Barbara’s Blog

I recently participated in a webinar hosted by Brother Online, and wanted to pull together a set of tips to help SMBs with filing their taxes for 2012.

If you have not yet filed your business’ income tax return for 2012, there are still some pointers that can help you legally minimize your taxes and avoid IRS scrutiny of your return.

Take advantage of extended tax rules and know what actions can trigger IRS audits so you can steer clear of them.

Use extended tax breaks

As part of the deal to avert the “fiscal cliff,” many tax breaks that had expired at the end of 2011 were extended for 2012 (and in many cases 2013 as well). Check to see if any of these favorable deductions, tax credits, or other tax rules apply to you:

Hiring incentives. If you hired certain employees in 2012, you may be eligible for a tax credit based on a portion of their wages. Such credits include:

• Work opportunity credit for hiring workers from certain targeted groups (e.g., certain veterans; ex-felons). To claim the credit, you must submit Form 8850 to your state workforce agency. Usually this must be done within 28 days of the workers’ start of employment. However, for workers hired in 2012, you have until April 29, 2013, to act.
• Empowerment zone credit for hiring workers for businesses within certain government-designated areas.
• Indian employment credit for hiring workers on Indian reservations.

Equipment purchases. Instead of depreciating the cost of equipment and machinery over three, five, or seven years, you can opt to claim first-year expensing (“Section 179 deduction”). The deduction limit for 2012 is $500,000. This limit phases out when total purchases for the year exceed $2 million. You must be profitable to benefit from this deduction. You can also use 50% bonus depreciation, provided the items are new (not pre-owned). You need not have been profitable for this write-off.

Certain building improvements. If you made leasehold, restaurant, or retail improvements (e.g., a new wiring system), you may not be limited to simply depreciating them over 39 years, the usual period for depreciating commercial realty. Instead, you can use first-year expensing up to $250,000. You can also depreciate costs over 15 years.

Of course, the full the cost of repairs are immediately deductible. Regulations defining repairs versus capital improvements were supposed to be effective for 2012, but have been postponed until 2014. However, you are permitted to use them for 2012 and 2013 returns. Check whether the safe harbors and de minimis rules in the regulations are helpful to you.

Avoid audit red flags

While there is no way to guarantee you won’t be audited, there are actions to follow that minimize your exposure.

• Classify your workers correctly. Don’t label an employee as an independent contractor merely to avoid the cost of being the worker’s employee. This IRS audit target can cost you dearly in penalties if you misclassify workers and the IRS finds out.
• Report income correctly. Merchants receiving Form 1099-K, reporting payment transactions through financial institutions, PayPal, and other payment processors, must report their gross receipts on their returns. They do not have to reconcile the income reported with amounts on this information return, but should report all income.

Work with your tax advisor

Your advisor can help you timely file your return. He or she can also help assess which tax breaks you qualify for.

Filing extensions. Your unincorporated business (e.g., partnership; sole proprietorship) has until April 15th to file the 2012 return. If, for any reason, you can’t file by this date, ask for a filing extension:

• Sole proprietors file Form 4868 to have a filing extension to October 15th.
• Partnerships (and limited liability companies filing partnership returns) file Form 7004 to have a filing extension to September 15th.

Returns for calendar-year corporations were due on March 15th.  Corporations that failed to file and did not request extensions should file as soon possible to minimize late filing penalties.

Conclusion

Taxes are a cost of doing business successfully. However, you do not have to pay more than the law requires. Staying current on tax developments and working with your advisor can go a long way toward obtaining favorable tax results. Good luck!

As the deadline for filing 2012 income tax returns for businesses and owners fast approaches, join Brother Online and me in a free webinar to discuss the changes implemented this year that will impact you now.

The discussion will cover:

• New laws from “fiscal cliff” legislation and what to look for on 2012 returns
• Inflation adjustments in tax rules impacting 2012 returns
• Tips and tricks for you and your tax advisor for 2012 returns
• Strategies for filing extensions
• Audit alerts
  

What you need to know about the clinic:

• Who: Brother Online and Barbara Weltman
• What: Discussion tailored to SMBs to provide tips and best practices for filing taxes this year
• When: Tuesday, March 12, 2013, from 2:00 pm ET to 3:00 pm ET
• Where: To join the discussion on March 12th, please use the following link promptly at 2:00 p.m. Eastern Time:  https://support.omnijoin.com/join?dn=TaxClinic

Also, you can follow the discussion on Twitter using #SMBTaxClinic.

If you would like to reserve a seat or have any questions, please e-mail Courtney Behrens from Brother at Courtney.Behrens @ Brother [dot] com.

We hope that you will be able to join us on March 12!

About 70% of Boomer-owned businesses are expected to change hands within the next 10 or so years, according to a 2006 article by Robert Avery of Cornell University.

Many of these owners have adult children or other relatives who work for them, and the owners may be thinking of ways to transition to retirement without a huge tax bill.

If you want your successors to own your business while you enjoy capital gains treatment for disposing of your ownership interest, follow tax rules scrupulously. Your successors can end up with 100% ownership of your corporation, you get the payout you want, and it won’t cost your successors a penny.

Here’s how the transaction should be set up:

• Assume you own 100% of your corporation (it doesn’t matter whether it’s a C or S corporation) and you have two adult children who work for you. You want them to own the business so you can retire to a nice community in a better climate and enjoy the fruits of your labor. You give some stock to each child; the amount is up to you. There’s no income tax when you give shares to your children. For federal gift tax purposes, you can give up to $13,000 worth of stock in 2012 with no tax (or $26,000 if you are married and your spouse consents to the gift).
• Now the corporation redeems all of your stock. If the corporation has sufficient cash, it can pay you the full redemption price. If not, the corporation can give you an installment note and pay you off over a fixed period (say five or 10 years).

Legal results: Following the redemption, your children own 100% of the corporation. You are no longer involved in the company (other than as a creditor if you are paid in installments).

Tax results: The redemption is treated as if you’d sold your stock to the corporation; this “sale” is taxed at the favorable capital gain rate (15% in 2012). If the corporation pays you out over time, then you report your gain over the period of the installments (unless your tax picture favors opting out of installment reporting so that you pick up all of the gain in the year of the redemption). Your children are not treated as having received a dividend from the corporation, even though they now own the entire business without any personal cash outlay.

Traps: This favorable redemption rule does not apply if you retain any interest in the business other than as a creditor (i.e., one who is owed money from the corporation). Caution is advised if you want to remain as a consultant or a board member; in some situations these positions can be considered a retained interest that prevents favorable redemption treatment. Doing the arrangement incorrectly can mean:

• You’re taxed on the proceeds as dividend income (which may not be taxed favorably after 2012 if you’re considered a high income taxpayer).

• Your children may be burdened with dividend income as well.

Because of the need to follow tax rules exactly, it is wise to work with a knowledgeable tax advisor who can help you structure the arrangement. You can also review this arrangement in a private letter ruling.

The first installment of 2012 estimated taxes is due on April 17, 2012. (The second will be due on June 15, 2012, the third on September 15, 2012, and the fourth on January 15, 2013.) Figuring the right amount of estimated tax is more challenging than ever. The reason: We don’t yet know many of the tax rules for 2012.

Expired tax rules
More than 50 tax rules affecting individuals and businesses expired at the end 2011. Most of the rules are noncontroversial; both sides of the aisle in Congress favor an extension. But when will an extension be enacted?

House Speaker Boehner (R-OH) said an extender bill likely would be enacted before the election. If Congress waited until this time to act, it would mean that three of the four estimated tax payments for 2012 will have already been made before we even know what the tax rules for this year will be.

A Ways and Means Committee hearing will be held in late April to consider tax reform that would make some extenders permanent. Ways and Means Committee Chairman Dave Camp (R-MI) said in a joint-statement with Rep. Patrick Tiberi (R-OH), “Far too many provisions in the tax code are temporary, making it hard for employers to plan, invest and create new jobs for American families.” Yah think?

Estimated tax safe harbors
So what are taxpayers supposed to do about their 2012 estimated taxes? They can rely on a safe harbor to avoid any estimated tax penalties for underpayments. This safe harbor requires taxpayers to base 2012 estimated tax on 2011 tax liability. If their 2012 estimated taxes total 100% of the tax 2011 tax bill (or 110% if adjusted gross income in 2011 was more than $150,000), then they are penalty free.

The problem with this safe harbor is that it overtaxes the very people who can least afford it. Suppose you already see that 2012 is not shaping up to be a great year. If you use the 100% safe harbor, you may overpay your estimated taxes and be out-of-pocket for the money that could better be spent reinvesting in your business.

You might consider closely monitoring estimated taxes so you can adjust payments going forward. If you wind up paying at least 90% of the taxes you’ll ultimately owe on your 2012 return through estimated taxes, there will not be any underpayment penalty. You could, for example, make a modest payment now on the theory that your revenues will be down and your taxes will be lower than last year. If, by June, things turn around, you can adjust your second estimated tax payment.

Even if you underpay estimated taxes, the cost is not that great at this time. The underpayment penalty is figured using the IRS interest rate. The rate for the second quarter of 2012 is only 3%!

You can learn more about making estimated tax payments through my book, J.K. Lasser’s Small Business Taxes 2012 and IRS Publication 505.

Bottom line
Monitor the fate of extenders as they move through Congress. Also keep a close eye on your estimated taxes for 2012. Hopefully, it won’t be too long until you’re better able to figure your tax payments for this year. Work with a knowledgeable tax advisor to help you avoid both penalties (however small) for underpayments as well as making interest-free loans to the government via overpayments.

Would the tax proposals that are part of the Gang of Six’ solution for the debt crisis be good or bad for you and for your business? Who knows? There are too many problems with these proposals to make an educated guess.

The numbers don’t add up
The highlights of the proposal say that taxes would be “fundamentally reformed,” resulting in tax relief of a net $1.5 trillion over 10 years. However, some particulars show that at the same time, taxes would rise by $1 trillion over the same period. And simultaneously, the alternative minimum tax would be eliminated at a cost over 10 years of $1.7 million. I studied calculus, but I don’t know of any equation that makes sense of these numbers.

The House Budget Committee’s initial take on the proposal shows a $2 trillion tax increase. Where those increases would come from is unknown at this time. The old refrain about “closing loopholes” always sounds good until special interest groups have their say.

Details are unknown
Precise tax rules are nowhere in the picture yet. The top tax rate for individuals and corporations supposedly would decline to between 23% and 29%. There would be two other tax rates of 8% to 12% and 14% to 22%. Those rates become possible only by eliminating many tax-favored deductions and credits.

So, what deductions, credits, and other tax-favored rules will be cut back or ended entirely? Will the itemized deductions for individuals for home mortgage interest and charitable contributions disappear? Will the exclusion for employer-paid health coverage be axed? Will businesses still enjoy incentives for R&D?

Bottom line
The Gang of Six (Senate Minority Leader Dick Durbin, D-Ill., Senate Budget Committee Chairman Kent Conrad, D-N.D., and Sens. Mark Warner, D-Va., Mike Crapo, R-Idaho, Saxby Chambliss, R-Ga., and Tom Coburn, R-Okla.) put an interesting bi-partisan plan on the table. Whether and to what extent the tax portions of the plan ultimately are adopted remains to be seen … and there’s a long, long way to go.

Health Savings Accounts (HSAs) may be an alternative way to obtain health coverage for you and your staff without experiencing the double-digit premium increases for traditional health coverage. As of January 1, 2010, there were about 10 million people covered by HSAs, which was an increase of 25% from the previous year; 2011 statistics are expected next month.

With no end in sight on the premiums hikes for traditional coverage, more small business owners and self-employed individuals are using or considering the use of HSAs–and for good reason.

Advantages of HSAs
Health savings accounts, combined with high-deductible health plans (HDHPs), can save businesses as much as 40% compared with traditional coverage (savings depend on whether the employer or employee pays the HDHP premiums and/or makes the HSA contributions). HDHPs are low-cost insurance plans designed primarily for catastrophic coverage; the shortfall in costs is supposed to be supplemented by HSAs.

HSAs are IRA-like accounts that produce a triple tax benefit:

• Contributions are tax deductible.

• Earnings on contributions are tax deferred.

• Withdrawals to pay eligible medical costs (e.g., doctors’ bills, prescription drugs, and doctor-prescribed over-the-counter medications) are tax free.

There’s yet another tax-savings incentive. There is no FICA tax paid on HSA contributions made by employees when made on a pre-tax basis. In order to do this, the employer needs to set up a salary reduction plan (“cafeteria plan”) to make pre-tax contributions possible.

Use an online calculator to figure your savings from an HDHP/HSA arrangement versus traditional coverage.

Tax rules for 2011
To be eligible to make contributions to HSAs in 2011, there must be an HDHP in effect that has minimum deductibles and maximum out-of-pocket limitations for costs such as policy deductibles, co-payments, and other amounts.

• Self-only (individual coverage) plans: minimum deductible of $1,200 and out-of-pocket limit of $5,950.

• Family plans: minimum deductible of $2,400 and out-of-pocket limit of $11,900

The maximum HSA contribution for 2011 is:

• $3,050 for self-only coverage

• $6,150 for family coverage

Anyone age 55 or older by the end of the year can add another $1,000.

Tax rules for 2012
It’s not too early to start planning for your health coverage in 2012. This gives you time to shop around and assess your options. To help you comparison shop, the IRS has announced the HSA limits for next year.

The HDHP parameters for 2012:

• Self-only (individual coverage) plans: minimum deductible of $1,200 and out-of-pocket limit of $6,050.

• Family plans: minimum deductible of $2,400 and out-of-pocket limit of $12,100.

The maximum HSA contribution for 2012 is:

• $3,100 for self-only coverage

• $6,250 for family coverage

Again, anyone age 55 or older by the end of the year can add another $1,000.

For more about Health Savings Accounts, see chapter 19 in my book, J.K. Lasser’s Small Business Taxes 2011, and IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.

Normally, a business’ tax planning for the year begins months in advance of the start of that year. Unfortunately, because of Congress’ inaction to extend dozens of tax rules that expired at the end of 2009 or decide on the fate of tax rules for 2011, 2010 is almost half over and tax planning for 2010 continues at this time to be on hold.

Extenders
The House finally passed an extender bill on May 28. Key business provisions extended, but for only one year (2010), include:

• Research credit
• Empowerment zone and renewal community tax incentives
• 15-year amortization of leasehold improvements
• 5-year depreciation for farming equipment

The Senate does not expect to take action on extenders until the week of June 7. It is likely to follow suit for most of the key provisions, but it’s not a done deal yet! And the Senate version contains a killer tax increase on S corporation shareholders. There’s a provision that would no longer limit Social Security and Medicare taxes for shareholder-employees to nominal salaries after 2010.

Because of the limited extension period — retroactive to January 1, 2010, through the end of this year — businesses don’t know what will happen to the provisions in the legislation after 2010. They could, of course, be extended again. Is this any way for Congress to act (and leave businesses up in the air and unable to plan)?

Expiration of the Bush tax cuts
Besides the uncertain state of extenders for 2010 and beyond, major provisions of the tax law are set to expire at the end of 2010. These include reduced personal income tax rates (the rates paid by sole proprietors and owners of pass-through entities on their share of business profits) and favorable rates for long-term capital gains and qualified dividends.

There have been hints about what’s to come. The President’s budget would retain low rates for taxpayers other than singles with income of $200,000 or more and joint filers with income of $250,000 or more. Congress has not yet faced these concerns. More uncertainty for some time to come!