IRS Changing Its Focus

No more Mr. Nice Guy! Not that the Internal Revenue Service was ever quite that, in spite of the agency's claims that it was becoming "kinder and gentler" and more oriented to serving its customers. But now the gloves are officially off. According to IRS Commissioner Mark Everson, the government's chief revenue collection agency has turned its primary focus from taxpayer service to enforcement. Audits are on the rise, aggressive tax positions are under increased scrutiny, and the agency is studying possible new ways of ensuring compliance with revenue laws.

Did you know that the so-called "tax gap," which is the difference between taxes owed and taxes collected, was bigger in 2005 than the entire Federal budget deficit? We didn't either, until Commissioner Everson announced that fact at a Nationwide Tax Forum in Atlanta this year and we read about it in a trade journal. The same goes for another interesting statistic: the Federal government collected $2.4 trillion overall, and the IRS brought in $2.3 trillion of the total.

With those tidbits in mind, it's small wonder that the IRS is putting more and more effort on enforcement! The Commissioner further noted that only one percent of wage earners whose income and withheld taxes are reported to the IRS on Form W-2 don't report their earned income. However, half of business owners fail to do so. The way he plans to change that second situation gives us a glimpse into what the IRS is planning for its "customers."

Mr. Everson believes that third-party reporting is a key factor in ensuring that everyone reports all of their income. Remember when your dependents didn't need social security numbers? Once the IRS started requiring dependents to have those numbers and to put them on tax returns, something like five million dependency exemptions vanished overnight. Mr. Everson wants to see credit card companies report businesses' gross revenues collected through their systems to the IRS. Next up may include forcing banks to report the deposits their business customers make. Yikes!

On average, taxpayers are audited twice as frequently as in recent years. Nonfilers' returns get audited when they are finally filed simply because the IRS has classified those taxpayers as nonfilers. People who earn more than $100,000 per year have also been targeted for examinations at an increased rate.

And if you operate a charity, your organization isn't "exempt" when it comes to IRS scrutiny. In 2005, they audited more than 50 percent of nonprofit credit counseling companies. The IRS is also very concerned about exempt-organization officers' and executives' perks, and what it considers excessive compensation.

Also, no charity wants to be found donating to a political campaign or endorsing a candidate for public office: a single incident could cost the nonprofit its income tax exemption. Individual officers, directors, volunteers, etc. can donate to any cause or candidate they want to, but the organization itself is prohibited from doing so.
The same goes for the states. They are all watching their Federal counterpart closely, following its philosophy and methods, and sharing information with the IRS and among themselves. Have you ever heard of an organization named the Multistate Tax Commission? We deal with it frequently. This is a coalition of states that are parties to an agreement to promote information-sharing, uniformity among and compliance (surprise!!) with their own various revenue laws.

We urge all of our clients to keep good records and to give us accurate and complete information when we report anything to the IRS, be it on a tax return, a financial statement submitted to IRS in a collections matter, or any other contact with the Feds' top bill collector. Ask us if you would like more information or have questions.
 

Au Pairs and Federal Taxes

The French term means "on par," and refers to a temporary boarder in the home of a host family. It is actually a narrowly defined technical phrase, and more specifically means someone between the ages of 18 and 26 who comes to the United States on a J-1 visa under a program administered by the U.S. Bureau of Economic and Cultural Affairs.

They cannot stay in the U.S. for more than one year, and their wages are set by the Department of Labor. They stay with host families that certain sponsoring organizations select, and the families provide a wage tied to the current hourly minimum and other benefits, in exchange for providing child care. Au pairs are also required to enroll at a post-secondary educational institution for a certain number of semester hours.

You may or may not be required to withhold FICA taxes from the au pair's wages. It depends on how he or she is classified: you need to withhold FICA from a resident alien's wages but not from a nonresident's. You can find more details on making the distinction in IRS Publication 926. Most, but not all, au pairs are nonresidents.
If you are required to withhold FICA, you'll need to get Form SS-4, either the online or paper version, and apply for an employer ID number. You'll also need to file Form W-2 and add Schedule H to your personal tax return, aka the 1040.

You won't need to withhold Federal income tax from the au pair's wages, because domestic employers aren't required to do so. But it's a good idea to check with your state, because it doesn't necessarily follow that a state will treat domestic wages the same way the IRS does.

If the au pair is considered a nonresident alien, you won't need to pay Federal unemployment tax (which is never withheld) from the wages you pay, but you will be liable for this tax on wages you pay to a resident alien if the wages exceed a certain threshold amount during any calendar quarter, or during the most recent calendar year. You also report and pay this tax on Schedule H. Remember to also check with your state about its unemployment taxes. The same caveat applies to state unemployment taxes as to income tax withholding.
From the au pair's perspective, simply because income tax withholding isn't required doesn't mean the wages do not need to be included in the au pair's U.S. gross income, and au pairs do need to file U.S. income tax returns. The au pair can pay his or her own estimated taxes, or request that you withhold U.S. income tax from his or her wages. We can also help your au pair deal with his or her obligations in this area... call or e-mail us anytime.

Money Sense
Honest Discussions Now Prevent Problems Later!

It’s a fairly well known fact that money and marriage often don’t mix. In fact, finances and relationships is such a hot topic that NBC’s Today show recently did a series on "Money for Women." And with good cause: according to the Association of Bridal Consultants, money is the biggest cause of spats during the first year of marriage!

As a tax specialist for more than 25 years, I have spent a lot of time on divorce consulting (alimony and child support, property settlements and tax issues), and have discovered that a lot of couples’ money problems could have been avoided if they had talked about their financial attitudes and values before tying the knot!

So, if you’re single, divorced or separated, here are some important issues to consider and discuss during the dating process:

Financial values are relatively permanent personal beliefs about what's important or desirable. Values tend to reflect upbringing and don't generally change without conscious and concerted effort. For example, faith is very important to some people and impacts their relationship to money, while education or business success might mean more to others. Examine your own money values and those of your partner.

• Financial attitudes are opinions that follow from values, and are more flexible. For example, you may place a high value on raising children, and have a positive attitude about giving them the best opportunities in life with a degree from a four-year university. Ask how your partner feels about those issues.
• Financial goals: Money is a finite resource (for most of us, anyway!) and must be allocated among various goals. Some questions to discuss are:
   • What are you willing to give up to reach a particular goal?
   • How hard are you willing to work for it?
   • How can you learn about and respect the goals of a potential partner?
• Simple observation goes a long way. What does a potential partner say about money when the subject comes up? What kind of lifestyle does he or she lead? Does he or she "come from money"? Does he or she always seem to be broke by payday? Does he or she seem controlling about finances? Secretive or evasive? Open to discussion?
• Quizzes to aid in self-analysis, e.g. what would you do with an unexpected $1,500 "windfall"? If you won the lottery, what would you do with the money? If you had to cut your current spending in a major way, what would you cut first? Finish the following sentence: "Buying on credit is _________."
• Consider the pros and cons of a prenuptial agreement. There are more pros than you might think, such as:
   • Avoiding litigation costs in the event of death or divorce
   • Dispelling fears of family members (such as children from a former marriage)
   • Protecting family and business assets from interference by former spouses
   • Protecting assets against creditors
   • Settling the disposition of marital property in advance
• Look at what you would do jointly if there were too much month at the end of the money. How would you prioritize debts to free up money to pay them down gradually?
• What are your real needs versus your wants?

What to Do if You Haven’t Been Filing Your Taxes

Of course you’ve meant to file your tax returns, but somehow you kept putting it off – maybe for a year or two – maybe a lot longer! Now the IRS is demanding those tax returns. What should you do?

If you or your business hasn't filed all of its tax returns, the first step should be hiring a competent tax professional. A good tax advisor will explain the possible consequences of nonfiling and should recommend that you hire a tax attorney, as willful failure to file required returns is technically a Federal crime.

It's possible to use a non-attorney tax advisor alone: just be forewarned that the so-called accountant-client privilege is so narrowly applied as to be nonexistent for practical purposes, and if the IRS does begin a criminal investigation, your accountant could be compelled to testify against you. However, criminal handling of nonfiler cases is labor-intensive and expensive for the IRS, and while there is no guarantee your case won't be referred for criminal action, if your income is all from legal sources and you come forward voluntarily to file the missing returns, it is less likely you'll wind up in that boat.

The IRS analyzes cases from a cost-versus-potential-benefit standpoint, just as you do for your business or yourself when you're considering changing the way you normally operate. If it doesn’t see evidence that many more dollars will result from a criminal investigation than from keeping matters on the civil (literally) side of the fence, the IRS generally tends to act in its own best interest.

Once you get up-to-date on your tax returns, work with your tax professional to ensure that you stay in control of your finances and begin to build a more secure future.

Not in My Shop!
A Primer on Small Business and Fraud,
and How to Help Prevent It

Fraud is the kind of disease that everyone thinks only other businesses catch. It's widely assumed that only big businesses such as Enron are vulnerable. And it's precisely that sort of illusory security that leads to complacency, even among veteran owners of successful small businesses. Perhaps especially there...we all tend to be more careful when we're just starting out, and everything is new and unfamiliar.

After all, we entrepreneurs are in business to make a living doing something we love. The lifeblood of any business is of course its cash, and a business' stock in trade, aka its merchandise inventory, is also a prime target for those whose intentions are less than honest. So are customer lists and specialized knowledge. There are other varieties of fraud that can affect any business, small, medium or large, including financial statement fraud, which is committed by management rather than rank-and-file employees. In a nutshell, the latter brand of fraud is what the Enron case was all about. But the little guys do it too, for example when they stretch the truth on a bank loan application or want to sell a business.

In this article, we'll outline some of the most frequently encountered species of fraud, and offer some tips on prevention and detection. Please keep in mind that this list is far from all-inclusive; but then, we aren't setting out to make instant experts of anyone. Our goal is to raise small business owners' awareness of the existence and the nature of fraud, and thereby hopefully to reduce the chance that it will happen to them.

If the motivation and opportunity to commit fraud exist, and if someone can justify his deeds to himself - the three legs of the so-called "fraud triangle" - the odds go up that fraud will take place.

The last factor, also called rationalization, points to a lack of integrity on the part of the perpetrator of a fraud. We cannot overemphasize that in all businesses, whatever their size, the ethical "tone" starts at the top. Have you ever noticed how certain businesses with a less than enviable reputation tend to be run by people of the same stripe? It's no coincidence. Fortunately, though, that same principle also works in reverse: if the owners are ethical and honest, define clearly to everyone in the business what honest and dishonest behavior are, and make it plain that breaking the rules won't be tolerated, tend to have fewer problems with fraud.

Cash is obviously the business asset that's most open to being fraudulently taken. The term "cash" here includes both currency and checks. Cash is portable, available, and can be used anywhere. The temptation is all around, all the more so in businesses that handle a lot of currency. People generally take cash fraudulently from a business according to one of two schemes: skimming and larceny. Skimming refers to the taking of cash before it is recorded on a business' books, while larceny means that the taking occurs after the cash is in the system. That's the only difference between the two. The result is naturally the same.

Skimming can involve either the outright taking of cash or of money due to the business (accounts receivable). Because the money never makes it onto the company's books, there is no audit trail, and thus it is often very difficult to detect. Dishonest salesmen, waiters, cashiers, anyone who receives cash from customers, can simply fail to record the sale and keep the cash, or change the payee on a check and deposit it in his own account.

Some examples of larceny are taking money from a cash register after it's already there; posting checks to the system as they are received, then stealing the checks; preparing a bank deposit but stealing some of the cash or checks listed. Larceny is more difficult to conceal than skimming, because something is going to be out of balance due to the missing money. The register tape won't show the same amount of cash that's in the drawer, accounts receivable will show payments coming in that the cash account doesn't indicate, or the bank statement won't show the same amount as the deposit slip. People who commit larceny often don't even try to hide the theft; they manage to convince themselves that they aren't actually committing a crime, but "borrowing" the money, or that they are somehow entitled to it.

Here are a few prescriptions for the prevention of skimming and larceny schemes...

• The owners need to communicate with employees, making sure everyone understands that cash controls don't imply mistrust, but are simply good business practice; ask for employees' input and give them time to learn how to handle anything new.
• To the extent possible, segregate cash handling duties: for example, the same person who opens the mail and receives cash and checks shouldn't also post payments to the system; the person who prepares the bank deposits shouldn't also reconcile the account. If there aren't enough employees to permit such segregation, the owner should check everyone's work regularly.
• Use pre-numbered cash receipts and account for all missing ones.
• Be sure cash is physically secure; don't leave it unattended or accessible to anyone.
• Perform periodic cash counts on a random basis and spot-examine bank deposit slips for anything that looks out of line.
• The owner should sign all checks personally.
• The bookkeeper should take a mandatory vacation.
• Be aware of employees who appear to be living beyond their means. It doesn't necessarily indicate dishonesty, but it's a possibility that it doesn't pay to ignore.
• Access to the accounting software should be password-protected, and change the password frequently.
• Consider fidelity bonds, and use background checks before you hire.
• Educate yourself...a business owner should understand how the accounting system works, and how to read and interpret financial statements, especially trends over time and relationships between certain figures.

(And by the way, don't forget to watch expense accounts and company credit card spending, and set spending limits....even if everyone is honest, money can be spent needlessly if people don't shop around.)

Once a business grows past the point where one person can do everything to run it, "sophomore slump" often sets in. It's difficult for entrepreneurs, who are used to being in complete control of their businesses, to delegate enough authority to employees to run the business for them. But all too often when that happens, the harried owner is stretched too thin to check things or pay attention to red flags, and the frauds that are committed in the presence of such opportunities can and do sink a business completely. Hire good people, communicate with them and delegate to them, but stay aware, and your company will be more resistant to the decay of fraud.

Rules for Tax-Exempt and Nonprofit Organizations

Often referred to as "nonprofits", the concept of charities and other organizations formed for purposes deemed worthy of exemption from taxation dates back to ancient times. Millennia ago, property belonging to religious institutions was considered by governments to belong to the gods, and therefore such institutions were excused from paying taxes that would otherwise be imposed on them. They were mentioned in Elizabethan English law at the beginning of the seventeenth century, and were exempted from Federal income taxes under United States law in the very first income tax law ever passed, in 1894. That act mentioned the relief of burdens that would otherwise be borne by government as the rationale for exemption, and this concept didn't appear to have even been debated because Congress seemed to consider it obvious on its face.

Nonprofits obviously perform useful functions, thus Congress wisely decided early on to encourage taxpayers to donate money and goods to them. This, of course, is the rationale for allowing donors to deduct the value of their donations on their own tax returns. More on that below.

Nonprofit versus Exempt
We use the terms "nonprofit" and "exempt organization" interchangeably in everyday speech, but the two are not precisely the same. Nonprofit status is a creature of state law, where states enact statutes to cover the formation and monitoring of corporations formed for other purposes than the enrichment of their owners.

Tax-exempt status, on the other hand, is a Federal concept, and refers to the IRS's recognition of the fact that the purpose for which an organization was formed entitles it to exemption from Federal income tax on its profits. "Nonprofits" and charities, other exempt entities, do make profits; it is what they do with those profits that form the basis for not having the usual range of income taxes imposed on them. If an entity is considered nonprofit under applicable state law, it is usually, but not always, also exempt from Federal income tax. In a nutshell, all tax-exempt organizations are nonprofits, but that isn't always the case the other way around.

There are several different types of tax-exempt organizations. What they all have in common is that they are organized under the rules of Internal Revenue Code Section 501(c). The best known is the 501(c)(3). These entities are "organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals". Donations to these organizations are generally tax-deductible to the giver, subject of course to a plethora of regulations and restrictions.

More about 501(c) organizations
However, there's more to Section 501(c). The IRS also provides for civic leagues, formed for the promotion of social welfare under Section 501(c)(4). Examples include the Lions Clubs; labor, agricultural or horticultural entities; business leagues and Chambers of Commerce; recreation clubs; fraternal lodges; voluntary employee beneficiary organizations, or VEBAs; domestic fraternal societies; teachers' retirement funds; some types of life insurance associations, irrigation companies, mutual or co-op telephone companies; cemetery companies; some credit unions, and certain insurance companies.

There are also several subtypes of 501(c)(3)s: public charities, private operating and nonoperating foundations, community foundations, supporting organizations, proprietary funds, and more. Each has its own advantages and disadvantages, and the distinctions among them are complex and technical (as is just about everything that has to do with tax law!).

Exempt organizations
Anyone can start and run an exempt organization. Generally, a person must first form a corporation under the laws of his state. The Articles of Incorporation must contain certain language to spell out the organization's exempt purpose, that is to say, the Articles must state the purpose for which the corporation was brought into existence, which reasons also entitle it to exemption from Federal income tax. The Articles must also, among other things, prevent so-called "private inurement", or the diversion of the entity's resources to any individual, and provide for distribution of its assets to another exempt organization qualified to receive them should the first entity dissolve.

Once the corporation is in existence, it must apply to IRS for exemption from Federal income tax. The process is exhaustive and generally expensive, but once the organization has secured a favorable determination, which is retroactive to the first day of the entity's existence, it can be very rewarding.

Then there are the annual reporting requirements. Most exempt organizations with gross annual revenues over a certain amount must file an information return with the IRS every year, which is public record. Filing annual returns is strongly recommended even if not demanded on the basis of gross revenues. It starts the running of the statute of limitations, tends to increase the comfort level of donors who research the organization before making a gift, and makes the entity's state filing easier. The states impose their own requirements, which are independent of their Federal counterparts, and if the charity's figures are already organized and presented in information-return format, very often a simple copy of the Federal return will also suffice for the state.

Of course, there are also charities that are simply not required to file an annual return at all. Examples are churches and those organizations that are subordinate units of a parent entity that files a group return. There are also several other types of tax-exempts in this category.

What if the IRS denies your request?
What happens if IRS denies an organization's request for exemption? If the IRS issues an adverse determination, the organization is treated as taxable, retroactive also to its first day, and must file Form 1120 like any other corporation for any year for which the three-year statute of limitations has not expired. Administrative appeal rights are available, and if the entity exhausts its administrative options, it can seek judicial relief in court.

The same rights and procedures apply if the IRS revokes or modifies the organization's exemption. This can happen for any one or more of a number of reasons, and the effective dates differ according to the circumstances. The main reasons for revocation include a change in the organization's conduct of its activities from a way that is consistent with its exempt purpose to one that is not; operating in a manner significantly different from that stated in the application for exemption, omitting a material fact or making a material misstatement on the application, or engaging in a prohibited act. Revocation of exemption also affects contributors to the organization. This is an area where competent professional advice is absolutely vital.

In summary, it takes a lot of work to obtain an exemption and maintain a tax-exempt organization, but it's one of the best ways to truly help other people. Many of our clients have reacted to tragic losses in their lives by forming a charity to fund medical research or to help similarly afflicted people. Out of great grief grows love for other human beings, and real practical help that might not have been available otherwise. Another client, a physician, operates a teaching and wellness medical clinic, which helps to train future physicians and treats the sick without regard to ability to pay. Still another runs a virtual animal shelter, with a network of volunteer foster care providers. They hold adoption events to find homes for animals that would otherwise die untimely deaths. We salute them all and support their good efforts personally and professionally.

Preparation is Key to Fulfilling Retirement Dreams

Endless rounds of golf, moving to a warmer climate, family visits, taking trips whenever the urge strikes ... that’s often part of our retirement dreams. But there’s also the reality of the financial decisions you need to make before you retire. Here’s a checklist to get you started:
 

• Check your financial resources and debts. How much will you need to live on each month?
• Do you have at least two years’ worth of living expenses set aside in lower-risk, liquid investments such as money market funds or shorter-maturity bond funds?
• At what point can you afford to stop working?
• How much can you draw each month while minimizing the risk that you’ll outlive your money?
• If you’re like most of us, your investments probably include several different types, with varying liquidity, rates of return, and tax consequences on withdrawal. How will you ensure that you don’t pay more taxes than you need to?
• When should you start taking Social Security? What benefit options should you choose?
• If you keep on working after you start receiving Social Security, will your benefits be affected?
• When will you be required to start taking pension or IRA distributions? What will happen to your taxes?
• Four documents everyone should have are: a durable power of attorney; a living will; a durable health care power of attorney; and a last will and testament. Of course, everybody should have them no matter how old they are, but they grow more important with the advancing years. Good legal advice is important. Have you reviewed your “big four” lately?

We can help you set up your dream retirement and make smart choices about taxes. We’ll also work with your own advisors, or our colleagues, to help you make the transition from working to retirement as smooth as possible. Give us a call!

What Form Does My Business Need to File?

When you start a business, one of the first hurdles you’ll face is figuring out which forms you need to file. Naturally, the government wants its share of your profits, and the complexities of reporting them are many.

• C corporations must file income tax returns, whether or not they have taxable income, unless they are nonprofits to which the IRS has granted an exemption. Domestic corporations generally file Form 1120, or Form 1120-A if they qualify.
   
• S corporations are corporations that have made a valid “S” election. They file Form 1120S once the election is in effect.
• Limited liability companies, or LLCs, generally don’t file their own returns if they have only one owner. These are called “disregarded entities”, and usually file Schedule C as part of the owner’s individual return. If the LLC has more than one owner, they file Form 1065, as do partnerships. However, if the LLC has elected to be taxed as a corporation, it will file Form 1120 or 1120-A.
• General and limited partnerships file Form 1065.
• Special types of organizations: Foreign corporations use Form 1120-F, unless they meet one of the exceptions or a special return is required; foreign sales corporations use Form 1120-FSC; homeowners’ associations file Form 1120-FSC; Form 1120-L is used by life insurance companies, and Form 1120-POL for political organizations (whether or not they are tax-exempt); most nonprofits will file Form 990, 990-EZ, or 990-T; property and casualty insurance companies use Form 1120-PC; real estate investment trusts use Form 1120-REIT; Form 1120-RIC is used by regulated investment companies, and farming cooperatives file Form 990-C.

Most of the kinds of organizations in the last section above won’t apply to our readers, but we encourage and welcome your questions.

Of course, state reporting requirements vary ... check with us for details on your state (or states). We can help not only with reporting, but also with planning to ensure that your business stays out of trouble with states to which it may not be aware that it owes a return or a tax. And naturally, we can prepare the returns you might need. We wish you the best of success in your business!

Win Any Prizes Lately?

Congratulations! Now guess what...your winnings are taxable income to you! It’s the same as if you had a gain from any other source, and bought the prize with it. It doesn’t matter whether the prize is actual money or something else.

It pays to be aware that organizations that award prizes will often inflate the value of the prize to increase their own tax deduction. If you receive a Form 1099 with a value that looks excessive to you, shop around and ask vendors at what price they sell the same merchandise. Ask vendors for a letter to confirm the value, or save copies of advertisements. If your return is audited and the prize value questioned, you’re entitled to report the income at the lowest price at which you could have purchased the prize item.

New Designation for Tax Expert

Catherine Nazarene has attained the credential of Accredited Tax Advisor^SM that is awarded by the Accreditation Council of Accountancy and Taxation (ACAT).

ACAT issues the designation to tax professionals who demonstrate a high level of knowledge, experience and ethical standards in their work, along with a lifetime commitment to continuing education. Candidates must have at least five years of experience in tax planning or consulting, and have earned at least 48 credit hours in tax education during the past two years. Once accredited, professionals are required to earn at least 40 tax education credit hours every two years.

“I’ve always been committed to learning,” says Ms. Nazarene. “Mastering tax laws is like trying to nail gelatin to a wall…it’s a moving target and a constant job to stay on top of it and make the laws work to the benefit of our clients. But I love the challenge!” she added.

Disclaimer

These articles are not intended as professional tax advice, and we cannot accept responsibility for your use of this information. For specific advice tailored to your situation, please contact the Catherine Ditman Group at the numbers below.