ARE YOU READY FOR THE NEW IRS PARTNERSHIP AUDIT RULES?

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Are You Ready for the New IRS Partnership Audit Rules?

Legislation enacted in 2015 established a new IRS audit regime for partnerships and limited liability companies (LLCs) that are treated as partnerships for tax purposes. Here's a comparison between the old and new partnership audit rules, along with a summary of recently proposed guidance to help partners prepare for the changes that are effective starting with the 2018 tax year.

Important note: To keep things simple, we'll refer to any LLC that's treated as a partnership for tax purposes as a partnership and any LLC member that's treated as a partner for tax purposes as a partner.

Old Rules

Under the old rules, the federal income tax treatment of partnership items of income, gain, deduction and credit is generally determined at the partnership level, even though these tax items are passed through to the partners and reported on their returns. After a partnership audit is completed and the resulting adjustments to partnership tax items are determined, the IRS generally recalculates the tax liability of each partner and sends out bills for additional taxes, interest and penalties to the partners.

This set-up was deemed to be inefficient, so Congress established a new audit regime for partnerships. However, the old rules will continue to apply to most partnerships for tax years beginning in 2017.

The Big Difference

The new partnership audit regime applies to partnerships with more than 100 partners at the partnership level. The big difference under the new rules is that, subject to certain exceptions, any resulting additions to tax and any related interest and penalties are generally determined, assessed and collected at the partnership level.

Specifically, the partnership — not the individual partners — will be required to pay an imputed tax underpayment amount, which is generally the net of all audit adjustments for the year multiplied by the highest individual or corporate federal income tax rate in effect for that year.

However, the partnership can pay a lower amount if it can show that the underpayment would be lower if it were based on certain partner-level information, such as:

  • Differing tax rates that may be applicable to specific types of partners (for example, individuals, corporations and tax-exempt organizations), and

  • The type of income subject to the adjustments (for example, ordinary income vs. capital gains or cancellation of debt income).

An alternative procedure, known as the "push-out election," allows the partners to take the IRS-imposed adjustments to partnership tax items into account on their own returns. Or, if eligible, a partnership can elect out of the new rules altogether. (See below for more details on both elections.)

Partnership Representatives

The new partnership audit rules eliminate the tax matters partner role that applied under the old rules. Instead, partnerships will be required to designate a partnership representative. The partnership representative has the sole authority to act on behalf of the partnership in IRS audits and other federal income tax proceedings.

If the partnership doesn't choose a representative, the IRS can select an individual or entity to fill that role. If the partnership representative is an entity (as opposed to an individual), the partnership must appoint a designated individual through whom the partnership representative will act.

Under the proposed regulations, the partnership representative has a great deal of authority, and no state law, partnership agreement, or other document or agreement can limit that authority. Specifically, the partnership representative has the sole authority to extend the statute of limitations for a partnership tax year, settle with the IRS or initiate a lawsuit. Any defense against an IRS action that isn't raised by the partnership representative is waived.

With all this authority comes the associated risk, which may mean that some partnerships will have a hard time finding someone willing to act as the representative. Partnerships should consider indemnifying or compensating their partnership representatives accordingly.

According to the proposed regulations, partnerships must designate a partnership representative separately for each tax year. The designation is done on the partnership's timely filed (including any extension) federal income tax return for that year.

Partnerships should amend their agreements to establish procedures for choosing, removing and replacing the partnership representative. In addition, the partnership agreement should carefully outline the duties of the partnership representative.

The Push-Out Election

As noted above, under the new rules, a partnership must pay the imputed underpayment amount (along with penalties and interest) resulting from an IRS audit — unless it makes the push-out election. Under the election, the partnership issues revised tax information returns (Schedules K-1) to affected partners and the partnership isn't financially responsible for additional taxes, interest and penalties resulting from the audit.

As the name suggests, the push-out election allows the partnership to push the effects of audit adjustments out to the partners that were in place during the tax year in question. This effectively shifts the resulting liability away from the current partners to the partners that were in place during the tax year to which the adjustment applies. The push-out election must be filed within 45 days of the date that the IRS mails a final partnership adjustment to the partnership. This deadline can't be extended. The proposed regulations specify the information that must be included in a push-out election. The partnership must also provide affected partners with a statement summarizing their shares of adjusted partnership tax items.

Partnership agreements should be updated to address whether the partnership representative is required to make the push-out election or the circumstances in which a push-out election will be made. When deciding whether to make the election, various factors should be considered, including:

  • The effect on partner self-employment tax liabilities,

  • The 3.8% net investment income tax,

  • State taxes, and

  • The incremental cost of issuing new Schedules K-1 to affected partners.

Partnerships may want to require their partnership representatives to analyze specified factors to determine whether a push-out election should be made.

Option to Elect Out of the New Rules

Eligible partnerships with 100 or fewer partners can elect out of the new audit rules for any tax year, in which case the IRS must separately audit each partner. However, the option to elect out of the new partnership audit regime is available only if all of the partners are:

  • Individuals,

  • C or S corporations,

  • Foreign entities that would be treated as C corporations if they were domestic entities,

  • Estates of deceased partners, or

  • Other persons or entities that may be identified in future IRS guidance.

The election out must be made annually and must include the name and taxpayer ID of each partner. The partnership must notify each partner of the election out within 30 days of making the election out.

Eligible partnerships may want to amend their partnership agreements to address whether electing out will be mandatory. In most situations, electing out will be preferable. However, partnerships looking to maintain flexibility in their partnership agreements should include provisions indicating how the decision to elect out will be made.

Partnerships choosing to elect out may want to amend their agreements to prohibit the transfer of partnership interests to partners that would cause the option to elect out to be unavailable. They also may want to limit the number of partners to 100 or fewer to preserve eligibility for electing out.

Important note: Many small partnerships may assume that they're automatically eligible to elect out of the new partnership audit rules because they have 100 or fewer partners. That's not necessarily true. For example, the option to elect out isn't available if one or more of the partners are themselves a partnership (including an LLC that is treated as a partnership for tax purposes). Also, if there is an S corporation partner, each S corporation shareholder must be counted as a partner for purposes of the 100-partner limitation.

Coming Soon

Although the new partnership audit rules don't take effect until next year, partnerships should start reviewing partnership agreements and amending them as necessary. At a minimum, partnerships that don't expect to elect out of the new audit rules should appoint a partnership representative before filing their 2018 returns. Your tax advisor can help you get up to speed on the new partnership audit rules and recommend specific actions to ease the transition.

YOU MAY NEED TO MAKE ESTIMATED TAX PAYMENTS

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You may have to make estimated tax payments if you earn income that's not subject to withholding, such as income from self-employment, interest, dividends, alimony, rent, realized investment gains, prizes and awards.

You also may have to pay estimated taxes if your income tax withholding on salary, pension or other income isn't enough, or if you had a tax liability for the prior year. Please consult a professional with tax expertise regarding your individual situation.¹

How to Pay Estimated Taxes

If you are filing as a sole proprietor, partner, S corporation shareholder and/or a self-employed individual and expect to owe tax of $1,000 or more when you file a return, you should use Form 1040-ES, Estimated Tax for Individuals, to calculate and pay your estimated tax. You may pay estimated taxes either online, by phone or through the mail.²

How To Figure Estimated Tax

To calculate your estimated tax, you must include your expected adjusted gross income, taxable income, taxes, deductions and credits for the year. Consider using your prior year's federal tax return as a guide.

When To Pay Estimated Taxes

For estimated tax purposes, the year is divided into four payment periods, each with a specific payment due date. If you do not pay enough tax by the due date of each of the payment periods, you may be charged a penalty even if you are due a refund when you file your income tax return.

Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller.

REAL ESTATE INVESTORS: LET'S TALK ABOUT LIKE-KIND EXCHANGES

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Are you thinking about divesting a real estate investment and then replacing it with another property? If you sell appreciated property outright, you'll incur a taxable gain, which lowers the amount available to spend on the replacement property. But you may be able to defer your tax bill (or even make it disappear) with a Section 1031 like-kind exchange.

Unfortunately, there are rumors that upcoming tax reform legislation could eliminate the time-honored like-kind exchange privilege. So, while tax breaks for like-kind exchanges are still in place, it could be a good idea to complete any like-kind exchanges that you're considering sooner rather than later. Here's what you need to know about like-kind exchanges under the current tax rules.

What Constitutes Like-Kind Property?

You can arrange for tax-free real property exchanges as long as the relinquished property (the property you give up in the exchange) and the replacement property (the property you receive in the exchange) are of a like kind. Under Internal Revenue Code Section 1031 and related guidance, "like-kind property" is liberally defined. For example, you can swap improved real estate for raw land, a strip center for an apartment building or a boat marina for a golf course.

But you can't swap real property for personal property without triggering taxable gain, because real property and personal property aren't considered like-kind. So, you can't swap an apartment building for a cargo ship. You also can't swap property held for personal use, such as your home or boat. Inventory, partnership interests and investment securities are also ineligible for like-kind exchanges. As a result, the vast majority of tax-free like-kind exchanges involve real property.

In 2002, the IRS clarified that even undivided fractional ownership interests in real estate (such as tenant-in-common ownership interests) can potentially qualify for like-kind exchanges. For example, if you sell an entire commercial building, you don't need to receive an entire commercial building as the replacement property in order to complete your tax-free exchange. Instead, you could receive an undivided fractional ownership interest in a building as the replacement property.

What Happens to the Gain in a Like-Kind Exchange?

Any untaxed gain in a like-kind exchange is rolled over into the replacement property, where it remains untaxed until you sell the replacement property in a taxable transaction.

However, under the current federal income tax rules, if you still own the replacement property when you die, the tax basis of the property is stepped up to its fair market value as of the date of death — or as of six months later if your executor makes that choice. This beneficial provision basically washes away the taxable gain on the replacement property. So your heirs can then sell the property without sharing the proceeds with Uncle Sam.

The like-kind exchange privilege and the basis step-up-on-death rule are two big reasons why fortunes have been made in real estate.

However, as noted earlier, the like-kind exchange privilege could possibly be eliminated as part of tax reform. Even if that doesn't happen, the estate tax might be repealed, which could also ultimately reduce the tax-saving power of like-kind exchanges.

Why? An elimination of the step-up in basis at death might accompany an estate tax repeal. For example, with the 2010 federal estate tax repeal (which ended up being temporary and, essentially, optional), the step-up in basis was eliminated, and that could happen again. An elimination of the step-up in basis would mean that a taxpayer inheriting property acquired in a like-kind exchange would have the same basis in the property as the deceased, and thus could owe substantial capital gains tax when he or she ultimately sells the property.

What's a Deferred Like-Kind Exchange?

It's usually difficult (if not impossible) for someone who wants to make a like-kind exchange to locate another party who owns suitable replacement property and also wants to make a like-kind exchange rather than a cash sale. The saving grace is that properly executed deferred exchanges can also qualify for Section 1031 like-kind exchange treatment.

Under the deferred exchange rules, you need not make a direct and immediate swap of one property for another. Instead, the typical deferred like-kind exchange follows this four-step process:

1. You transfer the relinquished property (the property you want to swap) to a qualified exchange intermediary. The intermediary's role is to facilitate a like-kind exchange for a fee, which is usually a percentage of the fair market value of the property exchanged.

2. The intermediary arranges for a cash sale of your relinquished property. The intermediary then holds the resulting cash sales proceeds on your behalf.

3. The intermediary uses the cash to buy suitable replacement property that you've identified and approved in advance.

4. The intermediary transfers the replacement property to you.

This series of transactions counts as a tax-free like-kind exchange, because you wind up with like-kind replacement property without ever taking possession of the cash that was transferred in the underlying transactions.

What Are the Timing Requirements for Deferred Like-Kind Exchanges?

For a deferred like-kind exchange to qualify for tax-free treatment, the following two requirements must be met:

1. You must unambiguously identify the replacement property before the end of a 45-day identification period. The period starts when you transfer the relinquished property. You can satisfy the identification requirement by specifying the replacement property in a written and signed document given to the intermediary. That document can list up to three properties that you would accept as suitable replacement property.

2. You must receive the replacement property before the end of the exchange period, which can last no more than 180 days. Like the identification period, the exchange period also starts when you transfer the relinquished property.

The exchange period ends on the earlier of: 1) 180 days after the transfer, or 2) the due date (including extensions) of your federal income tax return for the year that includes the transfer date. When your tax return due date would reduce the exchange period to less than 180 days, you can extend your return. An extension restores the full 180-day period.

Will Like-Kind Exchanges Survive Possible Tax Reform Efforts?

Under the current tax rules, like-kind exchanges offer significant tax advantages, but they can be complicated to execute. Your tax advisor can help you navigate the rules.

Looking ahead, it's uncertain when and if tax reform will occur and whether the tax benefits of a like-kind exchange will survive any successful tax reform efforts. So, if you own an appreciated real estate investment and you're contemplating swapping it out, it may be advisable to enter into a like-kind exchange sooner rather than later.

START SUCCESSION PLANNING NOW

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The majority of North American businesses are family owned and many are facing ownership-transfer issues as the baby-boomer founders enter retirement.

On the eve of a retirement, or following a death, family-run businesses have four basic choices. The first two involve giving up a family tradition: closing up shop or selling the business to outsiders or non-family employees.

The second two choices involve keeping the business under family control and either hiring outside managers or passing on the business to younger family members.

That final option of family succession can be difficult and not every business that attempts it is successful. Family dynamics often play a major role in the success or failure of a transition. Only a very small number of family businesses succeed in transfers to the second generation and even fewer make it to the third generation.

The key to success: Clear communication and the cooperation and commitment of everyone involved. Set up a family retreat early on in the process and bring in an independent third-party facilitator, such as your accountant, who can keep everyone's eye on the ball and smooth over the rough patches.

The facilitator can objectively help to determine strategy, assess the current situation, develop strategic plans and discuss, review, implement and monitor those plans. Other professionals, such as insurance agents and bankers, may also be called in to help devise the plans and put them into effect.

The planning involves mapping out four distinct strategies in this order:

1. A business plan that sets out the founders' original vision, mission and goals and gives other family members a clear picture of what the future should entail.

2. A family plan aimed at avoiding sibling rivalries and management-control issues. Here, you address compensation policies, management expectations, performance measures, job descriptions and codes of conduct within the business. You should also outline who is entitled to join the business and how to treat family members who aren't involved with the company.

3. An estate/retirement plan that incorporates a business valuation, how to finance the buyout, distribute retirement funds and calculate estate taxes. Another critical issue here is the inheritance of corporate and non-corporate assets.

4. A succession plan that sets the date for retirement, establishes a timetable for training new management, outlines any role the founders will continue to play and arranges for the management of cash flow.

It's never too soon to start: Succession planning helps you balance both personal and business interests and helps ensure that your family-run business gets through the transition successfully.

TEACH MANAGERS HOW TO MOTIVATE

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The workforce of your dreams is probably made up of brilliant, engaged employees who take the initiative, collaborate effortlessly, enthusiastically promote your company's goals, never take a sick day and offer to take a pay cut at their next performance appraisal, right?

Although it's unlikely that you can have a staff that maintains perfect health and is independently wealthy, it's possible that your staff can be brilliant, engaged, collaborative and all the other superlatives you can think of. They just need the right motivation, and your managers are just the ones to deliver it.

6 Motivational Tactics

There's no doubt about it, employees can and do get fired up from a rousing speech from the CEO or a day spent at a seminar conducted by a world-renowned speaker. However, humans tend to be creatures of habit. Once we get back to our offices and our normal routines, those pep talks often fade before they can take hold. That's where the steady, consistent actions of good managers come in. 

Here are six motivational tactics your managers should be comfortable with and regularly putting into practice with their staff:

1. Recognize the big and small. Recognition fuels motivation because it gives employees a sense that what they're doing matters and is important to the company. Recognize the big stuff, such as landing a huge account, as well as the small stuff, such as covering the phones for a co-worker.

Regularly communicate compliments, concerns and appreciation, and have a formal, yearly awards program. Keep in mind that the form of the recognition is less important than providing it regularly.

2. Understand the importance of individuality. One of the best lessons a manager can learn is that his or her staff is made up of individuals who have unique experiences, perspectives and skills. Being treated as a person, and not as just another cog in the wheel, helps motivate employees because they feel valued and see that their particular talents are contributing to the whole.

3. Get employees involved. Motivation also rises when employees work with their managers to solve problems and are actively involved in defining their work. This means managers need to be less focused on issuing orders and more willing to collaborate with staff to determine the best course of action in a given situation. In other words, being a manager doesn't mean one should be a micro-manager.

4. Be empathetic. Empathy requires having an open mind and being willing to step into someone's shoes to see things from their point of view. This is a key skill for managers to hone so that they can effectively relate to their employees — particularly when disagreements arise.

Even if employees' suggestions weren't heeded, as long as their bosses demonstrate empathy, employees will at least feel that their comments were heard. They'll likely still be disappointed by the outcome, but they'll be less likely to feel defeated.

5. Provide challenging and stimulating work. It's not an earth-shattering revelation to say that employees' motivation rises when they're passionate about their work and sinks when they're bored or uninspired by the job. A manager who is focused on motivation will work with his or her staff to find the silver lining.

For instance, turn the work into an important developmental milestone, such as an opportunity to delegate some portion of the task to a less experienced team member. Or a dual goal can be created: The employee will complete the task as well as analyze the process and come up with ways it can be done differently next time.

6. Communicate effectively. Being able to clearly convey goals, commitments and expectations to employees is another skill that managers must master. After all, employees can't get fired up to complete a task if they're not really sure what they're doing.

Remember, talking, e-mailing, text messaging or whatever method is being used to deliver information is only one half of the communication equation. Listening is equally important.

    Why Motivation Is Key

    If you teach the skills that are at the heart of motivation, you can coach any manager to become an inspiration to his or her staff. In addition to keeping productivity high, motivating managers will set the right tone for those who will move up the ranks in your organization. Those reasons should be motivation enough to focus on this essential element of leadership.

    DO YOU HAVE A DEDUCTIBLE BUSINESS LOSS OR A NONDEDUCTIBLE HOBBY LOSS?

    There's a fine line between businesses and hobbies under the federal tax code. If you engage in an unincorporated sideline — such as a marketing director by day and an artist on the nights and weekends — you may think of that side activity as a business and hope to deduct any losses on your personal tax return. But the IRS may disagree and reclassify the money-losing activity as a hobby.

    In general, the hobby loss rules aren't taxpayer friendly. But there's a ray of hope: If you heed the rules, there's a good chance you can win the argument and establish that you have a business rather than a hobby. Here's some guidance, along with a recent example of a taxpayer who ran afoul of the rules.

    Hobby Loss Rules

    If you operate an unincorporated for-profit business activity that generates a net tax loss for the year (deductible expenses in excess of revenue), you can generally deduct the full amount of the loss on your federal income tax return. That means the loss can be used to offset income from other sources and reduce your federal income tax bill.

    On the other hand, the tax results are less favorable if your money-losing side activity is classified as a hobby,which essentially means an activity that lacks a profit motive. In that case, you must report all the revenue on your tax return, but your allowable deductions from the activity are limited to that revenue. In other words, you can never have an overall tax loss from an activity that's treated as a hobby, even if you lose tons of money.

    Moreover, you must treat the total amount of allowable hobby expenses (limited to income) as a miscellaneous itemized deduction item. That means you get no write-off unless you itemize. Even if you do itemize, the write-off for miscellaneous deduction items is limited to the excess of those items over 2% of your adjusted gross income (AGI). The higher your AGI is, the less you'll be allowed to deduct. High-income taxpayers can find their allowable hobby activity deductions limited to little or nothing.

    Finally, if you're subject to the alternative minimum tax (AMT), your hobby expenses are completely disallowed when calculating your AMT liability.

    Why is the hobby loss issue an IRS hot button? After applying all of the tax-law restrictions, your money-losing hobby can add to your taxable income. That's because you must include all the income on your return while your allowable deductions may be close to zero.

    A Silver Lining: IRS Safe Harbor Rules

    Now that you understand why hobby status is unfavorable and for-profit business status is helpful, how can you determine whether your money-losing side activity is a hobby or a business?

    There are two safe harbors that automatically qualify an activity as a for-profit business:

    1. The activity produces positive taxable income (revenues in excess of deductions) for at least three out of every five years.

    2. You're engaged in a horse racing, breeding, training or showing activity, and it produces positive taxable income in two out of every seven years.

    Taxpayers who can plan ahead to qualify for these safe harbors earn the right to deduct their losses in unprofitable years.

    Intent to Make Profit

    If you can't qualify for one of these safe harbors, you may still be able to treat the activity as a for-profit business and deduct the losses. How? Basically, you must demonstrate an honest intent to make a profit. Factors that can demonstrate such intent include the following:

    • You conduct the activity in a business-like manner by keeping good records and searching for profit-making strategies.

    • You have expertise in the activity or hire expert advisors.

    • You spend enough time to justify that the activity is a business, not just a hobby,

    • You've been successful in other similar ventures, suggesting that you have business acumen.

    • The assets used in the activity are expected to appreciate in value. (For example, the IRS will almost never claim that owning rental real estate is a hobby even when tax losses are incurred for many years).

    The U.S. Tax Court will also consider the history and magnitude of income and losses from the activity. In general, occasional large profits hold more weight than more frequent small profits, and losses caused by unusual events or bad luck are more justifiable than ongoing losses that only a hobbyist would be willing to accept.

    Another consideration is your financial status — if you earn a large income or most of your income from a full-time job or another business you own, an unprofitable side activity is more likely to be considered a hobby.

    The degree of personal pleasure you derive from the activity is also a factor. For example, running film festivals in lively college towns is a lot more fun than, say, working as a finance executive — so the IRS is far more likely to claim the former is a hobby if you start claiming losses on your tax returns. (See "Lights, Camera, Action: Film Festivals Classified as a Hobby" at right.)

    Toeing a Fine Line

    Business losses are fully deductible; hobby losses aren't. So, taxpayers will prefer to have their side activities classified as businesses. Over the years, the Tax Court has concluded that a number of pleasurable activities could be classified as for-profit businesses rather than hobbies, based on the facts and circumstances of each case. Your tax advisor can help you create documentation to prove that you're on the right side of this issue.

    UNLOCK THE BIGGEST POSSIBLE DEDUCTION FOR A HOME OFFICE

    The IRS recently issued a reminder about claiming the home office deduction. In particular, it explained a simplified method that offers a time-saving option. But many taxpayers who maintain a home office fare better tax-wise by deducting expenses under the regular method. Others may not be eligible to deduct any home office expenses. Here's why.

    Regular and Exclusive Use

    Most home-related expenses, such as utilities, insurance and repairs, aren't deductible. But if you use part of your home for business purposes, you may be entitled to deduct a portion of these everyday expenses, within certain limits.

    In general, you'll qualify for a home office deduction if part of your home is used "regularly and exclusively" as your principal place of business. Here's an overview of these two tests:

    1. Regular use. You must use a specific area of your home for business on a regular basis. Incidental or occasional business use is not regular use. The IRS considers all the facts and circumstances for this determination.

    2. Exclusive use. You must use a specific area of your home only for business. This area can be a room or other separately identifiable space. It's not necessary for the space to be physically partitioned off from the rest of the room. However, you don't meet the requirements for the exclusive use test if the area is used both for business and personal purposes.

      Rules for Employees

      If you're an employee, the home office must be used for the employer's convenience. In essence, this requirement should be spelled out in an employment contract with the company. For this reason, home office deductions are more likely to be claimed by self-employed taxpayers than employees who work for an unrelated business.

      Typically, you won't qualify for deductions if you bring work home at night from your daytime office, either. Consider the relative importance of the activities performed at each place where you conduct business and the amount of time spent at each business location.

      Principal Place of Business Tests

      Your home office will qualify as your principal place of business if you 1) use the space exclusively and regularly for administrative or management activities of your business, and 2) don't have another fixed location where you conduct substantial administrative or management activities. (See "Tax Wisdom of Soliman" at right.)

      Examples of activities that are administrative or managerial in nature include:

      • Billing customers, clients or patients,

      • Keeping books and records,

      • Ordering supplies,

      • Setting up appointments, and

      • Forwarding orders or writing reports.

      Other Ways to Qualify

      If your home isn't your principal place of business, you may deduct home office expenses if you physically meet with patients, clients or customers on your premises. To qualify, the use of your home must be substantial and integral to the business conducted.

      Alternatively, you can claim the home office deduction if you use a storage area in your home — or if you have a separate free-standing structure (such as a studio, workshop, garage or barn) that's used exclusively and regularly for your business. The structure doesn't have to be your principal place of business or a place where you meet patients, clients or customers.

      Two Methods: Actual Expenses vs. Simplified

      Traditionally, taxpayers deduct actual expenses when they claim a home office deduction. Deductible home office expenses may include:

      • Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,

      • A proportionate share of indirect expenses, such as mortgage interest, property taxes, utilities, repairs and insurance, and

      • A depreciation allowance.

      Keeping track of actual expenses can be time consuming. Fortunately, there's a streamlined method that's allowed under a tax law change that went into effect in 2013: You can simply deduct $5 for each square foot of home office space, up to a maximum total of $1,500.

      For example, if you've converted a 300-square-foot bedroom to an office you use exclusively and regularly for business, you can write off $1,500 under the simplified method (300 square feet x $5). However, if your business is located in a 600-square-foot finished basement, the deduction under the simplified method will still be only $1,500 because of the cap on the deduction under this method.

      As you can see, the cap can make the simplified method less beneficial for larger home office spaces. But even for spaces of 300 square feet or less, taxpayers often qualify for a bigger deduction using the actual expense method. So, it can be worth the extra hassle.

      Hypothetical Example

      To illustrate how this might work, let's assume that your 3,000-square-foot home is your principal place of business. You use a 300-square-foot bedroom as your home office. For 2017, you expect to have $1,500 of direct expenses for your home office plus $10,000 of indirect expenses for the entire home, including utilities, insurance and repairs. (For simplicity, we'll disregard mortgage interest and property taxes that would be deductible on Schedule A, "Itemized Deductions.") Based on IRS tables, you're also entitled to a $500 depreciation allowance.

      Using the simplified method, you're eligible to deduct $1,500, as described above. But, if you keep the required records to deduct your actual expenses, you could deduct $3,000 for your home office — $1,500 in direct expenses, $1,000 in indirect expenses (10% of $10,000) and $500 in depreciation. That's double the maximum amount you could deduct with the simplified method. The deduction would be even greater if the home office space were larger.

      Flexibility in Filing

      When claiming the home office deduction, you're not locked into a particular method. For instance, you might choose the actual expense method in 2017, use the simplified method in 2018 and then switch back to the actual expense method thereafter. The choice is yours.

      This is a valuable tax-saving opportunity for many taxpayers, especially those who are self-employed and work from home. Consult with your professional tax advisor regarding what's right for your personal situation.

      PROJECT HONDURAS

      One of our big goals this year was to return to Honduras for the 5th time. Over the past five years our Fulling Management Team to Honduras has included staff and family members, clients, vendors and friends. During our June 1-9, 2017 trip, our objectives included:

      1. Partnering with local medical and dental Honduran professionals to provide medical care in three remote communities.

      2. Teaching the children how to prevent foot-borne illnesses and provide them their own pair of The Shoe that Grows.

      3. Providing funding and support for local Honduran men to build a new school in San Jose, Honduras.

      With assistance from over 150 people around the United States:

      - 150+ Honduran children and adults received medical and dental care (some for the first time!).

      - We washed several little toes and feet and provided The Shoes that Grows to 100 kids.

      - Now 100% funded, the new school building construction in San Jose is well underway and should be ready toward the end of summer.

      Part of our activities included hosting a soccer tournament for middle school boys. They traveled by buses from surrounding communities around La Fortunita, Honduras. This provided a great opportunity to build relationship with these young men and introduce them to our host group www.hondurasministries.org.

      If you would like to see more photos or read more about the Honduras trip adventures, you can check them out on the Fulling Management Facebook page. https://www.facebook.com/FullingMgmt/.

      - Rusty Fulling

      DOES YOUR CHILD NEED TO FILE AN INCOME TAX RETURN?

      As parents, we encourage our children to work so they can learn important values about work and independence. At what point, if at all, do children need to file an income tax return for the money they earn?

      The IRS does not exempt anyone from the requirement to file a tax return based on age, even if your child is declared as a dependent on your tax return.¹

      Your dependent children must file a tax return when they earn above a certain amount of income.

      Dependent children with earned income in 2017, in excess of $6,350 must file an income tax return.² This threshold may change each year (in 2016 it was $6,300), so please consult a professional with tax expertise regarding your individual situation.

      Even if your child earns less than the threshold amount, filing a tax return may be worthwhile if he or she is eligible for a tax refund. The standard deduction for a child is different from that of an adult: It is the greater of $1,050 or earned income plus $350, with the maximum equal to the regular standard deduction.³

      The rules change for unearned income, such as interest and dividend payments. When the annual total of unearned income exceeds $1,050, then a return must be filed for your child. If his or her unearned income only consists of interest and dividends, then you can elect to include it on your own return and combine it with your income, though it may result in higher income tax to you.

      If you decide to prepare a separate return for your child, the same reduced standard deduction rules detailed above will apply.

      JUNE, 2017 HONDURAS MISSION EXCERPT

      June 6, 2017


      Today our entire team journeyed to San Jose. I use the word “journeyed” because these were the most “exciting” roads yet. After the heavy rain this week, rather than the 12 passenger van, an airboat would have been my top choice of transportation this morning.

      San Jose is a community of 400 people, several chickens, a number of pigs, one cat and too many dogs to count. Pulling up to the existing church structure in San Jose, we were greeted by 40+ children and a few moms sitting outside the existing church structure waiting for our arrival.

      With help from the local families we chose a location in the middle of the community to setup the medical and dental areas. Let me just take a moment to say how amazing Dr. Sandra and Dr. Nora have been. These Honduran ladies work non-stop and model Christ’s love and compassion for the children and families in each community we have served.

      One of our big objectives for this trip was to assist in the building of a new school/church facility in San Jose that would accommodate the children and families. Part of that assistance included raising over $11,000 to provide work for local Honduran men. We also found out recently that a grant of $10,000 was also given towards the project. The $21,000 estimated cost for the project is now 100% funded! So far the concrete footings, pillars, and end beams have been poured. The men were constructing the trusses for the roof while we were there.

      Before we left for Honduras, the students at Meadow Lane Elementary School in Olathe, KS made friendship bracelets for the kids in San Jose. The bracelets were a big hit and very much appreciated.

      As we prepared to leave San Jose, the van decided it was not going to start. That was a bit concerning since AAA auto club does not service this area. Luckily Jim Martin, Juan Carlos, and Manuel were able to get it running.

      Our day concluded with a home cooked meal by Mama Blanca and heading back to the hotel before the evening rain began.

      Tomorrow we get to go to Cerco de Piedra where we get to continue serving the children with medical and dental care.

      - Rusty Fulling

      Please visit the Fulling Management & Accounting Facebook page to see the daily chronicles of the June, 2017 Honduras Mission.

      SURVIVORS: FAMILY BUSINESSES THAT LAST

      The phrase "family business" makes some people automatically think of mom-and-pop stores in small towns. But as you probably know, family-operated companies include everything from husband-and-wife sole proprietorships to companies like Mars Inc., the candy bar and food product company that employs about 70,000 people. For a perspective of just where family business fits into the landscape of commerce and employment in America, look at these facts from a study at Kennesaw State University in Georgia.

      • 50 percent of the nation's gross domestic product can be attributed to family-run businesses.

      • 60 percent of total employment in the U.S. stems from family-owned businesses, as well as 78 percent of all new jobs and 65 percent of all wages paid.

      • 35 percent of family-owned businesses are Fortune 500 companies, including Ford, Wal-Mart, and Anheuser-Busch.

      • 60 percent of all public companies are family-controlled.

      Judging from these statistics, family businesses are the backbone of our economy. While studies indicate that 30 percent of family companies fail within 20 years, a large number of these businesses have endured for hundreds of years.

      The Family Institute of Enterprise at Bryant University in Rhode Island recently compiled a list of the oldest family companies in America. The results of its study might surprise you. To be included on Bryant's list, a business must still be operating in the state of its origin, and, if it has become a public company, the family must maintain meaningful control. Among the oldest survivors:

      Tuttle Market Gardens, a grower of vegetables and strawberries that began around 1640 in New Hampshire. Tuttle also runs an on-site retail shop.

      Several still-functioning East Coast farms that began in the late 1600s to early 1700s and boast that their ancestors fed the colonial soldiers during the Revolutionary War. They include the Barker Farm of Massachusetts, the Miller Farm of Delaware and the Lyman Farm of Connecticut.

      Laird & Co., a New Jersey family distillery, which began large-scale production of applejack brandy in the early 1700s. Laird's history includes the fact that it once received a request for its brandy recipe from a Virginia farmer named George Washington.

      Other survivors with names you might recognize:

      • Antoine's Restaurant, in New Orleans, Louisiana, which began in 1840 and is currently operated by the fifth generation of the family of its founder, Antoine Alciatore.

      • Levi Strauss, which has overcome numerous obstacles and continued in business since its inception in 1853 in San Francisco, California. Strauss now employs 11,000 people worldwide.

      • Anheuser-Busch, started in 1860 by Eberhard Anheuser and Adolphus Busch. Today Anheuser-Busch is the nation's largest brewer, capturing nearly half of the U.S. beer market.

      Survival Factors

      In an environment where an estimated three out of 10 family businesses fail within two generations, what is it about these companies that keeps them surviving? Size and name-recognition are not key factors. For example, look at the Barker Farm of Massachusetts, which produces apples and dairy products. Now in its eleventh generation, the farm has been operating since 1642, and has only one full-time employee.

      Business historian Etna M. Kelley notes that a high percentage of family companies that survive supply basic needs, such as food. She points out that two of the most enduring businesses are those that service the beginning of life ... and the end: seed companies and funeral homes.

      Another basic need is provided by Levi Strauss, which started by making sturdy work clothes for the Gold Rush '49ers. Also on the list of survivor companies are distilleries and breweries, such as Anheuser-Busch.

      One factor that seems to be key among successful businesses: They exercise objective judgment in assessing their operations rather than making decisions based on emotion and tradition. That may mean appointing an objective advisory board made up of non-family members with a variety of business strengths, such as accountants, attorneys and bankers. While any business can benefit from objective oversight, it's even more important for family companies that can get mired in personal issues.

      Finally, it seems safe to assume that businesses that survive for any length of time have benefited from shrewd foresight. Planning for both economic downturns and for timely expansions has helped keep the doors of survivor businesses open through decades and even centuries.

      BE CAREFUL TO DOCUMENT HARDSHIP DISTRIBUTIONS AND PLAN LOANS

      The IRS cautions plan administrators that they must document and keep necessary records of all employees' hardship distributions and plan loans. The result of noncompliance could be a qualification failure for the plan.

      Hardship Distributions

      Basic information. In general, a retirement plan can make a hardship distribution only:

      • If the plan permits such distributions; and
      • Because of an immediate and heavy financial need of the employee. In this case, the distribution should only be an amount necessary to meet the financial need.

      Hardship distributions are generally subject to income tax in the year of distribution. And, if the employee is under age 59 1/2, the distribution is subject to the 10 percent early distribution tax unless some exception to this early distribution tax applies. However, hardship distributions aren't subject to mandatory 20 percent income tax withholding.

      In general, the question of whether an employee has an immediate and heavy financial need is based on the relevant facts and circumstances. Under IRS regulations, a distribution is treated as made on account of an immediate and heavy financial need if it is made for:

      1. Expenses for (or necessary to obtain) medical care that would be deductible under tax law, including expenses for the care of a spouse or dependent.
      2. Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments).
      3. Payment of tuition, related education fees, and room and board expenses, for up to the next 12 months of post-secondary education for the employee, the employee's spouse, children or dependents.
      4. Payments necessary to prevent the employee's eviction from a principal residence or foreclosure on the mortgage on the residence.
      5. Payments for burial or funeral expenses for the employee's deceased parent, spouse, children or dependents.
      6. Expenses for the repair of damage to the employee's principal residence that would qualify for the casualty tax deduction.

      Under IRS guidance, a 401(k) plan that permits hardship distributions of elective contributions to a participant only for expenses described above may permit distributions for medical, tuition and funeral expenses for a primary beneficiary under the plan. A "primary beneficiary" is someone named as a beneficiary under the plan who has an unconditional right to all (or part) of the participant's account balance upon the participant's death.

      A distribution won't be treated as necessary to satisfy an employee's immediate and heavy financial need to the extent it exceeds the amount required to relieve that need, or the need can be satisfied from other resources that are reasonably available to the employee.

      Unless an employer has actual knowledge to the contrary, it may rely on an employee's written representation that his or her immediate and heavy financial need can't reasonably be relieved:

      • Through reimbursement or compensation by insurance or otherwise;
      • By liquidating assets;
      • By stopping elective contributions or employee plan contributions; or
      • By other distributions or nontaxable loans from employer plans or by any other employer, or by borrowing from commercial sources on reasonable commercial terms.

      A hardship distribution can't exceed the "maximum distributable amount." In general, this amount includes the employee's total elective contributions on the distribution date, reduced by any previous distributions of elective contributions.

      Get and Keep Records

      In its Employee Plans News, the IRS states that failure to have hardship distribution records available for examination is a qualification failure that should be corrected using the Employee Plans Compliance Resolution System (EPCRS).

      The IRS tells plan sponsors to retain the following records in paper or electronic format:

      • Documentation of the hardship request, review and approval;
      • Financial information and documentation that substantiates the employee's immediate, heavy financial need;
      • Documentation to support that the hardship distribution was properly made in accordance with the applicable plan provisions and the Internal Revenue Code; and
      • Proof of the actual distribution made and related Forms 1099-R.

      It's not enough for plan participants to keep their own hardship distribution records, the IRS cautions, because they may leave employment or fail to keep copies of documentation, which would make their records inaccessible in an IRS audit.

      Also, electronic self-certification is not sufficient documentation of the nature of a participant's hardship. IRS audits show that some third-party plan administrators allow participants to electronically self-certify that they satisfy the criteria to receive a hardship distribution. While self-certification is permitted to show that a distribution was the sole way to alleviate a hardship, the IRS reminds plan sponsors that self-certification is not allowed to show the nature of a hardship. Plan sponsors must request and retain additional documentation to show the nature of the hardship.

      Plan Loans

      Basic information. A loan to a participant in a qualified employer plan won't be treated as a deemed (taxable) distribution if it satisfies certain amounts, terms, repayment and documentation requirements. A plan loan amount can't exceed the lesser of: $50,000, or one-half of the present value of the employee's nonforfeitable accrued benefit under the plan.

      But a loan up to $10,000 is allowed, even if it's more than half the employee's accrued benefit.

      If a plan loan (when added to the employee's outstanding balance of all other plan loans) exceeds these limits, the excess is treated (and taxed) as a plan distribution.

      A participant may have more than one outstanding plan loan at a time. However, any new loan, when added to the outstanding balance of all of the participant's plan loans, can't exceed the plan maximum amount.

      In determining the plan maximum amount, the $50,000 ceiling is reduced by the difference between the highest outstanding balance of all the participant's loans during the 12-month period ending on the day before the new loan and the outstanding balance of the participant's loans from the plan on the new loan date.

      A plan loan generally must be repaid within five years in substantially level payments, made not less frequently than quarterly, over the term of the loan. The five-year repayment limit doesn't apply to a loan used to buy a dwelling unit which, within a reasonable amount of time, is to be used as the participant's principal residence. In general, refinancing can't qualify as a principal residence plan loan. The plan loan must be evidenced by a legally enforceable written agreement with terms that demonstrate compliance with the requirements for nondistribution treatment, specifying the amount and date of the loan, and the repayment schedule.

      What to Keep

      The IRS tells plan sponsors to retain the following records, in paper or electronic format, for each plan loan granted to a participant:

      • Evidence of the loan application, review and approval process;
      • An executed plan loan note;
      • If applicable, documentation verifying that the loan proceeds were used to purchase or construct a primary residence;
      • Evidence of loan repayments; and
      • Evidence of collection activities associated with loans in default and the related Forms 1099-R, if applicable.

      If a participant asks for a loan with a repayment period in excess of five years to buy or build a primary residence, the plan sponsor must obtain documentation of the home purchase before the loan is approved. IRS audits have found that some plan administrators impermissibly allowed participants to self-certify eligibility for these loans. 

      THE INS AND OUTS OF DEDUCTING LEGAL EXPENSES

      Legal expenses incurred by individuals are typically not currently deductible under the federal income tax rules. Instead, they're most often treated as either personal outlays (which are nondeductible) or as part of the cost of acquiring an asset, such as real estate.

      In the latter situation, legal costs usually aren't deductible right away; instead, they may be capitalized and amortized over a number of years if the asset is used for a business or rental activity.

      A recent U.S. Tax Court decision and IRS Private Letter Ruling (PLR) showcase exceptions to the general rule and when taxpayers may be eligible for current deductions for legal expenses.

      Tax Court Decision

      In Ellen Sas v. Commissioner (T.C. Summary Opinion 2017-2), an employee who was fired by her employer was allowed to write off legal expenses as a miscellaneous itemized deduction.

      Here, the taxpayer received a $612,000 bonus from her employer before being terminated for alleged breach of fiduciary duty. When the employer attempted to recover the bonus, the taxpayer counterattacked, alleging employment discrimination.

      Eventually, all claims against the employee were dismissed, and she was allowed to keep the bonus. But she incurred almost $81,000 in legal fees — and wanted to deduct them on her personal tax return as part of the expenses for a business that she and her husband operated.

      IRS auditors concluded that the legal expenses constituted unreimbursed employee business expenses, which should be classified as miscellaneous itemized deductions. This category of deductions can be claimed only to the extent that they exceed 2% of your adjusted gross income (AGI). But you're allowed to combine unreimbursed employee business expenses with other miscellaneous itemized deduction items — such as job search costs, fees for tax advice and tax preparation, and expenses related to taxable investments — when attempting to clear the 2%-of-AGI threshold.

      Important note: Miscellaneous itemized deductions are disallowed under the alternative minimum tax (AMT) rules. So, if you're subject to the AMT, these deductions won't benefit you.

      The taxpayer took her case to the Tax Court. But it agreed with the IRS that the legal costs were unreimbursed employee business expenses because they arose from the taxpayer's business of being an employee (albeit a former employee at the point they were incurred).

      IRS Private Letter Ruling

      In a recent PLR, the taxpayer had experience managing closely held companies, and he had agreed to serve as the managing shareholder of a newly formed corporation in exchange for a management fee. After another shareholder became dissatisfied with the corporation's performance, the taxpayer was sued for alleged breach of contract, breach of fiduciary duty and fraud.

      The taxpayer incurred legal fees to unsuccessfully defend against these charges and unsuccessfully appeal the initial court decision against him. In addition, he paid fees to accounting consultants and an expert witness. And, he had to pay court-ordered compensatory and punitive damages to his legal adversary, as well as the adversary's legal fees.

      The taxpayer wanted to deduct all of these expenses, which clearly originated in the conduct of his business as the managing shareholder of the troubled corporation. Therefore, the IRS concluded that the taxpayer's payments to satisfy the final judgment against him (including compensatory and punitive damages and his adversary's legal costs) and his own legal expenses and related costs to unsuccessfully defend against the claims could be currently deducted as business expenses.

      Important note: This conclusion won't necessarily apply to other taxpayers in the same or a similar situation. By requesting a PLR, a taxpayer asks the IRS, for a fee, to provide guidance on federal income tax questions. PLRs interpret and apply tax laws to that particular taxpayer's specific set of facts. A PLR helps eliminate uncertainty before the taxpayer's return is filed — and it's binding on the IRS if the taxpayer fully and accurately described the proposed transaction in the request and carries out the transaction as described. Technically, a PLR can't be relied on by other taxpayers. However, as a practical matter, PLRs are often used by tax professionals as guides to the IRS position on issues.

      Business vs. Personal

      Individuals will sometimes incur legal expenses that are legitimately business-related and, therefore, deductible. But, if you're audited, the IRS will routinely disallow legal expense deductions unless you can adequately prove that the expenses are indeed business-related (including related to the business of being an employee). In the right circumstances, your tax advisor can help you put together evidence to support deductible treatment for legal expenses.

      WILL YOU BE ABLE TO COMMUNICATE DURING A CRISIS?

      If disaster struck your company tomorrow, would you know how to quickly reach employees and their families? Would you be able to talk to them quickly and efficiently? If the answer to those questions is anything but a resounding "yes," it's time to create or review your crisis communication plan.

      Basic Info

      One of the most important ingredients for emergency preparedness is also the thing that many companies pay minimal attention to: employee contact information. Although organizations typically ask new hires for these details, they often forget to update the data. So make it a habit to ask employees to refresh their contact information at least once a year. To help you remember, tie it to a specific event such as your benefits enrollment period.

      In addition to gathering employees' mailing and alternate e-mail addresses, and home and cell phone numbers, get similar information for their emergency contacts. And ask each worker to designate a few emergency contacts, such as spouses, friends and neighbors. Doing so will help you to quickly reach someone when necessary. It's critical that you safeguard this information and system access to it, and ensure employees understand the circumstances when the emergency information can be used and how to protect it.

      Additional Measures

      Most companies can quickly reach many, if not all, employees by simply sending an e-mail or posting an announcement to their intranets. But these methods aren't effective if there's a power outage or network interruption, or if employees are away from their computers. So be prepared to use other means, such as:

      Phone trees. Establish the flow of call responsibility, have up-to-date personal phone numbers and distribute a hard copy version of the tree to those who need it — and, most important, keep it current. A good backup measure to phone calls is text messages, assuming one of the numbers provided is a cell phone.

      Voice mail. Change the outgoing message of your company's main line to address the situation. If severe weather closes your office, for example, your message could direct employees to stay home. Instruct managers to also do this on their respective voice mail messages.

      Social media. Platforms such as Facebook and Twitter offer an easy way to push notifications to where they're accessible. Just bear in mind that these are public forums, so you don't want to divulge sensitive or errant information. On the other hand, communicating via social media allows you to demonstrate publicly how effectively your organization responds to a crisis.

        Informed and Protected

        Severe weather, accidents or other crises can occur at any time. By outlining communication methods in advance and keeping employee contact information up-to-date and in one location, you'll be able to keep your staff informed and protected.

        RELYING ON AUDIT TECHNIQUES GUIDES

        IRS examiners usually do their homework before meeting with taxpayers and their professional representatives. This includes reviewing any relevant Audit Techniques Guides (ATGs) that typically focus on a specific industry or audit-prone business transaction.

        Though designed to help IRS examiners prepare for audits, ATGs are available to the public. So, small business taxpayers can review them, too — and gain valuable insights into issues that might surface during audits.

        Auditor Specialization

        In the past, IRS examiners were randomly assigned to audit taxpayers from all walks of life, with no real continuity or common thread. For example, after an examiner audited a dentist, the next assignment he or she received might have been a fishing boat captain or a convenience store owner. Therefore, there was little chance to develop expertise within a particular niche.

        To remedy this, the IRS created its Market Segment Specialization Program (MSSP), which expanded rapidly during the 1990s. The MSSP allowed IRS auditors to focus on specific sectors. Through education and experience, examiners became better equipped to identify and detect noncompliance with the tax code.

        The IRS started publishing ATGs as an offshoot of the MSSP. Most ATGs target major industries, such as construction, manufacturing and professional practices (including physicians, attorneys and accountants). Other ATGs address issues that frequently arise in audits, such as executive compensation and fringe benefits.

        The IRS periodically revises and updates the ATGs and adds new ones to the list. (See "IRS Jumps into Golden Parachutes" at right.)

        A Closer Look at ATGs

        What does an ATG cover? The IRS compiles information obtained from past examinations of taxpayers and publishes its findings in ATGs. Typically, these publications explain:

        • The nature of the industry or issue,

        • Accounting methods commonly used in an industry,

        • Relevant audit examination techniques,

        • Common and industry-specific compliance issues,

        • Business practices,

        • Industry terminology, and

        • Sample interview questions.

        The main goal of ATGs is to improve examiner proficiency. By using a specific ATG, an examiner may, for example, be able to reconcile discrepancies when reported income or expenses aren't consistent with what's normal for the industry or to identify anomalies within the geographic area in which the taxpayer resides. The guides also help examiners plan their audit strategies and streamline the audit process.

        Over time, the information and experience gained about a particular market segment can help examiners conduct future audits with greater efficiency. Some of this information is incorporated into periodic ATG updates. Furthermore, IRS examiners are routinely advised about industry changes through trade publications, trade seminars and information sharing with other personnel.

        Site Visits and Interviews

        ATGs also identify the types of documentation that taxpayers should provide and information that might be uncovered during a tour of the business premises. These guides may be able to identify potential sources of income that could otherwise slip through the cracks.

        For example, the ATG for the legal profession identifies revenue streams derived from outside the general practice, such as serving on a board of directors, speaking engagements, and book writing or editing. The guide encourages IRS examiners to inquire about potential revenue sources during the initial interview with the taxpayer.

        Other issues that ATGs might instruct examiners to inquire about include:

        • Internal controls (or lack of controls),

        • The sources of funds used to start the business,

        • A list of suppliers and vendors,

        • The availability of business records,

        • Names of individual(s) responsible for maintaining business records,

        • Nature of business operations (for example, hours and days open),

        • Names and responsibilities of employees,

        • Names of individual(s) with control over inventory, and

        • Personal expenses paid with business funds.

        For example, one ATG focuses specifically on cash-intensive businesses, such as liquor stores, salons, check-cashing operations, gas stations, auto repair shops, restaurants and bars. It highlights the importance of reviewing cash receipts and cash register tapes for these types of businesses.

        Cash-intensive businesses may be tempted to underreport their cash receipts, but franchised operations may have internal controls in place to deter such "skimming." For instance, a franchisee may be required to purchase products or goods from the franchisor, which provides a paper trail that can be used to verify sales records.

        Likewise, when auditing a liquor store owner, examiners are taught to search for off-book wholesalers and check cashers. For gas stations, examiners must check the methods of determining income, rebates and other incentives. Restaurants and bars should be asked about net profits compared to the industry average, spillage, pouring averages and tipping.

        Bottom Line

        During an audit, IRS examiners focus on those aspects that are unique to the industry, as well as ferreting out common means of hiding income and inflating deductions. ATGs are instrumental to that process.

        Although ATGs were created to benefit IRS employees, they also help small businesses ensure they aren't engaging in practices that could raise red flags. To access the complete list of ATGs, visit the IRS website. And for more information on hot tax issues that may affect your business, contact your tax advisor.

        CONVERTING AN UNINCORPORATED BUSINESS INTO AN S CORP

        The federal self-employment (SE) tax just keeps going higher and higher. If you've reached the breaking point, there may be a way to tame the SE tax beast by converting your existing unincorporated small business into an S corporation.

        How to Evaluate the Option

        If you're a self-employed individual — meaning a sole proprietor, partner, or LLC member — you have to pay the SE tax on your net SE income. The SE tax has two parts:

        1. The 12.4% Social Security tax. Social Security tax is due on net SE income up to a certain amount. Unfortunately, the ceiling goes up every year because of inflation adjustments. For 2017, the Social Security tax ceiling is $127,200 (up from $118,500 for 2016).

        2. The 2.9% or 3.8% Medicare tax. The Medicare part of the tax is due on an unlimited amount of net SE income. In other words, there's no ceiling.

        So until your net SE income exceeds the Social Security tax ceiling of $127,200 in 2017 (up from $118,500 for 2016), you owe the SE tax at the painfully high rate of 15.3% consisting of 12.4% Social Security plus 2.9% Medicare.

        After the ceiling is exceeded, the Social Security tax portion drops away, and the SE tax rate falls to 2.9% to cover the Medicare tax. However, the Medicare tax jumps to 3.8% once your self-employment income exceeds the applicable threshold ($200,000 for unmarried individuals or $250,000 for married couples filing jointly).

        Note: The tax results are the same if you operate your business as a single-member LLC, which is treated as a sole proprietorship for federal tax purposes.

        While the SE tax is painful now, it's could get worse in the future.

        So it may be time to consider an S corporation conversion. Reason: The SE tax doesn't apply to earnings from an S corporation business.

        However, the FICA tax applies to salary compensation paid to an S corp shareholder-employee. In 2017, the FICA tax rate is 15.3% on salary up to the $127,200 Social Security tax ceiling. Salary above the Social Security tax ceiling is subject to a 2.9% or 3.8% FICA tax rate to cover the Medicare tax.

        The employee share of the FICA tax is withheld from an S corporation shareholder-employee's salary; the other portion is paid by the corporation directly to the U.S. Treasury.

        The Tax Savings

        The FICA tax is only due on an S corporation shareholder-employee's salary. So when the company pays only a portion of its profits to the owner, or owners, in the form of a reasonable salary, with the remaining portion paid out in the form of cash distributions, only the salary portion is hit with Social Security and Medicare taxes (in the form of the FICA tax). The profits paid out as cash distributions are exempt from the FICA tax (and exempt from the SE tax too).

        Key Point

        These tax-saving results are not a one-time phenomenon. You can collect similar Social Security and Medicare tax savings, or better, in future years if the business maintains or exceeds its current level of profitability.

        Converting an unincorporated small business into an S corporation is not a great idea in all situations but it works for some businesses. Consult with your tax advisor for more information.

        Of Course, there Are Caveats

        Potential audit target. The IRS is aware of the strategy of converting an unincorporated business into an S corp to save on taxes. The government is trying to audit more S corps to see if they are paying unreasonably low salaries to shareholder-employees. However, S corp audit rates are still low. The tax-saving advantage of converting is lost if the IRS successfully asserts that S corp distributions to shareholder-employees are actually disguised salary payments. If that happens, the IRS will assess unpaid FICA taxes, interest and penalties. Your tax advisor can help you build a case so that in the event of an IRS audit, you have well-documented support that salaries are not unreasonably low.

        Impact on retirement contributions. When considering an S corp, keep in mind that paying a modest salary can reduce the amount you can contribute to a tax-favored retirement program (such as a profit sharing or SEP plan). However, you may be able to mitigate this concern by setting up a 401(k) or defined benefit pension plan.

        Other complexities. An S corporation conversion creates some paperwork and other issues.

        That is because transactions between an S corp and its shareholders, including asset and liability transfers upon incorporation, must be carefully planned to avoid adverse federal (and possibly state) income tax consequences. You also have to meet state-law corporation requirements such as conducting annual meetings and keeping minutes.

        Plus, a number of tax law hurdles must be cleared for S corp status to be available. For example, shareholders must be individuals or specified types of trusts. The Social Security and Medicare tax savings must be big enough justify the extra effort of operating as an S corp.

        Partnerships and Multi-Member LLCs

        A business operated as a partnership or a multi-member LLC also faces high SE tax bills. Partners and LLC members are considered self-employed individuals for federal tax purposes. Therefore, they generally must pay SE tax on their shares of net SE income from the partnership or LLC.

        In this scenario, the same tax strategy is available. The co-owners can consider converting an existing partnership or LLC into an S corporation. Then, they can pay themselves relatively modest, yet reasonable, salaries while paying out the remaining profits as cash distributions. The salaries will be subject to Social Security and Medicare taxes, but the cash distributions will be exempt from those taxes. The tax savings will recur year after year, as long as the business maintains or exceeds its current profits.

        NURTURE UNDERSTANDING BETWEEN GENERATIONS FOR A PEACEFUL WORKPLACE

        Is there frustration building in your organization due to clashing generational attitudes about work? If so, you are not alone. The good news is it doesn't need to trigger an explosion.

        In many workplaces, Baby Boomer and Gen X supervisors are exasperated with younger workers — typically those in the Millennial generation, who were born between 1981 and 2000. Some older supervisors have trouble managing the younger workers.

        By the same token, Millennial generation employees often are demoralized by an environment they do not find conducive to doing their best work.

        Be Proactive

        If you are facing these issues, don't wait for things to get out of hand. It's better to be proactive and sensitize employees and supervisors to generational differences in typical attitudes and expectations about work.

        When a problem is evident, don't just hope it will go away or tell a younger employee chafing under the supervision and communication style of a Baby Boomer boss, "this is the way it is around here."

        One basic preemptive problem-solving strategy is to explain each group to the other. Understanding why each generation behaves as it does allows supervisors and workers to overcome the belief that one party is merely going out of its way to annoy or undermine the other. Next, improve on the golden rule. Instead of treating people the way you want them to treat you, treat them the way they want to be treated — within reason.

        An "aha moment" for Boomer and Gen X supervisors in understanding how Millennials want to be treated often comes when they are asked about how they raised their children. The younger generation was constantly told they were special. They won trophies merely for participating on sports teams (winning optional) and were heavily programmed with organized activities during their childhoods. Their school essays may have been proofread by their parents. All of these experiences lead to certain expectations in the work environment.

        In particular, these employees often expect lots of feedback (especially praise) and direction. They may also have less respect for hierarchies if they viewed their parents more as friends than as authority figures.

        Life is too Short?

        Many Millennials developed certain attitudes about work by witnessing the fate of some Boomer parents who devoted themselves fully to their jobs and companies, worked long hours without complaint, only to be laid off during times of economic difficulty. This can lead to an attitude that life is too short to sacrifice yourself for a job that might disappear without warning.

        Other common differences:

        • Millennials are more interested in collaboration and teamwork, while Generation Xers and Baby Boomers are more independent.

        • Millennials communicate through technology, while Boomers prefer face-to-face interaction.

        • Some Millennials resent having to perform menial tasks and resist the idea that you have to work your way up in an organization while Boomers and Gen Xers believe in the concept of "paying your dues."

        A Two-Way Street

        Mitigating inter-generational conflict is a two-way street. Millennials may need to be coached about the meaning of concepts such as initiative and "ownership" of projects. You may want to advise them to narrow down their requests from supervisors.

        When Millennials are sensitized to such issues, along with generational attitude differences, they may walk away realizing: "My boss isn't an evil person, just a product of his time." They may become content to make a few adjustments to "meet the boss in the middle," or perhaps embrace a more Boomer or Gen X-like attitude.

        When older supervisors are encouraged to make some accommodations to the emotional needs of younger workers, a common response is: "Hey, nobody did that for me." However, their grumbling may soften when they learn that the accommodations they need to make often aren't very time-consuming — and they can bring positive results. Examples include sending an occasional thank-you note for a job well done, or cc'ing a boss on an e-mail praising a younger employee.

        Some members of each generation are probably going to conclude that those of other generations are wrong and "just need to get over it." But the differences are not going away. Compromise is key, and if all sides are willing to give a little, the workplace can be a much more productive and pleasant place to be.

        FREEDOM FROM THE PAST, HOPE FOR THE FUTURE

        Fulling Management & Accounting partnered with IntelligeneCG and other local bioscience companies to gather needed items for the Kansas City Rescue Mission Women's Center (KCRM Women's Center). 

        The response was incredible.  Hundreds of items (shampoo, towels, make-up, basic necessities, etc.) were donated that the KCRM residents will be able to use in their recovery.

        The 20-bed KCRM Women's Center provides a safe, homelike environment where traumatized women can find hope, peace and security as they work to overcome life-challenging barriers to stability and success.   

        The KCRM Women's Center provides each resident with a long-term recovery and case management program designed just for her. After an intake assessment, she is paired with a case manager and certified counselor to determine a course of objectives that guide her toward freedom from the past and hope for the future. 

        Thank you for making a difference in the lives of our friends at KCRM Women's Center.

        Sincerely,

        Rusty Fulling

        KEEP THE LONG-TERM IN MIND WHEN INSTITUTING CHANGES

        Profit growth and business expansion are two key goals for many family businesses. But in order to successfully reach your targets, growth must be controlled. If you allow undisciplined expansion, you run the risk of diluting resources, leaving projects unfinished and destroying morale.

        Whether you are planning an expansion, developing a new growth strategy or looking to make changes to spark revenue growth, plan your moves carefully and continually evaluate the game plan by asking the following questions:

         

        Growth Checklist

        Is the plan financially sound? Does it fall within your core business? If not, should you proceed or do you need to change your business focus?

        How will you allocate resources?

        Have you arranged to provide adequate training to ensure employees have the new skills they might need?

        Are you paying attention to critical aspects of the business, rather than letting the upheaval dilute your focus?

        Are you continually evaluating progress to ensure that individual elements of the overall plan are completed on time? If too many projects are not complete, determine why and revise procedures appropriately.

        Have you instructed managers to set priorities for staff members to keep them focused on the most important projects?

        Have you clearly communicated company goals and the relevant time frame to staff members and any outside help that might be involved?

        Are you keeping managers current on the status of the project and setting up procedures to maintain accountability?

        Have you solicited insight from everyone who could make a valuable contribution in both evaluating the strategy and deciding if, and when, to proceed?

        Have you established a contingency plan to deal with problems?

        Have you ensured that all employees understand what the company does, the rationale for the changes and how they fit into the company's ultimate goals?

        There's Still Time to Set Up a SEP for 2016

        Simplified Employee Pensions (SEPs) are stripped-down retirement plans intended for self-employed individuals and small businesses. If you don't already have a tax-favored retirement plan set up for your business, consider establishing a SEP — plus, if you act quickly enough, you can claim a deduction for your initial SEP contribution on your 2016 tax return.

        Putting SEPs to Work for You

        Because SEPs are relatively easy to set up and can allow large annual deductible contributions, they're often the preferred retirement plan option for self-employed individuals and small business owners — unless they have employees. (See "Beware of Requirements to Cover Employees" at right.)

        The term "self-employed" generally refers to:

        • A sole proprietor,

        • A member (owner) of a single-member limited liability company (LLC) that's treated as a sole proprietorship for tax purposes,

        • A member of a multimember LLC that's treated as a partnership for tax purposes, or

        • A partner.

        If you're in one of these categories, your annual deductible SEP contributions can be up to 20% of your self-employment income. For a sole proprietor or single-member LLC owner, self-employment income for purposes of calculating annual deductible SEP contributions equals the net profit shown on their Schedule C, less the deduction for 50% of self-employment tax. For a member of a multimember LLC or a partner, self-employment income equals the amount reported on their Schedule K-1, less the deduction for 50% of self-employment tax claimed on their personal income tax return.

        If you're an employee of your own corporation, it can establish a SEP and make an annual deductible contribution of up to 25% of your salary. The contribution is a tax-free fringe benefit and is, therefore, excluded from your taxable income.

        For 2016, the maximum contribution to a SEP account is $53,000. For 2017, the maximum contribution is $54,000. However, there's no requirement to contribute anything for a particular year. So when cash is tight, a small amount can be contributed or nothing at all.

        As with most other tax-advantaged retirement plans, assets in a SEP can grow tax-deferred, with no tax liability until withdrawals are made. Early withdrawals (before age 59½) are generally subject to a 10% penalty, in addition to income tax. Certain minimum distributions are generally required beginning after age 70½.

        Setting Up Your Plan

        A SEP is fairly simple to set up, especially for a one-person business. Your financial advisors can help you complete the required paperwork in just a few minutes. A key benefit of SEPs is that you can establish your plan as late as the extended due date of the return for the year in which you claim a deduction for your initial SEP contribution.

        For example, say your business is a sole proprietorship or a single-member LLC that's treated as a sole proprietorship for tax purposes. If you establish a SEP and make your initial SEP contribution by April 18, 2017 — the deadline for filing your 2016 federal income tax return — you can deduct the contribution on your 2016 tax return.

        Important note: If you extend your 2016 return, you have until October 16, 2017, to set up the plan and make a deductible 2016 contribution.

        Need Help?

        SEPs can be a smart way for many small businesses to save tax. You still have time to retroactively set up a SEP for the 2016 tax year and make a contribution that can be deducted on your 2016 return. If you have questions or want more information about SEPs and other small-business retirement plan options, contact your tax or financial advisor.