This and That

Some stuff to think about:

A great estate planning opportunity expires on December 31, 2012.  Time is growing short, but if you can get it done before that date, you can transfer $5 million, completely free of federal estate or gift tax.  A bit of planning is involved, so this is not something that can be done overnight.  If you want to take advantage, contact your CPA or estate planning attorney immediately.  Even if you decide to do nothing, it is a good idea to review your estate plan every few years.


If you don't have a buy-sell agreement, or if you have one and have not reviewed it for a few years, now is the time.  Do you even know what your buy-sell agreement says?  When you review it and have to decide if it is fair, ask yourself if you would rather be a buyer or a seller.  The fact is, you don't know which you will be, so it should be fair to all parties.  Maybe you can even kill two birds with one stone, that is, do your estate planning in conjunction with your buy-sell agreement, and think about using the $5 million exemption to gift some business ownership to the next generation.


For those of you who are "too busy to do planning," you are planning, except your plan is to pay a ton more estate tax than you have to, and to let a judge decide how much your or your partners' business interests are worth.  That is definitely a plan, but probably not a good one.


The IRS is getting a lot more aggressive in assessing penalties, and I mean serious penalties like the accuracy related penalty.  We see these assessments more frequently, and they often appear to be arbitrarily based on the IRS' perception of the amount of tax underpayment, whether or not it is correct.  Whether you are a business or individual taxpayer, it is important that you are able to support your tax return income and deductions with documentation.  If you need help getting organized, call us.  We can help you.


In case nobody noticed, states need more money.  They get more money by collecting more tax.  They are on the lookout for businesses that operate in a state and don't pay taxes to that state.  If you enter a foreign state to make a delivery, a service call, provide customer training, or do practically anything else, your business is subject to tax in that state.  If you don't file tax returns and get caught later, it will be really ugly.  And the thing is, if you do it correctly you will not pay tax on the same income twice, but if you don't file and get caught later, you will, plus a lot of penalties and interest.  If you have questions about this, call us.


My daughter is leaving for college in two weeks.  After 18 years, this is really scary (for me).  I'm happy that she is doing well and has a great future, but I am going to miss her a lot.


I enjoy photography, and will include pictures from time to time.  I took this one in Grover Cleveland Park in Caldwell, NJ.  Click on it to view a larger version.

Tax the Rich

The new health care law includes many provisions to "tax the wealthy," that is those of us whose annual income exceeds $250,000.  Perhaps $250,000 of income makes you wealthy in some parts of America, but certainly not in the New York City metropolitan area.  Many of us work hard to earn whatever we do, often working 60 or more hours per week and taking many business risks.

What do we do with all this excess wealth?  Most of us send two or more children to college, and often help them with graduate school.  Of course we do all this without financial aid, because, after all, we are the wealthy.  We live in moderate homes, make our mortgage and property tax payments (which are among the highest in the country), without default.  In New Jersey, we also pay the highest state taxes in the country.  Those of us who are self employed pay our own health insurance, and of course we have the discipline to save for retirement because we don't expect any help when we retire.  And all this is after we pay federal income, social security, and medicare tax.

Oh, I forgot the best part.  We own businesses, provide jobs and provide health insurance to our employees.  But we have to be careful, because if the health insurance we provide is too good, it is also subject to tax.  The new law even contains a provision that provides for an additional tax on investment income.  For as long as I can remember, I've been hearing about how bad the savings rate is in the United States.  If this additional tax doesn't discourage savings, nothing will.

I do not disagree that all Americans should have access to affordable health care, but exactly who is it that decided that Americans with $250,000 of annual gross income  are wealthy and should bear the majority of the costs of the health care plan?  I guess it was a politician, probably one that has not had to   work an honest job to support his family.

Obama Care & Your Business

I've been reading a lot about Obama Care, and thinking about how it will affect small business.  Basically, if your business has more than fifty full time employees, it is not good.  For the purposes of the Health Care Act, a full time employee is defined as one who works 30 hours per week.  And the testing period to determine how many full time employees a business has is the calendar year preceding the year to which the Act applies.  Since the insurance portion of the Act (Employer Shared Responsibility) is effective after 12/31/13, the 2013 calendar year is the testing period for 2014.  If you plan to rearrange your workforce to fall below the fifty full time employee threshold, you should start working on it now.  Since the test is based on annual averages, if you wait until the end of 2013 to address this issue, you will be too late.

The Act contains penalty provisions for businesses that fail to comply with the insurance requirements.  For businesses that do not comply, it appears that the penalty is $2,000 per employee, after the first thirty employees.  If your business has eighty full time employees who are not covered by health insurance, the penalty will be $100,000 per year.  I observe many business owners who say that they will pay the penalty rather than provide health insurance, but I don't know if that is a wise choice.  For federal tax purposes, penalties are not deductible expenses.  To decide if the penalty less costly than the insurance coverage, one must analyze and compare the after tax cost of each.

For businesses that are labor intensive and low margin, the health insurance requirement will be devastating.  It is unfortunate that President Obama has never run a business.   Perhaps if he had, he would understand what he has done.

S Corp Reasonable Comp Part II

In January, I wrote about a Tax Court case (David E. Watson, P.C.) which held that the wages paid to a CPA by his 100% owned S corporation were unreasonably low, and that the difference between these wages and the amount determined by the Tax Court to be reasonable compensation constituted wages subject to FICA tax.   In addition to the tax liability, the CPA was assessed penalties and interest.  The CPA appealed the Tax Court decision to the US Court of Appeals for the Eight Circuit, which upheld the lower court ruling in favor of the Internal Revenue Service.

In making its ruling, the Court of Appeals found that Mr. Watson was a well qualified and experienced accountant working in a reputable and well-established firm, and that the nominal salary paid to him was unreasonably low in comparison to what a reasonable person in his role would have expected to earn.  Further, the Court held that the S corporation "dividend" paid to Mr. Watson was compensation for services paid to him as an employee/shareholder, rather than a distribution of the corporation's earnings and profits.  In this case, Mr. Watson received $24,000 of annual wages.  During the two years at issue, he received dividend distributions of approximately $203,000 and $175,000.

Many S corporation shareholders employ the same technique, that is, they take relatively low salary and large dividend distributions.  In order for this to have any chance of success against an IRS challenge, the wages received must be reasonable in comparison industry standards and services provided, and in relation to the dividends paid.  In any event, your case will be strengthened by contemporaneous written documentation of how and why the compensation was determined.  In Mr. Watson's case, $91,000 was determined to be reasonable compensation.  If his actual salary were not so very low, maybe $52,000 instead of $24,000, perhaps the IRS would not have even made an issue of it.  Proper planning and documentation are the key to all successful tax positions.

Please contact me if you would like a copy of the Watson case, or have any comments or questions.

Does Your Business Have an Effective Buy-Sell Agreement?

Buy-sell agreements are among the most important yet most often overlooked business agreements.  If you are a business owner or partner and are suddenly unable to work, what would happen to your business?  If the business has an effective buy-sell agreement, then you should not have to worry.

What is an effective buy-sell agreement?  It is an agreement that is clearly written and yields results that are fair to the buyer and the seller.  In working with closely held business owners as an advisor, and in working with attorneys as a business valuation professional and expert witness, I have seen the best and the worst of buy-sell agreements, and the results that they bring.

A bad but all too frequently used buy-sell provision calls for the buyer and seller to each have a valuation of the business interest performed, and if the two valuations do not agree, a third appraiser is agreed upon and hired to perform a binding valuation.  Are you surprised to know that the first two valuations never agree, and it is always necessary to have a third one done?  And for this process, you have paid for three appraisals, when only one was necessary.  Furthermore, if the process is at all contentious, agreement on the third business appraiser is also very difficult.  I was involved in a three appraiser dispute, and the legal and professional fees paid were more than two times the amount paid for the retiring partner's interest.  What is the solution to these problems?  Change the agreement now to require only one appraisal, and specify in the agreement who (or what firm) will perform that appraisal.

Another buy-sell provision that will often produce disastrous results is one that values the business based on a formula, such as a multiple of something such as sales, net income, or book value.  Although the formula may have made sense when it was written, business conditions change, and the formula result may no longer be fair.

We recently helped a client where one of the owners became ill and passed away within one year of diagnosis.  Although I had tried to get the business owners to address buy-sell issues for a number of years, they refused to focus on it until the illness was diagnosed.  In this case, the owners were fair minded and reached an agreement that was equitable to all the parties.  But this is the exception rather than the rule.  If you wait until a triggering event such as disability or death to start negotiating the buy-sell agreement, it is very difficult to reach an agreement.

A fair buy-sell agreement is one in which no one is overpaid and no one is underpaid, and the payment structure does not place an unfair burden on the business.  Although buy-sell agreements are frequently funded with life insurance, what is the funding mechanism if the seller is disabled and does not pass away?  Can the business afford to make the required payments without the benefit of life insurance proceeds?

Do yourself a favor.  Get out your buy-sell agreement and read it.  If the price specified by the agreement is formula based, ask your CPA to use the formula to calculate the price for the business? Keeping in mind that you don't know if you will be a buyer or a seller, are you happy with the result?  Is the agreement structured in a way that will minimize income taxes for both parties?  If the answer to either question is no, it is time for a new agreement.

As always, we welcome your comments and thoughts, requests for additional information, and suggestions for new topics.