Barbara’s Blog

From time to time, every business experiences a cash shortfall. Bills come in from vendors, employees have to be paid, an installment on your bank loan is due, and the landlord is knocking at the door.

What do you do?

Don’t use the money you’ve set aside for certain tax obligations because you can be held personally liable for 100% of this money.

Tax money that’s sacrosanct
Some of the money that a company collects is not to be touched. The company is merely a fiduciary holding the money in trust.

Examples of trust fund taxes:

• Withholding from employees’ paychecks for federal income taxes and FICA
• Withholding from employees’ paychecks for state income taxes and, where applicable, other state tax obligations (e.g., disability contributions)
• State sales taxes

Potential penalties
If you fail to pay over these trust fund taxes, you can face a 100% penalty for the unpaid taxes. The federal government has a Trust Fund Recovery Penalty. And many states, including California, have the same rule for state payroll taxes. The penalty applies if a “responsible person” (someone with decision-making power and check-writing authority) willfully fails to pay these taxes. Willfulness is inferred when a responsible person knows the taxes are unpaid but chooses to pay others instead.

Regardless of whether there are other owners besides you or that you set up your company as a corporation or limited liability company to achieve personal liability protection, the government can seek to recover all of the trust fund money from you. The government has three years to go after any responsible person and up to 10 years to collect the amount owed. The personal assets of the responsible person are fair game here. And the IRS can get your assets using a federal tax lien, levy, or seizure action.

Let’s take an example. Say you have an S corporation with three equal owners, all of whom have the authority to make day-to-day business decisions (including who to pay) and to write checks or make electronic bank transfers. Your business is in a cash crunch and with the limited funds you have, you choose to pay your vendors so you’ll continue to have inventory. You don’t pay the U.S. Treasury the amount owed for income tax withholding and the employees’ share of FICA. The IRS can choose to recoup all of the unpaid taxes from you alone. You and your co-owners are “jointly and severally liable” for these taxes. It means that the government usually pursues the person with the deepest pockets. If you pay, you can seek to recover a share from your co-owners, but that isn’t the government’s concern.

State sales taxes
Like wage withholding, merchants who collect sales taxes are merely holding the funds for their states. Say your state has an 8% sales tax rate and you sell a $10 item. You collect $10.80 from the customer; 80¢ belongs to the state. The failure to pay your sales tax collections can result in serious penalties. Ever notice a store on Main Street that’s been shut with a notice posted on the door saying “Closed due to failure to pay sales taxes”?

What to do?
If you find yourself in a cash crunch, recognize that the first parties to be paid are the federal and state government with respect to trust fund money. After that, it’s up to you to decide how to apportion the limited funds you have among your employees, vendors, and other creditors.

If you need additional cash, don’t be tempted to use trust fund money. Use any other resource you can to meet your obligations. Borrow from family and friends. Tap out your credits. Even take distributions from your retirement accounts (though this should definitely be a last resort).

Finally, let this difficult experience teach you a valuable lesson about cash flow management. Use software or online solutions to help. And work closely with your CPA or other financial advisor so you never again face a cash crunch.

On January 1, 2013, the top tax bracket for individuals rose to 39.6% (the top bracket used to be 35%). The 39.6% bracket applies to singles with taxable income over $400,000 and joint filers over $450,000. However, this new top tax bracket does not only impact individual income taxes. It also affects some business taxes, which will have the overall impact of raising income taxes even more.

Taxation of capital gains and qualified dividends
If you are a sole proprietor or an owner of/or in a partnership, limited liability company, or S corporation, your share of capital gains from the sale of your business’ property is subject to a 20% tax if you are in the 39.6% tax bracket. Last year, the top capital gain rate for this purpose was 15%.

If your business is incorporated and it distributes dividends to you which are treated as “qualified dividends,” those dividends are taxed at 20% if you are in the 39.6% tax bracket. Again, the top rate on qualified dividends was 15% last year.

Section 444 election
Partnerships and S corporations usually must use a calendar year (the same tax period used by its owners). However, they can elect to use a fiscal year if they make a special tax payment intended to thwart the benefit of tax deferral under the fiscal year. This election is called a Section 444 election, and the required payment is the highest individual income tax rate, plus one percentage point. Thus, the payment amount for 2013 is 40.6% (39.6% + 1%). Last year, the required payment was 36%. This required payment applies regardless of whether the owners in these electing entities are high-income taxpayers.

The required payment is due on May 15, 2013, for a company that has already made an election. The due date for a company first making the election in 2013 is May 15, 2014. The required payment is made with Form 8752, Required Payment or Refund Under Section 7519, which must be filed each year the section 444 election is in effect. Find out more about this required payment in IRS Publication 538.

PHC tax
Owners of personal holding companies (PHCs), which is a special type of C corporation that has limited ownership and receives certain types of income, may be subject to a special tax on excess passive income. The PHC tax rate for 2013 is 20%; it was 15% last year. Again, the rate applies without regard to the tax bracket of the PHC’s shareholders.

Accumulated earnings penalty
If a C corporation accumulates more than a set amount of its earnings rather than distributing it to shareholders, it may be subject to a special penalty. The corporation can accumulate any amount for the reasonable needs of the business (e.g., a proposed expansion project or a buyout of a retiring owner). Above these reasonable needs, accumulations are restricted to $250,000 ($150,000 for personal service corporations). Excess accumulations are taxed in 2013 at 20%; the penalty rate had been 15% last year. The penalty applies without regard to the tax bracket of the corporation’s shareholders.

Conclusion
Talk with your tax advisor to learn all of the ramifications that the new top personal tax bracket may have on your overall tax picture.

On May 6 the Senate decisively (69 to 27) passed a bill that would require online sellers (other than “small” ones) to collect sales tax from remote buyers if they are based in a state with sales tax. The House is about to take up the matter; passage in the House is questionable.

Here are some of the key issues about the law that I think are worth noting and are often overlooked or mischaracterized in serious discussions about “fairness.” I also offer my solution.

The tax is on consumers
Discussions seem to imply that online and mail order merchants are paying the sales tax. This isn’t so. The tax is levied on customers; the merchants act as tax collectors responsible for turning over the collected sales tax to their state.

It is true, however, that the act of collection entails considerable cost to merchants. As things stand now, they would have to compute the appropriate amount of tax. There are more than 9,000 different sales tax jurisdictions in the U.S., so calculation is no small feat. (The bill would require states to simplify their tax rates and provide free software to merchants to compute collections.) Then there are the administrative costs of filing sales tax returns and remitting the taxes.

The tax exempts very small sellers
Under the bill, there is a $1 million pass for online and mail order merchants (“remote sellers”), effectively exempting very small businesses. The collection obligation would apply only if total annual from remote sales exceed $1 million. It should be recognized that bricks-and-mortar stores with sales of $1 million or less are not exempt from sales tax collections.

The law could be better
The Marketplace Fairness Act attempts to right a wrong; that the absence of sales tax on online purchases drives consumers away from Main Street and to the Internet or mail order catalogs. It makes sense to me that all businesses, large and small, wherever based, should be subject to the same rules. However, a better solution would be to simplify the tax rules for all merchants. Let states that want to use the new law (if enacted) enable merchants to collect sales taxes at a flat rate (if the states in which they are based impose a sales tax). Then let the states sort out how to apportion that tax among its cities and counties.

Conclusion
It’s always hard to use the words “tax” and “fair” in the same sentence. I don’t want consumers to lose sight of their added sales tax burden if the law is enacted. Many who have enjoyed sales tax-free online purchases will have to factor in the new tax cost to their spending. The revenue that the online merchants have been reaping has always been subject to income taxes (assuming they are in states with an income tax).

Will this impact overall sales and have a negative effect on the economy? Will it depress total tax collections (income tax and sales tax)? Who knows?

The Tax Foundation says today is the date on which taxpayers will have earned enough money to cover government obligations (federal, state, and local) for 2013.

Tax Freedom Day means that all of the productivity of Americans for more than 3½ months is required to support the government’s activities. What’s more, with rising taxes and higher income, Tax Freedom Day is 5 days later than in 2012. Depending on the state you’re in, your Tax Freedom Day may be earlier or later. Residents in Louisiana and Mississippi had theirs on March 29; for residents in Connecticut, their day is May 13.

Professor John Cochrane, professor of finance at the University of Chicago Booth School of Business, argues in a Wall Street Journal article that America needs an alternative maximum tax (AMaxT).

At what point does paying a sizable chunk of income for taxes become too much for individuals and start to hurt the economy? While he doesn’t have a magic number, he suggests that 50% of income might be the tipping point. His reasoning: If the government takes more than half of what someone earns, the economy will suffer because people will work less, which will result in less revenue.

When he says “taxes” he’s referring to the entire government take in the form of federal income taxes; Social Security and Medicare taxes; property taxes; sales taxes; state and local income taxes; real estate transfer taxes; estate taxes; and for business owners, the employer share of Social Security and Medicare taxes; state unemployment insurance; licensing fees; and other government fees (that are really taxes).

He also says that corporate taxes, which are really paid by people (investors; consumers) should be credited in some way to individual taxpayers if there is an alternative maximum tax.

He concludes: “So the AMaxT is most important for the backstop promise it makes to young people and entrepreneurs. Yes, start a company, go to school, work hard, invest, hire people. We guarantee you that no matter what happens, no matter how loud the zombies chant, no matter what clever “revenue enhancers” they come up with, you will get to keep some reasonable fraction of what you earn. Go for it.”

Readers in my age group may remember that when the marginal personal income tax rates ran to 70%, there was a 50% “max tax” on earned income (starting in 1972). (Remember Form 4726?) This cap on the federal income tax rate for earnings (wages; net earnings from self-employment) ended when the top marginal rate fell in 1981, so the need for the max tax ended.

Karl Marx said “There is only one way to kill capitalism—by taxes, taxes, and more taxes.” Are government officials trying to kill capitalism? Your guess is as good as mine.

Yes, if you check the definitions under the Affordable Care Act.  Definitions matter because they govern what rules you must follow. The Affordable Care Act has conflicting definitions for different purposes.

• Employer mandate to provide health coverage. Here you’re a large employer if you have more than 50 full-time employees on your payroll. If you do, then starting in 2014, you’ll have to provide affordable health coverage or pay a penalty (“play or pay”) (it’s much more complicated than this brief statement). By exclusion, you’re a small business exempt from this mandate if you have 50 or fewer employees.
• Health exchanges. Here you’re a small business if you have more than one but fewer than 100 employees. If so, you can use the Small Business Health Options Program (SHOP) to offer a menu of health coverage plans to employees. Unfortunately, however, SHOPs were supposed to be open on October 1 of this year to enable employees to select their coverage for 2014; employees have only a single plan until 2015. Note: Just to confuse things even more, states can limit participation in these exchanges to up to 50 employees until 2016.

Thus, if you have 60 employees, you must comply with the employer mandate in 2014 but you can put employees in the SHOPs if you don’t want to use private health insurance. Make sense?

Other federal laws
The Affordable Care Act isn’t the only place where definitions for small business are confusing. The Tax Code has more than a dozen different definitions for different purposes. Like the Affordable Care Act, some are based on the number of employees. However, some definitions are based on gross receipts, some on the value of assets, and one on the amount of equipment purchased in the year.

For your convenience, here is a partial list of federal laws that tie the definition of small business to the number of employees. If you have fewer employees than the number listed, you are exempt from complying with the law.

• Age Discrimination in Employment Act: 15
• Americans with Disabilities Act: 20
• COBRA: 20
• Equal Pay Act: 2
• Fair Labor Standards Act: 2
• Family and Medical Leave Act: 50
• Title VII of the Civil Rights Act: 15

State laws
States often adopt more stringent definitions to force smaller companies to offer benefits and rights to employees than otherwise required under federal law. For example, a number of states have “mini-COBRA” requiring companies that offer health coverage to extend continued coverage if they have as few as two employees. Check your state’s laws carefully to make sure you are in compliance.

Bottom line
Don’t assume you are a small business because you don’t view yourself as large. The government may put you into the “large business” category for some purposes even though you are still a small business. When in doubt, consult with a knowledgeable attorney on the area you are concerned about.

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!

The NFIB’s recent survey of small business owners found that 85% of them were in favor of tax reform. If I were able to unilaterally craft tax reform, here are five changes I’d make.

1.  Simplify, simplify

We get it; the Tax Code is complicated. There are an estimated four million words in it, and even tax experts (myself included) often disagree on what some of them mean. Let’s go back to square one when taxes were meant solely to raise revenue and were not designed to encourage or discourage certain activities (e.g., encouraging “green” activities with special tax credits).

The advantages:

a)  It would surely help to bring down the tax rates overall and eliminate the impact of lobbyists on tax law.

b)   It likely would reduce tax evasion; a low rate makes it less beneficial to engage in fraudulent activities that, if detected, could result in civil or even criminal penalties.

c)  It would give small business owners and other taxpayers more time to devote to their businesses and other activities rather than having to be concerned with the tax implications that their decisions may have.

d)  It would save taxpayers money on recordkeeping (e.g., there would be no need to track mileage for car use if no deduction for it were allowed) and tax preparation.

Simplification could be done with a flat tax, which has one or two low tax rates and only a limited number of permissible write-offs.

2.    A single tax

Right now, there are income taxes, employment taxes, and excise taxes. All of these taxes are funneled into the federal coffers to pay the government’s expenses (which include such things as promised Social Security benefits).

Why have separate taxes? Adopt a single type of tax and levy it. This would make it clearer to taxpayers exactly what they pay. Take the example of a self-employed person who is single and whose business nets $275,000. In 2013, he’s paying income tax (perhaps at the 28% rate if deductions bring taxable income below $225,050), self-employment tax of 12.4% on $113,700 and 2.9% on $275,000, and an additional Medicare surtax of 0.9% on $75,000 (earnings over $200,000). You tell me what his effective tax rate is!

3.    Eliminate different tax treatment based on marital status

The tax law treats single individuals differently from married couples. Some singles (e.g., heads of households and surviving spouses) have special tax breaks that most singles do not. When two spouses with substantial earnings file jointly, they pay a marriage penalty (they pay more than they would if they had been single).

On the other hand, when two spouses, one with high earnings and the other with little or no earnings, file jointly, they have a marriage bonus (they pay less than they would if they were single). And why should spouses in community property states have community property rules apply for most federal tax purposes (they are disregarded when it comes to “earnings” for IRA contributions, self-employment tax, and some other purposes). Why should disparate treatment remain?

4.    Make everybody pay something

At last count, 46% of Americans pay no income tax. This means they have no interest in whether taxes are high or low, fair or unfair; they have no skin in the game. Yet, many of these people vote for representatives who make tax law and impact the other 54%.

I’d make everyone, regardless of income (or even receipt of tax refunds) file an income tax return and pay at least a nominal amount (say $25). Non-profits could help low-income individuals with this perfunctory filing and payment.

5.    Collect from tax deadbeats

It was reported that federal workers owe $3.5 billion in back taxes for 2011. Federal workers aren’t the only taxpayers who are delinquent. The IRS offers various options for paying back taxes, including installment agreements and, when paying is a hardship, offers in compromise. And, let’s not forget that garnishment is a tool the IRS is allowed to use to collect unpaid liabilities and it could easily be applied for delinquent federal workers and other taxpayers.

Conclusion

I believe that tax reform can be accomplished. What needs to be done upfront is reaching an agreement on the goals for tax reform. Sweeping overhaul is needed for any meaningful changes from the status quo.

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!

Legislation, the Marketplace Fairness Act of 2013 (H.R. 684; S. 336) was introduced in Congress last week. The bill would effectively impose state sales taxes on Internet purchases even though sellers are in different states from buyers.

More specifically, the law would allow a state to enforce its sales tax rules against Internet sellers in other states. The purpose of the legislation is to put bricks-and-mortar stores based in states with sales taxes on a more competitive basis with Internet-based sellers who, until now, have offered their customers a sales-tax free ride.

The challenge for Internet-based sellers is to deal with 9,600 sales tax jurisdictions (counting not only state but local sales tax rates). The bill addresses this problem by requiring states to simplify their sales tax rules on “remote sales.” Toward this end, states must set up a single agency for sellers to deal with for collections, filing returns, and audits. States must also make available to Internet-based sellers at no cost the software that can be used to make them sales-tax compliant. Sellers that use certified software providers (currently Avalara, ADP, Accurate Tax, Exacto, and FedTax) to figure collections would have no liability for any errors made by these companies.

Alternatively, states can work within the existing Streamlined Sales and Use Tax Agreement.

The bill would not necessarily change sales taxes, but would not bar any changes either.

Small business exception

Despite the simplification requirements in the bill, sales tax collection on remote sales, followed by remitted collections to multiple states, and filing sales tax returns in multiple states will be burdensome. The good news: The bill would exempt “small sellers” from collections and other related sales tax responsibilities. The exemption would apply to businesses with less than $1 million in gross annual receipts from domestic online sales.

Prospects for passage of the bill

The idea of requiring remote sellers to collect sales taxes is not new. The Main Street Fairness Act was a regular feature on the legislative calendar in recent years but failed to gain passage.

This bill is different and has a greater chance of success. It has extensive bi-partisan support and the support of a number of major business groups, including NFIB and the National Retail Federation. (It is opposed by the American Catalog Mailers Association and eBay, among others.) And, because a number of states are in a revenue crunch that could be somewhat alleviated by new sales tax collections, there is extensive support from state legislatures and governors.

Find out more about the bill and its progress in Congress here.

A century ago this month (February 25 to be precise), the 16th Amendment to the U.S. Constitution was ratified, allowing for a direct tax on income:

“The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

We call this the income tax. The following are some interesting factoids about our beloved tax (my sources are “Our Changing Tax Laws,” issued by CCH in 1988 on the 75th anniversary of the income tax, and the National Taxpayer Advocate’s Annual report released last month.

Then

• The federal tax law was 16 pages.
• Every citizen with net income of $3,000 or more was required to file a return.
• The return contained graduated income tax rates of 1% to 6%; the top rate applied to income over $500,000. The first 1% was a normal tax; the additional tax rates were a super tax.
• The tax return was three pages; another page was instructions.
• The return had to be signed before an officer authorized to administer oaths.
• The filing deadline for individuals and corporations was March 15th. (The due date changed after enactment of the Tax Code of 1954.)
• Tax was collected by the Bureau of Internal Revenue. (The Bureau became the Internal Revenue Service in 1953.)
• You can view the original income tax form, called Form 1040 even then, at the Tax Foundation.

Now

• Today the Internal Revenue Code is comprised of nearly 4 million words.
• 59% of taxpayers use paid preparers.
• Individuals and businesses spend about 6.1 billion hours and $168 billion each year filing returns and complying with the tax law.
• By my last count, there were at least 18 different definitions of “small business” (some dependent on income, some on assets, and some on the number of employees) and taxpayers must distinguish between a qualifying child, a qualifying dependent, and a qualifying individual (all who are the same in most cases) for different tax credits.
• The Internal Revenue Service (IRS) processes more than 133 million returns.
• The IRS collects taxes of more than $1.2 trillion.

Tomorrow

What is the future of the income tax? There is much talk about sweeping reform to eliminate “loopholes” (which are merely tax breaks created for special purposes, such as encouraging home ownership or charitable contributions) and, perhaps, reduce tax rates to a flat (or nearly flat) rate.

Personally, I don’t believe that today’s political climate would allow for real reform, no matter how much I think it is needed. There may be a new tax code in the offing, but likely it won’t be dramatically different from the one we have now.  However, a hundred years from now, there may indeed be a different tax landscape. For instance, down the road, the income tax may be scrapped for a national sales tax or other revenue raiser.

Whatever the change, it is certain that we will still be paying taxes. Oliver Wendell Homes, Jr. said (in a 1927 decision) that “taxes are what we pay for civilized society.”