRS has increasingly focused on small business underreporting, which is responsible for 84% of the $450 billion tax gap. At national and regional tax forums held this summer, the IRS projected small business areas where it will focus through 2013.

Here are the highlights:

1. Fringe benefits, especially personal use of company cars. The IRS is completing its third and final year of a National Research Project on employment tax compliance. Early findings from these audits indicate that employers are not reporting employees’ personal use of company vehicles on Forms 1099 or W-2. Look for the IRS to investigate the use of all company cars, especially luxury autos, in its audits.

2. High income/high wealth taxpayers. The IRS defines high income/high wealth taxpayers as those who bring in a total positive income of more than $200,000 a year. Total positive income includes all gross receipts and sources of income before expenses and deductions. Through 2013, the IRS will focus on taxpayers with a total positive income of more than $1 million who file a Schedule C business return. Last year, the IRS audited 12.5% of all individuals with incomes of more than $1 million – a significant increase from 2010, when the IRS audited 8.4% of these taxpayers.

3. Form 1099-K matching. The IRS announced that it will start Form 1099-K matching in late 2013. The IRS provided a reprieve from merchant card reporting on business returns for 2011 Schedule C and Forms 1065, 1120S and 1120; however, the IRS plans to change its approach after 2012 returns are filed. The IRS has indicated that it plans to pilot a business-matching program that can address a large amount of small business noncompliance.

4. Credit for small business employee health insurance, under Section 45R. This credit, first available on 2010 returns, is now coming under IRS scrutiny. The IRS will examine small business employers and tax exempts for compliance with Section 45R eligibility requirements.

5. S corporations, with an emphasis on losses in excess of basis. The IRS is interested in S corporation audits in which losses are taken in excess of basis on shareholder returns. The IRS will review basis computations in these audits to determine whether tax preparers are properly completing due diligence requirements before deducting losses on Form 1040.

6. S corporations, with additional emphasis on reasonable compensation paid to officers. The IRS is also interested in the use of S corporation distributions to avoid payment of Social Security taxes. The IRS will focus on S corporations with income, distributions and little or no salary paid to officers.

7. Proper worker reclassification. Almost all business audits also include employment tax issues. In particular, the IRS is interested in worker status. The IRS understands that businesses have an economic incentive to misclassify workers as independent contractors rather than employees. It costs about 30% less for a business to employ an independent contractor than an employee. The IRS thinks there is significant noncompliance in worker classification and will continue to focus its field examination resources in this area.

Understand that small businesses, and specifically those who fit any of the above issues, will be a focus for IRS audits in 2012 and 2013. A best practice is to proactively address these audit areas now with us, and prevent future problems through proper education and planning. Going forward, we must schedule frequent meetings so we can stay informed and avoid audit surprises.

How Will Taxmageddon Affect You?

From www.openforum.com by Courtney Rubin

By now you've probably heard plenty about Taxmageddon, Dec. 31, when the 2001 and 2003 tax cuts expire.

The Tax Policy Center says the cuts—which affect things including marginal income tax rates, marriage penalty rates and the estate tax—will result in 83 percent of U.S. households facing an average of $3,701 in tax increases. Ninety-eight percent of households with income above $50,000 will be affected.

President Obama has proposed extending many of the tax rates, but not for people with income over $250,000, which would impact thousands of small businesses.

Now you can figure out exactly what and how you'll be affected. The U.S. House of Representatives' Committee on Small Business has created what it calls a "one stop shop for information" on the tax cuts. The website has a list of expiring 2001 and 2003 tax provisions thatmost affect small business.

It also has a list of expiring tax extenders that will affect small business, plus a link to a report from the nonpartisan Joint Committee on Taxation, which found that the amount of flow-through business income that would be subject to President Obama’s proposed tax hike has increased from 50 percent in 2011 to 53 percent in 20

13, with the number of entities subject to the tax increase going up from under 750,000 in 2011 to approximately 940,000 in 2013. Most small businesses are organized as flow-through entities: partnerships, limited liability companies, S corporations and sole proprietorships.

Lastly, there is a link to an Ernst & Young study that predicts tax hikes would eliminate 710,000 jobs in 2013.

In June, one CPA who specializes in estate, trust and gift taxes told a hearing of the House Subcommittee on Economic Growth, Tax and Capital Access that the estate tax, at least, should not be a huge issue for small businesses.

“Over the last 10 years, a number of extremely wealthy families have done an excellent job of convincing small-business owners into believing that they will lose their businesses to the estate tax,” said Thala Taperman Rolnick, a Phoenix CPA. “In reality,

at its current level, it affects very few individuals.”

But a small business owner disagreed. Karen Madonia, CFO of Illco, a Chicago-area distributor of heating, ventilation, air-conditioning and refrigeration equipment, parts and supplies, talked about the uncertainties faced by her father in the family-owned business he has been operating since 1973.

“Over the last few years, my dad has spent countless hours and entirely too much money trying to navigate the estate planning waters. Instead of focusing on growing his business so he can open more branches and employ more people, he has had to strate

gize about how to pass his company on to his kids without having to dismantle it,” she says. “And if that isn’t enough of a challenge, he has had to do it with an ever-changing tax landscape."

Tax Provisions in Obama-Care

In addition to making sweeping changes to the U.S. health care system, the health care reform legislation added a number of new taxes and made various other revenue-increasing changes to the Code to help finance health care reform. The legislation also made several health care–related changes to the Code to benefit certain taxpayers, including a credit to offset part of the costs of health insurance for low- to middle-income individuals and families and a credit to offset part of the costs to small businesses of providing health insurance for their employees.

Here is a list of tax-related items from the health care reform legislation—in addition to the Sec. 5000A individual health care mandate—that were upheld as a result of the Court's decision:

Premium-assistance credit (Sec. 36B): Refundable tax credits that eligible taxpayers can use to help cover the cost of health insurance premiums for individuals and families who purchase health insurance through a state health benefit exchange. (Effective 2014.)

Small business tax credit (Sec. 45R): Small businesses—defined as businesses with 25 or fewer employees and average annual wages of $50,000 or less—would be eligible for a credit of up to 50% of nonelective contributions the business makes on behalf of their employees for insurance premiums. (Effective 2010.)

Tax-exempt health insurers: Program administered by the Department of Health and Human Services that will foster the creation of qualified nonprofit health insurance issuers to offer health insurance.

Reporting requirements (Sec. 6055): Requires insurers (including employers who self-insure) that provide minimum essential coverage to any individual during a calendar year to report certain health insurance coverage information to both the covered individual and to the IRS. (Effective 2014.)

Medical care itemized deduction threshold (Sec. 213): Threshold for the itemized deduction for unreimbursed medical expenses is increased from 7.5% of adjusted gross income (AGI) to 10% of AGI for regular income tax purposes. (Effective 2013 generally, 2017 for certain taxpayers.)

Cafeteria plans (Sec. 125): A qualified health plan offered through a health insurance exchange is a qualified benefit under a cafeteria plan of a qualified employer. (Effective 2014.)

Additional hospital insurance tax on high-income taxpayers (Sec. 3101): Employee portion of the Medicare hospital insurance tax part of FICA is increased by 0.9% on wages that exceed a threshold amount. (Effective 2013.)

Employer responsibility (Sec. 4980H): An "applicable large employer" that does not offer coverage for all its full-time employees, offers minimum essential coverage that is unaffordable, or offers minimum essential coverage that consists of a plan under which the plan's share of the total allowed cost of benefits is less than 60%, is required to pay a penalty if any full-time employee is certified to the employer as having purchased health insurance through a state exchange with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee. (Effective 2014.)

Fees on health plans (Sec. 4375): Fee is imposed on each specified health insurance policy. (Effective Oct. 2012.)

Excise tax on high-cost employer plans (Sec. 4980I): Excise tax on coverage providers if the aggregate value of employer-sponsored health insurance coverage for an employee (including, for purposes of the provision, any former employee, surviving spouse, and any other primary insured individual) exceeds a threshold amount. (Effective 2018.)

Tax on health savings account (HSA) distributions (Sec. 223): Additional tax on distributions from an HSA or an Archer medical savings account (MSA) that are not used for qualified medical expenses is increased to 20% of the disbursed amount. (Effective 2011.)

Tax on indoor tanning services (Sec. 5000B): 10% tax on amounts paid for indoor tanning services. (Effective 2010.)

Health flexible spending arrangements (FSAs) (Sec. 125(i)): Maximum amount available for reimbursement of incurred medical expenses under a health FSA for a plan year (or other 12-month coverage period) must not exceed $2,500. (Effective 2013.)

SIMPLE cafeteria plans for small business (Sec. 125): An eligible small employer is provided with a safe harbor from the nondiscrimination requirements for cafeteria plans as well as from the nondiscrimination requirements for specified qualified benefits offered under a cafeteria plan. (Effective 2011.)

Expansion of adoption credit, adoption-assistance programs: Maximum adoption credit was increased and, for adoption-assistance programs, the maximum exclusion was increased. (Effective 2010; scheduled to expire at end of 2012.)

Charitable hospitals (Secs. 501(r) and 6033(b)(15)): New requirements applicable to Sec. 501(c)(3) hospitals, regarding conducting a community health needs assessment, adopting a written financial-assistance policy, limitations on charges, and collection activities. (Effective March 2010; community health needs assessment effective March 2012.)

Information reporting (Sec. 6051(a)(14)): Requires employers to disclose on each employee's annual Form W-2 the value of the employee's health insurance coverage sponsored by the employer. (Effective 2012.)

Return information disclosure (Sec. 6103): Allows the IRS, upon written request of the secretary of Health and Human Services, to disclose certain taxpayer return information if the taxpayer's income is relevant in determining the amount of the tax credit or cost-sharing reduction, or eligibility for participation in the specified state health subsidy programs. (Effective March 2010.)

Medicare tax on investment income (Sec. 1411): Imposes a tax on individuals equal to 3.8% of the lesser of the individual's net investment income for the year or the amount the individual's modified AGI exceeds a threshold amount. (Effective 2013.)

Annual fee on pharmaceutical manufacturers and importers: Fee on each covered entity engaged in the business of manufacturing or importing branded prescription drugs for sale to any specified government program or pursuant to coverage under any such program. (Effective 2011.)

Excise tax on medical device manufacturers (Sec. 4191): Tax equal to 2.3% of the sale price is imposed on the sale of any taxable medical device by the manufacturer, producer, or importer of the device. (Effective 2013.)

Codification of the economic-substance doctrine (Sec. 7701(o)): Codifies the judicially created economic-substance doctrine and makes underpayments due to transactions that do not have economic substance subject to the Sec. 6662 accuracy-related penalty. (Effective 2010.)

Change to cellulosic biofuel producer credit (Sec. 40): Excludes from the definition of cellulosic biofuel any fuels that (1) are more than 4% (determined by weight) water and sediment in any combination or (2) have an ash content of more than 1% (determined by weight) (so-called black liquor). (Effective 2010.)

Deductions for federal subsidies for retiree prescription plans (Sec. 139A): Eliminates the rule that the exclusion for subsidy payments is not taken into account for purposes of determining whether a deduction is allowable for retiree prescription drug expenses. (Effective 2013.)

Adult dependent insurance coverage: Changes the definition of "dependent" for purposes of Sec. 105(b) (excluding from income amounts received under a health insurance plan) to include amounts expended for the medical care of any child of the taxpayer who has not yet reached age 27. The same change is made in Sec. 162(l)(1) for purposes of the self-employed health insurance deduction, in Sec. 501(c)(9) for purposes of benefits provided to members of a VEBA, and in Sec. 401(h) for benefits for retirees. (Effective 2010.)

Restrictions on use of HSA and FSA Funds (Sec. 223): Amounts paid for over-the-counter medications will no longer be reimbursable from HSAs, Archer MSAs, health FSAs, or health reimbursement arrangements. (Effective 2011.)

Time for payment of corporate estimated taxes for 2014: For corporations with assets of at least $1 billion (determined as of the end of the preceding tax year), estimated tax payments due in July, August, or September 2014 were increased.

Expanded 1099 reporting: This change was repealed by the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011, P.L. 112-9.

Making Gifts Can Be Taxable

Eight Tips to Determine if Your Gift is Taxable

If you gave money or property to someone as a gift, you may owe federal gift tax. Many gifts are not subject to the gift tax, but the IRS offers the following eight tips about gifts and the gift tax.

1. Most gifts are not subject to the gift tax. For example, there is usually no tax if you make a gift to your spouse or to a charity. If you make a gift to someone else, the gift tax usually does not apply until the value of the gifts you give that person exceeds the annual exclusion for the year. For 2011 and 2012, the annual exclusion is $13,000.

2. Gift tax returns do not need to be filed unless you give someone, other than your spouse, money or property worth more than the annual exclusion for that year.

3. Generally, the person who receives your gift will not have to pay any federal gift tax because of it. Also, that person will not have to pay income tax on the value of the gift received.

4. Making a gift does not ordinarily affect your federal income tax. You cannot deduct the value of gifts you make (other than deductible charitable contributions).

5. The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. The following gifts are not taxable gifts:

• Gifts that are do not exceed the annual exclusion for the calendar year,
• Tuition or medical expenses you pay directly to a medical or educational institution for someone,
• Gifts to your spouse,
• Gifts to a political organization for its use, and
• Gifts to charities.

6. You and your spouse can make a gift up to $26,000 to a third party without making a taxable gift. The gift can be considered as made one-half by you and one-half by your spouse.

If you split a gift you made, you must file a gift tax return to show that you and your spouse agree to use gift splitting. You must file a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, even if half of the split gift is less than the annual exclusion.

7. You must file a gift tax return on Form 709, if any of the following apply:

• You gave gifts to at least one person (other than your spouse) that are more than the annual exclusion for the year.
• You and your spouse are splitting a gift.
• You gave someone (other than your spouse) a gift of a future interest that he or she cannot actually possess, enjoy, or receive income from until some time in the future.
• You gave your spouse an interest in property that will terminate due to a future event.

8. You do not have to file a gift tax return to report gifts to political organizations and gifts made by paying someone’s tuition or medical expenses.

For more information see Publication 950, Introduction to Estate and Gift Taxes. Both Form 709 and Publication 950 are available at www.IRS.gov.

Farm Income and Deductions: 10 Key Points

Farm Income and Deductions: 10 Key Points

You are in the business of farming if you cultivate, operate or manage a farm for profit, either as an owner or a tenant. A farm includes livestock, dairy, poultry, fish, fruit and truck farms. It also includes plantations, ranches, ranges and orchards.

Here are 10 key points for farmers regarding income taxes.

1. Crop insurance proceeds

You must include in income any crop insurance proceeds you receive as the result of crop damage. You generally include them in the year you receive them.

2. Sales caused by weather-related condition

If you sell more livestock, including poultry, than you normally would in a year because of weather-related conditions, you may be able to postpone until the next year the reporting of the gain from selling the additional animals.

3. Farm income averaging

You may be able to average all or some of your current year's farm income by allocating it to the three prior years. This may lower your current year tax if your current year income from farming is high, and your taxable income from one or more of the three prior years was low. This method does not change your prior year tax, it only uses the prior year information to determine your current year tax.

4. Deductible farm expenses

The ordinary and necessary costs of operating a farm for profit are deductible business expenses. An ordinary expense is an expense that is common and accepted in the farming business. A necessary expense is one that is appropriate for the business.

5. Employees and hired help

You can deduct reasonable wages paid for labor hired to perform your farming operations. This includes full-time and part-time workers. You must withhold Social Security, Medicare and income taxes for employees.

6. Items purchased for resale

You may be able to deduct, in the year of the sale, the cost of items purchased for resale, including livestock and the freight charges for transporting livestock to the farm.

7. Net operating losses

If your deductible expenses from operating your farm are more than your other income for the year, you may have a net operating loss. You can carry that loss over to other years and deduct it. You may get a refund of part or all of the income tax you paid for past years, or you may be able to reduce your tax in future years.

8. Repayment of loans

You cannot deduct the repayment of a loan if the loan proceeds are used for personal expenses. However, if you use the proceeds of the loan for your farming business, you can deduct the interest that you pay on the loan.

9. Fuel and road use

You may be eligible to claim a credit or refund of federal excise taxes on fuel used on a farm for farming purposes.

10. Farmers Tax Guide

More information about farm income and deductions is in IRS Publication 225, Farmer’s Tax Guide, which is available at www.irs.gov.

Tax Changes for 2011 - 2013

14 Big Changes for Tax Years 2011-13

Some changes have already happened, some will happen this year if Congress doesn't act, and then there's next year...

There are “no good things” for taxpayers in any of these changes. . . OUCH and then some !

Already Gone

The first five items to watch expired at the end of 2011:

1. The Alternative Minimum Tax (AMT) Patch—Kiely says that, going forward, this could mean millions will pay the AMT who were never subject to it before.

2. Charitable Contribution of IRA Assets—A taxpayer who was receiving required minimum distributions (RMDs) from an IRA and wished to contribute that money to charity could have had it sent directly from the IRA custodian to the charity. In so doing it would bypass the individual’s tax return, lowering total income and possibly income tax as well. Alas, no longer.

3. State Sales Tax Deduction—Taxpayers will no longer be able to deduct state sales tax. Since it has been a choice of whether to deduct state sales tax or state income tax, residents of states without an income tax will lose out.

4. Home Energy Tax Credit—This credit for $500 is no longer available.

5. School Teachers’ Expense Deduction of $250—Teachers who have been dipping into their own pockets to help provide for their students can no longer rely on this deduction.

On Their Way Out

Five measures also expire at the end of 2012—again, barring Congressional action. They are:

1. Payroll Tax Cut of Two Percentage Points—This will go away, resulting in the resumption of the customary 6.2% rate.

2. Top Income Tax Rate of 35%—This will change to 39.6%.

3. Capital Gains Tax Rates—Both the 0% and the 15% brackets will disappear, to be replaced by a single bracket of 20%.

4. Qualified Dividends Tax Rate—This bracket, which taxes qualified dividends at 15%, will disappear entirely and those dividends will be taxed as ordinary income.

5. American Opportunity Education Credit—This, too, will disappear.

Coming Next Year

Four tax increases scheduled to take effect in 2013 are:

1. Net Investment Income Tax—This will be 3.8% for filers making over $200,000 (individuals) or $250,000 (married)

2. Phaseout of Personal Exemption—For a number of years the personal exemption was phased out as your income went up. While the phaseout expired (briefly), it is set to resurrect in 2013.

3. Itemized Deductions Limit—The “Pease” limit on itemized deductions will hit those with incomes over $150,000.

4. Flexible Spending Account Limits—These are being cut from $5,000 to $2,500.

Then the biggest of them all . . . . Obama-care

Home Office Deduction

Work at Home? You May Qualify for the Home Office Deduction

If you use part of your home for business, you may be able to deduct expenses for the business use of your home. The IRS has the following six requirements to help you determine if you qualify for the home office deduction.

1. Generally, in order to claim a business deduction for your home, you must use part of your home exclusively and regularly:

• as your principal place of business, or

• as a place to meet or deal with patients, clients or customers in the normal course of your business, or

• in any connection with your trade or business where the business portion of your home is a separate structure not attached to your home.

2. For certain storage use, rental use or daycare-facility use, you are required to use the property regularly but not exclusively.

3. Generally, the amount you can deduct depends on the percentage of your home used for business. Your deduction for certain expenses will be limited if your gross income from your business is less than your total business expenses.

4. There are special rules for qualified daycare providers and for persons storing business inventory or product samples.

5. If you are self-employed, use Form 8829, Expenses for Business Use of Your Home to figure your home office deduction and report those deductions on Form 1040 Schedule C, Profit or Loss From Business.

6. If you are an employee, additional rules apply for claiming the home office deduction. For example, the regular and exclusive business use must be for the convenience of your employer.

For more information see IRS Publication 587, Business Use of Your Home, available at www.IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Links:

• Publication 587, Business Use of Your Home
• Instructions: Form 8829, Expenses for Business Use of Your Home

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