MANAGE YOUR BUSINESS WITH A FEW NUMBERS
Regardless of the type of business you’re running – whether it’s
selling electronics, making furniture, or servicing automobiles -
monitoring a few key financial indicators is often all that’s needed
to keep your company growing and prosperous.

A BANK LINE OF CREDIT: WHEN DOES IT MAKE SENSE TO USE ONE?
Just exactly what is a bank line of credit and who should be using one?
A bank line of credit is not a great deal different from a credit card.
You make draws against your line of credit from time to time as you need
cash.

PRIOR LAW CHANGES 2013 TAX RULES
A number of provisions in the 2010 health care reform legislation go into
effect this year. Here are some of the changes that could affect you.

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The new Internal Revenue Code Section 1411 defines and applies the 3.8 percent tax on unearned income for high-income individuals (listed above); in addition to a new 0.9 percent Medicare tax on earned income. The combination of these two new taxes is estimated to raise $317.7 billion over the next 10 years.

The surtax on individuals equals 3.8 percent of the lesser of 1) net investment income or 2) the excess if any of the individualʼs adjusted gross income (AGI) for the tax year over the threshold income levels listed above. One of our clients, a married couple, has salaries of $225,000 and about $90,000 of investment income and rental income. The extra 3.8 percent tax in 2013 is approximately $2,500. We are suggesting moving a portion of their investments into tax-free municipal bonds versus taxable bonds, in addition to raising their 401-K contributions so they can minimize this surtax.

Types of Income Excluded

Recently the IRS and Treasury issued proposed regulations which precisely define what is subject to the 3.8 percent tax. It does not include Social Security income, tax-exempt interest, retirement income, alimony, or any item taken into account in determining selfemployment income for the tax year. Also excluded are distributions from pensions, profit-sharing plans, a 403(b) tax-sheltered annuity, any other kind of qualified annuity (held inside a retirement account), IRAs, Roth IRAs and 457(b) plans. However, be aware that the distribution from retirement plans might push oneʼs AGI over the threshold to make the investment income subject to the surtax. Also, it excludes income from a trade or business in which the taxpayer actively wor ks in. S corporation distributions escape both the 3.8 percent Medicare tax and the 0.9 percent Medicare tax on earned income as long as the taxpayer is an active participant in the business (if ownership is passive, all partnership, LLC or S corporation income would be classified as passive investment income and subject to the surtax). For example, a client who owns and operates nursing homes in a Florida S corporation but does not materially participate in the business will be subject to the Medicare surtax. Gain on a sale of a partnership, LLC or S Corporation interest in which there was a material participation by the taxpayer at the time of sale is not subject to the surtax.

Gains that are not recognized for income tax purposes in a particular year are not subject to the surtax, including: (1) installment sales (2) tax-free exchanges; (3) involuntary conversions; and (4) excludable gain ($250,000/$500,000) on the sale of principal residence.

One concern receiving a lot of attention lately has been the application of the 3.8 percent surtax on gains from the sale of a residence. Any capital gain that is otherwise subject to income tax on the sale of a principal residence would also be subject to the surtax. Investing in life insurance is definitely an easy way to avoid the tax. All growth in a life policy is tax deferred if designed properly. Income withdrawn is not taxable as long as it does not exceed your investment. Any withdrawals beyond your investment can be taken out in the form of loans which are non-taxable. In addition, borrowing from a life insurance policy can help prevent being subjected to any income or Medicare surtax.

Proper Planning is Key

Net capital gains from investment accounts are perhaps the most common type of income subject to the surtax. In that regard, it is important to note that short-term or long-term gains are subject to the same 3.8 percent surtax, irrespective of the ordinary income rate applied to short term gains or the lower rate applied to long-term capital gain. Year end capital gain harvesting has never been more important given the recent increase in the capital gain rate plus this Medicare surtax. Basically, anyone in these income levels should consider planning opportunities very carefully in order to minimize the impact of this new tax along with all the other recent changes in income taxes that have gone into effect.

For more information, please contact Bradford Hall, CPA at 949.910.4255 or bh@hallcpas.com.

Mike Song, CPA

Song brings with him over 18 years of audit experience in private and publicly held companies in industries including manufacturing, distribution, technology and retail. Prior to joining the firm, Song was a partner at PK LLP and previously worked at Grant Thornton and PriceWaterhouseCoopers.

He was also the Director of Operations of a privately owned company. Song is a member of the American Institute of Certified Public Accountants and the California Society of CPAs.

Priscilla Bintoro-Yean, CPA joins the firm as a Tax and Accounting Manager. She has over 13 years of public accounting experience. Her expertise includes preparing tax returns for individuals, corporations, partnerships, trusts and nonprofits; compiling, reviewing and auditing financial statements; pension audits, and all aspects of accounting, etc. Before joining Hall & Company, Bintoro-Yean was a manager at Martin Werbelow in Pasadena.

She has also worked for Squar Milner in Los Angeles. With more than 250 years of collective experience in the field of public accounting, Hall & Company CPAs & Consultants offers professional services that assist businesses and individuals with all their accounting, tax and financial concerns.

Because Republicans and Democrats were unable to agree on how to pay for the extended tax cut, the law included no spending cuts to offset the estimated $93 billion cost of this provision.

The law also provides for long-term federal unemployment benefits, setting the maximum at 73 weeks in states with the worst unemployment and 63 weeks for other states.

Another provision in the law includes the so-called “doc fix” that prevents a scheduled 27% reduction in Medicare payments to doctors.

The unemployment benefits and doctor payments will be paid for by government sales of broadband spectrum, requiring federal workers hired after this year to contribute more to their pensions, and cuts in certain health programs.

© copyright – Mostad & Christensen, Inc.

Under the 2011 Offshore Voluntary Disclosure Initiative (OVDI), the penalty framework required individuals to pay 25-percent of the amount in the foreign bank account in the year with the highest aggregate account balance covering the 2003 to 2010 period. The IRS also created a new penalty category of 12.5-percent for “small offshore accounts.” Taxpayers whose offshore accounts or assets were less than $75,000 in any calendar year covered by the OVDI qualified for this lower rate. In addition, some taxpayers qualified for a 5-percent penalty, including taxpayers who did not open the foreign account, or cause the account to be opened, if additional requirements were met; and foreign residents who were unaware that they were U.S. citizens.

The overall penalty structure for the new program is the same as that for the 2011 program, except for taxpayers in the highest penalty category. For OVDP, the penalty framework requires individuals to pay a penalty of 27.5 percent of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the eight full tax years prior to the disclosure. Some taxpayers will be eligible for 5-percent or 12.5-percent penalties; these remain the same in the new program as in 2011. Participants must file all original and amended tax returns and include payment for back-taxes and interest for up to eight years, as well as pay accuracy-related and/or delinquency penalties. Taxpayers who have come forward to make voluntary disclosures since the 2011 program closed will be treated under the provisions of the new OVDP.

The OVDP can be a significant benefit to affected taxpayers. Penalties outside the program can be onerous and can include, among others: penalties for failing to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR); civil penalties; penalties for failing to file a return; and accuracy related penalties. In addition, criminal prosecution may be a risk.

Be well informed in this area if you have foreign accounts.

Employers need to exercise great caution in doing so, since employers who misclassify employees as independent contractors may find themselves liable for paying workers’ compensation benefits out of their own pockets, paying employment taxes, or providing retroactive benefits, such as vacation pay and retirement plan contributions to a misclassified worker, together with hefty penalties and interest payments. In an extreme case, if an employee suffers a workplace injury while the employer is uninsured for workers’ compensation (for example, because the employer has classified its entire staff as independent contractors and has no workers’ compensation coverage), the employer can be fined up to $100,000. The owners of the company can be held personally liable for this fine, together with any workers’ compensation benefits paid to the injured worker, even if the employer is a corporation. It is important to remember that in any California workers’ compensation action, the worker is legally presumed to be an employee and the employer has the evidentiary burden of proving that the worker meets the legal requirements for independent contractors.

Unfortunately, there is no single, clear-cut test to determine whether a worker is an independent contractor or an employee. Although California applies its own test, it is still useful to refer to the IRS’ list of 20 factors to determine a worker’s status, which is available in IRS Publication 15-A, Employer’s Supplemental Tax Guide on the IRS Web site at www.irs.gov. While no single factor is determinative, according to the IRS, the following are characteristics of independent contractors: setting their own work hours; furnishing their own tools; not receiving training from the hiring firm; working for more than one firm at a time; being paid by the job rather than by the hour; not providing progress reports; making their services available to the general public; and paying for their own business and travel expenses. California also places emphasis on whether a worker has a substantial investment in his or her business and has a legitimate opportunity to make a profit (or loss) from the operation of the business based upon his or her skills. The level of control over the worker’s activities, i.e., who exercises it and how, is a key factor.

The bottom line is that the test for establishing whether a worker is an employee or independent contractor under California law is complicated. Senate Bill 459 does not contain language in how to establish a safe harbor in deciding who qualifies for independent status. Therefore, California businesses are left in the dark on this and must look at each worker on a case by case basis. You could also review the topic on the California websitehttp://www.dir.ca.gov/dlse/faq_independentcontractor.html

ACT SOON TO SAVE TAXES
Want to lower your 2011 tax bill? The time for action is running
out, so consider these tax-savers now.

UNDERSTAND “SUNK COSTS” IN MAKING DECISIONS
Emotions add zest to life. They propel us to our feet when our
favorite running back scores a touchdown. They warm us at an
inspirational concert or movie. But in the realm of business and
investing, emotions sometimes hinder good choices.

SCAMS AGAINST THE ELDERLY: KNOW THE DANGER SIGNS TO PROTECT
YOUR FAMILY
News of yet another investment scam is alarming enough, but when
the victim is elderly, the crime seems especially offensive.

1. The first thing to ensure is that the organization in which you are donating to is a  qualified organization, as it must be religious, charitable, educational, scientific or literary in nature.   In general it is safer to donate to the more established organizations such as the Red Cross, but you should be able to verify any organization’s charitable status through checking their website or through direct contact.

2. The second thing is to ensure that you obtain a receipt, as a receipt is necessary for any donation claimed on Schedule A of your tax return.  For donations made through text messaging, a copy of your phone bill showing the donation made will suffice for your tax purposes.

Another factor to consider is that you can only deduct the entire amount of your donation if you do not receive anything of value in return for your donation.  For example, if you donate $20 but receive a t-shirt worth $15 for the donation, you can only deduct the $5 in excess of the t-shirt’s value.   For more complex transactions however, especially ones involving non-cash contributions such as property, stock, or other capital assets, don’t hesitate to contact our Irvine CPA firm and we will be more than happy to assist!

A breakdown of the elements of this guidance is as follows:

Expenses Paid or Incurred During the Taxable Year – The deduction must relate to an actual outflow of cash or an expense that was related to an action that took place in the current year.  This implies however that the expense does not necessarily have to be paid for in the current year, just that it be incurred.  For example, if you charged business expenses on the business credit card on December 31, 2010 and you don’t pay the credit card bill until sometime in 2011, you are still entitled to deduct the expenses.

Ordinary and Necessary – This implies that the deductions must be for expenses that are part of the normal and expected course of business.  If you own a pizza restaurant in Irvine, it would not be ordinary or necessary to purchase a $10 million mansion in the Hamptons, so that expense would not qualify as a deduction.

In Carrying On any Trade or Business – The expenses must be related to a business that is past the start-up phase, because deductions for expenses related to starting a company may need to be spread out over 15 years.  Also, the expense must be solely for the purpose of running the business, and not for a personal hobby or for pleasure.  Going along with the previously mentioned credit card example, if the expense was incurred on a personal trip to Las Vegas on New Year’s, the expense would not be related to the trade or business and would not be allowed to be deducted.

The moral of the story is that there may be business-related expenses that you have been incurring that can qualify under these criteria, so be sure to ask us and our Irvine CPA firm can straighten things out!

Since the IRS receives millions of tax returns, they obviously do not have to resources to go through them all, so they need some sort of method to determine which returns they should further examine.  There are a variety of methods that the IRS uses, which include ‘tips’ the IRS may receive, looking at large corporations, complex transactions, returns with forms that do not match or even by scanning Facebook or Twitter posts, but the most systematic approach the IRS uses is an automated computer-based scoring system called the Discriminant Function System.   Per the IRS website, the Discriminant Function System (DIF) score ‘rates the potential for change, based on past IRS experience with similar returns,’ meaning they use their computer system to check for irregularities in returns that may indicate an erroneous return.  Though the calculation of the actual scoring system is a well-kept secret, the purpose behind the programming is likely an attempt to determine which returns would have the most potential of generating additional revenue for the IRS.  This seems logical, because it would be a waste of time for the IRS to pursue errors on returns that would not create additional tax revenues for the government.

What this means for you is that if you are taking more deductions than the average person in your tax bracket is, your DIF score may be higher than normal.  Of course, our Irvine CPA firm would take care of these issues for you, but as a reference the average itemized deductions for 2007 per CCH are listed below.  If you are taking more than these levels beware, the IRS may come knocking!