New 2011 Tax Reporting Requirements Place Greater Burden on Taxpayers

The IRS has published many 2011 tax forms on its website, and let me tell you, it is getting ugly.  Each year, a greater compliance burden is placed on taxpayers, making tax reporting even more time consuming and complicated.  Although I haven't had a chance to review all the form changes, I did look at Schedules C and E,  and it is scary.

Schedule C is the form used by individual taxpayers to report the income and expenses of a business operated as a sole proprietorship or a single member LLC.  Schedule E the form used to report the income and expenses of operating rental real estate.  Each of these forms contains two new questions.  The first is "Did you make any payments that would require you to file forms 1099?"  The second question is "If yes, did or will you file all required forms 1099?"

Form 1099 is generally required to be issued to report payments made in the course of a trade or business to any individual or unincorporated entity if the total of the payments is $600 or more in a calendar year.  This seems simple enough, right?  Wrong!  Whether you own a two family house or operate a small business on a part time basis, you are subject to the 1099 filing requirements. For you rental property owners, are the landscaper and snow plower corporations?  What about the roofer and the plumber?  If they are unincorporated, do you have their addresses and federal tax identification numbers?  After all, you do need this information to file the 1099 forms with the government by February 15.  Do you see where I'm going with this?  And by the way, if the 1099's are late filed, you are subject to penalty, so unless you plan to prepare these forms on your own, you can't wait until whenever you get around to it to see your accountant.

Getting back to the two questions, how will you answer them if you are required to but do not file forms 1099?  It doesn't take a genius to know that the IRS is not asking these questions for their health.  Keep in mind that when you sign your tax return, you are doing it under penalties of perjury, so you do not want to give a false answer.  I would love to hear your thoughts on this, so please comment if you have any.  I will provide more information as it becomes available.  And by the way, these questions also appear on the 2011 partnership tax return form 1065.  S Corporation form 1120 S has not yet been released for 2011, but I suspect the question will also appear on it.

Next time, I will discuss the new basis reporting requirements on Schedule D and new form 8949, which requires disclosure of whether or not basis was reported to you on form 1099, and potentially requires the filing of six different forms 8949 to comply with these reporting requirements.  Like I said, it is getting really ugly.

Please contact us if you have any questions or we can be of assistance in any way.

Thanksgiving Thoughts

As the holidays approach, our thoughts turn to how fortunate we are, and how we can help those who are truly in need of assistance.  Although KRS provides generous financial support to many worthwhile causes, there are three special causes that we support with direct involvement, that is, providing pro-bono accounting, tax, and when needed, consulting services.  Each of these charities is operated for the benefit of the needy; no one who manages or works for these charities receives compensation of any kind.  With cutbacks in government programs, these and other charities fill a need that is greater than ever before.  It is our hope that you will pause for a moment and think about how you can help, whether it be with financial support or volunteering your time.

The Gardiner Foundation http://thegardinerfoundation.org/ was founded in the Bronx by Dexter Gardiner, in memory of the loss of six family members in a horrific car accident.  Since organizing the Foundation, Dexter has worked tirelessly for its cause, also making up financial shortfalls with his limited resources.  The Gardiner Foundation supports the Bronx community, providing college scholarships, computers, school supplies, burial assistance, mentoring and guidance.  This week, Dexter gave out over 200 free turkeys to help need families celebrate Thanksgiving.  The Gardiner Foundation's main fund raiser is a basketball tournament that takes place each August.  Please visit the website to learn more about the Gardiner Foundation and how to contribute.

The Wells Mountain Foundation http://www.wellsmountainfoundation.com/ was organized and is run by our good friend Tom Wells.  This Foundation provides funding and support in the areas of education, literacy, and the arts, primarily in the developing world.  During 2011, 28 new scholarships were awarded from 982 applications, bring the total to over 40 scholarships in more than a dozen developing countries.  After the Haitian earthquake, The Wells Mountain Foundation stepped up in a big way, providing food and clothing to the victims.  Please visit the website to learn more about the Wells Mountain Foundation and how to contribute.

Although the Zabota Foundation does not yet have a website, it does help fill an urgent need for semi-independent housing for disabled adults.  In New Jersey, the waiting list for this type of housing is several years long, but the need continues to grow.  This Foundation is run by Errol Seltzer, who has devoted his life to helping the elderly and disabled.  Thanks to the donation of a house by a generous contributor, the Zabota Foundation now houses four disabled adults, allowing them to live independently with assistance when needed.  But this is only the beginning.  Additional funds are needed to continue Zabota's worthwhile mission.  If you are inclined to contribute to this cause, please send me an email and I will help arrange it.

Whether it is by time or money, to one of the charities described above or another, please consider helping those less fortunate than you.  Helping others is truly rewarding.  As so eloquently stated by Mahatma Gandhi, "You must be the change you want to see in the world."

Maria, Brad, and I want to thank our employees, our clients, our friends, and our families, and extend our best wishes to all. Although we don't say it nearly often enough, we are truly thankful for all of these relationships.  Happy Thanksgiving!

New Jersey Will Follow Federal Tax Relief for Hurricane Irene Victims

On September 1, 2011, the New Jersey Division of Taxation announced that it is following the federal guidlines for tax relief for victims of Hurricane Irene.  Taxpayers who reside or have a business in a designated Presidential Disaster Relief Area will now have until October 31, 2011 to file their New Jersey tax returns such as individual income tax, corporation business tax, sales tax inheritance tax, estate tax, partnership and other business taxes admininstered by the Division of Taxation.

The Presidential Disaster Relief Area consists of Bergen, Essex, Morris, Passaic, and Somerset counties.  Should the President expand the scope of the disaster declaration the Division will append their notice to include additional counties.

This announcement also extends to October 31 the due date for all payments which have an original or extended due date on or after August 27, 2011 and on or before October 31, 2011.  Estimated tax payments for the third quarter of 2011 are now due October 31, 2011 instead of September 15, 2011.

Please contact us or post a comment if you have any questions on this announcement.

Tax Filing Due Date Extended

The IRS announced today that the tax filing deadline for certain taxpayers has been extended to October 31.  The affected taxpayers include corporations and businesses that have previously received September 15 extensions, and individuals that have previously received October 17 extensions.  It also includes third quarter 2011 estimated tax payments, which would normally be due September 15.

This relief applies to New Jersey residents of Bergen, Essex, Morris, Passaic and Somerset Counties, and certain counties and municipalities in New York, North Carolina, and Puerto Rico.  Check the IRS website for further details and information.

Be aware that as of now, no state has announced similar due date relief.  This may be especially troublesome to business taxpayers who file in many states, because some states require copies of the federal tax return as part of their filing.  Although I expect that New York and New Jersey will follow the IRS and extend the filing and payment due date, we have many clients who file in states not affected by the hurricane.  It is not likely that those states will extend the due date.

Although Hurricane destruction in Vermont received a lot of television coverage, the initial IRS announcement does not extend the tax due date for any Vermont residents.  It is not clear why Vermont residents received no relief.

Please contact us if you have questions or we can be of any assistance.

Foreign Account Reporting Deadline Extended to September 9

For those of you who have unreported foreign financial accounts, today the IRS extended the deadline for reporting the accounts to September 9.  The previous August 31 due date was extended because of Hurricane Irene.  This may very well be the last chance to report these accounts and take advantage of reduced penalties. Taxpayers who have or had foreign financial accounts who do not self report by September 9 will be subject to enormous penalties if the accounts are later discovered by the IRS.

In order to participate in the self reporting program, complete information must be submitted to the IRS by September 9.  If you have unreported foreign financial accounts, I urge you to contact your tax professional  to get the ball rolling.  Time is running out.

The Process Works

Back in June, I wrote about a provision in the New Jersey Unemployment law that allows the State to assess unemployment tax on payments to independent contractors, even if the contractor is a corporation.  In my client's situation, they hired a bus company to transport clients.  It turned out that the bus company was not properly reporting and paying NJ Unemployment Tax, so the tax was assessed against my client.  By the time the audit of my client had occurred, the bus company could no longer be found.

Although it will not benefit my client, it looks like there will be a good outcome for New Jersey employers.    We recently attended a legislative dinner  sponsored by the NJ Commerce and Industry Association and the NJ Society of Certified Public Accountants.  I had the pleasure of sitting with NJ Assemblyman Jon Bramnick.  I told Assemblyman Bramnick about this law, and how I believed that it is patently unfair to New Jersey employers.  Remarkably, he agreed!  He asked that I send him a copy of the specific provision, along with my suggestion for changing it, which I did the next day.

Since then, I have been working with the Assemblyman's legislative aide, Carlos Cruz.  Mr. Cruz has kept me informed every step of the way, and this week sent a draft of the proposed law change for my review.  I thank Assemblyman Bramnick and Mr. Cruz for their efforts to make New Jersey a better place to be in business.  I never expected my voice to be heard, and certainly did not expect that it would result in a law change.  I will keep you posted and let you know if and when the new law is enacted.

Something You Didn't Know About New Jersey Unemployment Tax

Is that person that provides services to your company an employee or independent contractor?  The answer to this question has always been a contentious issue between businesses and federal and state governments.    The primary reason for contention is that payment for independent contractors' services are not subject to payroll taxes, and payment for services of employees are.  Therefore, independent contractor classification causes the government to lose much needed payroll tax revenue.

The determination of independent contractor status is largely dependent on the degree of control exercised by the business that engages the subcontractor.  Basically, if the business controls when, where, and how the work is done, the person doing the work is an employee, not an independent contractor.  The IRS has developed a list of twenty questions to assist in this determination.  This list of questions can easily be found on the internet.  Please contact me if you want me to send you a copy.

It has been our experience that disputes over independent contractor status have centered around services provided by individuals.  The IRS and most states have generally respected arrangements where payments were made to other businesses for services provided by those businesses.  Some examples of these types of relationships include landscapers, building cleaning and maintenance companies, and transportation (school and other bus) companies.  However, it now appears that New Jersey Unemployment will no longer respect such arrangements.  Authorized by NJSA 43:21-19(3)(g), NJ Unemployment auditors are classifying employees of other businesses as employees of the business under audit and assessing tax for the payments made to these businesses.

The final sentence of NJSA 43:21-19(3)(g) states "Each individual employed to perform or to assist in performing the work of any agent or employee of an employing unit shall be deemed to be employed by such employing unit for the purposes of this chapter...whether such individual was hired or paid directly by such employing unit or by such agent or employee; provided the employing unit had actual or constructive knowledge of the work."

Read it again and think about it.  As long as you know that your grass is being cut or your office is being cleaned, New Jersey has the right to require your business to pay unemployment and disability tax on the payments for services that you make to the business performing such services.  Practically, this provision will not be applied unless the subcontractor fails to comply with NJ Unemployment laws, but there is no mechanism to determine if subcontractors are in compliance.  We recently had an audit where this law was applied.  When asked how a business could determine if subcontractors are in compliance, the auditor's response was that before hiring a subcontractor, we should request copies of their NJ Unemployment Tax reporting forms.  That is ridiculous!  Would you share your confidential payroll information with a customer?

New Jersey doesn't understand why businesses are leaving and relocating to more tax and business friendly states.  It is time to wake up, and stop trying to tax businesses out of existence.

Buy Sell Agreements

When was the last time you reviewed your buy sell agreement?  If you are like most business owners, the most likely answer is NEVER.  Maybe you read it before you signed it when you started the business, and maybe you didn't.  Many buy sell agreements are formula based, that is, they call for the application of a multiple to a business performance measure.  Examples of simple formula based valuation methods are 1 times sales, 5 times net income, or something in between.

The problem with formula based valuations is that a result that may have made sense ten or twenty years ago may not make sense today.  For example, a formula based on a multiple of sales is probably not fair if the business consistently loses money.  Because no one knows if they are going to be a buyer or seller until the buy sell is triggered, it is important that the agreement be fair to both parties.  If the formula isn't fair, it is not uncommon for a costly and time consuming dispute to arise.

The thing to do it get out your buy sell agreement, read it, and ask your accountant to calculate the formula value specified by the agreement, as of December 31, 2010 or any other date.  You may be surprised by the result.  Look at it from the standpoint of both a buyer and a seller, because you don't know which one you will be.  If you were the seller, would you be happy with the price that you would receive?  If you were the buyer, how do you feel about the price to be paid?  What you will probably see is that formula based valuations never yield results that are fair to both parties.

There is a simple and effective solution to the problem of formula based valuations.  That solution is to change the buy sell to require that upon the occurrence of a triggering event, the business be valued by a qualified professional.  The agreement should define the triggering event, the standard of value, and the qualifications or credentials of the valuator.  To avoid disputes, many agreements actually name the individual or firm who will preform the valuation.  It is much easier to agree on such matters when the agreement is drafted then when it is triggered and emotions may be running high.

I learned a lot about buy sell agreements when I did a prepublication review of Chris Mercer's new book  Buy Sell Agreements for Closely Held and Family Business Owners.  If you are interested in purchasing this book, you can do so at  www.mercercapital.com.

Your thoughts and comments are welcome.

How Much Alternative Minimum Tax Do You Pay?

I've been reading and hearing a lot of talk about proposals to increase tax rates for the wealthy, that is, those with taxable income above $250,000.  I imagine there are some places in America where $250,000 of income qualifies you as wealthy, but the New York metropolitan area is definitely not one of those places.  In New Jersey we pay the highest state income tax, real estate tax, and sales tax in the country.  And the worst part is, that thanks to the alternative minimum tax, many of us do not even get any federal tax benefit from paying these taxes.  The alternative minumum tax ("AMT")is a separate computation, one that includes adjustments to your regular taxable income.  The adjustement that affects so many of our clients is the one that disallows the deduction for all state income taxes and real estate taxes.    If the tax computed using the AMT calculation is higher than the regular tax, the alternative minimum tax becomes your tax liability.

As I recall, the AMT was implemented as another way to tax "the rich", especially those who participated in tax shelters.  Although we haven't finished all of our 2010 tax returns, so far 138 of our clients have paid a total of $1,373,000 of alternative minimum tax.  These clients include a single working mother with $84,000 of adjusted gross income, and another individual with $59,000 of adjusted gross income. These examples are some of the many.  I don't think that anyone can argue that either one is "rich", or that the AMT was intended to apply to them.  After all, state income taxes and real estate taxes on a residence are far from qualifying as tax shelters.

However, there is a bright side to the AMT.  If regular income tax rates are increased, those of us who are subject to AMT will not pay any additional income taxes unless the alternative minimum tax rate is also increased, or the regular income tax rate increase causes your regular tax to exceed the AMT.  Many people pay so much AMT that a small increase in the regular tax rates will have no effect on their liability.

The alternative minimum tax is unfair to people who pay high state income and property taxes.  If Congress plans to make changes to our tax code that result in additional tax on individuals and families, I urge them to also change the AMT to eliminate state income taxes and property taxes as an add-back.  I believe that such a change will give AMT relief to most people who are currently subject to it.

End of Tax Season Ramble

A little over two weeks remaining in tax season; it has been one of the harder ones in recent memory.  Clients received their tax information late, and as a result sent us their stuff much later than in prior years.  We never forget that we are in the client service business, but with so many clients sending their tax stuff at the last minute, each probably thinking that they are the only one, but not realizing that they are one of at least a hundred.  At KRS we all work very hard to get it done, and done right, but as April 18 draws closer, it becomes physically impossible to get all the work done at the last minute.  I guess that is why the IRS invented extensions.  If you are one of those who has not yet sent us your documents, let us know and we will get an extension.

Speaking of customer service, when did the US Post Office forget, or when will they figure out, that they are in the customer service business?  This week we learned that after six years in the same office, mail that did not include our recently assigned suite number (585), was returned to the senders.  We attempted to contact everyone to let them know that the suite number is required, but, as people do, many forgot.  Our office is in a relatively small town, and the post office knows who we are, and what we are.  There is no excuse for returning our mail without so much as a telephone call.  I see a lot of news about the Post Office financial problems and how to solve them.  Thinking about customer service would be a step in the right direction.

A friend just turned me on to Joe Bonamassa, a great young blues guitarist.  He has a fair amount of stuff on YouTube; my favorite is at Royal Albert Hall where he performs with Eric Clapton.  His music is also on itunes.  I have not liked most of the new music I hear, but Joe is breath of fresh air.  Check him out and let me know what you think.

Capital Grill opened up in Garden State Plaza mall.  Great food, great service, and the biggest wine list I ever saw.  Not inexpensive, but definitely worth it.  I had a steak with a Kona coffee crust, it was delicious.  If you are going, be sure to make a reservation.  On the Saturday we were there,  the wait was over two hours for those without reservations.

This is my favorite time of year.  Three things I love are the NCAA basketball tournament, the Masters, and the end of tax season.

Next time I will get back to business, that is, how to improve yours.  I also welcome comments and suggestions.  I see that I have many readers in England and France.  If you are one of them, please let me know what you think.

What Is Your Business Worth?

What is my business worth?  I am often asked that question by business owners who think the answer is as simple as multiplying some number (usually gross receipts) by some other number (usually five) to come up with the answer.  Trust me, valuing a business is not that simple.

In order to know what a business is worth, one must understand what is being sold, and how the buyer evaluates how much he will pay for it.  The price paid for a business is based on a thorough and unemotional analysis, one that evaluates the subject company and compares its potential risks and rewards to other potential investments.  What does this mean in plain language?  No one cares about the sacrifices you made in starting the business, or how much money you made last year or last week.  The buyer is interested in projected future cash flow (reward) and the chance that the cash flow will not be achieved (risk).  The bottom line is this: if I buy this business, how much money will I make?  If the business is a risky one, there is a greater chance that the projected cash flows will not be achieved, so he will probably require a higher return to compensate me for taking the risk, and pay less for the business.  If there is little risk associated with the business, he is probably willing to pay a higher price.  But if the business does not have positive cash flow, it probably isn't worth much more than the value of its net assets.

There are two types of risk; those that can be controlled and those that cannot.  Examples of risks that cannot be controlled are the economy, unemployment, tax law, and other government policy.  Risks that often can be controlled are diversification risk (customer, product, supplier), technology, competition, and management depth.  For example, when the economy is in recession, almost all business is affected, and little can be done about it.  But a business that lacks diversification can take steps to diversify.  For example, if the continued success of your business is based on one product, customer, or supplier, you should take steps to diversify; the loss of the one customer or supplier upon which your business depends would be viewed as a great risk by any potential buyer.  Management depth is a risk that is often overlooked.  I know so many business owners that are so proud of the fact that they know everything about their business and no one else knows anything.  Guess what?  This is very bad.  If something happens to that person, the business is not worth much.

Another way to decrease the perceived risk, and increase the price of your business, is to maintain excellent accounting records,  records that tell the story of your business without explanation.  Time and time again, I see businesses sold where the seller left dollars on the table because the accounting records did not tell the complete story.  Every business owner thinks they can explain away the problems, but each explanation adds to the buyer's perception of risk, until there are so many explanations that the buyer just walks away. There are many excellent accounting software packages available, and there is no reason why every business does not have computerized accounting records, that tell the financial story of your business.

When should you start getting ready to sell your business?  Right now is the perfect time. Even though you think you are not a seller, you never know when the time will come, and when it does you have to  be ready.  What can you do right now to improve cash flow?  A few ideas are reducing payroll, managing inventory, and dropping unprofitable products or customers.  What about risk?  When was the last time your looked for new customers?  Can you identify other sources for your products?  What are you doing to be better than the competition?  You should be thinking about these things every day!  What about your accounting records?  Do you have accurate accrual basis financial statements within two weeks after the end of every month?  If not, something is wrong.  Go to Staples and buy QuickBooks.  You will be glad you did.

We welcome your comments, both positive and negative, and are happy to respond to all questions.

Is Our Unemployment System Broken?

My partners and I frequently get calls from clients who are trying to hire, but find that many qualified candidates are collecting unemployment benefits and do not want something like a job getting in the way of these benefits.  The conversation goes something like this "We really like this person and want to hire them.  Tell me how I can pay them so they can continue to collect."  Of course we tell the client that can't be done, and that participation in any kind of scheme like this would be  fraud, with most serious consequences.  Although many unemployed people are desperately searching for employment, and willing to take almost any job,  there are many who are thrilled to stay home and collect benefits.

I know that this is not original thinking, but it seems that this situation is representative of the problem with our unemployment system, that is, it gives able and employable people incentive to not work.

Rather than paying the unemployed not to work, why not give the money to private industry through a tax credit, with the requirement that it be used to hire the unemployed?  Perhaps the credit could be a dollar for dollar match where half of the wages came from the government and the other half from the employer.  This would effectively double the amount of money available for the formerly unemployed, because the employer would effectively be paying half of the employee's wage.  Taking it one step further, the wages paid to this class of employee could be exempt from payroll taxes for a limited period of time, say one year.  After all, no payroll tax is being paid on the money that the unemployed are paid to stay home.  In New Jersey, weekly unemployment benefits range from $300 to $600.  This money could be put to much better use paying people to work rather than to stay home.  It could be the economic stimulus that our economy needs.  Because more people would be working, productivity would increase, and the employers would be profitable, because half the wages are paid by tax credit, and are exempt from payroll tax.  The result of these additional profits would be increased tax collections, which would contribute to deficit reduction.

I suspect that my idea will be dismissed by many, who can identify a multitude of reasons why it cannot work.  Perhaps many critics will be those on the receiving end of unemployment benefits, I don't know.  And maybe my numbers don't work, but I don't think anyone will dispute the fact that if someone is paid not to work, then that is exactly what they will do.

Do you agree?  Please let me know.  Your comments, both positive and negative, are welcome.

NY Tax on Nonresidents - Part II

Several weeks ago I blogged about state taxes, and how New York State collects a lot of tax by auditing non-residents who maintain living quarters in that state and also enter New York more than 183 days in a year.  

Today's Wall Street Journal has an article (Out-of State Owners Could Face Tax Bill, page A15)  that leads the reader to believe that the 183 day rule no longer applies, and that mere ownership of property such as a vacation home is sufficient to trigger New York residence and the obligation to pay New York tax on all of your income.  That is not the case.  New York law clearly states in order to be a New York resident for tax purposes, New York must be your domicile, or you must maintain New York living quarters and enter the state more than 183 days.

The issue in the Barker case discussed in the WSJ is the exception to the 183 day rule, that is, if the living quarters are not a "permanent place of abode" then you will not be a resident even if you pass the 183 day threshold.    The New York regulations provide that a permanent place of abode means "a dwelling place permanently maintained by the taxpayer...  However, a mere camp or cottage, which is suitable and used only for vacations, is not a permanent place of abode."  In this case, the taxpayer entered NY more than 183 days and unsuccesfully argued that his three story home in the Hamptons did not consitute a permanent place of abode.

I'm sure that the WSJ article caused a lot of unecessary panic.  If you want a copy of the case, email me or comment on this blog, including your email address.

IRS Offers Second Chance to Report Foreign Financial Accounts

The IRS announced yesterday that it has opened a second voluntary disclosure program for taxpayers who have undisclosed foreign financial accounts.  In exchange for disclosure of unreported offshore accounts, the IRS offers reduced penalties.  This progam is scheduled to run through August 31, 2011.

In a similar 2009 program, approximately 15,000 taxpayers came forward, resulting in collections of approximately $400 million.  Our office assisted several taxpayers with voluntary disclosure, and we found that they wound up paying approximately 50% of the highest account balance in the account during the preceding six years.  Although certainly painful, the penalties were substantially lower then they would have been absent the disclosure, and the taxpayers avoided  prosecution.

Under the new framework, taxpayers are required to pay tax on the unreported income for the years 2003 through 2010, a penalty of 25% of the highest aggregate account balance during that period, and interest.  In order to participate in the program, taxpayers must file amended returns for all years and include payment for taxes, interest and penalties.  The IRS has posted a penalty computation worksheet on its website.  The program ends August 31, 2011.  All paperwork must be received by the IRS by that date.

If you have an undisclosed foreign financial account, we urge you to participate in this program.  It is rare that the IRS gives taxpayers a second bite at the apple.  This may be your last chance to come forward.  If you don't take advantage of this program, and your undisclosed accounts are discovered by the IRS, the consequences will be devastating.  The tax, penalties, and interest will wipe out the entire account balance, and, it is possible that you will also go to jail.

Plan For Success

Does your business have a written business plan?  If it does, when was the last time you or anyone else referred to it?  When was the last time it was updated?  Has your business, or the climate in which it operates, changed since the original business plan was conceived?  I have been in the practice of public accounting for over thirty years, and in all that time I can recall only a handful of clients who had written business plans.

The process of writing or updating a business plan will help you to identify and deal with issues facing your business; short term and long term budgeting, customers, suppliers, products, personnel, marketing, competition, technology, succession, and legal issues, just to name a few.  It will force you to think about your short and long- term goals and how you hope to achieve them, and provide a way to measure your progress in meeting these goals.

The elements of a traditional business plan are a business description, an analysis of markets and competition, and marketing, operating, and financial plans.  The business plan will help communicate goals and ideas to investors, lenders, and employees.  If your management team and employees will be responsible for implementing the plan, they should have input in its formulation.   In our consulting engagements, we often find that the best ideas come from employees, who before being interviewed by us, have never been asked to share their ideas.  Also, it is much easier to get buy in and accountability from someone who participates in planning rather than having the plan thrust upon them.  Although it is a topic for another day, we are currently assisting a professional service firm client prepare financial projections.  Rather than projecting revenue based on an arbitrary estimate of billable hours, we asked each of the firm’s professionals to give us their commitment for 2011.  Not only does this help us more accurately project firm revenue, it introduces individual accountability, and an element of competition and peer pressure, which in this case is expected to result in additional revenue for the firm.

The business plan should begin with a mission statement, which clarifies what is most important to you, explain why your business exists, what it hopes to achieve, and the principles and beliefs will you employ along the way.

The market analysis section of the business plan should identify your target customers and your competition.  What are the characteristics of the market for your product and how has it changed since your business was started?  Identification of the profile of your target customers and why they might purchase your product or service will allow you to efficiently focus your efforts.  In analyzing your competition, you should evaluate their strengths and weaknesses compared with your own.

The operating plan addresses the internal operational structure, including management, production, technology, facilities, and staffing.  The plan should outline management responsibilities, production methods, the use of technology, and staffing needs.  For example, is any new technology available that will allow you to reduce labor costs?  Can any production methods be improved, resulting in greater efficiency and profitability?  These are just a few of the issues to be addressed in the operating section of the plan.

Although the financial plan may be the most difficult section to prepare, it is also one of the most important and useful tools in running a business.  The plan should be five years, prepared on a monthly basis for the next year, and an annual basis for the following four years.   Accurate projection of revenue and expense will tell you how much profit you can expect to earn for the year, and monthly comparison of actual and projected results will help monitor your progress.  Also, if you are falling short of goals, your will know about it immediately, while you can still do something about it, rather than after year-end, when it is too late.  If your company lacks the internal expertise to prepare a financial plan, your outside CPA firm will certainly be glad to assist you with this most important task.

A thoughtfully written business plan will be a most useful tool in contributing to the success of your business.  The insight gained in preparing and writing the plan will provide benefits that go far beyond the effort expended.  Spend the time now and prepare a 2011 business plan; you will be glad you did.

Can S Corp Shareholder Wages Be Unreasonably Low?

In a recent US Tax Court case, the Internal Revenue Service successfully recharacterized dividend distributions from an S corporation to its sole shareholder, employee, and director as wages.  In the case of David E. Watson 2010-1 U.S.T.C. 50,444 (May27, 2010), the Court held that the corporation structured the individual's salary and dividend payments in an effort to avoid employment taxes, with full knowledge that dividends paid were actually remuneration for services performed.

In this case, Mr. Watson, who is a CPA, was the sole shareholder and employee of this CPA firm, which operated as an S corporation.  During the year 2002, he received salary of $24,000 and dividends of $203,651.  In 2003, Mr. Watson received the same $24,000 salary, but received $221,577 of dividend payments from the corporation.  In February 2007, the Internal Revenue Service assessed approximately $48,500 in tax, penalties, and interest for the years 2002 and 2003.

Over the years, I have seen many S corporation shareholders save payroll taxes by using the same technique as Mr. Watson, generally with no problem.  Although I have read and heard about various IRS initiatives to identify S corps that pay unreasonably low wages to their stockholders, I have not seen the issue raised.  Now I have the feeling that the Watson case is a sign of things to come.  Perhaps if Mr. Watson had not been so aggressive in taking only $24,000 annual salary, which he admitted was insufficient to cover his basic living expenses, this would not be an issue.  However, with all the talk about taxing the "rich" this is certainly an easy way to do it.  After all, the people affected by this program are business owners, not employees.  The rich are such an easy target!

There is also a tax proposal before Congress that make earnings of professional service S corporations subject to self employment tax.  Even if this law is not enacted, the Watson case shows how the IRS can accomplish the same result.

What does this mean to you, the S corporation shareholder?  Take a look at your compensation structure, and be sure that your compensation is reasonable.  If it is low, document the reason.  Do you work part time?  Is the business unprofitable?  Are you reinvesting the profits in the business?  How do the amount of dividend distributions compare to shareholder compensation?  Think about these things and talk to your tax advisor today.  Don't wait until the IRS contacts you.

Time for a State Tax Checkup

Facing declining revenues and increasing budget shortfalls, many states have found a new way to raise significant money; through enforcement of existing tax laws.   From residency audits of individuals to collection of sales, income and payroll taxes from out of state businesses, if you are not complying with state tax laws, you are flirting with disaster.

In recent years, New York State has collected billions of tax dollars from people who maintained a residence in New York but claimed to be a resident of another state (often Florida).  If you maintain a residence in New York and enter the state more than 182 days, you are a New York resident, and subject to all its tax laws.  Maintaining a residence can be owning or renting, and entering the state can be going to work; you do not have to spend the night or even visit the residence.  If you do spend the night, it automatically counts as two days, the first is the day you go to sleep and the second is the day you wake up.  If you have a house anywhere in New York State work in Manhattan every day, you are a New York resident who is subject to New York State income tax, because you maintain living quarters and enter the state more than 182 days during the year.

There is also bad news for New Jersey people who claim residency in another state - the New York State Tax Commissioner who did all this good work has just started working for Governor Christie, so get ready for a lot of residency audits.  Do you spend the winter in Florida and keep your house in New Jersey, but claim to be a Florida resident?  If you do, must keep records and documentation to prove where you are each and every day of the year.

As bad as it may be for individuals, the potential ramifications are much worse for business.  Let's say you have a business in New Jersey, and your customers are all located in the state.  Your business sells something, say household appliances.  One day you get a call from someone in New York City who wants to buy a washing machine.  You sell him the washing machine, deliver it to his location, remove the old washing machine, and install the new one.  And by the way, since you are a New Jersey company and not registered for New York tax, you don't bother collecting New York Sales Tax.  He is so happy to save 8.8% sales tax, he tells all his friends, and before you know it you are making deliveries every week.  You also forget to tell your CPA about the New York sales.  Several years go by, and you get a notice from New York.  What taxes are you liable for?  New York State and City income taxes, payroll taxes, and sales taxes, and if your business is a partnership or LLC taxed as a partnership, the partners are liable for New York nonresident personal income tax as well.

In these situations, sales tax is often the biggest problem, the one that may put you out of business.  Even though you did not collect sales tax, you are still responsible for remitting it for all taxable sales.  With the addition of penalties and interest, the liability can be staggering.

One more thing that often suprises business owners is use tax.  If you purchase a taxable goods or services and the seller does not collect sales tax, you are required to voluntarily remit the tax to the State.  If you are audited by the State and the auditor identifies purchases on which you should have paid sales tax but did not, you will be required to pay the tax, plus penalties and interest.  The fact that the seller should have collected  tax but did not will not relieve you of this liability.

The consequences of noncompliance with State tax laws can be devastating to a business.   Now is the time to conduct a review of your business operations to identify and deal with State tax compliance issues.