Straight cash

Cash basis taxpayers can make decisions during these last few days of December to improve their tax situation.

Cash basis taxpayers report income and expenses in the year that they actually occurred.  This allows cash basis taxpayers to defer income or accelerate expenses as the situation requires.

Income

Income must be recognized by a cash basis taxpayer when it has been constructively received and is available to the taxpayer.  If a taxpayer receives a check in January for work performed in December, that income is taxable in the next year.  However, if a taxpayer receives a check in December for work performed in December but puts it in a drawer and doesn't deposit the check until January, this is still income to the taxpayer because it had been constructively received and was available in December.  With this being the case, tax basis taxpayers can manage their cash inflows at year-end by sending out bills later to defer collection to next year, or requiring customers to prepay if more cash/income is needed.

Expenses

Expenses can be recognized by a cash basis taxpayer in the year paid or charged.  Yes, you read that correctly, charged.  The IRS will allow charges on a credit card as cash basis expenditures, even if the bill is not paid until the next month.  This provides some wiggle room for businesses that have cash flow concerns at year-end, because they can use a credit card to make purchases instead of cash.

Cash basis taxpayers can also use the end of the year to stock up on capital assets, especially right now due to the expiring Section 179 and Bonus depreciation provisions.

A word of caution: just because an entity is a cash basis taxpayer does not mean that every cash expense is deductible.  All expenses must still be properly substantiated and properly deductible.

Cash basis taxpayers should also consider their business operations when making year-end decisions on spending.  Yes, buying $5,000 of office supplies on New Years Eve will reduce the tax burden on the entity, but will that cash outlay penalize the business operations in January?

All I want for Christmas is a new bulldozer

Beginning in 2010, businesses have been afforded beneficial tax breaks via fixed asset additions and depreciation. These breaks are primarily Bonus depreciation and Section 179 expensing. Absent further action by Congress, Bonus is scheduled to go away and the 179 limits will be greatly reduced after 2013. Taxpayers can make an election to expense 100% of the cost of a new asset in the year of purchase under code section 179 of the Internal Revenue Code.  This method, commonly known as "179", has both cost and income limits.  In 2013, taxpayers can expense up to $500,000 under Section 179.  If the taxpayer's acquisitions exceed $2 million, their allowable expense is reduced and the taxpayer's 179 deduction cannot exceed taxable income for the year.  However, in 2014 the allowable expense drops to $25,000, with an acquisition limitation of $200,000.

Similarly, in 2013 taxpayer's can expense expense 50% of an acquisition up front, and then take normal depreciation on the other 50% for the year.  For example, taking bonus on a $1,000 asset would result in a $500 expense up front, plus regular depreciation for the year on the remaining $500.  It does not matter if the asset is new or used, there are no income or acquisition limits, and bonus can still be taken even if the taxpayer has no taxable income or the depreciation causes the taxpayer to have a net operating loss.  But, in 2014, bonus depreciation will "retire".

Now that we've discussed the rules, take a look at this bad boy.

This is a fine bulldozer made by Caterpillar, one of the largest heavy machinery manufacturers in the world.  Let's say that a taxpayer is in the market for this bulldozer and finds one at their local heavy machinery dealer with a list price of $250,000 (not actual list price, hypothetical only).  We can now look at how making that purchase in December 2013 vs. January 2014 will affect the taxpayer's situation.

If the bulldozer is purchased in December 2013, the taxpayer can either expense 100% of the cost assuming they had < $2 million in total additions and taxable income of at least $250,000, or the taxpayer can expense $125,000 of the bulldozer under bonus depreciation regardless of their other acquisitions and taxable income.

If the bulldozer is purchased in January 2014, the taxpayer will not be permitted to expense any of the addition under 179 because their acquisitions will exceed the limit.  The taxpayer will not be able to take any bonus depreciation either.

In this case, assuming a 39% tax rate, delaying the purchase to 2014 will cost the taxpayer savings in tax dollars of $97,500 if 179 could be taken, or $48,750 if bonus could be taken.

Although it is likely that Congress might pass some kind of extension to these depreciation rules, at this time there is no indication that the rules will be changed.  Taxpayers that have been considering making fixed asset additions, from bulldozers to printers to office furniture, should take advantage of the tax benefits in 2013 while they last.

The not-so-Alternative Minimum Tax, Part 2

A few days ago, this blog addressed the Alternative Minimum Tax (AMT) as it applies to individuals.  A little known fact is that businesses, like individuals, can be subject to the AMT.  Although the purpose is the same - assure that taxpayers with certain types of income and deduction structures pay at least a minimum amount of tax - the way in arriving at the AMT is slightly different.  This article addresses AMT as it applies to tax-paying corporations (C Corps).  It does not apply to passthrough entities such as S Corps or Partnerships, because AMT is calculated at the individual level.

Not all businesses are alike

Unlike individuals, some corporations are exempt from the AMT.  A corporation that qualifies as a "small corporation" is exempt from the AMT.  To be classified as a small corporation, the entity must:

• Be in its first year of existence, i.e. the current tax year is the year the entity began operations, or
• The company was treated as a small corporation for all prior tax years beginning after 1997, and
• The company's gross receipts did not exceed an average of $7.5 million for the preceding 3 tax years ($5 million if the entity has been in existence for 3 years or less)

After determining that the corporation is subject to the AMT, the taxpayer will complete Form 4626 with the Form 1120.  Form 4626 is organized similar to Form 6251 for individuals.  It begins with the corporation's taxable income, and then adds back / takes away various adjustments and preferences, such as:

• Differences in depreciation
• Differences in gains and losses
• Depletion
• Intangible drilling costs
• Adjusted Current Earnings adjustments (ACE)

After the corporation accounts for these adjustments and preferences, they arrive at their alternative minimum taxable income (AMTI).  Corporations are afforded an exemption if their income falls in a certain range, typically $40,000.  The AMTI is then multiplied by 20% to arrive at the AMT.

Just like individuals, if the AMT exceeds the corporation's regular tax, then they must pay the higher amount.

Because corporation's do not receive the same preferential treatment of gains being taxed at a lower rate like individuals, the biggest factor in a corporation's AMT calculation is depreciation.  A corporation needs to be mindful when capitalizing depreciable property that a large difference between the tax and AMT depreciation methods could subject the corporation to a higher tax rate.  Some assets, when capitalized using the 200% double-declining method of depreciation can only be depreciated using the 150% MACRS method for AMT purposes.  This will cause the AMT depreciation expense to be lower than the tax depreciation, resulting in an addition to taxable income in arriving at AMTI.

Corporate minutes scam

Over the past few weeks, several businesses in Arkansas have received solicitations in the mail requesting that the business pay a service to keep them in compliance with an "Annual Minutes Requirement Statement".  On November 5, Attorney General Dustin McDaniel released on his website information regarding the solicitations, confirming that it was a scam.  After a simple Google search, this same scam appears to be present in several states around the country. Arkansas law does require corporations to maintain minutes of the meetings of owners and board of directors.  But, as noted in the Attorney General's release, these minutes are not required to be filed with the State.

Best practice is for owners and directors to meet at least annually in order to satisfy their obligations as those charged with governance of the entity.  Topics to cover at such meetings can include (but are not limited to):

• Elect corporate officers
• Review and analyze financial results
• Approve corporate borrowing or debt financing
• Approve incentive compensation plans
• Review employer-sponsored retirement plans and performance
• Retain independent auditors, and approve audit reports or tax returns prepared by external CPA's
• Discuss status of pending or threatened litigation

Minutes should be signed by the Secretary and Chairman and evidence all members present, and the original signed minutes should be stored in a safe place with other corporate records.

Minutes are required to be kept by all corporations, whether they are $1 billion businesses with 20 board members, or a small S-corporation with one shareholder.  In the event of an IRS exam, one of the items the IRS will most likely request to review is the company's meeting minutes for the year under exam.

A copy of the Attorney General's announcement can be found on his webpage here.

Employee vs. contractor

A hot topic with the IRS right now is classifying workers between employees and independent contractors.  There can be both positive and negative results on how a worker is classified, both for the company/employer and the worker.  The IRS considers three factors when determining whether a worker is an employee or an independent contractor. Behavioral control

This characteristic deals with how the company/employer behaves towards the worker and the work they are performing.  If the employer/company has the right to direct or control how the worker does the work, then they are most likely an employee.  The business does not actually have to direct or control the way the work is done, as long as they still have the right.  Also, if the company/employer requires the worker to attend any kind of training, this suggests that the worker is an employee.  If the business does not have the right to direct how the work is done, but merely suggests timing and deadlines, then the worker is most likely an independent contractor.

Financial control

This characteristic deals with how the company/employer directs or controls the financial and business aspects of the work.  If the worker has a significant investment in their work, has unreimbursed expenses related to the work, or has the opportunity to realize a profit or loss on the work, then they are most likely an independent contractor.  Employees typically do not incur expenses that are not reimbursed by their employer, including significant investments such as vehicles or computers.  Employees also do not realize a profit or loss from performing their work since they are paid their same hourly/salary rate.

Relationship of the parties

This characteristic deals with the relationship the parties have and includes written contracts, benefits, the term of the relationship, and whether the services provided are a key part of the company’s/employer’s business.  If the worker is provided any kind of benefit by the company/employer, such as health insurance or participation in a retirement plan, they are most likely an employee.  If the services provided by the worker are at the core of the business’ operations, then they are most likely an employee.

The terms of the worker’s relationship can be easily defined in a written contract, which will also serve as evidence if the worker’s status is called into question.  The worker and employer/company can use the contract to pass or fail all of the tests listed above in order to classify the worker as expected.  A word of caution – if the signed contract says one thing but the actual work performed is different, the classification of the employee or independent contractor can be reversed based on what actually occurred.

In closing, with the IRS calling into question employment status more often, both employers and employees are encouraged to revisit their staffing arrangements and verify that workers are properly classified based on the characteristics above.

Ordinary and Qualified Dividends

When a taxpayer receives a form 1099-DIV at the end of the year, a common question they have is "what is the difference between an ordinary and qualified dividend?".

A taxpayer that owns or is the beneficiary of an investment that pays dividends will typically receive a form like this at the end of the year.  The dividends they received during the year are reported in box 1a "Total ordinary dividends" and any of those dividends that are qualified will be reported in box 1b "Qualified dividends".  If dividends are received through a passthrough entity such as a trust or partnership, they will be reported on the Form K-1.

Dividends are the most common way for a corporation to distribute profits to its shareholders.  All of the dividends paid to a shareholder during the year are reported as ordinary dividends and are taxable to the taxpayer.  Qualified dividends will be included in the amount of ordinary dividends, but are subject to capital gains tax rates.

Qualified dividends are subject to the 15% capital gains tax rate if the taxpayer's regular tax rate is 25% or higher.  But, if the taxpayer's regular tax rate is less than 25%, then the qualified dividends are subject to a 0% tax rate.  For 2013, the 25% bracket kicks in when adjusted gross income hits $72,500 MFJ / $36,250 S.

In order for dividends to be considered qualified, they must meet three criteria.  First, the dividends must have been paid by a US or qualified foreign corporation.  Second, the dividends must not be considered capital gain distributions, payments in lieu of dividends, or payments from a tax-exempt organization or a farmer's cooperative.  Third, the taxpayer must meet the holding period for the investment.

For a dividend to be considered qualified, the taxpayer must have held the investment for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.  So if an investment's ex-dividend date (first day someone can own the investment without receiving the dividend) is September 1, then the taxpayer would have had to own the investment for at least 60 days during the period of July 1 to Nov 1 (121-day period beginning 60 days before ex-dividend date).

Confusing?  It can be, but in theory the investment should be owned for a longer term in order for the dividends to qualify for capital gains tax rates.

In all, taxation of qualified dividends with capital gains tax rates is an attractive reason to own domestic, qualified, dividend paying investments for the long-term, as long as the taxpayer is familiar with how the qualified dividends are calculated and whether or not their investments meet the characteristics for qualified dividends.

Bonus

One of the better moves made by Congress at the end of 2012 was to extend the 50% bonus depreciation allowance to 2013. This is a great resource for businesses, but is often confused with its less beneficial counterpart, the Section 179 depreciation allowance. Bonus depreciation allows a business to expense 50% of the original cost (depreciable basis) of a qualified asset in the year of acquisition. The taxpayer can then take normal depreciation on the remaining 50%, beginning in the first year. For example, if a business buys a $5,000 piece of equipment, they can expense $2,500 in the first year plus the normal depreciation on the remaining $2,500. This is why it's called "bonus" depreciation - because you get your normal depreciation, plus a "bonus" of 50%.

Bonus depreciation has benefits that make it more useful than Section 179 in some cases. There is no income limitation, which means a business is eligible to take advantage of bonus depreciation no matter their level of income (or even loss). As a matter of fact, bonus is considered to be automatic, and the taxpayer actually has to elect not to take it. Bonus is also elected by "class life" instead of by specific asset.

Bonus can be helpful because, unlike Section 179, it can be used to reduce taxable income below zero. Using bonus to create a loss can be an especially helpful planning tool for 2013. With the 50% special bonus depreciation allowance slated to go away in 2014, a taxpayer can take advantage of the special allowance in 2013 by making as many planned PP&E acquisitions as possible. By utilizing bonus depreciation, the taxpayer can push their company into a loss for 2013, and the net operating loss (NOL) can be carried forward to 2014 (and future years) and used to offset ordinary income.

In some cases, electing out of bonus is a better decision for a business. For businesses that do not turn over PPE very often and count on depreciation each year to keep their taxable income down, bonus might not be ideal. It will provide a 50% write-off in year one, but the depreciation expense in each subsequent year will be significantly lower. Also, some states (such as my state of Arkansas) do not conform to the same rules as the IRS, which can create a Federal to State difference in depreciation. Although this is not a reason in itself to elect out of bonus, it does require the taxpayer to keep a record of the Fed to State difference in future years.

Thanks to my colleague for suggesting this topic. Have something you want to hear about? Email me.

Charity

An area that can be considered as one of the most hotly contested on a tax return is charitable contributions. Charitable contributions can be made to qualified organizations in either monetary or non-monetary form. This could be as simple as putting a check in the offering plate at church on Sunday morning, or more complex, such as a charitable remainder trust. Following are some things to keep in mind as you select a charity to contribute to, how to determine what to contribute, and your recordkeeping responsibilities to justify your deduction. Type of charity

When donating to a charity, it's important to know what kind of charity it is. Most charities that you will contribute to are qualified non-profit organizations under the proper Internal Revenue Code section, such as 501(c)(3). Large national/international charities like the American Cancer Society or the United Way, and the majority of organized churches, fall under this category. But there are other types of organizations, like private operating foundations, that do not fall in the same category. Knowing the kind of charity you're giving to is important because contributions are limited to a certain level of your adjusted gross income (AGI). The deduction for contributions to qualified organizations are typically limited to 50% of AGI, whereas contributions to private operating foundations can be limited to 30% or 20% of AGI.

Cash is king

When contributing to a charity, cash is king for two reasons. First, this is the easiest way for you to keep up with your contribution; you write the check, and the charity will send you a receipt saying that you contributed $xx, and that no goods or services were received in exchange for the contribution. Second, cash is the best asset for them to support their programs. With cash they can buy supplies and pay their employees, as opposed to if you contributed a car, which they would have to maintain or sell.

What do I keep?

As mentioned above, when making a contribution to a qualified charity, they should issue you a receipt. You should keep these with your tax documents to support your deduction if you are ever audited by the IRS. Charities that receive non-cash contributions are getting pretty good about issuing receipts as well, such as Goodwill or Habitat ReStore.

There are some contributions that, regardless of what kind of paperwork you come up with, are not deductible. For example, payments to individuals and support of political organizations are usually not deductible.

Benefits of a paid preparer

The United States of America is a great country.  We have many freedoms, a democratic government, and as a population we have to opportunity to chase the American dream and live our lives as we please.  But those benefits come with a price.  As I like to say, "America is the greatest country club in the world, and the membership fees are the taxes that we pay." For most Americans, getting together tax information, figuring out how to report it to the IRS, and filing a tax return can be a cumbersome and stressful process.  To alleviate some of this stress, consider hiring a paid tax preparer.  There are many benefits to engaging a paid preparer to do your taxes.

We know the rules

The tax code is complicated.  Without a full knowledge of the code, you are likely to report income incorrectly or miss deductions.  CPAs know the code and know how to report your information.  They also know the differences between Federal tax code and states in which you might have to file.  They can also help if you get a nasty letter from the IRS and amend previous tax returns if necessary.

We can help you through life changes

Whether you just bought a house or had a child, got divorced or had a death in the family, CPAs know how to guide you through life changes.  They can make sure that you report your situation transparently and accurately, and also explain to you what it all means.

We keep you up to date

Not a day goes by when I don't read something or see something on the news and think "wow, that really might affect my client."  We worry about your taxes so you don't have to, and we keep you up to date on the changing landscape to help you plan during the year.

It's important to find a tax preparer that you trust, that understands your business and family, and that takes a genuine interest in your situation.  Don't be afraid to be honest with your preparer, especially about deadlines and fees.  Instead of stressing about your taxes, let a CPA help and rest easy knowing you are taken care of.