DAVID J. BAILEY & CO., P.C.

Small businesses such as those we serve often have just one or two employees handling all the financial duties, so often there is insufficient separation of duties or other checks and balances in place to minimize the opportunities for employee embezzlement. This means that the small business owner needs to be vigilant and aware of potential warning signs of embezzlement. We have provided this general reminder letter to our business clients in order to communicate the risks and to offer suggestions to help reduce your chance of being victimized.

Are your business assets as protected as you think they are? Small businesses such as those we serve often have just one or two employees handling all the financial duties, so often there is insufficient separation of duties or other checks and balances in place to minimize the opportunities for employee embezzlement. Sometimes business owners assume that when their accountants prepare tax returns or compile financial statements for them, the scope of the engagement includes procedures designed to uncover embezzlements or fraud, but that is not the case.

This means that the small business owner needs to be vigilant and aware of potential warning signs of embezzlement. We have provided this general reminder letter to our business clients in order to communicate the risks and to offer suggestions to help reduce your chance of being victimized.

Here are some simple steps you can take to safeguard your company's assets and reduce the risk of forgery and certain other types of embezzlement:

Don't sign blank checks, even though it may be more convenient to have someone fill them in later to pay the bills. Other check signing tips:
Sign completed checks only when presented with the original supporting documentation.
Sign your checks with a tamper-proof ink pen (never in pencil).
When paying utility or credit card bills, include the account number in the "Pay to the order of" space so that the check cannot be used to pay someone else's account.
Receive and review the monthly bank statements, preferably before anyone else. Whether online or on paper, view check images, both front and back, to look for unusual payees or endorsements. Ask questions so that employees know that you are monitoring the account.
Insist on timely bank reconciliations. It is best that bank reconciliations are prepared by someone other than the employee who handles accounts payable, but even if that is not possible, reconciliations should be done within 10 days and submitted to you for review.
Control check stock. Blank checks should be kept under lock and key with very limited access, and checks should be used in numerical order.
Monitor payroll periodically to make sure there are no "ghost" employees and the salaries are correct.
Review vendors occasionally to look for unfamiliar or outdated vendors in the system.
Segregate duties where possible. By properly segregating accounting functions, you create cross-checks for accuracy between duties such as writing/signing checks, ordering/receiving/paying for materials, handling/recording cash etc. Such cross-checks between different people help to prevent fraud and errors.

There is much more you can do, and we have provided a checklist below that will help identify potential problem areas in your business. If you have any questions or would like us to help you establish better internal controls, please give us a call and we will be happy to assist you in any way we can.

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An Internal Control Checklist

Recognizing warning signs and preventing problem situations

I. Introduction/Concept

Why are consistent internal controls important?

Management decisions, financial reports, and company taxes rely on the accuracy of figures recorded.
Gives owner control of dollars in and out.
Standardizes good management practices and procedures.

Advantages of improved internal control:

Can reveal errors and omissions.
Discourages employee theft.
Protects assets.

How to use the checklist:

Review the concept for each internal control area and answer the questions following each section.
Each answer identifies an area that needs stronger internal controls.

II. Segregation of Duties

CONCEPT:

Certain accounting/bookkeeping functions are designed to cross-reference each other for accuracy. If the same person is responsible for multiple duties, the natural checks and balances of the system are removed.
Trust is not the issue; verifying business transactions is. Giving a single person unquestioned authority of your finances is not a wise business practice.

CHECKLIST: Each “yes” answer identifies a potential problem area.

Is the person who handles your cash also responsible for recording the cash?	 Yes  No
Does the person who pays or orders inventory also receive the materials?	 Yes  No
Are two or fewer people responsible for the accounting function?	 Yes  No
Is only one person responsible for reviewing financial statements each month?	 Yes  No
Is your review of financial journals sporadic?	 Yes  No

III. Bank Reconciliations

CONCEPT:

Bank statements can only flag discrepancies if they are reconciled on a timely basis. Reconciliations should be done once a month. Bank adjustments need to be tracked carefully from one month to another.
Segregating duties is also important in this area. Reconciliations should be performed by one person and reviewed by another. Also, the person who writes the checks should not have the authority to sign checks.

CHECKLIST: Each “no” answer identifies a potential problem area.

Do you review canceled checks and endorsements on a monthly basis?	 Yes  No
Do you compare payroll checks with your current employee records?	 Yes  No
Do you question funds transferred between bank accounts?	 Yes  No
Do you track the number of credit card bills you sign per month?	 Yes  No
Are bank reconciliations performed on a timely basis?	 Yes  No
Is someone responsible for reviewing the reconciliations each month?	 Yes  No
Do you verify reconciled items?	 Yes  No

IV. Supporting Documentation

CONCEPT:

Enhances communications and serves as final checkpoint.

CHECKLIST: Each “yes” answer identifies a potential problem area.

Do you ever sign blank checks?	 Yes  No
Do you ever sign checks without original supporting documentation?	 Yes  No
Do you ever sign checks without canceling supporting documentation?	 Yes  No
Have funds ever been transferred between accounts without review or verification?	 Yes  No
Do you ever sign checks for new business vendors without knowing or verifying their name and association with your company?	 Yes  No

V. Employees/Personnel

CONCEPT:

Know your employees and be aware of changes in behavior.

CHECKLIST: Each “yes” answer identifies a potential problem area.

Are any of your employees extremely possessive of their work records and reluctant to share their tasks?	 Yes  No
Are any of your employees apprehensive about vacations and time off, while always being the first in the office and the last out?	 Yes  No
Have you noticed a substantial change of lifestyle in any of your employees?	 Yes  No
Do any of your employees have a possible substance abuse problem?	 Yes  No
Are any of your employees living beyond their means?	 Yes  No
Have you ever hired an employee before checking references?	 Yes  No
Do you permit your accounting personnel to work longer than a year without taking a vacation?	 Yes  No
Do you have any accounting staff or key personnel who have not been secured with a fidelity bond?	 Yes  No

VI. Safeguarding Assets

CONCEPT:

Limit and monitor access to important documents and supplies.

CHECKLIST: Each “no” answer identifies a potential problem area.

Are blank check stocks and signature stamps safely secured?	 Yes  No
Do you restrictively endorse all checks when received?	 Yes  No
Do you deposit cash and checks daily?	 Yes  No
Do you maintain a list of office furniture, equipment, and company vehicles?	 Yes  No

VII. Other

Adequate insurance coverage for assets.
Off-site storage.
Importance of backing-up information.
Password restriction and security.

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The IRS's improper handling of applications for tax-exempt status from conservative groups has led to the removal of top officials, the appointment of a new Acting Commissioner, a 30-day top-down review of the agency's operations, Congressional hearings, and a criminal investigation. The outcome of all these activities may reshape how the IRS operates and how it interacts with taxpayers. In coming weeks and months, more details are expected to be uncovered about how the IRS treated conservative groups seeking tax-exempt status, who knew of a problem, and what can be done to prevent any reoccurrence in the future.

Applications for tax-exemption

In 2012, a House Committee asked the Treasury Inspector General for Tax Administration (TIGTA) to investigate reports of the IRS improperly handling applications for tax-exempt status from conservative groups. TIGTA launched a lengthy investigation that included interviewing IRS employees in Cincinnati, who process applications for tax-exempt status. On May 10, a few days before TIGTA was scheduled to release its findings, an IRS official apologized for the agency's inappropriate treatment of applications for tax-exemption from conservative groups.

TIGTA confirmed what the IRS official had said. TIGTA found that the IRS personnel in Cincinnati had used inappropriate criteria that identified for review Tea Party and other organizations applying for tax-exempt status based upon their names or policy positions. These included names such as Tea Party, Patriots and 9/12.

TIGTA further discovered that the IRS had sent requests for unnecessary information to these organizations. According to TIGTA, examples of this unnecessary information included the names of past and future donors, listings of all issues important to the organization and what the organization's positions were regarding the issues, and whether officers or directors have run for public office or would be running for public office in the future. TIGTA told Congress that all of the IRS's actions were inappropriate because they went beyond what was authorized by federal law and regulations. The IRS's inappropriate criteria may have led to inconsistent treatment of organizations applying for tax-exempt status, TIGTA concluded.

New leader, 30-day review

On May 15, President Obama announced that the Acting Commissioner of the IRS had resigned at his request. President Obama appointed Daniel Werfel, a career government employee, as the new Acting Commissioner. "The American people deserve to have the utmost confidence and trust in their government as we work to get to the bottom of what happened in the IRS," the President said.

Werfel has been ordered by the White House to undertake a 30-day review of the agency's operations, processes and practices. Werfel is to report his findings and recommendations for improvements to President Obama before the end of June. Since Werfel's appointment, the head of the IRS Tax-Exempt Division has retired and the official who oversaw the Cincinnati office was placed on administrative leave, after reportedly being asked to resign by Werfel. White House officials have indicated that more personnel changes may take place after the results of the 30-day review are announced.

Congressional investigations

Three Congressional Committees - the Senate Finance Committee, the House Oversight and Government Reform Committee and the House Ways and Means Committee - held hearings in May. The former Commissioner of the IRS, Douglas Shulman, and the ex-Acting Commissioner, Steven Miller, both told lawmakers that they were dismayed at TIGTA's report. "As a general principle, as the IRS commissioner, I didn't touch individual cases and I certainly didn't touch cases that involved political activity." Shulman said. Shulman added that he was "saddened" that these activities occurred on his watch. Miller acknowledged that the IRS had acted improperly but denied any partisan motivation for the conduct of employees.

For many lawmakers, the key question is whether IRS officials mislead them in previous hearings. "We are concerned about the extent to which senior officials became aware of these practices, when they found out, and what they did or did not do to put a stop to them. And, perhaps most important, we want to know why the IRS purposefully misled Congress when they led us to believe that no groups were being targeted," Sen. Orrin Hatch, R-Utah, said.

More Congressional hearings are scheduled. "We need to understand how and why this targeting occurred," Senate Finance Committee Chair Max Baucus, D-Montana, said. "We need to know who was involved and who was responsible, and we need to install new safeguards to ensure this targeting never happens again."

Criminal investigation

The U.S. Department of Justice has opened a criminal investigation into the IRS's scrutiny of applications from conservative groups. "The FBI is coordinating with the Justice Department to see if any laws were broken in connection with those matters related to the IRS," Attorney General Eric Holder said on May 14. Holder has not said when the results of the investigation will be released.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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The government continues to push out guidance under the Patient Protection and Affordable Care Act (PPACA). Several major provisions of the law take effect January 1, 2014, including the employer mandate, the individual mandate, the premium assistance tax credit, and the operation of health insurance exchanges. The three agencies responsible for administering PPACA - the IRS, the Department of Labor (DOL), and the Department of Health and Human Services (HHS) - are under pressure to provide needed guidance, and they are responding with regulations, notices, and frequently asked questions.

The health law provisions interact. Individuals are supposed to carry health insurance or pay a tax. Employers are supposed to offer coverage or pay a tax. The exchanges will provide information about the availability of different health care plans and will certify individuals eligible for the premium assistance tax credit. Individuals who cannot obtain affordable coverage may purchase insurance through an exchange and may be entitled to a premium assistance tax credit.

Exchanges

The DOL, in a technical release, provided temporary guidance to employers about their obligation to notify their employees of the availability of health insurance through an exchange and of the potential to qualify for the premium assistance tax credit if they purchase insurance through an exchange. Exchanges will begin operating January 1, 2014 and will provide open enrollment for their coverage beginning October 1, 2013. DOL provided model notices for employers to send out beginning October 1, 2013. Notices must be issued to all employees, whether or not the employer offers insurance and whether or not the employee enrolls in the employer's insurance.

Employer mandate

As part of the regulatory process, the IRS recently held a hearing on proposed regulations regarding the employer mandate, which imposes a penalty on employers who fail to provide adequate health insurance coverage in certain circumstances. The employer mandate takes effect January 1, 2014. Twenty different groups testified on relevant issues, including: the definition of a large employer subject to the penalty, the definition of a full-time employee who must be offered coverage, and the determination whether the coverage is affordable.

Minimum value

The IRS issued proposed regulations to clarify the minimum value requirement for employer-provided health insurance. The regulations provide additional guidance on how to determine whether an individual is eligible for the premium assistance tax credit. Taxpayers will not be eligible for the credit if they are eligible for other "minimum essential (health insurance) coverage" (MEC). MEC includes employer-sponsored coverage that is affordable and that provides minimum value. Employer coverage fails to provide minimum value if the employer pays less than 60 percent of the cost of plan benefits. Taxpayers may rely on the proposed regulations for years ending before January 1, 2015.

Medical loss ratio (MLR)

The IRS issued proposed regulations on MLRs. Insurance companies must provide premium rebates to their customers if they fail to spend at least 80 percent (85 percent for large companies) of their premiums directly on health care, as opposed to executive salaries and other expenses. The provision took effect in 2012; and the first round of MLR rebates was distributed in 2012. The IRS issued several notices to implement the program; the proposed regulation would apply to tax years beginning after December 31, 2013.

Annual limits on benefits

PPACA generally prohibits group health plans and health insurance issuers that offer group or individual health insurance from imposing annual or lifetime limits on the value of essential health benefits. Although some limits are allowed for plan years beginning before January 1, 2014, HHS regulations provide that HHS may waive the limits if they would cause a significant decrease in benefits or significant increase in premiums. IRS, DOL, and HHS issued frequently asked questions (FAQs) to clarify that plan or issuer receiving a waiver may not extend the waiver to a different plan or policy year.

Summary of benefits and coverage

PPACA generally requires insurers, employers and other health care plan providers to give a Summary of Benefits and Coverage (SBC) to participants and other affected individuals. In recent FAQs, the three government agencies advised that an updated SBC template and a sample SBC are available on the DOL's website. These documents can be used for coverage beginning in 2014. The agencies also extended certain enforcement relief. The agencies issued final regulations in 2012, and indicated that providers can continue to use coverage examples in current guidance, without adding new examples to their SBC.

Employer reporting

The Treasury Inspector General for Tax Administration (TIGTA) issued a recent report on some of the new information reporting requirements that PPACA has imposed on employers. For example, health insurance providers must report information for each individual who receives coverage. Large employers must report details about the coverage offered to employees and their dependents, including the premiums and the employer's share of costs. Employers must also report the cost of coverage to employees on their Forms W-2. The IRS will use these reports to administer PPACA's requirements.

PPACA is a complicated law. Many of its most important provisions take effect in 2014. The IRS and other responsible federal agencies continue to issue guidance and to take comments on the administration of the law.

If you have any questions about PPACA and what strategies you or your business might adopt, please contact our office.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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On May 6, 2013 the Senate passed the Marketplace Fairness Act of 2013 (a.k.a, the "Internet Sales Tax Bill" by 69-27. Passage in the Senate was considered a major hurdle for taxing Internet sales. The bill, if passed in the House and signed by the President, would enable states to collect from certain online sellers sales and use tax on sales made to customers in the state. The bill proposes a complete change from the current law, which provides that a state may not compel a seller to collect the state's tax unless the seller has a physical presence within that state.

Small seller exemption

The Marketplace Fairness Act includes an exception intended to protect small businesses. For example, a state would not be allowed to require tax collection by a seller that had gross annual receipts in total remote sales in the preceding year of $1 million or less. Persons with one or more ownership relationships to one another would have their sales aggregated if such relationships were determined to have been designed with the principal purpose of avoiding the application of the Act.

Proponents of the bill say that the main issue is fairness. Brick-and-mortar retailers have long argued that the physical presence restriction provides Internet sellers with an unfair advantage. By not collecting sales tax, an online retailer seller can, in effect, sell an item at a lower price than a store. Retailers who operate stores have increasingly complained of "showrooming" by customers who come to a store to browse and then order the same merchandise online where they will not be charged for sales tax.

On the other hand, opponents of the bill say it would kill jobs and place an unreasonable compliance burden on small online businesses that are forced to deal with more bureaucracy and collect tax in approximately 9,600 jurisdictions. Conservative groups also contend that the Marketplace Fairness Act allows overreaching by state governments.

Authority to require tax collection

The Marketplace Fairness Act would allow a state to require all online sellers that do not qualify for the small seller exemption to collect tax on all taxable sales sources to that state. Streamlined sales tax member states would be granted this authority beginning 180 days after the state publishes notice of its intent to exercise its taxing authority under the Act, but not earlier than the first day of the calendar quarter that is at least 180 days after the enactment of the Act.

Non-streamlined sales tax member states, on the other hand, would receive this authority beginning no earlier than the first day of the calendar quarter that is at least six months after the date that the state enacts legislation to exercise the authority and implements the Marketplace Fairness Act's mandatory simplification requirements.

The Marketplace Fairness Act is currently sitting in the House of Representatives. For information on any recent developments, please contact our offices.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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Vacation homes offer owners many tax breaks similar to those for primary residences. Vacation homes also offer owners the opportunity to earn tax-advantaged and even tax-free income from a certain level of rental income. The value of vacation homes are also on the rise again, offering an investment side to ownership that can ultimately be realized at a beneficial long-term capital gains rate.

Homeowners can deduct mortgage interest they pay on up to $1 million of "acquisition indebtedness" incurred to buy their primary residence and one additional residence. If their total mortgage indebtedness exceeds $1 million, they can still deduct the interest they pay on their first $1 million. If one mortgage carries a substantially higher rate than the second, it makes sense to deduct the higher interest first to maximize deductions.

Vacation homeowners don't need to buy an actual house (or even a condominium) to take advantage of second-home mortgage interest deductions. They can deduct interest they pay on a loan secured by a timeshare, yacht, or motor home so long as it includes sleeping, cooking, and toilet facilities.

Capital gain on vacation properties. Gains from selling a vacation home are generally taxed as long-term capital gains on Schedule D. As with a primary residence, basis includes the property's contract price (including any mortgage assumed or taken "subject to"), nondeductible closing costs (title insurance and fees, surveys and recording fees, transfer taxes, etc.), and improvements. "Adjusted proceeds" include the property's sale price, minus expenses of sale (real estate commissions, title fees, etc.). The maximum tax on capital gain is now 20 percent, with an additional 3.8 percent net investment tax depending upon income level. There's no separate exclusion that applies when selling a vacation home as there is up to $500,000 for a primary residence.

Vacation home rentals. Many vacation home owners rent those homes to draw income and help finance the cost of owning the home. These rentals are taxed under one of three sets of rules depending on how long the homeowner rents the property.

Income from rentals totaling not more than 14 days per year is nontaxable.
Income from rentals totaling more than 14 days per year is taxable and is generally reported on Schedule E of Form 1040. Homeowners who rent their properties for more than 14 days can deduct a portion of their mortgage interest, property taxes, maintenance, utilities, and other expenses to offset that income. That deduction depends on how many days they use the residence personally versus how many days they rent it.
Owners who use their home personally for less than 14 days and less than 10% of the total rental days can treat the property as true "rental" property, which entitled them to a greater number of deductions.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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Loans without interest or at below-market interest rates are recharacterized so that the lender must recognize market-rate interest income. Put another way, below-market loans are loans for which a rate of interest that is lower than the applicable federal rate (AFR) (which is computed by the government and released by the IRS on a monthly bases). Special adjustments might be necessary to determine the interest rate on short period loans, variable rate loans, and loans denominated in foreign currencies.

Categories of bargain-rate loans. The below market loan rules apply to a loan within one of six categories:

gift loans;
compensation-related loans;
corporation-shareholder loans;
tax avoidance loans;
loans to qualified continuing care facilities; or
other below-market loans.

A below-market loan is further characterized as either a demand loan or a term loan:

Below-market demand loans. Below-market demand loans are restructured for tax purposes so that the foregone interest is treated as transferred from the lender to the borrower, either as a gift, charitable contribution, dividend, compensation, or other payment, and retransferred by the borrower to the lender as interest. The foregone interest attributable to each calendar year is treated as transferred and retransferred on the last day of that year.

Below-market term loans. Below-market loans other than gift or demand loans are term loans, which are restructured for tax purposes so that the excess of the loan amount over the present value of all required loan payments, that is, the loan's original issue discount (OID), is treated as transferred from the lender to the borrower on the date of the loan. The lender and borrower recognize the interest under the OID rules over the life of the loan.

The principal distinction between the treatment of a gift or demand below-market loan and a term below-market loan, therefore, is in the timing of the consideration deemed transferred by the lender to the borrower. In both instances, the borrower is treated as paying interest and the lender as receiving interest income.

Exceptions/exemptions

The below-market loan rules include several exceptions and exemptions. There is a $10,000 de minimis exception for gift loans, compensation-related loans, and corporation-shareholder loans. Israeli bonds, loans between an employer and an employee stock ownership plan (ESOP), and loans to qualified continuing care facilities are also excepted from the rules. For gift loans directly between individuals, the imputed interest payment cannot exceed the borrower's net investment income for the borrower's tax year. Special rules apply to below-market employee relocation loans, loans from foreign persons, loans between spouses, and interest obligations that are cancelled, waived or forgiven. A lender must attach a statement to an income return that reports income or deductions arising from below-market loans.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of June 2013.

June 5
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 29-31.

June 7
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 1-4.

June 10
Employees who work for tips. Employees who received $20 or more in tips during May must report them to their employer using Form 4070.

June 12
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 5-7.

June 14
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 8-11.

June 17
Individuals, partnerships, passthrough entities and corporations make the second installment of 2013 estimated quarterly tax payments.

Individuals who were living abroad on April 15, 2013, must now file their 2012 tax year income tax return under the extended deadline. Extension to file but not to pay until October 15, 2013, are available upon application.

June 19
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 12-14.

June 21
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 15-18.

June 26
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 19-21.

June 28
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 22-25.

June 30
Employees and officers report any financial interest in, or signature authority over, a foreign financial account that exceeded $10,000 at any time during the 2012 calendar year on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR).

Employers. The deadline for certain employers to enter the expanded Voluntary Classification Settlement Program.

July 3
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 26-28.

July 8
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 29-30.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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Hopes for a pre-election resolution to the fate of the Bush-era tax cuts, extenders and other tax incentives are quickly fading as summer approaches. This year is increasingly looking like a replay of 2010, the last time the Bush-era tax cuts were facing imminent expiration. The White House, the Democratic-controlled Senate and the GOP-controlled House all have different opinions on the fate of these tax incentives and negotiations, which have been few and far between, and have quickly bogged down. One solution, which is being talked about more and more, is a temporary extension of the tax cuts. While this would punt the issue to the next Congress, it does little to ease taxpayers’ concerns about tax planning in a climate of constant uncertainty.

Bush-era tax cuts

Unless extended, the tax cuts in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) (as extended by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010) will sunset after December 31, 2012. The list of expiring tax incentives is long and includes reduced individual income tax rates and capital gains/dividends tax rates; the $1,000 child tax credit; enhancements to the earned income tax credit (EIC); and much more.

On May 15, House Speaker John Boehner, R-Ohio, said that the House will vote before the November elections on legislation to extend the Bush-era tax cuts. Boehner gave no timetable for a vote. It is unclear at this time if the GOP plans to vote on making the Bush-era tax cuts permanent or merely to extend them one or two more years. Also unclear is whether or not any extension would be offset with revenue raisers elsewhere. Even if the House votes on the tax cuts, there is no guarantee the Senate will take them up.

Complicating matters is the federal budget deficit. After months of partisan wrangling last year, Congress passed the Budget Control Act of 2011 (BCA). The BCA imposes mandatory, across-the-board spending cuts through sequestration. The BCA’s spending cuts are scheduled to take effect in 2013. The GOP wants to repeal the BCA and on May 10, the House approved legislation to effectively do that. The GOP bill has no chance of passage in the Democratic-controlled Senate. So the BCA remains, for now, law.

Few Capitol Hill observers expect Congress to take any meaningful action on the Bush-era tax cuts before the November elections. This leaves the fate of the Bush-era tax cuts to the lame duck Congress. Depending on the outcome of the November elections, the lame duck Congress could do nothing and allow the Bush-era tax cuts to expire, make the tax cuts permanent, or – and this appears to be the most likely scenario – extend the tax cuts for one year. Either way, the uncertainty complicates tax planning for 2012 and beyond.

Small businesses

Lawmakers are also dueling over competing small business tax bills. The House has approved the GOP-sponsored Small Business Tax Cut Act. The GOP bill would, among other provisions, provide a deduction for 20 percent of qualified domestic business income of the taxpayer for the tax year, subject to limitations. In the Senate, the Democrats’ small business bill would give a 10 percent income tax credit to small employers that increase wages or create jobs in 2012 and extend 100 percent bonus depreciation through 2012 (which had expired at the end of 2011). If the Senate approves the Democratic bill, the two chambers could iron-out the differences in the bills in conference.

Tax extenders

Since January, supporters of the tax extenders have tried several times, all unsuccessfully, to attach the extenders to other bills. Some of the extenders were initially attached to the Middle Class Tax Relief and Job Creation Act of 2012, which extended the employee-side payroll tax cut for all of calendar year 2012, but were subsequently dropped. Supporters also tried to include many of the extenders, especially energy-related tax incentives, to the Senate’s highway funding bill: the Moving Ahead for Progress in the 21st Century (MAP-21) Act. At the last minute, the extenders were removed from the Senate bill.

A drag on the extenders is their estimated cost to the federal budget. According to the Congressional Research Service, renewing all of the extenders for 2012 would cost $35 billion. This is one reason why supporters have tried to move only some of the extenders. There have also been calls in Congress to let some of the extenders expire permanently; but every extender has its supporter.

Federal estate tax

Another big question mark hovers over the federal estate tax. Unless Congress acts, the federal estate tax is schedule to revert to its pre-EGTRRA levels (a top tax rate of 55 percent with a $1 million exclusion). In 2010, the White House and the GOP agreed on a top tax rate of 35 percent with a $5 million exclusion (indexed for inflation) for decedents dying in 2011 and 2012 (special rules applied to decedents dying in 2010). The GOP has proposed to eliminate the estate tax entirely or, if not abolished, to retain the 35/$5 million amounts for decedents dying after 2012; the White House has proposed to reduce the exclusion amount to $3.5 million.

Our office will monitor developments and keep you posted of any changes. If you have any questions about legislative developments, please contact our office.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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More small businesses get into trouble with the IRS over payroll taxes than any other type of tax. Payroll taxes are a huge source of government revenue and the IRS takes them very seriously. It is actively looking for businesses that have fallen behind in their payroll taxes or aren't depositing them. When the IRS finds a noncompliant business, it hits hard with penalties.

Your most important responsibility is depositing all of your payroll taxes on time. Before you do that, however, you have to know:

Who are your taxable workers?
What payroll taxes apply?
What compensation is taxable?
When are your payroll taxes due?
What payroll and other returns should you file?

Taxable workers

The first step is to determine who is a taxable worker. If you hire only independent contractors, they, and not you, are responsible for paying federal payroll taxes.

It's more likely that you hire employees. In that case, you are responsible for withholding federal income tax and Social Security and Medicare taxes. You are also responsible for federal unemployment (FUTA) taxes along with any state taxes.

There are some exceptions to who is an employee for payroll taxes but they are few. The most common are real estate agents and direct sellers.

If you have any questions about the status of your workers, give our office a call. Misclassifying workers is a common mistake. If you treat an employee as an independent contractor, and your treatment is wrong, you will be liable for federal income tax and Social Security and Medicare taxes. They add up very quickly.

What taxes apply

Once you've determined that your workers are taxable employees, you have to determine what federal payroll taxes apply. Most employers must withhold federal income tax and Social Security and Medicare taxes. You are also liable for federal unemployment taxes (FUTA) but these are not withheld from an employee's pay. Only you pay FUTA taxes.

You have to withhold at the correct rate. Form W-4, which your employee fills out, tells you how much federal income tax to withhold for an employee. The Social Security, Medicare and FUTA tax rates are set by statute.

Failing to withhold at the correct rate is a surprisingly common mistake. Sometimes, an employee completes a new W-4 but the employer forgets to adjust his or her withholding. It's a good idea to review the W-4s of all your employees and make sure they are current.

Compensation

Almost every type of compensation, and not just wages, is taxable. The IRS wants its share of tips, bonuses, employee stock options, severance pay, and many other forms of compensation. This includes non-cash or in-kind compensation.

There are exceptions. Health insurance plans generally are not subject to federal payroll taxes. Per diem payments and other allowances, if they do not exceed rates set by the government, are generally not taxable as wages. Some fringe benefits are not taxable, such as employee discounts, an occasional taxi ride when an employee must work overtime and inexpensive holiday gifts.

Determining what compensation is taxable and what is not is often difficult. The complex tax rules are easy to misinterpret and you may be failing to withhold taxes on taxable compensation. It's a mistake that can be avoided with our help.

Deposit schedule

Most small employers deposit payroll taxes monthly. Large and mid-size businesses make semi-weekly deposits. Very small employers may make annual deposits.

Your deposit schedule is based on the total tax liability that you reported during a four-quarter "lookback" period. The lookback period begins July 1 and ends June 30. If you reported $50,000 or less of taxes for the lookback period, you make monthly deposits. If you reported more than $50,000, you make semi-weekly deposits.

Determining the lookback period is tricky. If the IRS finds that your lookback period is wrong, you could be heavily penalized for not making timely deposits. Your deposit schedule can also change and you have to know what can trigger a change.

Forms

If you withhold federal payroll taxes, you must file Form 941 quarterly. Of course, there are exceptions. The most important one is for very small employers. They file their returns annually instead of quarterly.

The IRS encourages employers to file Form 941 electronically. Depending on how large your business is, you may have no choice but to file electronically. A common mistake is filing more than one Form 941 quarterly. This only causes unnecessary delays.

Penalties are costly

Often, a small business just doesn't have the cash on hand to make a timely deposit. The owner thinks that he or she will double-up the next time and make things right. More often than not, that doesn't happen and the unpaid liability snowballs.

The penalties for failing to withhold or deposit federal income tax and Social Security and Medicare taxes are severe and they can be personal. If your business cannot pay the unpaid taxes, the IRS will go after you personally.

You may be using a payroll agent to pay your taxes. Keep in mind that you are still liable for those taxes if your agent doesn't pay them. Reliance on a payroll service, or anyone else, does not excuse your failure to pay.

Reporting obligations

Your payroll tax obligations also do not end with filing tax returns and depositing payments. You have reporting obligations to your employees and, in some cases, to your independent contractors.

Staying out of trouble with the IRS

Even if you believe you understand and are compliant with the federal payroll tax rules, give our office a call. The rules are riddled with exceptions that we haven't even touched on in this brief article. We'll take a look at your operations and make sure you are 100 percent compliant. It's worth avoiding any costly mistakes down the road.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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The AMT is difficult to apply and the exact computation is very complex. If you owed AMT last year and no unusual deduction or windfall had come your way that year, you're sufficiently at risk this year to apply a detailed set of computations to any AMT assessment. Ballpark estimates just won't work

The AMT is difficult to apply and the exact computation is very complex. If you owed AMT last year and no unusual deduction or windfall had come your way that year, you're sufficiently at risk this year to apply a detailed set of computations to any AMT assessment. Ballpark estimates just won't work.

If you did not owe AMT last year, you still may be at risk. The IRS estimates that half million more individuals will be subject to the AMT in 2006 because of rising deductions and exemptions. If Congress doesn't extend the same AMT exclusion amount given in 2005, an estimated 3 million more taxpayers will pay AMT.

For a system that was intended originally to target only the very rich, the AMT now hits many middle to upper-middle class taxpayers as well. Obviously something has to be done, and will be, eventually, through proposed tax reform measures. In the meantime, expect AMT to be around for at least another year.

Basic calculations. Whether you will be liable for the AMT depends on your combination of income, adjustments and preferences. After all the computations, if your AMT liability exceeds your income tax liability, you will be liable for the AMT. Here are the basic steps to take to determine in evaluating whether you will owe the AMT:

Step #1: Calculate your regular taxable income. If your regular tax were to be determined by reference to an amount other than taxable income, that amount would need to be determined and used in the next steps.
Step #2: Calculate your alternative minimum taxable income (AMTI) by increasing or reducing your regular taxable income (or other relevant amount) by applying the AMT adjustments or preferences. These include business depreciation adjustments and preferences, loss, timing and personal itemized deductions adjustments, and tax-exempt or excluded income preferences. This is the step with potentially many sub-computations in determining increases and reductions in tax liability.
Step #3: If your AMTI exceeds the applicable AMT exemption amount, pay AMT on the excess.

While no single factor will automatically trigger the AMT, the cumulative result of several targeted tax benefits considered in Step #2, above, can be fatal. Common items that can cause an "ordinary" taxpayer to be subject to AMT are:

All personal exemptions (especially of concern to large families);
Itemized deductions for state and local income taxes and real estate taxes;
Itemized deductions on home equity loan interest (except on loans used for improvements);
Miscellaneous Itemized Deductions;
Accelerated depreciation;
Income from incentive stock options; and
Changes in some passive activity loss deductions.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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You've waited until the last minute to fill out your income tax return. Instead of owing more taxes to the IRS, as you feared, you discover that you're entitled to a big refund. You breathe a sigh of relief.

What's wrong with this picture?

You're parking your money with the IRS; in effect, you have made an interest-free loan to the U.S. government. Wouldn't you rather have the money yourself, sooner?

It's true that you can't anticipate every facet of your tax return. You may have last-minute medical expenses. You may decide to increase your end-of-the year charitable giving. You may decide to sell off that investment that's a money-loser. Last-minute actions like these will all reduce your tax liability.

Over-Withheld?

But if you're getting a sizeable refund, you may want to reduce your income tax withholding this year. You should consider reducing your withholding in the following circumstances:

You got a big refund and your tax items will be about the same.
Your income will remain the same but your adjustments, deductions and credits will increase significantly.
You got a refund and you will qualify for one or more tax credits this year that you did not qualify for last year.

Any of the following common situations during a tax year also can lead to over-withholding:

You and your spouse both withhold at the individual rate, when one of you could withhold at the lower married rate.
You had child care expenses.
You bought a home with a higher mortgage.
You worked part-time but withheld at the higher annual rate as if you were working full-time.
You bought a hybrid automobile and can claim a deduction or credit.

The unpredictable

Of course, a larger-than-expected refund also can be the result of uncovering "hidden treasures" at tax preparation time -- unexpected deductions and other tax benefits that will lower the amount of income taxes that you thought you would have to pay. That's terrific; tax return time often does result in "finding" deductions and opportunities for post-year end tax planning as you pour over receipts and other paperwork. However, to what degree could many of these "hidden treasures" be discovered earlier and your tax withholding and estimated tax payments lowered earlier as a result?

Personal and financial factors also might change your tax liability: lifestyle changes, wage income, decreased income not subject to withholding; increased adjustments to income, and increased itemized deductions or tax credits.

Taking action!

If your circumstances change, or you want to make any changes to your withholding allowances, give your employer a new Form W-4. If you're starting a new job and are having trouble determining your withholding amount, you should still submit Form W-4. Otherwise, the employer must withhold at the highest rate.

Please contact this office if you need assistance in determining the right balance of wage withholding and estimated tax payments needed to cover your tax liability while not giving Uncle Sam an interest free loan. Remember, when you get a tax refund you are getting back money that you did not have to pay into the tax system in the first place.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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