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Deciding When to Start Receiving Social Security Benefits


As you approach retirement age, you must decide whether to begin taking reduced social security benefits early or wait until full benefit retirement age (FBRA), or even later. In many cases, this decision will depend on factors other than trying to receive the greatest lifetime benefit from social security. Remember that while you have the option of receiving social security benefits as early as age 62, the eligibility age for Medicare remains at 65. So, although you may be able to replace a sufficient amount of your earned income with social security benefits beginning at age 62, you may not be able to adequately replace your employer-provided health insurance.


Even if you have sufficient funds to live on without considering social security, many people prefer to begin receiving benefits as soon as possible. For 2013, the benefits at age 62 are reduced by 25% of what they would be at age 66 (i.e., the FBRA); but, you will receive more social security checks if benefits are drawn early. In addition, drawing early social security benefits may allow you to leave tax-deferred retirement accounts untouched and growing for longer periods.


Another reason to receive benefits early is if you have children living at home. Children under age 18 (or up to 19 if a full-time student) may be eligible for benefits if you are also receiving social security benefits.


Furthermore, if you wait until the FBRA to draw benefits, it will take several years to reach the break-even point to make up for the years of payments that were not received.


Example: Receiving social security benefits at age 62 versus the FBRA.

Curt is single and plans to begin receiving social security benefits on his 62nd birthday in 2013 when his benefit, based on his earnings history, is $1,000. He will receive monthly social security retirement benefits of $750, or 75% of his benefit. Therefore, he will receive 48 benefit checks of $750 each (not considering annual inflation adjustments), a total of $36,000, by the time he reaches age 66 (his FBRA).


Curt’s benefit would have been $1,000 if he had waited until age 66 to begin receiving benefits. Therefore, it would take him 12 years (starting at age 66) before the additional $250 per month ($1,000 − $750) benefit caught up to the $36,000 he would have received between ages 62 and 66.
When the present value of future social security benefits is considered, it could be more favorable to start the benefits as soon as possible (if the money is going to be invested). However, if you are simply using early social security benefits to replace a similar amount of earned income, the short-term financial position will not be improved and the long-term outlook could suffer.


Another factor to consider in taking retirement benefits early is the increased tax cost. With a smaller social security retirement benefit, you may need to work or draw on other resources to meet expenses. If the additional taxable income you generate exceeds certain thresholds, 50% to 85% of your social security benefits will be taxable.


You might carefully consider the long-lasting advantages of waiting until FBRA based on the following factors.


Life Expectancy. Your life expectancy may be the biggest factor in deciding whether to receive benefits early. By age 62, you should have a good handle on your own life expectancy based on your current health and the longevity of your parents. In general, 77 years might be a good cutoff point. If you reasonably expect to reach that age, waiting until FBRA may be a wise choice.


Shortening the Retirement Period. A significant factor in retirement planning projections is the length of the retirement period. For example, if you want to retire at age 62 and you have a life expectancy of 85, you have a 23-year retirement period to fund. By working past age 62, you are shortening the retirement period and lowering the amount of money needed to fund your retirement regardless of longevity.


The Earnings Test. If you are considering receiving retirement benefits before your FBRA but you intend to keep working, you must consider the earnings test. For 2013, social security benefits are reduced $1 for every $2 in earnings above the exempt amount of $15,120.


Replacing Lower-wage Years. Your social security benefits are calculated based on your highest 35 years of indexed earnings. If you can replace lower-wage years early in your career with higher-wage years after age 62, the benefit can be increased. This can lead to a greater benefit when you retire.


Inflation Adjustments. Social security benefits receive an annual inflation adjustment. By taking early benefits, your starting base for these annual adjustments is smaller. For example, if your benefit was $1,000, but you retired early and received only $750, each year you would miss out on the compounded inflation adjustment of that $250 in lost benefits. In other words, the gap between the early retirement benefit you receive and the amount you would have received by waiting will get bigger and bigger.


The Effect on Your Spouse. Your decision to start receiving social security benefits before reaching FBRA may also affect your spouse’s benefits. If your spouse does not have a personal earnings record, he or she will only receive half of your retirement benefit.


After FBRA. If you delay receiving benefits until after your FBRA, you will receive larger benefits because of the delayed retirement credit. You may receive a credit of up to 8% per year for each year you delay receiving benefits until age 70.


If you are able to wait, the delayed retirement credit can have a significant impact. In addition to the higher retirement benefit you will receive, you will also shorten your retirement period and increase your spouse’s survivor’s benefit.





Why baby boomers are making the wrong Social Security moves



Boomers don't make the right decisions about collecting Social Security because the present often takes precedence over the future. Photo courtesy of Flickr user Leenata Bankhele.


Larry Kotlikoff's Social Security original 34 "secrets", his additional secrets, his Social Security "mistakes" and his Social Security gotchas have prompted so many of you to write in that we now feature "Ask Larry" every Monday. We are determined to continue it until the queries stop or we run through the particular problems of all 78 million Baby Boomers, whichever comes first. Kotlikoff's state-of-the-art retirement software is available here, for free, in its "basic" version.


Larry Kotlikoff: I've taken of late to asking myself a broader Social Security question before answering your specific ones. This is my academic economist side coming out. We dismal scientists are trained to focus on the big picture, especially when the big picture is bad. And, from everything I can tell, the vast majority of the 10,000 baby boomers retiring every day are making the wrong Social Security decisions.


Social Security, as I've belabored, is an impossibly complicated system, forcing most new retirees to consider thousands of options to find the one that maximizes their lifetime benefits.Getting this exactly right requires using software that solicits the right inputs and that's extraordinarily precise under the hood.


But only a handful of retiring boomers -- 500 a day is my guesstimate -- seem to be using Social Security-maximizing software. Those that are using software appear to be using programs like AARP's free software, which provides wrong answers, even ignoring the calculations under the hood. (Full disclaimer: My small software company sells Social Security maximization software, but also offers a free version, available on this page.)


The calculators that are dangerous are those that ask for too few inputs to generate the right answer. In addition, the inputs they solicit are the wrong numbers. For example, the AARP calculator asks for either your current salary or sends you to a Social Security calculator to recover your monthly full retirement benefit. But your current salary, even if you are working full time, may have very little connection to your actual earnings history, which one needs to determine the right Social Security maximization strategy.

And the Social Security Administration's calculator, which is based on your earnings record, assumes the economy will experience what it has not experienced for well over a half century: zero inflation and zero economy-wide real wage growth. Social Security makes these assumptions in order to produce low-ball benefit estimates for workers out of fear that workers won't save enough on their own if they think their future benefits will be as large as they actually will be.

The bias in the Social Security estimate depends on the age of the person using the calculator. So a husband and wife who are, say, five years apart, will have differentially wrong Social Security benefit estimates, which can seriously impact the optimal strategy if, and this is a huge if, AARP is calculating everything correctly under the hood. Their casual treatment of inputs does not instill much confidence.

Other retiring baby boomers are relying on non-specialists at Social Security, either those available on the phone or those in the local offices, for Social Security benefit collection advice. As my recent columns suggest, the last people you want to ask for Social Security advice are the very conscientious, but very poorly trained folks at Social Security.


There are brilliant current and former Social Security technical experts (like Jerry Lutz, who double checks my responses to your questions every week), but there are far too few of them to serve 10,000 people per day. Nor can even the best technical expert run thousands of comparisons in his or her head.

(Jerry, by the way, thinks I'm being too harsh on many of his former Social Security colleagues. Maybe. But I get emails every few days from people who have been steered the wrong way, some extremely badly, by the good folks at Social Security.)

Yet other baby boomers are relying on the advice of financial planners. But most planners are giving advice from their hip pockets. Two weeks back, I spoke in Florida at a conference for financial planners specializing in giving advice to prospective and current retirees. To check their knowledge of Social Security's provisions, I asked the roughly 75 planners if any of them were aware of Social Security's option to suspend your retirement benefit upon reaching full retirement age and start it up again at a permanently larger level at or before age 70.

(If, for example, you suspend at 66 and wait until 70 to restart your retirement benefit, it will start at a 32 percent larger value after inflation.) Not a single financial adviser was aware of this option. And their questions after my talk suggested they too had very little knowledge of Social Security's other provisions.

There are also many baby boomers who are living hand to mouth and have no option but to "take the money and run" -- to take whatever they can get as soon as they can get it.

But many boomers do have choices, like waiting until 70 to take benefits that will be 76 percent higher adjusted for inflation than the benefit available at age 62. Yet fewer than 2 percent are waiting this long. Again, this may be ignorance -- folks using bad calculating tools or receiving bad advice. But I think there is a deeper, darker explanation that comes from the economics of behavioral finance that might loosely be called economic schizophrenia.

We like to think of ourselves as being one person -- one self. But an alternative view is that we are one body comprising multiple selves -- one for each future period or year. And these multiple selves are duking it out inside our brains to protect their living standards. But the current self is in charge, and if it doesn't care enough about the future selves, it will try to over-consume today and let the future selves fend for themselves later. Taking Social Security retirement benefits early is ignoring your fiduciary responsibility to care for your future self.

Telling baby boomers to save for their futures hasn't succeeded in getting them to save. Perhaps, the trick is to get boomers to think of their future selves as their own children, whom they need to protect, which in this context, means spending the effort to get Social Security right and putting the concerns of tomorrow ahead of the demands of today.



Using an S Corporation to Hold Stock in Other Corporations


When choosing an entity for your business, keep in mind there are opportunities to use an S corporation to hold stock in other corporations, but not the stock of other S corporations. If any corporation acquires the S corporation’s stock, that S corporation becomes a C corporation, which is generally detrimental. The truth is that taxpayers with S corporations have a great deal of flexibility in structuring their corporate holdings. This flexibility allows an S corporation to hold C corporation subsidiaries and qualified Subchapter S subsidiaries, as explained below.


Regular C Corporation Subsidiaries. S corporations can own up to 100% of the stock in another corporation. A corporation that owns more than 50% of the stock of another corporation has the right to control that corporation. Ownership of 80% or more of the stock of another corporation establishes an affiliated group relationship. Thus, S corporations may have 80%-or-more-owned regular C corporation subsidiaries. These C corporation subsidiaries are allowed to file a consolidated return with any other C corporations they are affiliated with. However, the parent S corporation cannot be included in this return. In summary, S corporations can own and operate one or more chains of subsidiary C corporations or brother/sister C corporations, but cannot join in the filing of a consolidated return.


Qualified Subchapter S Subsidiaries. Because an S corporation cannot have a corporate shareholder, subsidiary corporations cannot be treated as S corporations. However, an S corporation can have one or more qualified Subchapter S subsidiaries (QSubs) if it owns 100% of the subsidiary corporation and makes the required election.


A QSub is ignored for federal tax purposes, and its operations are reported as part of the parent S corporation’s income tax return. In addition to the efficiency of eliminating multiple tax returns, the shareholders gain the ability to offset losses from one or more QSub entities against the income of other members of the parent S corporation/QSub group. Furthermore, QSubs generally limit the parent company’s legal liability. The use of multiple corporate entities helps prevent problems in one business or location from affecting others.


A QSub is not treated as a separate corporation. Instead, its assets, liabilities, income, deductions, etc., are treated as those of the parent S corporation. The QSub’s accumulated earnings and profits, passive investment income, and built-in gains are also treated as those of the parent. Other tax consequences relating to QSubs can be complex.


Please contact us if you would like us to analyze the benefits and costs of using a QSub arrangement.





IRS Affordable Care Act Website


The IRS has a new website that provides information on the Affordable Care Act ( The site explains tax benefits and responsibilities for individuals, employers, and other organizations. In addition, it provides information about tax provisions that are in effect now and those that will go into effect in 2014 and beyond. Topics include premium tax credits for individuals, new benefits and responsibilities for employers, and tax provisions for insurers, tax-exempt organizations, and other types of businesses.




New Tax Rules for Legally Married Same-sex Couples


The U.S. Supreme Court’s decision in the Edith Windsor Case, invalidating a key provision of the Defense of Marriage Act, raised many questions regarding the federal income tax rights and responsibilities of same-sex couples. The U.S. Department of the Treasury and the IRS recently ruled that same-sex couples, legally married in a jurisdiction that recognizes their marriages, will be treated as married for federal tax purposes. This ruling applies regardless of whether the couple lives in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not. However, the ruling does not apply to registered domestic partnerships, civil unions, or similar formal relationships recognized under state law.


Same-sex couples will now be treated as married for all federal tax purposes (income, gift, and estate taxes) where marriage is a factor. The ruling applies to filing status, personal and dependency exemptions, the standard deduction, employee benefits, IRA contributions, and the earned income and child tax credits.


For 2013, legally married same-sex couples must file their tax return using either the married filing jointly or married filing separately filing status. For years prior to 2013, these couples may, but are not required to, file amended returns choosing to be treated as married for federal tax purposes for one or more prior tax years still open under the statute of limitations.




Tax Extenders Set to Expire

October 31, 2013

By Roger Russell, Senior Editor, Accounting Today

It’s the time of year to again start thinking about expiring tax provisions. Usually the first thing that comes to mind is the alternative minimum tax, but this particular issue was “fixed” in January of this year by the fiscal cliff bill. That still leaves a number of expiring provisions, according to Robert Kerr, senior director of government relations at the National Association of Enrolled Agents.

Among them, Kerr noted, are the deduction for state and local sales taxes; the deduction for mortgage insurance as qualified interest; the above-the-line deduction for qualified tuition and related expenses; the above-the-line deduction for certain expenses of elementary and secondary school teachers; the Work Opportunity Tax Credit; the increase in expensing and the expansion of the definition of Section 179 property; the Research and Experimentation Tax Credit; and the 15-year straight line cost recovery for qualified leasehold, restaurant and retail improvements.

Every year the alternative minimum tax was at the head of the list of things that needed fixing, observed Kerr.  “Each year that we didn’t have a fix, we had a growing number of people on the AMT bubble. It created a ‘whale tail’ when you paid for the patch. Since the increase in cost to pay for the patch wasn’t linear, it was exponential. It didn’t grow gently. Probably the piece that got our attention was there were some 20 million potentially affected out of the total population of taxpayers.”

There are a number of reasons that less attention is being paid this year to the extenders, Kerr indicated. “One reason is that AMT is no longer the engine that drives the extender train,” he said. The other is the overall legislative environment this year—the budget, the sequester, the shutdown, and talk of tax reform. At least the Ways and Means Committee had visions of managing the extenders within the context of tax reform.”

“The net is that we’re sitting here with 10 legislative days left in the year, and we don’t have any word on the extenders except for the notion that they will be included in the El Dorado of tax reform,” he said. “My take on that is tax professionals desire stability and predictability above all else, and the current state of affairs on extenders provides us with neither.”

Will Congress act before the end of the year to extend some or most of these? Will they all expire, only to be resurrected retroactively during the filing season—or in 2015? Or will they just expire, period? 

“None of us should be surprised if we find ourselves in precisely the same situation as at the beginning of 2013, and proceed all the way through 2014 without knowing which ones will be retroactively extended,” said Kerr.



Federal Workers with Security Clearances Owe $85M in Unpaid Tax Debts

Washington, D.C. (October 31, 2013)

By Michael Cohn

Approximately 8,400 federal employees and contractors who were judged eligible for a security clearance from April 2006 to December 2011 owed approximately $85 million in unpaid federal taxes as of June 2012, according to a new government report.

The report, from the Government Accountability Office, noted that the figure represents about 3.4 percent of the civilian executive-branch employees and contractors who were favorably adjudicated during that period. As of October 2012, about 4.9 million civilian and military employees and contractors held a security clearance.

The GAO found that about 4,700 of the approximately 8,400 individuals were federal employees, while the others were mostly federal contractors. In addition, about 4,200 of these individuals had a repayment plan with the Internal Revenue Service to pay back their tax debts.

Federal laws do not prohibit an individual with unpaid federal taxes from holding a security clearance, but tax debt poses a potential vulnerability, the report pointed out.

GAO used clearance data from the Office of Personnel Management’s Central Verification System database to compile the report. The CVS database does not maintain information on the denial of security clearances on the basis of an individual's nonpayment of federal taxes, however, so the GAO was unable to determine the number of individuals who were denied security clearances for this reason.

The GAO pointed out that federal agencies have established mechanisms to identify the unpaid federal tax debts of security-clearance applicants, but these mechanisms have limitations. To detect federal tax debt for clearance applicants, federal investigators mainly rely on two methods: the self-reporting of tax debts by applicants, and validation techniques such as the use of credit reports or in-person interviews. Each of these methods has shortcomings in detecting unpaid federal tax debts of clearance applicants.

For example, credit reports are the primary means for identifying tax debts that were not self-reported, but these reports only contain information on tax debts for which the IRS has filed a lien on the debtor's property. According to the GAO's analysis, 5 percent of the 8,400 delinquent taxpayers who were favorably adjudicated as eligible for security clearances had a tax lien filed on them. In addition, federal agencies generally do not routinely review federal tax compliance of clearance holders.

There is no process to detect unpaid federal tax debts accrued after an individual has been favorably adjudicated unless it is self-reported, reported by a security manager due to garnishment of wages, or discovered during a clearance renewal or upgrade, the report noted. The GAO's analysis found that 6,300 individuals (or approximately 75 percent) accrued their tax debt after approval of the security clearance.

Additional mechanisms that provide large-scale, routine detection of federal tax debt could improve the ability of federal agencies to detect tax debts owed by security-clearance applicants and current clearance holders, but statutory privacy protections limit access to this information, the report pointed out. Federal agencies may obtain information on federal tax debts directly from the IRS if the applicant provides consent. In addition, federal agencies do not have a mechanism, such as the one used by the Treasury Department, to collect delinquent federal debts.

Such information could help federal agencies perform routine, automated checks of security-clearance applicants to determine whether they have unpaid federal debts, without compromising statutory privacy protections, the GAO noted. Such a mechanism could also be used to help monitor current clearance holders' tax-debt status. “Gaining routine access to this federal debt information, if feasible, would better position federal agencies to identify relevant financial and personal-conduct information to make objective assessments of eligibility for security-clearance applicants and continued eligibility of current clearance holders,” said the report.

The GAO recommended that the Office of the Director of National Intelligence study the feasibility of federal agencies routinely obtaining federal debt information from the Treasury Department for the purposes of investigating and adjudicating clearance applicants, as well as for monitoring current clearance holders' tax-debt status. The ODNI agreed with the GAO's recommendation.

“Although the investigative process involves mechanisms for detecting unpaid financial obligations, including some federal tax debt, it can be difficult to identify each and every instance of unpaid debt,” wrote Jim Crumpacker, director of of the Departmental GAO-OIG Liaison Office. “Reliance on self-reporting and legal restrictions on data sharing with the Internal Revenue Service complicates potential efforts to improve debt detection. Furthermore, it is not currently a condition of employment that all federal employees, regardless of whether or not they hold a clearance, be current on federal tax debt.”


IRS Changes Pension Plan Limitations for 2014

October 31, 2013

By Michael Cohn

The Internal Revenue Service released the annual cost-of-living adjustments Thursday affecting dollar limitations for pension plans and other retirement-related items for tax year 2014, allowing taxpayers to contribute up to $17,500 to their 401(k) plans in 2014.

In addition, the IRS announced Thursday that it is modifying the “use or lose” rule for health care flexible spending arrangements, permitting a carryover of up to $500 to provide greater flexibility to plan participants (see Treasury Relaxes 'Use or Lose' Rule for Flexible Spending Accounts). The agency also issued the annual inflation-adjusted tax rate schedules and other changes in tax benefits for 2014 on Thursday (see IRS Adjusts 2014 Tax Rates for Inflation).

The IRS added that some pension limitations such as those governing 401(k) plans and IRAs will remain unchanged because the increase in the Consumer Price Index did not meet the statutory thresholds for their adjustment, but there will be changes in some pension plan limitations.

•  The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan remains unchanged at $17,500.

• The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan remains unchanged at $5,500.

• The limit on annual contributions to an Individual Retirement Arrangement (IRA) remains unchanged at $5,500.  The additional catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000.

• The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are covered by a workplace retirement plan and have modified adjusted gross incomes (AGI) between $60,000 and $70,000, up from $59,000 and $69,000 in 2013. For married couples filing jointly, in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phase-out range is $96,000 to $116,000, up from $95,000 to $115,000. For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $181,000 and $191,000, up from $178,000 and $188,000. For a married individual filing a separate return who is covered by a workplace retirement plan, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

• The AGI phase-out range for taxpayers making contributions to a Roth IRA is $181,000 to $191,000 for married couples filing jointly, up from $178,000 to $188,000 in 2013. For singles and heads of household, the income phase-out range is $114,000 to $129,000, up from $112,000 to $127,000.  For a married individual filing a separate return, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

• The AGI limit for the saver’s credit (also known as the retirement savings contribution credit) for low- and moderate-income workers is $60,000 for married couples filing jointly, up from $59,000 in 2013; $45,000 for heads of household, up from $44,250; and $30,000 for married individuals filing separately and for singles, up from $29,500.

Here are some details on both the unchanged and adjusted limitations:

Section 415 of the Tax Code provides for dollar limitations on benefits and contributions under qualified retirement plans. Section 415(d) requires that the Secretary of the Treasury annually adjust these limits for cost of living increases. Other limitations applicable to deferred compensation plans are also affected by these adjustments under Section 415. Under Section 415(d), the adjustments are to be made pursuant to adjustment procedures which are similar to those used to adjust benefit amounts under Section 215(i)(2)(A) of the Social Security Act.

Effective Jan. 1, 2014, the limitation on the annual benefit under a defined benefit plan under Section 415(b)(1)(A) has increased from $205,000 to $210,000.  For a participant who separated from service before Jan. 1, 2014, the limitation for defined benefit plans under Section 415(b)(1)(B) is computed by multiplying the participant's compensation limitation, as adjusted through 2013, by 1.0155.

The limitation for defined contribution plans under Section 415(c)(1)(A) is increased in 2014 from $51,000 to $52,000.

The Tax Code provides that various other dollar amounts are to be adjusted at the same time and in the same manner as the dollar limitation of Section 415(b)(1)(A). After taking into account the applicable rounding rules, the amounts for 2014 are as follows:

The limitation under Section 402(g)(1) on the exclusion for elective deferrals described in Section 402(g)(3) remains unchanged at $17,500.

The annual compensation limit under Sections 401(a)(17), 404(l), 408(k)(3)(C), and 408(k)(6)(D)(ii) is increased from $255,000 to $260,000.

The dollar limitation under Section 416(i)(1)(A)(i) concerning the definition of key employee in a top-heavy plan is increased from $165,000 to $170,000.

The dollar amount under Section 409(o)(1)(C)(ii) for determining the maximum account balance in an employee stock ownership plan subject to a 5 year distribution period is increased from $1,035,000 to $1,050,000, while the dollar amount used to determine the lengthening of the 5 year distribution period is increased from $205,000 to $210,000.

The limitation used in the definition of highly compensated employee under Section 414(q)(1)(B) remains unchanged at $115,000.

The dollar limitation under Section 414(v)(2)(B)(i) for catch-up contributions to an applicable employer plan other than a plan described in Section 401(k)(11) or Section 408(p) for individuals aged 50 or over remains unchanged at $5,500. The dollar limitation under Section 414(v)(2)(B)(ii) for catch-up contributions to an applicable employer plan described in Section 401(k)(11) or Section 408(p) for individuals aged 50 or over remains unchanged at $2,500.

The annual compensation limitation under Section 401(a)(17) for eligible participants in certain governmental plans that, under the plan as in effect on July 1, 1993, allowed cost of living adjustments to the compensation limitation under the plan under Section 401(a)(17) to be taken into account, is increased from $380,000 to $385,000.

The compensation amount under Section 408(k)(2)(C) regarding simplified employee pensions (SEPs) remains unchanged at $550.

The limitation under Section 408(p)(2)(E) regarding SIMPLE retirement accounts remains unchanged at $12,000.

The limitation on deferrals under Section 457(e)(15) concerning deferred compensation plans of state and local governments and tax-exempt organizations remains unchanged at $17,500.

The compensation amount under Section 1.61 21(f)(5)(i) of the Income Tax Regulations concerning the definition of “control employee” for fringe benefit valuation purposes is increased from $100,000 to $105,000. The compensation amount under Section 1.61 21(f)(5)(iii) has increased from $205,000 to $210,000.

The Tax Code also provides that several pension-related amounts are to be adjusted using the cost-of-living adjustment under Section 1(f)(3). After taking the applicable rounding rules into account, the amounts for 2014 are as follows:

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for married taxpayers filing a joint return is increased from $35,500 to $36,000; the limitation under Section 25B(b)(1)(B) is increased from $38,500 to $39,000; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D) is increased from $59,000 to $60,000.

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for taxpayers filing as head of household is increased from $26,625 to $27,000; the limitation under Section 25B(b)(1)(B) is increased from $28,875 to $29,250; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D) is increased from $44,250 to $45,000.

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for all other taxpayers is increased from $17,750 to $18,000; the limitation under Section 25B(b)(1)(B) is increased from $19,250 to $19,500; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D) is increased from $29,500 to $30,000.

The deductible amount under Section 219(b)(5)(A) for an individual making qualified retirement contributions remains unchanged at $5,500.

The applicable dollar amount under Section 219(g)(3)(B)(i) for determining the deductible amount of an IRA contribution for taxpayers who are active participants filing a joint return or as a qualifying widow(er) is increased from $95,000 to $96,000. The applicable dollar amount under Section 219(g)(3)(B)(ii) for all other taxpayers (other than married taxpayers filing separate returns) is increased from $59,000 to $60,000. The applicable dollar amount under Section 219(g)(3)(B)(iii) for a married individual filing a separate return  is not subject to an annual cost-of-living adjustment and remains $0.  The applicable dollar amount under Section 219(g)(7)(A) for a taxpayer who is not an active participant but whose spouse is an active participant is increased from $178,000 to $181,000.

The adjusted gross income limitation under Section 408A(c)(3)(B)(ii)(I) for determining the maximum Roth IRA contribution for married taxpayers filing a joint return or for taxpayers filing as a qualifying widow(er) is increased from $178,000 to $181,000.  The adjusted gross income limitation under Section 408A(c)(3)(B)(ii)(II) for all other taxpayers (other than married taxpayers filing separate returns) is increased from $112,000 to $114,000.  The applicable dollar amount under Section 408A(c)(3)(B)(ii)(III) for a married individual filing a separate return is not subject to an annual cost-of-living adjustment and remains $0.

The dollar amount under Section 430(c)(7)(D)(i)(II) used to determine excess employee compensation with respect to a single-employer defined benefit pension plan for which the special election under Section 430(c)(2)(D) has been made is increased from $1,066,000 to $1,084,000.


Gov. Snyder Signs Off on Changes to Unemployment System

Governor Rick Snyder signed legislation last Tuesday that would allow for the denial of unemployment benefits to someone if they fail or refuse a drug test needed for employment and had a job offer revoked by a potential employer. House Bill 4952, now Public Act 146 of 2013, is effective immediately. He also signed other bills that would make additional changes to the unemployment system. Read more in this online recap from MACPA’s lobby firm, Public Affairs Associates.


IRS Wants $2.7 Million from Race Driver Montoya

Washington, D.C. (November 5, 2013)

By Michael Cohn

The Internal Revenue Service is asking for $2.7 million in taxes from race driver Juan Pablo Montoya, and he has filed a lawsuit in the U.S. Tax Court challenging the IRS’s assessment.

The tax dispute centers around the use of an offshore corporation in the Bahamas to which the Colombian race car driver assigned the rights to his “driver identity”—including his image, name, appearance and voice—before moving to the U.S. in 2007, according to Forbes.

In his lawsuit, Montoya reportedly has admitted that he had almost $800,000 in income than he and his wife originally reported for 2007 and 2008 on their joint return, but he disputed the IRS’s assertion that they had $9.5 million in taxable income for those two years instead of the $2.4 million they had reported.

The IRS also disallowed tax deductions that Montoya had claimed after his company JPM Motorsport sold his image to another of his companies, Monty Motorsport, for $15 million in 2006 and began amortizing the investment, claiming deductions of $1.4 million in 2007 and $1 million in 2008. And the agency rejected another deduction for $267,000 related to Montoya’s professional fees and a grantor trust that the Formula One driver set up when he moved to the U.S. to compete in Nascar races. Montoya also claimed tax breaks on the purchase of an $8.7 million Lear jet to attend Nascar races, which the IRS also denied. He plans to move on to IndyCar racing next year.

The case is reminiscent of an IRS tax evasion case against another race car driver, Helio Castroneves, also involving income from his image and likeness funneled through an offshore corporation. The two-time Indianapolis 500 champion was acquitted of criminal charges but still ended up paying millions of dollars in taxes to the IRS (see Racecar Driver Castroneves Acquitted of Tax Charges).


Senate Introduces Bill to Rescind Corporate Tax Write-offs for Illegal Behavior

November 6, 2013

By Michael Cohn

A pair of senators have introduced bipartisan legislation that would rescind tax write-offs for illegal corporate behavior in an effort to hold corporate wrongdoers accountable.

Senators Jack Reed, D-R.I., and Chuck Grassley, R-Iowa, introduced the Government Settlement Transparency & Reform Act, which aims to close a loophole that has allowed some corporations to reap tax benefits from payments made at government direction stemming from settling misdeeds.

Corporations accused of illegal activity routinely settle legal disputes with the government out of court because it allows both the company and the government to avoid the time, expense and uncertainty of going to trial, the senators noted. Federal law prohibits companies from deducting public fines and penalties from their taxable income. But under current law, offending companies may often write off any portion of a settlement that is not paid directly to the government as a penalty or fine for violation of the law. This allows some companies to lower their tax bill by claiming settlement payments to non-federal entities as tax deductible business expenses.

“A penalty is supposed to deter others because it causes pain to a company’s bottom line,” Reed said in a statement. “If a company is paying thousands, millions, or even billions in fines, it shouldn’t save money for those same misdeeds, it should be held accountable. The law needs to change to ensure the punishment fits the crime.  Congress needs to close this settlement loophole.”

The Reed-Grassley bill would require the government and the settling party to reach pre-filing agreements on how the settlement payments should be treated for tax purposes. The bill clarifies the rules about which settlement payments are punitive and thus non-deductible, and increases transparency by requiring the government to file a return at the time of settlement to accurately reflect the tax treatment of the amounts that will be paid by the offending party.

“A penalty should be meaningful or it won’t have the deterrent effect it’s supposed to have,” Grassley said.  “This issue comes up regularly, and this bill would make deductibility clear going forward.”

The Government Settlement Transparency & Reform Act (S. 1654) would close the tax loophole that allows tax write-offs for corporate violations. The bill would also amend the Tax Code to deny tax deductions for certain fines, penalties and other amounts related to a violation or investigation or inquiry into the potential violation of any law.

In addition, the bill would amend Subsection (f) of Section 162 of the Tax Code, which says that no deduction will be allowed for any fine or similar penalty paid to a government for the violation of any law. The amounts paid by corporations that constitute restitution for damage caused by the violation of any law are exempted and remain deductible. This section requires that nongovernmental entities that exercise self-regulatory powers be treated as government entities for purposes of disallowing deductions under this section. The bill would require the government to stipulate the tax treatment of the settlement agreement.



IRS Expands Fast-Track Settlement Program for Small Businesses under Audit

Washington, D.C. (November 6, 2013)

By Michael Cohn

The Internal Revenue Service expanded nationwide on Wednesday the rollout of its streamlined Fast Track Settlement program, which aims to help small businesses under audit settle their differences with the IRS over their tax debts more quickly.


The Fast Track Settlement program is designed to help small businesses and self-employed individuals who are under examination by the Small Business/Self Employed Division of the IRS. Modeled after a similar program that has long been available to large and midsize businesses with more than $10 million in assets, the FTS program uses alternative dispute resolution techniques to help taxpayers save time and avoid a formal administrative appeal or lengthy litigation. As a result, audit issues can usually be resolved within 60 days, rather than months or years, according to the IRS. In addition, taxpayers who choose the FTS option lose none of their rights because they still have the right to appeal even if the FTS process is unsuccessful. 


Jointly administered by Small Business/Self-Employed Division and the IRS Appeals office, FTS is designed to expedite case resolution. Under FTS, taxpayers under examination with issues in dispute work directly with IRS representatives from SB/SE’s Examination Division and Appeals to resolve those issues, with the Appeals representative typically serving as mediator.


The taxpayer or the IRS examination representative may initiate Fast Track for eligible cases, usually before a 30-day letter is issued. The goal is to complete cases within 60 days of acceptance of the application in Appeals.


SB/SE originally launched FTS as a pilot program in September 2006 and expanded it in December 2007. For more information on taking advantage of the Fast Track Settlement program, see the Alternative Dispute Resolution page on and IRS Announcement 2011-05.




Workers Crossing State Lines Mean More Employer Audits: Taxes

By Michael Baer - Nov 4, 2013 12:00 AM ET

Workers who perform their tasks in different states may expose their employers to additional tax liabilities as states seek to collect levies from nonresidents by increasing enforcement actions.


Payroll systems that aren’t configured to track employee earnings for multiple work locations can expose employers to tax audits from numerous states, said Mary Hevener, a partner at Morgan, Lewis & Bockius LLP in Washington.


Employers that fail to collect and pay taxes to appropriate jurisdictions for traveling workers generally are liable for the taxes, Hevener said at a conference on payrolls in Newport News, Virginia last month, Bloomberg BNA reported. States audit employers because it is easier and more efficient than scrutinizing employees, especially those who haven’t been in a state for long.


The exposure occurs because “a lot of businesses don’t try to track the travelers,” she said.


Employers with mechanisms that track multistate work sometimes can receive complaints after mobile employees see wages and taxes for more than one state reported on their W-2 forms, Hevener said. Employers that report wages and taxes to more than one state essentially obligate the employee to file individual returns in those states. Hevener said she files tax returns in nine states.


Nineteen states with income taxes have certain thresholds of time spent and money earned while working in their state, according to a map that Hevener displayed. Twenty-two states technically subject workers to tax on the first day of travel in the state.


New York

Of those states with thresholds, New York generally doesn’t apply state tax for certain work activities performed inside its borders for 14 days or fewer in a year, Hevener said. Georgia allows out-of-state workers to work in the state up to 23 days in a quarter without applying state taxes, or up to 5 percent of total compensation derived from in-state work. Other states have poorly explained rules on income allocations, she said.


To add to the issue’s complexity, states can tax stock options and restricted stock after employees move elsewhere, Hevener said. The taxing states also have tracking mechanisms for stock option income and stock appreciation rights, though there are no set rules among states for how these amounts are to be taxed.


Four general methods are used to identify when stock compensation is earned for tax purposes: grant to vest, grant to exercise, year of exercise and degree of appreciation. Some states, Hevener said, haven’t adopted any option-sourcing rules.


Federal law bans states from taxing certain types of deferred compensation earned in one state for those now living in other states.


Standardization Proposals

Several attempts have been made to standardize how multistate workers are treated for state tax purposes, said Patrick Rehfield, a lawyer at Morgan Lewis who spoke with Hevener at the conference.


Under the Mobile Workforce State Income Tax Simplification Act, proposed in the past several congressional sessions, nonresidents would have to work at least 30 days in a state before becoming subject to out-of-state taxes, Rehfield said. The legislation, which would exclude professional athletes, professional entertainers and some public figures from the time frame, has encountered strong state opposition, he said.


Another proposal, the Multistate Tax Commission’s mobile workforce withholding and individual income tax model statute, would establish a 20-day threshold, Rehfield said.


Some states with income thresholds instead of day-counting thresholds are critical of the model statute. Under it, high-earner nonresidents working fewer than 20 days would be exempt from filing returns, while lower-paid nonresidents working more than 20 days in a state would have to file, Rehfield said.



The Unexpectedly High Cost of a Bad Hire

Ryan Holmes

July 16, 2013

In the course of running my own businesses for more than two decades, I’ve done my fair share of hiring. And I can tell you with absolute certainty that one of the most costly, time-consuming blunders a business can make is picking the wrong person for the job.

How costly? The U.S. Department of Labor currently estimates that the average cost of a bad hiring decision can equal 30% of the individual’s first-year potential earnings. That means a single bad hire with an annual income of $50,000 can equal a potential $15,000 loss for the employer.


This loss is compounded by the impact of a bad hire on productivity and team morale. One subpar employee can throw an entire department into disarray. Team members end up investing their own time into training someone who has no future with the company.

Tony Hsieh, CEO of Zappos, feels my pain. He once estimated that his own bad hires have cost the company well over $100 million. (That’s part of the reason he now offers new hires a $2000 bonus to quit after their first week on the job.)

I don’t give my new employees thousands of dollars to leave (yet!), but here are a few techniques I’ve used in my hiring process that I’ve found to be effective in preventing hiring mishaps:

1. Over-prepare: A job candidate isn’t the only one who should cram before the interview.

When you’re hiring employees for specific, technical roles, it can be hard to prepare the right interview questions. I always find it useful to first find an expert in the candidate’s specific field and get some advice on the best questions to ask. This is worth the extra effort, even if it means consulting someone outside your company.

So if you’re hiring for an IT role, find and talk to an IT person about what makes a good team member. Then, add three specific IT-related questions to your interview. Don’t be afraid to loop back with your expert advisor to get his feedback on the responses.

2. The secretary test: Great collaborators don’t pull rank.

Recently, we had various people applying for a high-level sales role, and time and time again the candidates would bulldoze over my executive assistant. I checked in with her and was surprised to find out that many people who had been personable and courteous to me were downright rude to her.

The ability to work well with others is a skill that benefits any workplace. An obvious way to gauge this is to contact the candidate’s references. But, why not take it a step further and dig into a candidate’s social media profiles? Savvy HR departments are already looking through candidates’ Facebook and LinkedIn profiles. I recommend going as far as checking a candidate’s Twitter feed to gain insight.

A few years ago a promising candidate for a job at our company tweeted this from his personal Twitter account: “going to a phone interview with @hootsuite and I am drunk after a few hours in the ‪ #congress2012 beer tent.” We found it and needless to say, he was not hired.

3. The curveball: Hide an unexpected question in the fine print.

Over the years, I’ve found that effective employees are those who take the time to read the fine print. So one thing I’ve done in the past is to throw a small, unconventional request into a job application. This can be something as innocuous as, “Please list three websites you visit often.” Candidates who overlook this question or don’t provide a full answer aren’t worth interviewing.

Why? People tend to be the most alert and thoughtful during this initial stage of the job application process. If they can’t pay attention to details here, how will they perform once they’re hired?

When it comes to hiring, I think Steve Jobs once said it best (as he often did): "I noticed that the dynamic range between what an average person could accomplish and what the best person could accomplish was 50 or 100 to 1. Given that, you're well advised to go after the cream of the cream. ...A small team of A+ players can run circles around a giant team of B and C players."

How do you find your “cream of the cream”? What are your unique or tried-and-tested hiring strategies?


Tax Planning Ideas for Your Schedule C (Sole Proprietor) Business

Posted by Joe Turnes on Tue, Nov 12, 2013 @ 10:36 AM


A tax planning question we often hear is: "I have a Schedule C business I report directly on my individual Form 1040.  As I approach the end of the year, what are some tax planning ideas to save income taxes for 2013?" Let's answer that question.


Tax planning can be complex due to the ever changing tax laws introduced each year.  However, some fundamentals remain the same even as taxes, credits and deductions are modified.  A few ideas for you:


1.If your business is on the cash basis, you can postpone income until 2014 and accelerate expenses into 2013 to lower your 2013 tax liability.  Besides reducing your tax liability, you may also increase other credits and deductions.


2.If you need to purchase business equipment, it may be wise to do so in 2013 instead of waiting until next year.  Certain depreciation tax breaks are set to expire at December 31, 2013.  Therefore, you may want to buy fixed assets in 2013 vs. 2014, as you may not get as much benefit for the purchase next year:



  • Section 179 fast depreciation is presently allowed up to $500,000, but will decrease to $25,000 for 2014.


  • 50% Bonus Depreciation for new first-year property will be eliminated in 2014.



3.Consider using a credit card to prepay expenses that can generate deductions for this year.  The credit card balance can be paid in January 2014 to avoid any interest charges.


4.To help fund new healthcare legislation, there is a new 3.8% surtax on unearned income (interest, dividends, capital gains, rent, passive pass-through income) and an additional 0.9% Medicare tax that applies to individuals receiving wages in excess of $200,000 ($250,000 MFJ).  Depending on your circumstances, you may want to find ways to increase/decrease your wages/unearned income for 2013 vs. 2014.



5.Depending on your situation, you should try “bunching” your itemized deductions into one year (i.e. pay winter property tax bill in January 2013 and December 2013).


6.For individuals, some tax breaks are set to expire at the end of the year and may or may not be extended.  For example, the above the line deduction for qualified higher education expenses and tax-free distributions by those age 70 ½ or older from IRAs for charitable purposes.  If either tax break applies to you, you will want to make sure it is done in 2013 vs. 2014.



As with all tax planning, the best way to save taxes is to have level income over the years and to avoid spikes in income or losses.




IRS Plans to Step up Audits of Small Business Partnerships

Washington, D.C. (November 14, 2013)

By Michael Cohn


The head of the Internal Revenue Service’s small business unit said his division expects to move from focusing on audits of small corporations to partnerships.


During a speech at the American Institute of CPAs’ National Tax Conference in Washington, D.C., last week, Faris Fink, the commissioner in charge of the IRS’s Small Business/Self-Employed Division reportedly told attendees that his unit would make a top priority of auditing the tax returns of partnerships and other pass-through entities. “The Service has for a long time focused its energy on corporations,” he said, according to Bloomberg’s Lydia Beyoud. “Frankly, we’re a little bit behind the curve in getting around to developing a partnership strategy.”


Part of that strategy will involve training agents at the IRS to look more closely at S corporations, partnerships and other pass-through entities, which now make up 95 percent of all U.S. businesses, according to figures from the IRS.


 “Frankly, our training was not geared for dealing with those types of large, complex partnerships,” he said. “Historically, we would think of a partnership as having, say, 10 partners” with a limited number of tiers.


However, the IRS is now encountering partnership returns listing 82,000 partners and 182 tiers.


Fink indicated that the IRS plans to step up its scrutiny of such returns in the future.


“We as an organization have recognized that this is something that we’ve got to be paying attention to, not just this year, but going forward,” he said.



IRS Backs Down, Returns Seized Cash To Family Businesses

Kelly Phillips Erb Contributor


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Imagine heading to your bank to make a withdrawal and finding it empty.


Next imagine finding out that your identity hasn’t been stolen, your banking information hasn’t been compromised, but rather the federal government has emptied your account. On purpose. And there’s nothing you can do about it.


Move up t Move down


That’s what happened to Terry Dehko and his daughter. The Dehkos own a small grocery store in Fraser, Michigan, a city of less than 15,000. It’s a family run business that the Dehkos have run since 1978.


In January, the federal government seized all of the money that the Dehkos had in their store bank account. The reason? The federal government alleges that the Dehkos were violating federal money-laundering rules. They were accused of structuring their deposits in order to avoid being subject to bank reporting rules. You can hear more about their story in their own words here:


Under federal law, banks are required to report any transactions (cash deposits or withdrawals) to the Treasury which total more than $10,000 in any single day: this information is included on a currency transaction report (CTR). The purpose of the CTR is to help the government track large transactions and prevent money laundering. Money laundering works this way: the bad guys get money through illegal activities – like drugs or theft. It’s important to get rid of that “bad” cash and replace it with more legitimate funds. The easiest way, of course, is to run the cash through a bank or other financial institution and replace those dollars with new ones. In order to prevent this, federal laws require that large transactions be reported.


One of the ways that folks try to get around the law is to break down really large transactions into smaller ones, an act called structuring or sometimes, smurfing. So, if you had $100,000 in bad funds that you wanted to get rid of, rather than putting it all in at once, you would break it down into smaller transactions: say, 11 deposits of $9,091 in a number of different accounts or on a number of different days. The folks who make those deposits are sometimes called “runners” or “smurfs” (yes, after the little blue guys from the 1980s cartoons). And what they do – smurfing or structuring, is illegal. It’s important to note that the actual practice of making cash deposits of less than $10,000 is not illegal under 18 U.S.C. § 5324(a); it only violates the law when the transactions are structured “for the purpose of evading” those reporting requirements.

This is what the federal government alleged the Dehkos were doing: structuring deposits in order to avoid reporting requirements. The Dehkos have consistently denied any wrongdoing. Instead, they insist that the deposits were generally less than $10,000 because their insurance policy covers the theft of cash only up to that sum. As a result, they do not let their employees carry more than that amount at any time, including walking deposits to the local bank.


That didn’t stop the feds from seizing the Dehkos’ remaining funds. Using a process called civil forfeiture, the federal government can seize assets on the basis of suspicion: there is no requirement for firm evidence nor are the property owners entitled to notice. The government didn’t ask the Dehkos about their deposits or they would have found out about the insurance policy.


Months after the seizure, prosecutors had never offered any evidence to prove that the Dehkos were engaged in money laundering or that they were avoiding income tax. In fact, a Bank Secrecy Act examination from last year resulted in a notice stating that “no violations were identified.” And the Internal Revenue Service had not indicated that there were any concerns about taxes and had assessed any delinquent taxes or penalties on the Dehkos.


The government’s case, as filed in federal court, is not actually against the Dehkos. It is, by law, filed against the Dehkos’ property. The official case name is United States of America v. Thirty Five Thousand Six Hundred And Fifty-One Dollars And Eleven Cents ($35,651.11) In U.S. Currency From PNC Bank Account Number XXXXXX6937. That’s the case for all such seizure matters, referred to as civil-asset forfeiture. And seizures don’t have to be in cash: they can be real estate or other real property. All of it done without notice and without a timely hearing.

As is often the case with these matters, months after the seizure, there had been no hearing. The Dehkos were still out of pocket. So they decided to fight back.


On September 25, 2013, the Dehkos, with the attorneys at the Institute for Justice (IJ), filed a constitutional lawsuit challenging the federal government’s use of civil forfeiture in their case. The complaint in that case, TARIK DEHKO; SANDRA THOMAS; and DEHKO FOODS, INC. d/b/a SCHOTT’S SUPERMARKET v. ERIC H. HOLDER, Jr., in his official capacity as Attorney General of the United States; DANIEL I. WERFEL, in his official capacity as Acting Internal Revenue Service Commissioner; and BARBARA L. McQUADE, in her official capacity as United States Attorney for the Eastern District of Michigan can be found here (downloads as a pdf).


In the complaint, the Dehkos asked for their money back. They also requested a federal court ruling declaring that property owners are entitled to a prompt hearing either before or immediately after their property is seized, something that isn’t the case now. The lawsuit also asks the court to confirm that law-abiding businesses who make frequent cash deposits for legitimate business purposes are not in violation of the federal statute.


Last week, a federal judge scheduled a hearing for the Dekhos: they would finally get their day in court. The hearing was scheduled for December 4: nearly one year after their funds were seized. IJ Senior Attorney Clark Neily said, about the ruling:


… the fact that it took nearly a year for them to get that hearing highlights the due process problems with civil forfeiture law. No American should have to wait so long without an opportunity to challenge the seizure of their property.


The Dehkos won’t have to wait until December, however. Today, the IRS filed motions to voluntarily dismiss their forfeiture actions against the Dehkos. As a result, the money which was seized without warning nearly a year ago from their bank accounts will be returned. A dismissal was also filed for a similar case: Mark Zaniewski of Sterling Heights, Michigan, who is also represented by the IJ will get his money back, too.


That doesn’t mean that the plaintiffs are ready to walk away. Their attorney, Neily, said, about the cases:


The IRS should not be raiding the bank accounts of innocent Americans, and it should not take a team of lawyers to put a stop to this behavior. We are thrilled that Terry, Sandy, and Mark will finally get their money back, but their fight does not end today. Our constitutional lawsuit against the federal government seeks to rein in the shameful practice of civil forfeiture.


Meanwhile, the government continues to take in forfeiture money at a breakneck pace. In 1985, proceeds from forfeitures were just $27 million: last year alone, the government took in more than $4 billion in forfeiture.




High-Income Earners Seek Strategies to Cut Year-End Tax Bite

New York (November 15, 2013)

By Margaret Collins and Richard Rubin



The higher tax rates passed by Congress this year have some top U.S. earners seeking last-minute strategies to lower their tax bite as year-end calculations turn up unpleasant surprises.

“There are many, many high-income taxpayers now who are finding themselves facing tax rates in excess of 50 percent,” said Suzanne Shier, a tax strategist and director of wealth planning at Chicago-based Northern Trust Corp. “That really gets their attention.”


High earners are seeing a combination of federal tax increases for 2013: a top marginal rate of 39.6 percent, up from 35 percent; a 20 percent tax on long-term capital gains and dividends, up from 15 percent; and a new 3.8 percent tax on investment income. Also, limits on exemptions and deductions are taking effect for this tax year.


Some top earners are only now realizing they may owe much more by April 15 because they’ve been paying quarterly estimated taxes based on their liability for 2012, which the Internal Revenue Service allows in a “safe-harbor” rule, said Elda Di Re, a partner at Ernst & Young LLP.

Others are absorbing the effects as they rush to implement strategies before Dec. 31 to limit the tax bite on earnings, market gains and stakes in businesses.


States’ Take

State taxes can push the bill higher for some high earners. In California, the top rate is 13.3 percent on income exceeding $1 million.


Investors with significant portfolios are seeing some of the biggest increases this year, said Martin Kalb, co-chairman of the global tax group at Greenberg Traurig LLP.


For wealthy taxpayers, the rate on long-term capital gains and qualified dividends now can be as much as 25 percent, including the new surtax and limits on deductions, Kalb said. That’s a 67 percent increase from 2012. The rate on other investment income such as royalties, interest and rents can exceed 43 percent.


“Clients are a little startled at the amount of additional taxes they are paying,” said Maury Cartine, a partner at Marcum LLP whose clients include private equity and hedge fund managers.

According to an analysis by Cartine, a married couple in New York with $600,000 in wages, $100,000 in qualified dividends and $300,000 in long-term capital gains—as well as $145,000 in itemized deductions for real estate taxes, mortgage interest and state and local taxes—would pay about 17 percent, or $37,000, more in U.S. taxes this year.


$450,000 Threshold

By comparison, a family with $600,000 in wages, no investment income and $105,000 in itemized deductions would see about a 2 percent, or $3,000 increase, he said.


Congress set the top tax rate for income above $450,000 for married couples or $400,000 for individuals, after deductions. Those are the same thresholds for the top levy on long-term capital gains and dividends.


Additionally, two new taxes to help finance the 2010 health-care law—a 3.8 percent surtax on investment income and 0.9 percent added levy on wages—apply to income of more than $250,000 a year for married couples and $200,000 for individuals.


Lawmakers also reinstated phaseouts of personal exemptions and itemized deductions for adjusted gross income exceeding $250,000 for individuals and $300,000 for married couples.


‘Big Surprise’

“It’s going to be a big surprise when they find out they aren’t going to be able to take all of their itemized deductions,” said Tracy Green, a vice president in tax and financial planning in the advisory unit of Wells Fargo & Co.


With less than two months left in the tax year, advisers and accountants are focusing on clients with closely held business stakes, mutual-fund holdings, charitable donations and retirement accounts to help maneuver around higher rates.


To minimize the effect of the 3.8 percent tax, high earners are reviewing their interests in S corporations and other flow-through entities to see if they can become active rather than passive participants, said William Zatorski, a partner in PricewaterhouseCoopers LLP’s private company services practice. Business income from active participation isn’t subject to the surtax and that shift in S corporations doesn’t trigger self- employment tax, he said.


This year’s stock market rally—the Standard & Poor’s 500 Index returned 25 percent through October—has tax implications for many investors with mutual funds, said Green of Wells Fargo Advisors.


Capital Gains

“This year the chances of having long-term capital gain distributions are going to be pretty good,” she said.


Mutual fund companies are releasing estimates of distributions this month, which investors can use to plan, Green said. Those intending to sell a fund should do so before distributions, while investors seeking to buy shares should wait until after, she said.


Some high earners may have to shift their usual year-end strategies because the new top rate means they are no longer subject to the alternative minimum tax, or AMT, said Di Re of Ernst & Young. Taxpayers not subject to the minimum tax can pre-pay state income or real estate taxes before Dec. 31 to lower their taxable income, Zatorski of PwC said.


Bumping up charitable donations is another strategy, Kalb of Greenberg Traurig said. Taxpayers with gains in publicly traded stocks can donate them to a public charity or their own private foundation. They’d be eligible for a charitable deduction equal to the fair value of the security, and would avoid the long-term capital gains rates, he said.


Retirement Plans

Individuals age 70 1/2 or older should consider giving as much as $100,000 to a qualified charity directly from an individual retirement account, Wells Fargo’s Green said. The donation can meet all or a portion of the annual required minimum distribution for IRA owners and isn’t recognized as income.


Also, high earners can maximize contributions to tax-advantaged retirement plans and realize some losses to offset capital gains, Green said.


Another recommended strategy is to defer income by investing in private-placement life insurance and private annuities. These are designed for high net-worth individuals, Kalb said.


Looking Ahead

Beyond 2013, high-income investors can add tax-exempt bonds or convert some retirement savings to Roth accounts, Green said. When savers put money into Roth IRAs and Roth 401(k)s, they pay taxes on the money upfront in exchange for tax-free withdrawals later.


Funds that capture losses throughout the year to offset gains will be especially attractive to investors because the strategy can reduce net income reported on tax returns at year-end, Shier of Northern Trust said.


Once high earners figure out this year’s strategy, advisers are saying they should keep an eye on moves in Congress that could change their future tax picture.


House and Senate panels are considering making the biggest changes to the U.S. tax code since 1986. Representative Dave Camp, chairman of the House Ways and Means Committee, wants to lower the top individual rate to 25 percent in a way that would require eliminating or curbing many tax breaks. Camp, a Michigan Republican, has said he will release a plan this year.


Passage of any revisions would be difficult and wouldn’t happen until sometime in 2014, at the earliest.


The possibility of more tax changes has some high earners taking advantage while they can of breaks such as the sales tax deduction, Kalb said. That benefit, which allows deducting sales tax instead of state income tax, is set to expire Dec. 31 along with some other breaks.


“A lot of my clients are looking to buy very expensive assets that will pay a lot of sales tax, especially in Florida,” which doesn’t have a personal income tax, Kalb said. “If someone buys a $2 million boat this year, they can get the deduction for sales taxes.”




IRS Cracks Down on Tax Breaks Tied to Land of Rich Americans

Washington, D.C. (November 15, 2013)

By Richard Rubin



(Bloomberg) Behind the glazed white terra cotta facade of the Ritz-Carlton hotel in New Orleans is a 16-year legal battle with the Internal Revenue Service.


The developers of the hotel, which is housed in a former department store on the edge of the French Quarter, say their promise to preserve the century-old facade entitles them to a $7.4 million deduction. The U.S. tax agency disagrees.


In this case and dozens like it, the IRS is challenging a complex and obscure tax break that benefits some of the nation’s wealthiest property owners. Without giving up land, they donate the hard-to-calculate value of a perpetual promise to leave the property undisturbed. For that, they claim a big tax deduction.


“They’re overwhelmingly to high-end individuals and provide little to no benefit to the public,” said Dean Zerbe, who examined easement donations as a Republican aide on the Senate Finance Committee. “I don’t know if I could design a tax break that’s more targeted toward the millionaire set.”


The conservation easement break is one of hundreds scattered throughout the tax code that members of Congress are reviewing as they consider making the most significant revisions since 1986. The lawmakers are looking for ways to curtail breaks that benefit the richest Americans to offset the revenue that would be lost through lower tax rates.


Increasing Value

In 2010, 2,933 U.S. taxpayers deducted $766 million in easement donations from their taxes, according to the most recent IRS data. While that’s down from a $2.2 billion peak in 2007, the conservation easement break is more valuable than ever this year because of tax-rate increases for top earners and a temporary incentive that expires on Dec. 31.


The break’s bipartisan defenders include wildlife groups, conservationists and a mini-industry of appraisers, lawyers and land trusts that’s grown up around it over four decades.


That coalition and the break’s relatively small size in a U.S. tax system that raised $2.8 trillion last year demonstrates how narrow interests can keep targeted provisions anchored in the code.
Between 2003 and 2006, taxpayers saved an estimated $4 billion through easement donations, about 6 percent of the revenue that the U.S. government will forgo because of the mortgage interest deduction next year alone.


The IRS has been litigating dozens of easement cases, challenging deductions taken by an Idaho congressman, the National Golf Club of Kansas City and the co-founder of a New York investment firm managing $1.4 billion.


‘Southern Ambience’

In the case of the Ritz-Carlton Hotel, which advertises its “traditional Southern ambience,” the developers initially said their inability to alter the historic facade of the Maison Blanche building was worth $7.4 million.


The IRS said it was worth about 15 percent of that, and the lawyers and appraisers have been arguing ever since. The case is heading to a federal appeals court for the second time. It hinges on a dispute about the proper appraisal method for valuing the restriction.


Congress first specifically allowed tax deductions for conservation easements in 1976 and made the rule permanent in 1980, even with concerns from the Treasury Department.


After numerous court decisions and congressional changes that tightened rules for appraisers in 2006, the break is still open to golf-course developers who promise not to build houses on fairways, owners of historic townhouses who pledge not to build skyscrapers, and rural landowners who donate development rights on 20-acre backyards they don’t intend to sell.


Two Appraisals

In a typical transaction, a property owner receives an appraisal of the value of land if developed with houses and a second appraisal of the value with restrictions. The landowner then signs a legal document assigning the development rights to a land trust and claims a tax deduction for the difference between the two appraisals.


Conservation easements are different from cash or stock donations where easy-to-value liquid assets change hands. In these cases, the benefit to the public is often far less than the amount claimed as a charitable deduction, said Daniel Halperin, a Harvard Law School professor.


The IRS, even with diminishing resources and added responsibilities to implement the 2010 health-care law, is trying to curb taxpayers’ ability to take advantage of the conservation easement tax break.


‘Awkward Position’

The provision is susceptible to abuse because the definition of what qualifies as conservation can be vague and subjective. It includes preserving the “harmonious variety of shapes and textures” and “the degree of contrast and variety provided by the visual scene.” Furthermore, it’s difficult to value transactions with few, if any, comparable deals.


“It’s putting the IRS in the awkward position of trying to determine what’s a conservation purpose,” said Roger Colinvaux, who analyzed the issue when he was at the nonpartisan Joint Committee on Taxation. “You don’t really know what you’re getting for your money.”


The Ritz-Carlton case is an extreme example of the legal complexities and time that can be spent on a conservation easement case. It dates to 1997, three years before the hotel opened, when the developers claimed a deduction for their contribution to the Preservation Resource Center of New Orleans.


The project’s originator was Stewart Juneau, a New Orleans developer who kept a hotel penthouse as his own residence. He left the ownership group—Whitehouse Hotel Limited Partnership—several years ago, said Gary Elkins, the partnership’s attorney.


Upholding Penalty

Juneau now runs a nonprofit African village and safari camp in central Louisiana for underprivileged children. He didn’t respond to a request for comment.


The case wound its way through the IRS and the appeals process before the developers sued the agency in the U.S. Tax Court in 2003. They cited appraisals supporting the deduction.


Five years later, the court rejected most of the developers’ arguments, declared the deduction worth $1.8 million and upheld a penalty for a “gross valuation misstatement.” The court last year adjusted the value to $1.9 million.


The IRS’s aggressive enforcement ignores the fact the hotel’s owners have already spent more than the value of the donation restoring and maintaining the facade as required by the easement, said Elkins, of Elkins PLC in New Orleans. The agency’s approach has also curtailed donations against Congress’s intent, he said.


‘Potentially Punitive’

“No one wants the Internal Revenue Service to become their best friend and move into their house for a period of 16 years,” he said. “And so people will not utilize an incentive when the use of it is so uncertain and the consequences of the use of it have potentially punitive results.”

The IRS didn’t respond to questions about its enforcement of the tax break or requests to interview officials.


“These are hard to administer and very expensive to administer,” Ruth Madrigal, an attorney-adviser in the Treasury Department, said at an American Bar Association conference in May, according to a transcript provided by EO Tax Journal. “If you step back a minute and look at it from a policy perspective, how much charitable benefit are we really getting out of those easements that are put on golf courses anyway?”


The tax benefit’s backers say it has helped preserve historic buildings and millions of acres of land across the country. According to the Land Trust Alliance, state and local land trusts held 8.8 million acres under easements in 2010, up from 2.3 million a decade earlier.


Expansion Expires

An expanded benefit for conservation easements expires on Dec. 31, and lawmakers are focusing more on a long-term change than on a routine extension. Any limits on the charitable deduction would shrink the value of this specific break. President Barack Obama has proposed limiting all deductions to the value they would have in the 28 percent bracket. That means a $1 million donation would save someone in the top bracket $280,000 instead of $396,000.


“There is a real state of awareness that we may have no more than until the end of the year,” said Stephen Small, a former IRS official who is now a real estate lawyer in Massachusetts.


“It’s very unlikely that the incentives are going to be extended into 2014,” he said. “When more people realize that, I think we are likely to see a flurry of easement donations.”


50% Deduction

A coalition of preservationists and wildlife groups is lobbying to extend the expanded break, and they’ve largely been successful in Congress.


The temporary break lets people deduct up to 50 percent of their adjusted gross income, instead of 30 percent. It allows some farmers and ranchers to deduct all of their adjusted gross income and lets donors spread their deductions over 16 years instead of having just six years to generate enough income to take the entire break.


Congress last extended the deduction in January as part of an agreement to let top tax rates increase. The extension covered 2012 and 2013 and will cost the government an estimated $254 million over the next decade in forgone revenue.




Black Market Tax Preparers Continue To Defy IRS

Kelly Phillips Erb, Contributor - Forbes


When the Internal Revenue Service announced intentions to regulate tax preparers, the idea was to save taxpayers from “unscrupulous” (IRS’ favorite word in this context) preparers who wished to take advantage of them.


The IRS didn’t contemplate the notion that some taxpayers simply don’t wish to be saved.

Since 2006, the IRS has made efforts to increase oversight of tax preparers a key component of taxpayer services. The arguments for and against regulating preparers are, at this point, well known. The IRS claimed it needed to pass these regulations to “ensure uniform and high ethical standards of conduct for all tax return preparers.” Those opposed to the regulations argued that such mechanisms already exist under federal law and new regulations simply create unnecessary bars to competition.


The result was a licensing system, of sorts, that requires all preparers who are “paid to prepare or assist in preparing federal tax returns or claims for refund” to have a PTIN, or a Preparer Tax Identification Number. If you have a paid preparer, you’ve seen the PTIN on your return, just below your own signature:


In addition to a PTIN, the IRS also sought to enforce a new designation, Registered Tax Return Preparer, for preparers who did not meet an exemption or exception. That designation was shot down earlier this year when a federal judge ruled in Loving v. U.S. that IRS did not have the lawful authority to regulate preparers in that way (the case is being appealed).


For now, however, in order to prepare returns commercially, you have to register with the IRS and get a PTIN. A PTIN doesn’t make you a better preparer. It simply means that you’re on a list. A list that cost you $64.25 each year.


That keeps taxpayers safe, right? Knowing that their tax preparers are on that list?


Not exactly. Notwithstanding that being on the list doesn’t guarantee that you have any idea what you’re doing, a number of tax preparers are still offering tax services without obtaining a PTIN.


In 2011, the IRS pegged the number of unlisted preparers at 100,000, or about 1 in 8 of every preparers. To bolster compliance, beginning in 2012, the IRS began sending letters to those preparers who prepared returns for the 2011 tax season but failed to register for a PTIN. That only worked, of course, if tax preparers signed the returns. The solution for tax preparers who didn’t want to register and pay the fee? They simply don’t sign the returns.


And yes, that’s against the rules. But a number of paid tax preparers do it anyway. They are referred to in the business as “black market preparers” or sometimes, “ghost” tax preparers.


We tend to associate the black market with items like booze, drugs, guns and cigarettes – underground transactions to skirt existing laws. But that’s exactly what is happening in the tax world. It’s just maybe not as sexy.


Black market tax preparers don’t hide under the cover of night, only opening their doors with a secret handshake. They don’t guard their turf with automatic weapons. And they don’t live in fear of getting caught.


Black market preparers set up shop around tax time, usually as a short time rental in a busy area. Most will set up early since their target market tends to be taxpayers banking on a refund: statistically, those taxpayers file early (last year, one-third of all refunds were issued in February). They tout “big and fast” tax refunds to taxpayers, almost always in combination with a rapid-refund type loan. Fees are advertised as very low to get taxpayers in the door but the costs for other services – like refund loans – quickly add up to thousands of dollars. And since many of these taxpayers can’t afford to pay high fees for returns, the preparers do them one more “service” by tying tax prep and loan fees to the size of the anticipated refunds. The result? Incentive after incentive to cheat.


Business for these preparers grows not because of newspaper advertising or LinkedIn profiles: it’s word of mouth. Around tax time, word on the street quickly becomes that “XYZ Preparer” can get you the biggest refund in the fastest period of time.


And IRS is often none the wiser to all of this activity because it’s nearly impossible to track. Why? That box at the bottom for the PTIN? It remains empty. In fact, there’s no name or address listed for a preparer. The returns are filed with IRS as though they were self-prepared.

It’s much more common than you think: in 2011, Lonnie Gary EA, USTCP Chair, National Association of Enrolled Agents, testified before Congress that a “significant number” of taxpayers use black market preparers (downloads as a pdf). Our office has witnessed the post-audit aftermath of these cases – and the potential for audit is fairly high since taxpayers are often talked into claiming bogus deductions and credits in order to boost refund dollars. Tactics rarely vary: the classic scenario involves Head of Household filing status (regardless of whether it’s appropriate), jacked up Earned Income Tax Credit (since it’s refundable), education credits (since they are often not checked) and Schedule C expenses (since the taxpayer doesn’t have to itemize to claim those). The thinking tends to follow the notion that once you’ve made up one little white lie, what’s to stop you from the next?


Eventually, all of those missteps do catch up to the taxpayers. By this time, however, the tax preparer is out of the picture. He or she won’t return calls – if taxpayer ever had a number to begin with. And clearly, there’s no audit support. In almost every case, the taxpayer braves the audit on their own. They have no documentation and no real excuses. Often, they never even mention the black market tax preparer  at all out of fear of making their situation worse. The result? Refund repayments. Tax obligations. Penalties. Interest. And a lot of grief.


Chances are, you’d be surprised if you met a taxpayer who admitted using a black market preparer: they are surprisingly normal. I say “surprisingly” because I think we want to believe that the sort of folks who would engage in this activity are stereotypes or simply bad  people – perhaps unemployed or engaged in illicit activities. But that’s not the case. They’re nurses and supervisors and retail workers. They’re moms and dads and sons and daughters. They have families and houses and jobs. And they’ve made poor choices – often at the urging of friends and families who swear they won’t get caught – which are exacerbated by pressures from these black market preparers.


I fully expect to see more – not less – of these results. The reality is, to quote Joe Kristan, tax is hard. And it’s getting harder. The Tax Code is becoming increasingly complicated. And tax preparers make it easier to navigate. A 2003 GAO study (downloads as a pdf) found that nearly 80% of taxpayers were “generally confident” that they would not pay more tax than was necessary by using a paid preparer and nearly 90% of those who used a tax preparer would use one in the future.


While the IRS initially signaled that PTIN registration would help ferret out black market preparers, it seems to be doing just the opposite: chasing more unscrupulous preparers underground. IRS Regulations impose significant penalties on tax preparers who fail to sign and/or use a PTIN for commercially prepared returns. But – and there’s a huge but – all of the punishments in the world are meaningless if you can’t pin down the bad behavior. That’s exactly what these black market preparers are counting on.


Tax fraud 'queen' sentenced to 21 years

"It's easy, judge, very easy to make fun of my client," said defense attorney Mark O'Brien, who said a picture of Rashia Wilson wearing a blonde wig and hoisting wads of cash "is a result of her mental illness." TAMPA POLICE DEPARTMENT


By Elaine Silvestrini | Tribune Staff 
Published: July 16, 2013   |   Updated: July 17, 2013 at 06:08 AM


TAMPA - When Rashia Wilson taunted authorities on Facebook that she was the "queen" of tax refund fraud and that authorities would never catch her, she was in the grips of mental illness, her lawyer told a judge Tuesday.

"It's easy, judge, very easy to make fun of my client," said defense attorney Mark O'Brien, who said a widely publicized picture of Wilson wearing a blonde wig and hoisting wads of cash "is a result of her mental illness."

"No one's making fun of his client," responded Assistant U.S. Attorney Mandy Riedel. People are "pointing out the facts that she put into the media." What's easy, the prosecutor said, is "to get a job and live within your means."

O'Brien implored U.S. District Judge James Moody to sentence Wilson to 10 to 15 years in prison, and not a longer sentence as called for under federal guidelines.

But Moody was unmoved. "She knew what she was doing was wrong," he said. "She reveled in the fact that she was doing wrong."

With that, the judge sentenced Wilson to 21 years in federal prison on tax fraud and weapons charges, the highest sentence for any defendant yet in the stolen identity tax refund fraud outbreak that has overtaken the Tampa area in the last three years.

According to the prosecution, Wilson used part of the millions she stole from federal taxpayers to throw a $30,000 birthday party for her one-year-old daughter. She also paid cash for a $90,000 car, telling the salesperson she didn't care what kind of car she bought, as long as it was the most expensive one on the lot, Riedel said.

On Tuesday, the single mother of three asked if she could hug her young children who were in court to see her sentenced. But U.S. Marshals would not allow it, and so the youngsters were taken weeping from the courtroom, crying out for their mother as Wilson collapsed in tears before being led away.

It was a long way from the days when Wilson saw herself as on top of the world, invincible.




On Tuesday, Wilson was contrite and apologetic. "Your honor, it is with sincere regret and my deepest apology that I come before you today," she told the judge, reading from a letter. "My actions have caused great pain and humiliation for myself, loved ones and professional clientele.

"Please don't take me away from my children by sending me to prison for a long time," she said.

"That would be something you should have considered" at the time of the crime, the judge responded, "that you didn't want to be taken away from your children."

"Yes, sir," Wilson said.

The defense presented a psychological expert who testified that Wilson suffers from bipolar disorder and other issues related to her birth to a cocaine-addicted mother and her own substance abuse. Valerie McClain testified that she thinks Wilson was in the throes of a manic episode when she posted on Facebook.

O'Brien said the irrational bravado in the Facebook posts proves Wilson was unbalanced at the time. Wilson's mental illness "does not excuse her behavior, but my hope is it mitigates her behavior," the defense lawyer added.

O'Brien said he hopes that while Wilson is in prison, the "IRS will figure out a way to prevent this from happening in the future so someone with a sixth-grade education can't defraud them so easily."

Moody noted that Wilson committed the fraud while collecting government assistance for herself and her children.

O'Brien conceded that was "egregious" and "offensive," and he said, "I can't run away from that fact, and neither can my client."

Riedel said Wilson is blaming the IRS, her parents and her bipolar disorder, but it was she who stole "actual money from every single American who pays into the tax system," as well as the thousands of people whose stolen identities she used.

Riedel asked for a 19-year sentence, added to the 18-month sentence Wilson received for the weapons offense. That, the prosecutor said, would reflect "the scope of her harm" and "the role that she chose for herself as being a leader in tax fraud in Tampa."

While investigators later determined Wilson stole between $7 million and $20 million from federal taxpayers, because of the terms of her plea agreement, Moody sentenced her based on an earlier calculation that she had stolen $3.1 million.

Moody ordered Wilson pay that amount in restitution jointly with her boyfriend, Maurice Larry, who is scheduled to be sentenced in September.


Twitter: @ElaineTBO


Increase in IRS Audits – A Positive Trend?

Posted by Cari Weston, CPA on Nov 21, 2013

As the newest member of the AICPA Tax team, I was awestruck during my experience at the National Tax Conference. I had a front row seat for Acting Internal Revenue Service Commissioner Danny Werfel’s address; alternated between laughing my head off and cheering at National Taxpayer Advocate Nina Olsen’s candid presentation; and instinctively ducked under the table so as not to be called out by the Director of the Office of Professional Responsibility.

But the presentation that hit me the most? Faris Fink, Commissioner of the IRS Small Business/Self Employed Division, who spoke about the division’s initiative to provide advanced partnership examination training to their revenue agents (aka “auditors”). The goal is to increase audits of partnership tax returns with an emphasis on administrative matters in addition to the usual compliance issues.

My initial reaction was panic at the idea of an army of highly trained IRS auditors on the hunt for partnership prey, especially as a previous tax practitioner who specialized in closely held pass-through taxation. However, upon reflection, I can appreciate the need for this system. I am not interested in driving up the market for IRS representation service fees for our members, nor do I want the IRS to drive fear into the hearts of partners across the country. What I do want is for the examination process to be a better experience for those on both sides of the table.


Having been through a number of audits, I can say that I would take a well-trained, seasoned auditor any day over someone new to the field. In fact, early in my career, someone compared a new IRS auditor to a baby rattlesnake. Having been raised in the Arizona desert, I knew right away what they meant.

If you are unlucky enough to be bitten by a rattler, just hope that when you look down there is a not a tiny snake still stuck to your leg. Baby rattlesnakes haven’t learned to pace the amount of venom they unleash when they bite. So, a bite from a baby can actually be more dangerous than the bite of a full grown rattlesnake, a fact you will soon grasp as the painful venom starts coursing through your bloodstream.

In the same way, many of my peers often thought that newer, less experienced IRS auditors might be overly aggressive in applying their authority, having not been through the painful process of appeals and finding a case file back on their desk to rework. Perhaps they did not have the experience to know which items were truly material, so instead would ask for everything but the kitchen sink and then scrutinize every single item. I have heard stories from many colleagues who felt they spent much of their time during an audit educating the auditor.

This new initiative leads me to believe that things are actually looking up in the area of partnership audits. Yes, audits are expected to increase, however I believe the very nature of a highly trained team making targeted selections is beneficial for everyone. Partnerships that are following their operating agreements and complying with applicable filing requirements will have far less to fear from such a team than they would facing a young, untrained auditor.

Knowing that the IRS will be coming to the table with a competitive edge, you should arm yourself with as much knowledge as possible. Two resources I recommend for partnership audit preparation: 



Tax return preparers suspected of filing inaccurate EITC claims to be targeted by IRS



NOVEMBER 12, 2013


The IRS announced in an email to tax practitioners that it will send letters in November and December to return preparers “suspected of filing inaccurate EITC [earned income tax credit] claims” (Quick Alerts for Tax Professionals, Nov. 6, 2013). According to the IRS, the letters will explain “critical issues identified on the returns,” the consequences of filing inaccurate EITC claims, and that the IRS will continue monitoring the types of EITC claims the preparers file.

The consequences of filing inaccurate EITC claims include a penalty assessment under Sec. 6695(g), losing IRS e-file privileges, and other sanctions that could include barring preparers from tax return preparation. The IRS will also visit some tax preparers in person to provide education and outreach on meeting the EITC due-diligence requirements.

The IRS has been increasing its emphasis on EITC due diligence in recent years. The Service estimates that 22% to 26% of all EITC claims submitted contain some type of mistake, costing the government between $13.3 and $15.6 billion in 2013.

In 2012, the IRS issued final regulations modifying the due-diligence requirements on tax return preparers who prepare tax returns on which taxpayers claim the EITC (T.D. 9570). The earlier rules required preparers to complete Form 8867, Paid Preparer’s Earned Income Credit Checklist, or to otherwise record the information it required for each return claiming the EITC and keep it in the preparer’s records. The new due-diligence rules required tax return preparers to submit Form 8867 to the IRS.

The IRS has also issued Publication 4687, on EITC due diligence, in which it states that “[d]ue diligence is more than a check mark on a form or clicking through tax preparation software.” It explains in detail the steps tax preparers must take to verify the information the client has provided that is used as the basis for claiming the EITC. The publication notes that preparers should be especially careful about the three most common errors in claiming the EITC: (1) claiming a child who does not meet the age, relationship, or residency requirements, (2) filing as single or head of household even though the taxpayer is married, and (3) reporting income or expenses incorrectly. 

Sally P. Schreiber ( is a JofA senior editor.








Tax-Exempt Hatred


November 19, 2013 RSS Feed Print


A few weeks ago, Forbes magazine published an intriguing column by Peter J. Reilly that asked an important question: If the Southern Poverty Law Center calls the Family Research Council a hate group, should the IRS take action?

In the column, Reilly criticizes a paper by University of Georgia Professor Alex Reed. Reed argues that the IRS must do a better job enforcing its procedure 86-43, which is the standard it uses to determine if a tax exempt organization is advocating an educational point of view or one that produces materials that are factually unsupported, distorted or make substantial use of inflammatory and denigrating language. If it organization does the latter, the procedure indicates that it does not qualify for tax-exempt status.

Reed writes that the IRS' poor oversight of 86-43 has allowed many out-of-compliance organizations to keep their preferential tax benefits, particularly hate groups. Hate groups advocate hostility toward certain groups of people because of their race, ethnicity, religion, sexual orientation or gender identity. He references The Family Research Council, which has a long history of publishing offensive propaganda about the LGBT community.

[See a collection of editorial cartoons on the IRS Scandal.]

Other tax-exempt organizations not mentioned by Reed, but with similar reputations include: the anti-LGBT Family Watch International,  whose research archive contains numerous offensive, junk science studies on gays and lesbians, and the xenophobic Federation for American Immigration Reform, which has volumes of distortions broadly denigrating immigrants.

Reilly argues that strict enforcement of 86-43 wouldn't work because “if somebody expresses a view that you find threatening to your world view, you are likely to conclude that they hate you.” In other words, it would be impossible for any IRS employees to enforce 86-43, because any threat to their beliefs would trump their professional obligations. He ignores the possibility that the IRS could punish employees for targeting organizations based on their personal or political beliefs, an obvious, much needed reform given the IRS's political targeting of tea party organizations earlier this year.

Both Reilly and Reed would do better not framing their arguments around what organizations the Southern Poverty Law Center deems hate groups. In fact, the hate group term doesn't even need to be involved. Any organization whose educational materials don't conform to the procedure should be scrutinized. The IRS must ground its enforcement on its rules, not the Southern Poverty Law Center's position.

[See a collection of political cartoons on the economy.]

Enforcement has nothing to do with limiting an organization's free speech. The Family Research Council, Family Watch International, Federation for Immigration Reform or any other group masquerading as educational institutions don't need tax-exempt status to exercise their civil liberties. One is not necessary to the other.

Enforcement has to do with the fair application of rules designed to maintain the integrity of the tax-exempt system. Preferential tax treatment is, for all intents and purposes, a government subsidy administered through the tax system. If a tax-exempt organization is flouting the standards by which its status is awarded, it shouldn't expect the government to continue to assist it in the coordination of its financial activities. The government is not obligated to make it easier for these organizations to threaten people's basic rights and freedoms. In fact, the government has a moral, legal and ethical obligation to do the opposite.

How One Small Retailer Combats Showrooming

Mary Ellen Biery, Contributor


Shoe Train’s back-to-school fashion show. Photo credit: sasse agency

From monthly shoe-tying clinics that are booked solid months in advance to a fashion show that doubled as a school-supplies drive for local schools, the Shoe Train store in Potomac, Md., has fought head on against the challenge of shoppers who browse products in stores then buy them online from a rival.

Shoe Train owner Marina Fradlin doesn’t sell children’s shoes online, but she uses the Internet to combat showrooming. She connects frequently with customers online – answering common parent questions about shoe fit and promoting the shoe-tying clinics as well as community sponsorships of Girls on the Run events and shoe-collection drives.

She makes sure the website, social media and events tie into the store’s natural business cycle (busy during back-to-school, slow in January/February, busy for spring shopping, etc.) and the calendar year. The goal is to make sure that when people are ready to buy, the ongoing relationship with the store and its employees makes a purchase at Shoe Train more likely.

The moves are paying off, she says. For example, the holiday season isn’t typically a shoe store’s busiest (back-to-school season is), but Fradlin looks for this year to be strong, based on where sales are now vs. previous years at this time.

“The holiday season definitely started earlier this year,” she said, attributing part of the boost to Hanukkah falling so early this year. “It’s already been a strong holiday season for us,” she said by email, adding that UGG boots so far have been “a big gift item from Grandma.”

Shoe Train owner Marina Fradlin. Photo credit: Michael Bennett Kress Photography and sasse agency


Such efforts to create loyal customers and fight showrooming can be critical for retailers, especially as the U.S. economy continues to face growth headwinds. Wary of disappointing sales, major retailers including Wal-Mart Stores Inc. and Best Buy are discounting earlier than ever for theholiday shopping season.


Recent retail industry data from Sageworks, a financial information company, show that sales growth among privately held retailers is virtually non-existent so far this year. Private retailers are growing sales at an annual rate of less than 1 percent year to date – the lowest annual rate since 2009. Smaller private retailers, those with less than $5 million a year in sales, are seeing sales contract at an annual rate of 2 percent so far this year, according to Sageworks’ financial statement analysis.

Sageworks analyst Libby Bierman said consumers’ apprehension about the economy couldn’t have come at a worse time for private retailers. “These companies are sustaining rather than growing sales so far this year, and a holiday season boost would be tremendously helpful,” she said. “These companies are showing slightly improved profit margins now, but if their rate of sales growth doesn’t increase, these margins could be difficult to sustain, impacting retailers’ hiring and investing practices in the future.”

Sageworks’ data doesn’t break out how much of that sales rate is tied to in-store sales vs. e-commerce.


Retail industry data from Sageworks

But it’s clear that stores will need to fight in order to keep holiday sales, which can represent one-fifth or more of a retailer’s annual sales, from being snatched away by online sites. The National Retail Federation expects the average person will complete nearly 40 percent of their holiday shopping online. And the NRF, which forecasts holiday sales growth of 3.9 percent, expects online retailers will post stronger growth than retailers overall.

Fradlin acknowledges she continues to encounter the challenge of shoppers who undervalue customer service and buy online. Nevertheless, she’s optimistic for this holiday season as she believes customers in general are feeling better about buying. “There’s a definite feeling of optimism in the air,” she said.

In fact, her bigger concern this holiday season has to do with hot air. “Unlike for a lot retailers, where warmer weather brings a boost in sales, for me, warm weather keeps people away,” she said. “My big seller during the holiday season is seasonal shoe-wear: fashion boots, hiking boots, UGGS. In other words, warm is bad.”



CPAs Worried over Uncertainty in Expiring Tax Provisions





The on-again, off-again nature of the federal tax provisions traditionally known as tax extenders is leading to uncertainty and unnecessary complexity, according to tax policy experts at the American Institute of CPAs.

With 2014 approaching, CPAs are busy meeting with clients to discuss year-end tax planning, and the uncertainty over what is happening with the tax extenders is making those consultations more difficult. “Typically, as a part of that process, we will discuss with clients transactions and the timing of those transactions—should it be before year end or after year end, for example—but that process is especially difficult with 57 tax provisions expiring on December 31,” said AICPA Tax Executive Committee chair Jeffrey A. Porter in a statement. “It is challenging to advise clients if you do not know what the tax laws will be in 2014.”

Some of the expiring tax extenders are significant, noted AICPA vice president for taxation Edward Karl. “For businesses, these include increased expensing under Section 179, where the limit is dropping from $500,000 to $25,000, the 50 percent bonus depreciation, the Work Opportunity Tax Credit, and the credit for research and development expenses.”

“The on-again, off-again nature of the expiring provisions creates a lot of uncertainty, and that uncertainty then creates more complexity in the tax code,” said Porter. “It’s not unusual for the expiring provisions to be reinstated retroactively, also adding to the uncertainty and the complexity for long-term planning. Many taxpayers have come to anticipate that these expiring provisions are going to be retroactively reinstated. If they’re incorrect, that can prove to be a very costly decision for a small or medium-sized business. And the impact is not just limited to businesses. There are a number of individual provisions that are expiring, such as the deduction for state and local sales tax, the above the line deduction for tuition and tax-free distributions from individual retirement plans for charitable purposes.”

Karl anticipates lawmakers will consider the tax extenders at some point, but that the timing is uncertain. “We encourage Congress to act now to either extend the provisions or to signal that it intends to allow them to expire,” he said. “We also urge Congress to make permanent those provisions that it intends to extend. In addition, we encourage Congress to enact future tax changes with a presumption of permanency, except in rare situations in which there is an overriding and explicit policy reason for making provisions temporary, such as short-term stimulus provisions or when a new provision requires evaluation after a trial period.”

For a complete list of the expiring provisions, click here



Congressmen Introduce Bill to Roll Back Health Insurer Tax for Small Businesses and Families





A pair of congressmen who are also physicians, Ami Bera, M.D., D-Calif., and Charles Boustany, M.D., R-La., introduced a bipartisan bill late last month to make health care more affordable for working families, small businesses and seniors.

The Small Business and Family Relief Act would delay for two years the health insurance tax that is slated to begin next year as part of the Affordable Care Act.

“We must do everything we can to lower the skyrocketing cost of health care for middle class families,” said Bera. “The Affordable Care Act is giving millions of people health care who didn’t have it previously, but we need to work together to fix the areas of it that are problematic and make it work better for the American people. This bill would delay the collection of the health insurance tax until 2016, to allow health insurance markets time to stabilize while providing immediate relief to working families, small businesses and seniors.”

Both the Congressional Budget Office and the Joint Committee on Taxation have concluded that the health insurance tax will be passed onto consumers in the form of higher premiums. The tax starts at $8.4 billion in 2014, and increases to $11.3 billion in 2015.

The way the tax is designed disproportionately affects individuals who purchase their own health insurance, small businesses and seniors with Medicare Advantage, the congressmen contend. In 2014 and 2015 alone it is expected to cost the typical family an additional $660. For Medicare beneficiaries enrolled in a Medicare Advantage plan or a prescription drug plan, this tax means $220 in reduced benefits and higher out-of-pocket costs.

Bera represents Sacramento County. Born and raised in California, Bera is a physician and the only Indian American currently serving in Congress.  Boustany chairs the tax-writing House Ways and Means Committee’s Oversight Subcommittee.



Congressmen Urge Accounting Flexibility in Small Business Tax Reform





A bipartisan group of lawmakers is asking the tax-writing House Ways and Means Committee to avoid enacting any proposed tax reforms that would limit accounting flexibility for small businesses.

letter signed by Reps. Mike Quigley, D-Ill., Blaine Luetkemeyer, R-Mo., Brad Schneider, D-Ill., and Richard Hudson, R-N.C., along with 67 other members of the House, urged the Ways and Means Committee to fully consider the negative ramifications of such proposals. The draft Tax Reform Act of 2013 sets new limits on the use of cash accounting by pass-through entities, farms and professional service firms, and would inhibit growth by moving many to a more cumbersome accrual accounting method once they grow above $10 million in gross receipts.

In a letter sent Monday to Ways and Means chairman Dave Camp, R-Mich., and ranking member Sander Levin, D-Mich., the legislators wrote, “For many small businesses, mitigating the one-time costs of switching accounting methods would be extremely difficult, as would the continued use of the more complex accrual method of accounting.…Across sectors, small business owners are concerned at the possibility of complying with a more complex accounting system that requires them to report income before they receive the cash….it is our shared goal to simplify and reform the tax code into one that enables growth and competitiveness while reducing the cost of compliance and maintaining fairness.” 

Pass-through entities account for more than 90 percent of all business entities in the United States and are represented across a diverse range of business professions and sectors, including dentists, physicians, accounts, lawyers and engineers, they noted.

The cash method of accounting, in which receipts are recorded when revenues are received, is a simple and appropriate manner for taxing both individuals and the many businesses that are taxed at the individual rate, the lawmakers said. Instead of expanding the use of a more simple accounting technique, this reform would move many businesses to the accrual method of accounting, in which receipts are recorded when transactions are made rather than when payments are received.

The letter has received support from the American Institute of CPAs, the American Farm Bureau Federation, the American Council of Engineering Companies and the American Dental Association.



Call Me Before You Do Anything

NOVEMBER 25, 2013



I have always told my clients to call me before they did anything major or new financially to see if there was anything tax-wise that could be done to help them.

Nowadays, there is much less tax maneuvering, but much more from a financial aspect, and it is amazing how accountants can help.

One of my clients was offered a job of setting up and managing an American menswear operation for a world-famous ladies designer. The offered salary was about double what he was currently earning.

The licensee was told by the designer that he preferred that my client be hired to establish the business. This was because of my client’s expertise, élan and reputation in the menswear area. He was jumping out of his boots with the offer and wanted to see me to find out what his new take-home salary would be and what type of deductions he could take against the income.

After a brief discussion I let my client know that I could have gotten him double what he was offered. My questioning revealed that the whole deal hinged on his acceptance. The licensee was one of the largest menswear manufacturers in Italy, with a worldwide sales organization. The association with that designer would add to the prestige of everything else the company was already doing, and the licensee had agreed to pay a royalty substantially above what was normal or economical given the parameters set for the new business.

I told my client that his salary was peanuts compared to the big picture of what was involved and that since the deal was contingent on the manufacturer delivering him, he had “settled” for much too little. I asked him to try to arrange a meeting for me with the principals and I was sure I could get him much more. This was a Thursday afternoon, and all the principals were in Italy. My client was scheduled to see them the following Tuesday.

I had an Italian-speaking secretary at the time. She called Italy and arranged for me to attend the meeting with my client. We were on an evening flight to arrive early morning on Tuesday. On Monday and later during the flight, my client and I worked up a financial projection for the new business. This included a startup timeline, startup costs, and a five-year profit and cash flow analysis. The numbers indicated an even greater upfront commitment than we had discussed, and further that the manufacturer could not make money based on the deal they made unless sales were substantially higher than was indicated to my client.

My client was confident he could reach the higher targets. I then made up a second projection showing much higher sales and included a bonus for my client based on the increased sales. Understanding that I might use these projections in negotiating for my client’s “revised” salary, I threw in some extra items that I could give up on, keeping focused on what I wanted to get for him.

When we arrived in Italy, we were met at the airport and driven to our hotel to give us some time to freshen up. We would be picked up in another hour.

During the meeting, we learned that there had been no projections or financial models done by the licensee, and my numbers became the base amounts upon which the company was going to be capitalized. The size and scope were, if not complete, then a major surprise to them. We spent the entire day going over the projections and in effect “setting up” the company.

I always have believed that if you couldn’t make it come out on paper sitting in the calm of your office, what chance did you have to make it happen under the pressure of running the business, arranging financing, hiring and supervising staff, getting the right sales staff and support, developing and executing a marketing, advertising and public relations plan, opening a showroom, and the myriad other things involved with starting and running a business?

The meeting was held in a stark office with a long narrow table, with my client and me on one side. As the day wore on, a larger and larger group joined the other side. Coupled with them having to excuse themselves many times to speak to the owner, who was in another part of the building, the meeting didn’t even touch on my client’s salary, which was much larger than what had been previously offered and accepted.

The meeting lasted all day until everyone was totally exhausted and we broke for dinner. I actually dozed off waiting to be seated in the restaurant since I had hardly slept the night before on the plane because of my number crunching and thinking.

The next morning (Wednesday) started with the controller and CFO introducing their own hastily drawn up overnight projections, which I saw right away had my client’s previously agreed upon salary prominently displayed.

I knew there was a noon meeting scheduled with the designer in his studio about an hour’s drive away. The meeting here started at 9 am, and I decided it would be better to delay looking at their projections until it was time to leave for that meeting. Since we had a working model at the end of the previous day that we had all agreed was reasonable and set doable objectives and financing amounts that were manageable, I said that there was nothing that could be added by diverting our attention to an entirely new set of numbers and that we should prepare for our meeting with the designer.

The meeting with the designer was to tell him that a deal with my client was agreed to and for him to meet with my client to discuss the clothing line and the marketing of it. I also knew that if we used their alternative numbers, mine would be discarded and theirs would become the benchmark against which I would have to argue. So I sat there and took a position that a deal was struck the night before and there was no reason to go over their numbers, and even if we did, there would be no time to do it carefully and seriously.

They naturally disagreed and we literally sat there for almost two hours, with me refusing to look at their “masterpiece” and with my client sitting next to me busting a gut, feeling he might lose the deal if we didn’t go over their numbers. The manufacturer’s accountants had a micro attitude toward each entry they had made. The company’s general manager had a big picture look and wanted this deal, no matter what!

The arguing for almost two hours was not about the numbers, but was about us looking at them or not. I prevailed because time ran out and the general manager was nervous about how the meeting with the designer would go. In the car ride my client and I were alone with the general manager (and his interpreter) while his staff rode in another car.

I told him we would reduce our proposed compensation package to make him look good with his financial people. But my client still ended up with a package that was more than three times higher than what he had initially “accepted” and approximately seven times what he had been earning! 
Nothing beats understanding the situation, plus some careful preparation.


Edward Mendlowitz, CPA, is a partner in WithumSmith+Brown, PC, CPAs. He has authored 20 books and has written hundreds of articles for business and professional journals and newsletters plus a Tax Loophole article for every issue of TaxHotline for 27 years. Ed also writes a blog twice a week that addresses issues his clients have at He is the winner of the Lawler Award for the best article published during 2001 in the Journal of Accountancy. He has also taught in the MBA graduate program at Fairleigh Dickinson University, and is admitted to practice before the U.S. Tax Court.  Ed welcomes practice management questions and he can be reached at WithumSmith+Brown, One Spring Street, New Brunswick, NJ 08901, (732) 964-9329,



A Clear and Present Danger

The Need to Switch Off Windows XP

NOVEMBER 25, 2013



Let’s face facts: In less than six months Windows XP will be at its “end of life” and if you are still on this system your business will be on its own. So how do you keep your business and clients safe and stable after April 8, 2014?


For anyone still unaware, on the aforementioned date Microsoft will stop supporting Windows XP. This means that there will be no more bug fixes, security patches, or even free and paid phone and online support for this operating system, regardless of if you have a support contract. So what is the risk of continuing to run Windows XP after its end of support date?  If you have not already, you need to start upgrading your computers to a new, supported operating system immediately and every day you choose to continue to use XP your practice is vulnerable.

Unsupported systems can be hacked. Malicious users can take control of your machine and use it as a platform to attack other computers on the internet. This wastes your valuable computing resources and network bandwidth. It could also make you liable for damages caused by these attacks because they came from your network.

XP is more much more likely to be infected by a virus or spyware than modern, supported operating systems like Windows 7 and 8. These programs are designed to alter, steal, or destroy your data. CryptoLocker, for example, is a piece of malware that locks the data on your machine and holds it for ransom. It secretly encrypts your files, making them impossible to access, and then sends an email demanding money (usually paid by Bitcoin – essentially untraceable) in exchange for unencrypting the files. If you don’t pay the ransom by the deadline in the email your files are lost forever.

On supported versions of Windows, updates are developed to fix security holes as soon as they are identified. With XP there will be no new security updates. Hackers will continue to find ways to attack your XP system and no one will be working to stop them. Between July 2012 and July 2013 Windows XP was affected by 45 Microsoft security bulletins. The represents 45 known exploits in just one year. New vulnerabilities are discovered all the time. If you run XP you will never be able to trust that your computer is safe - ever again.

The process Microsoft uses to identify and fix bugs will actually help criminals attack Windows XP. The details of each vulnerability fixed in Windows 7 and 8 are published as part of the patch process. Some of these defects will also be present in XP. Microsoft will tell hackers exactly how and what to attack on your unsupported system. 

Windows XP was the state of the art when it was release 12 years ago, but the security countermeasures built into the OS are no longer effective against modern exploits and attacks.  XP created an arms race between tech savvy criminals and corporate security experts. Every time a flaw was fixed or a hole filled, hackers found new ones to exploit. The ongoing brinkmanship resulted in new operating systems with robust security controls and features. It also resulted in better criminals with formidable skill. This evolution changed the way hackers approach a system. In 2013 using Windows XP is the equivalent of a prop plane having a dogfight against an F-22 jet fighter.

Subject to compliance laws?

If you accept credit cards, you are subject to PCI compliance. If you are a healthcare provider or a company who does business with a healthcare provider then you are subject to HIPAA compliance.  These laws are complex, but clear that you must apply security patches and keep your computers up to date.  With Windows XP this will no longer be possible and is an immediate failure on your compliance audit.

How can I protect my machines and business?

The new versions of Windows are secure, stable and supported by Microsoft. These operating systems have much better security and performance and a great new user experience. Windows 7 is now the most popular OS in the world. As of July 2013 it runs on almost 45 percent of computers in the world. It, and the recently release Windows 8, offer many more features, better security, and increased performance over Windows XP.

Windows 7 is supported until 2020 and Windows 8 to 2023. Microsoft will provide systems and security patching and new features and functionality for at least the next decade. Moving to a modern OS now will help keep your business safe and secure now and for years to come.

Jeffery Cusick is a business process improvement specialist at business technology consultancy Flexible Business Systems. His team helps small and medium sized businesses adopt technology to transform their business. Jeff holds many certifications from vendors such as Microsoft, Cisco, CompTia, and Epic Systems. He possesses an expertise in general business process and ERP, CRM, eCommerce, and warehouse management systems.



Building a Better Income Statement

If neither companies nor investors find GAAP-reported earnings useful, it’s clearly time for a new approach.

Bottom of Form

A company’s annual income statement should be a transparent disclosure of its revenues and expenses that investors can readily interpret. Most aren’t, largely because income and expenses classified according to generally accepted accounting principles (GAAP) can be difficult to interpret. In fact, many sophisticated investors tell us they have to re-engineer official statements to derive something they’re comfortable using as the starting point for their valuation and assessment of future performance. In response, many companies — including all of the 25 largest U.S.-based non-financial companies — are increasingly reporting some form of non-GAAP earnings, which they use to discuss their performance with investors.

Eliminating that duplicated effort should be simple. A common-sense revision of GAAP-based income statements would divide the report into two parts: recurring operating income in the first, and non-operating income or expenses and nonrecurring items in the second. Such a structure would provide investors with a clearer summary of income and expenses. It would also be consistent with two core principles for financial-statement presentation proposed by a joint project of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) in 2010, which state that financial-statement information should be presented “in a manner that disaggregates information so that it is useful in predicting an entity’s future cash flows” and “portrays a cohesive financial picture of an entity’s activities.”

The trouble with GAAP-based income statements
Strict adherence to the conceptual principles of accounting often leads to confusion and distortions in an income statement. When companies make an acquisition, for example, GAAP requires they allocate part of the difference between the purchase price and current market value to intangible assets. It then requires companies to amortize the value of those assets over some period of time, reducing their future earnings — in the same way they would depreciate physical assets. The calculation is theoretically consistent but provides no insight into future required cash investments. The annual amortization of acquired intangibles is a non-cash expense and, unlike physical assets, companies either don’t replace them or if they do invest in them, those investments show up as expenses, not on the balance sheet.

Not surprisingly, we haven’t seen any investors or companies using the amortization of intangibles for analysis or valuation work. Most sophisticated investors we talk to tell us they add the amortized value of these intangibles back into income when they analyze a company’s performance — as do most of the companies that report non-GAAP numbers.

A bigger problem with GAAP is its emphasis on producing a single number, net income, that is supposed to be useful to the company as well as its investors and creditors. But sophisticated investors don’t care about reported net income. They want to know its components — or, specifically, to be able to distinguish operating items (sales to customers less the costs of those sales) from non-operating items (interest income or interest expense). They also want to know which items are likely to be recurring and which are likely to be nonrecurring (that is, restructuring charges). Finally, they want to know which items are real and which, like the amortization of intangibles, are merely accounting concepts.

A modest proposal to revise GAAP requirements
It would make life easier for everyone if GAAP requirements themselves were adjusted to require what companies and investors already use, after making all their adjustments, instead of making everyone do twice the work. That wouldn’t require big changes. Simply separate operating and non-operating items in a standardized manner and combine acquired intangible assets with goodwill without amortizing them. Such an approach would enable investors to quickly understand a company’s true earnings and operating performance. It would provide them with the detail they need to assess the economic significance of non-operating and nonrecurring items and decide for themselves how to treat them. And it would enable them to notice trends and patterns and compare performance reliably with peers.

The treatment of non-operating items may warrant some additional transparency relative to today’s reporting. Many are obvious and clearly identified in the current income statement, such as interest income, interest expense and goodwill impairments. Others should be treated differently. For example, gains and losses from asset sales should be treated as non-operating items, with detailed explanations in footnotes. Costs related to closing plants or restructuring operations should be highlighted in their own line items, once again with detailed disclosure in footnotes so investors can assess whether they are truly one-time costs or will be recurring. Pension-related items, such as revaluation of liabilities due to changes in interest rates, expected earnings on the portfolio of assets, and interest on the pension liability, should be separated into their operating and non-operating components. The operating component would be what is currently called the current-year service cost. Everything else is related to the performance of the pension portfolio and changes in the value of the pension liability and thus should be classified as non-operating.

Several leading companies have already started to report their non-GAAP results this way, with approval from investors. The effect can be substantial. For example, IBM reports the non-operating component of pension expense (after taxes) ranged from negative $1.2 billion in 2001 to $400 billion in 2012, with both positive and negative effects in between. Before IBM introduced non-GAAP reporting, investors had to hunt through the footnotes to see what the effect of the pension items was. This also made communication about results quite complex. Now the results and communication with investors are much simpler. It would be even easier if GAAP statements reflected this change.

Changing financial-reporting standards is a slow and complex process, of course. At a fundamental level, U.S. reporting depends on a rules-based system with a strong preference for bright-line definitions, whereas what we’re calling for would require some judgment.

Stringent rules on the disclosure of non-GAAP metrics do prevent companies from using them to mislead investors. Yet the issue remains that companies already provide investors with these data — though investors do need to dig for it in financial statements and public filings. If anything, the current practice of spreading out non-operating adjustment information increases the likelihood that something critical will be overlooked and makes it harder for investors to make informed decisions.

Some users of financial statements may also be concerned, on an income statement like the one we propose, that recurring operating income typically would be higher than the current GAAP-reporting equivalent, which might give investors a rosier-than-warranted view of companies. However, if the new profitability metric were more closely related to continuing operations — and it likely would be — then it would still be more useful for valuation purposes than the GAAP equivalent. Furthermore, net income might end up being the same as current GAAP net income, but investors would have more information to work with in a consistent way. And adjustments won’t always work in a company’s favor; operating income can be adjusted down. From 2000 to 2004, and again in 2008, for example, IBM disclosed that its non-GAAP earnings would have been lower than its GAAP earnings due to negative pension-related adjustments. Finally, sophisticated investors armed with more detailed disclosure are unlikely to be misled.

To prevent abuse, the Securities and Exchange Commission and FASB can take additional steps to require more disclosure about items the company classifies as non-operating or nonrecurring expenses. This will also make for easier comparison across companies, as investors would be confident that items classified as a particular expense would be similar across peers.

Changing the way the GAAP income statement is structured will help investors find the information they need for decision-making in one place and in a format that is easy to understand and compare.

Ajay Jagannath is an analyst in McKinsey’s New York office, where Tim Koller is a principal.

This article was originally published on Copyright © McKinsey & Company. All rights reserved. Reprinted by permission.



Perks Ease Way in Health Plans for Lawmakers

T.J. Kirkpatrick for The New York Times


Jacqueline A. Thomas, a congressional aide, said she was able to reduce her monthly premium by half on an insurance exchange.

Published: November 19, 2013


WASHINGTON — Members of Congress like to boast that they will have the same health care enrollment experience as constituents struggling with the balky federal website, because the law they wrote forced lawmakers to get coverage from the new insurance exchanges.


That is true. As long as their constituents have access to “in-person support sessions” like the ones being conducted at the Capitol and congressional office buildings by the local exchange and four major insurers. Or can log on to a special Blue Cross and Blue Shield website for members of Congress and use a special toll-free telephone number — a “dedicated congressional health insurance plan assistance line.”

And then there is the fact that lawmakers have a larger menu of “gold plan” insurance choices than most of their constituents have back home.

While millions of Americans have been left to fend for themselves and go through the frustrating experience of trying to navigate the federal exchange, members of Congress and their aides have all sorts of assistance to help them sort through their options and enroll.

Lawmakers and the employees who work in their “official offices” will receive coverage next year through the small-business marketplace of the local insurance exchange, known as D.C. Health Link, which has staff members close at hand for guidance.

“D.C. Health Link set up shop right here in Congress,” said Eleanor Holmes Norton, the delegate to the House from the nation’s capital.

Insurers routinely offer “member services” to enrollees. But on Capitol Hill, the phrase has special meaning, indicating concierge-type services for members of Congress.

If lawmakers have questions about Aetna plan benefits and provider networks, they can call a special phone number that provides “member services for members of Congress and staff.”

On the website run by the Obama administration for 36 states, it is notoriously difficult to see the prices, deductibles and other details of health plans.

It is much easier for members of Congress and their aides to see and compare their options on websites run by the Senate, the House and the local exchange.

Lawmakers can select from 112 options offered in the “gold tier” of the District of Columbia exchange, far more than are available to most of their constituents.

Aetna is offering eight plan options to members of Congress, and Blue Cross and Blue Shield is offering 16. Eight are available from Kaiser Permanente, and 80 are on sale from the UnitedHealth Group.

Lawmakers and their aides are not eligible for tax credit subsidies, but the government pays up to 75 percent of their premiums, contributing a maximum of $5,114 a year for individual coverage and $11,378 for family coverage. The government contribution is based on the same formula used for most other federal employees.

In debates leading up to passage of the Affordable Care Act, members of both parties suggested that all Americans should have coverage as good as what Congress had. President Obama said in 2009 that people should be able to buy insurance in a marketplace, or exchange, “the same way that federal employees do, same way that members of Congress do.”

For decades, members of Congress have received coverage through the Federal Employees Health Benefits Program. They generally like their coverage, but — like millions of Americans facing the loss of their policies next year — they cannot keep it.

In the past, if lawmakers did nothing in the open enrollment period, their coverage would automatically continue. This year, by contrast, they must affirmatively pick a plan. Their coverage under the federal employee program will end on Dec. 31. If they do not choose a plan via D.C. Health Link by Dec. 9, they will lose the government contribution to their premiums and could lose their right to retiree health benefits as well.

In addition, lawmakers who go without insurance next year may, like other Americans, be subject to tax penalties.

Some congressional aides, especially older employees who face higher premiums, are unhappy about the changes. But some who carefully compare their options on the exchange find that they can save money.

Jacqueline A. Thomas, a 26-year-old legislative correspondent for Representative Debbie Wasserman Schultz, Democrat of Florida, said she was able to reduce her monthly premium to $60, from $120, by switching to a Kaiser plan from a Blue Cross and Blue Shield plan.

“I’ll be paying half as much for comparable coverage,” she said.

The congressional work force is full of young, healthy people like Ms. Thomas, precisely the type of customer insurers want to attract.

Congressional aides naturally have a few complaints. Some are confused by the large number of options. When they sign up for a plan online, they get no confirmation, so they are apprehensive. In addition, the website for the local exchange does not display the government contribution for members of Congress and their aides.

It shows, for example, that a couple with one child may pay $1,300 a month for a plan, when, in fact, their share of the premium is only $352; the government pays $948. Local exchange officials said their website had not been set up to calculate premium contributions using the formula required for lawmakers and other federal employees.

One part of the new insurance program is veiled in secrecy. Lawmakers may allow some or all of their employees to keep their current insurance by declaring that they do not work in the “official office” of a member of Congress. Members do not have to disclose such decisions, though some have voluntarily done so.

Thus, for example, a spokesman for Representative Darrell Issa, Republican of California, said the congressman had decided that all of his staff members, including those who work in his personal office, could stay in the Federal Employees Health Benefits Program and would not have to go into an exchange.

By making it easier to compare the costs and benefits of different health plans, the exchange could make it easier for insurers to compete with Blue Cross and Blue Shield, which has long dominated the market on Capitol Hill.

For its part, Blue Cross and Blue Shield says it can best meet the needs of lawmakers and their aides because its national plans have a large network of providers, including nearly 90 percent of all doctors in the United States.

One perk is not in danger. Lawmakers can receive care from the attending physician to Congress, conveniently located in the Capitol, for an annual fee of $576. And they can get care at military hospitals.





Disclaimer: This article is for general information purposes only, and is not intended to provide professional tax, legal, or financial advice. To determine how this or other information in this newsletter might apply to your specific situation, contact us for more details and counsel.


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