Accounting and Tax Planning Archives - Page 3 of 3

Despite Ambiguity, This Is Still a Time for Tax Planning

We have a challenging year before us on the tax-planning front, with expiring provisions leading to uncertain future rates and pending elections leaving us with little in the way of legislative expectations.

Historically, the last few months of the year are used to implement tax-planning techniques to manage individuals’ tax liability for the current year with the relative certainty that comes from having the majority of the year behind us. This year, the only certainty appears to be everyone’s uncertainty.

Ambiguity in the tax realm can have a paralyzing effect on planning, but a wait-and-see approach can lead to lost opportunities or last-minute scrambles to seize the remains of an opportunity. Although the tax future remains unclear, planning opportunities remain. There are gifting provisions that are largely considered once-in-a-lifetime opportunities and rates that may be the lowest to be seen in a while. They provide an opening to make meaningful tax-planning decisions before 2012 comes to a close.

The focus in this piece is on tax-planning techniques that can be initiated during the remainder of 2012. But, depending on one’s facts and circumstances, these are just the beginning of the opportunities that might be available. If you think any of these strategies apply to you, be sure to contact your tax professional or advisor.

Changes on the Horizon

Despite the quiet year for tax legislation, significant changes are before us for 2013. Two years ago, when faced with a comparable series of expiring provisions, the can was legislatively kicked down the road. Conclusive action was deferred in favor of short-term extension solutions.

Here we stand, nearly two years later, with a similar collection of rate reductions, deductions, credits, and incentives set to expire as the calendar flips from one year to the next. In addition, two new taxes stemming from healthcare-reform legislation become effective in January.

Absent any late-year legislation, the significant changes on the horizon in 2013 are as follows:

• Two new taxes established under the Patient Protection and Affordable Care Act will go into effect on Jan. 1 — a 0.9% tax on wages and self-employment income, and a 3.8% contribution tax on investment income;

• Individual tax rates will universally climb, with the highest rate rising from 35% to 39.6% before accounting for the new taxes stemming from the act. Including the 3.8% UIMC tax, the top rate on investment income will rise to 43.4%. The current 10% rate bracket expires, reverting back to 15% as the lowest tax rate. The UIMC tax is explained below;

• Federal estate and gift-tax rates will increase from 35% to 55%, and the exclusion amount will drop from $5.12 million to $1 million;

• A series of tax rules designed to reduce what is commonly referred to as the ‘marriage penalty’ will sunset at the end of this year, raising taxes for many dual-income couples;

• Preferential tax rates on capital gains and dividends, currently 15% for most individuals, will expire at the end of the year, with the tax rate on long-term capital gains returning to 20% and qualified dividends losing preferential treatment altogether, returning to the ordinary income rates of up to 43.4%;

• Limitations on itemized deductions and personal exemptions will return in 2013 for higher-income taxpayers;

• It is anticipated that millions of additional taxpayers will become subject to the alternative minimum tax (AMT) with the expiration of the ‘AMT patch’; and

• The child tax credit will be reduced by half for 2013.

Business Tax Strategies

Kristina Drzal-Houghton

• Section 179 Expensing: IRS Code Section 179 provides businesses the option of claiming a full deduction for the cost of qualified property in its first year of use rather than claiming depreciation over a set period of years. For 2012, the Section 179 dollar limitation is $139,000, with a $560,000 investment limitation.

The dollar limitation for 2013 is scheduled to drop to $25,000, with a $200,000 investment limitation. Businesses might want to consider accelerating scheduled purchases into 2012 to take advantage of the higher limits.

Businesses with a fiscal year-end should note that the $139,000 deduction limit applies to property purchased and placed in service during tax years beginning in 2012.

• Bonus Depreciation: Property not qualifying for an immediate tax write-off under the expensing election may qualify for an increased first-year depreciation deduction under bonus depreciation rules. This deduction is equal to 50% of the cost of qualifying property purchased and placed in service by Dec. 31, 2012.

Unlike the Section 179 deduction, bonus depreciation is not limited in amount or by an investment limitation, and it can create a current-year net operating loss.

• Changes to Repair Regulations: Comprehensive repair and capitalization regulations issued by the IRS late in 2011 may open up planning opportunities.

A new de minimis expensing rule allows a business to deduct certain amounts paid or incurred to acquire or produce a unit of tangible property if the company has an allowable policy. There is an overall ceiling limiting the total expenses a company may deduct under the de minimis rule. Accounting policies and existing depreciation schedules should be reviewed to determine whether changes in accounting methods should be filed and adjustments taken. In many cases, the change will result in accelerated expensing.

• Corporate Dividends: Traditional C corporations face double taxation on distributed earnings. Profits are taxed at the corporate level, and dividends paid out to shareholders are again subject to tax at the individual level. With the maximum 15% tax rate for qualified dividends during 2012 rising to 43.4% for 2013, this may be the year to consider paying out accumulated earnings that the corporation is not otherwise using.

• Health Insurance Tax Credit: A tax credit is available for an eligible small employer to purchase health insurance for employees. To qualify as an eligible small employer, the company must:

— Pay for at least 50% of the premium cost for employees;

— Generally have no more than 25 full-time equivalent employees employed during the year; and

— Pay its full-time equivalent employees annual wages averaging no more than $50,000.

Individual Tax-planning Strategies

• Planning for the New Healthcare Taxes: Effective Jan.1, a 0.9% hospital insurance (HI) tax applies to wages and self-employment income, while a 3.8% Medicare contribution (UIMC) tax applies to investment income. Neither tax becomes applicable until income exceeds the established threshold noted in the table below.

The HI tax may be managed through withholding for employees, but in certain circumstances, such as for dual-income households or in years of employer transitions, withholding may not fully cover the wages subject to the HI tax.

For the purposes of the UIMC tax, net investment income has been defined to include dividends, rents, interest, passive-activity income, capital gains, annuities, and royalties. Specifically excluded from the definition are self-employment income, income from an active trade or business, gain on the sale of an active interest in a partnership or S corporation, IRA or qualified plan distributions, and income from charitable remainder trusts.

For individuals, the amount subject to the UIMC tax is the lesser of your net investment income, or the excess of your modified adjusted gross income, which is generally your adjusted gross income with certain foreign earned-income adjustments, over the applicable threshold amount.

For both taxes, the applicable thresholds are as follows:

Keep in mind that the UIMC tax applies if you have net investment income and your modified adjusted gross income is above the threshold. The impact of the tax may be minimized through shrewd management of your net investment income, proximity to the thresholds, or both.

Year-End Tax Planning Strategies

Bearing in mind the new Medicare taxes and the scheduled changes in tax rates, traditional year-end tax planning techniques may need to be reversed to take advantage of the known lower rates of 2012.

• Shifting Taxable Income Between Years: When you’re expecting stable rates in the future, the traditional year-end strategies are largely focused on deferring income and accelerating deductions. But with the rates set to rise for most taxpayers, the better tax answer may come from an opposite approach.

Income accelerated into 2012 could potentially result in a significantly lower rate than the same income recognized during 2013. Because rates remain relatively uncertain, now may not be the time to accelerate income. But having a plan in place should the rates hold will allow taxpayers to act deliberately as the rates become more certain.

• Managing the AMT: When undertaking tax planning, both regular and AMT tax liabilities need to be evaluated. At times, certain deductions may need to be shifted between years to manage the alternative minimum tax.

• Paying Estimated State Income Taxes: The payment timing of the fourth-quarter estimated state-tax payment, generally due Jan. 15, 2013, has some flexibility. It may be paid before year end for a current-year federal itemized deduction. The alternative minimum tax should be considered before employing this tax-planning tool because state income taxes are not deductible for AMT purposes.

• Fulfilling Charitable Goals: An alternative to cash donations is the contribution of appreciated assets. When contributing assets, you can deduct the fair market value of certain property and avoid paying taxes on the appreciation. However, if you would like to donate securities that have declined in value, you will likely want to sell them first to realize the loss and then gift the proceeds to your organization of choice. In some circumstances, particularly when there is expiring capital loss, a direct donation may not be the most effective tax-planning tool.

• Funding Retirement Plans: For retirement contributions to qualify for a deduction in 2012, contributions must be in place usually before the end of the year. The exceptions to the rule are IRAs and SEP (simplified employee pension) plans. An IRA can be created and funded by April 15, 2013, and a SEP by the extended due date of your tax return.

• Converting to a Roth IRA: Roth IRAs have long-term advantages over traditional IRAs because money grows and can be distributed tax-free. Some taxpayers find that the benefits of tax-free withdrawals in the future are in line to be greater than the tax cost on conversion.

Converting before-tax earning plans — 401(k)s, traditional IRAs, etc. — to the after-tax Roth IRA creates taxable income in the year of conversion. The upfront tax cost does not make conversion the right answer for every taxpayer, but for taxpayers with certain circumstances, conversion can be an extremely powerful tool.

• Paying with Credit Cards: As a reminder, paying tax-deductible expenditures, including charitable contributions, with a credit card secures the deduction in the current year, even if you do not actually pay the credit-card company until the following year.

• Deducting Losses from Pass-through Entities: If you are expecting a 2012 loss from a partnership, LLC, or S corporation, ensuring that you have sufficient tax basis will help to secure your ability to deduct the loss. You may be able to increase your tax basis prior to year end, but given the rates for 2013 as enacted, you might want to purposely avoid doing so until 2013 to push the loss into the higher rates of 2013.

Capital Gains and Losses

You should consider a few basic rules when planning for capital gain or loss transactions:

• Gains and losses from securities sales generally are recognized on the trade date as opposed to the settlement date. So a December trade will be a 2012 transaction, even if the settlement date is in the following year;

• Sales at a loss reduce other capital gains, and a net capital loss in excess of capital gains of up to $3,000 is available to be used to offset other income, with excess losses being carried forward to future years; and

• Before you sell an asset to recognize a gain, check your holding period. Capital assets held for over a year are eligible for a significantly lower tax rate than those held less than a year.

Estate- and Gift-tax Planning

Absent congressional action, the $5.12 million estate and gift-tax exemptions and current top tax rate of 35% will revert to a $1 million exemption with a top tax rate of 55% beginning Jan. 1, 2013. Moreover, the estate-tax exemption will no longer be portable between spouses.

Because of the reversion to a lower exemption and a higher tax rate, what could be a once-in-a-lifetime opportunity exists to transfer significant assets to the younger generation without incurring any estate and gift tax. Also note that:

• The annual gift tax exclusion for 2012 remains at $13,000. It is expected to rise to $14,000 for 2013;

• If you are married, you can avoid federal gift-tax ramifications by gifting up to $26,000 per donee, or recipient, in 2012 under the gift-splitting rules. Annual gifting is a relatively simple method to reduce your taxable estate; and

• Along with the high gift-tax exemption, the generation-skipping transfer-tax exemption is also $5.12 million during 2012. So, the door is open to bypass children and transfer significant wealth to future generations.

Developing an overall tax strategy under ambiguous circumstances can feel daunting. But the deliberate, informed implementation of a plan for what is known now can also protect against what remains to be seen — as what is unknown becomes known.

Kristina Drzal Houghton, CPA, MST, is partner-in-charge of Taxation at Meyers Brothers Kalicka, P.C. in Holyoke; (413) 536-8510.

Disappearing Acts

There Are a Host of Vanishing Tax Provisions for Small Businesses

Jana Bacon

It has been difficult to miss all the hoopla over vanishing tax provisions. This article addresses the more common provisions affecting small businesses, including the fixed-asset expensing provisions, bonus depreciation, depreciation of specialized real-estate assets, the research credit, the new-markets tax credit, and the Work Opportunity Tax Credit (WOTC).

Section 179 and Bonus Depreciation

Since 1997, Internal Revenue Code Section 179 has allowed for the deduction of certain qualified expenditures that normally would be required to be capitalized and depreciated. Section 179 property is defined generally as tangible personal property acquired and placed in service in connection with the active conduct of a trade or business. Over the years, the maximum allowable deduction amount has varied.

For 2011, the maximum allowable deduction was $500,000 and was reduced dollar-for-dollar as qualified expenditures exceeded $2 million. For 2012, the maximum allowable deduction is $139,000 with reduction as expenditures exceed $560,000. For 2013, the maximum amount is currently scheduled to decrease to $25,000 with the phase-out beginning at $200,000.

Bonus depreciation is another tax benefit scheduled to disappear after this year. In 2011, 100% first-year bonus depreciation applied to qualified tangible personal property additions with no limit. In 2012, that was reduced to 50% first-year bonus depreciation.

Although there has been considerable discussion about the fate of these provisions — because we have no idea whether they will be reinstated by Congress or, if so, at what levels — businesses may wish to take advantage of the higher Section 179 amount and/or bonus depreciation for this year by acquiring and placing in service qualified tangible personal property purchases prior to Dec. 31, 2012.

Cost Recovery for Specified

Real Property

Qualified leasehold improvements and qualified restaurant property placed in service between Oct. 22, 2004 and Dec. 31, 2011, and qualified retail-improvement property placed in service between Jan. 1, 2009 and Dec. 31, 2011, were subject to straight-line depreciation over a 15-year period. For such property placed in service after 2011, however, straight-line depreciation over a 39-year period is required.

Also, because these assets were previously considered 15-year property, they had qualified for Section 179 expensing and bonus depreciation. Effective Jan. 1, 2012, they no longer qualify for either.

Research and Experimentation Credit

The tax credit for research and experimentation expenses (R&E credit) was originally enacted in 1981, and applied to amounts paid or incurred on or before Dec. 31, 1985. The credit had been extended 14 times since then but expired on Dec. 31, 2011. The R&E credit had been allowed to expire only once before from July 1, 1995 through June 30, 1996. The traditional R&E credit provision had allowed a taxpayer to claim a credit equal to 20% of the amount by which the taxpayer’s qualified research expenditures exceeded a base amount.

The base amount reflects past research expenditures that were incurred over a fixed period of time, so the credit was really a credit on incremental increases in research costs. The credit was generally available on both in-house and contract research costs. Also available was an alternative simplified credit, which was only partially incremental and utilized a rolling three-year base period and a 14% credit rate.

New Markets Tax Credit

Originally enacted in 2000 for investments made after Dec. 31, 2000, the new markets tax credit provided a credit on qualified investments to promote economic and community development in low-income communities. The credit was taken over a seven-year period and totaled 39% of qualified equity investments made in a qualified community-development entity (CDE).

CDEs were required to invest in qualified low-income community business, and applications were required by CDEs to obtain an allocation of a portion of the credit authorized for the year. The last amount authorized was $3.5 billion for 2011.

Work Opportunity Tax Credit

Enacted in 1997, the work opportunity tax credit (WOTC) provided a credit to employers on wages paid to eligible employees who began work for the employer before Jan. 1, 2012. The amount of the credit ranged from $2,400 to $9,000 per each eligible employee, depending upon the type of eligible employee. Eligible employees included qualified members of families receiving assistance under the Temporary Assistance for Needy Families (TANF) program, qualified veterans, qualified ex-felons, designated community residents, vocational rehabilitation referrals, qualified summer youth employees, qualified members of families in the Supplemental Nutritional Assistance Program (SNAP), qualified Supplemental Security Income recipients, or long-term family-assistance recipients.

To qualify for the credit, the employee had to complete at least 120 hours of service for the employer. The credit has been extended for wages paid through Dec. 31, 2012 only for qualified veterans.

The uncertainty of whether Congress will reinstate or extend these tax benefits makes planning extremely difficult. Pay close attention after this year’s elections to see if any new or extending tax legislation is enacted that may affect your business.

Please note that this article contains only a general discussion, so you should consult your tax advisor for additional information or assistance.

Jana Bacon is a member of the firm at Wolf & Company, P.C. and focuses on tax compliance and planning services; (413) 747-9042.

The Fiscal Cliff Approaches

And with It Come Questions and Uncertainty for Taxpayers

Nicholas LaPier, CPA

On Jan. 1, the country may find itself falling back into recession, personal income taxes will go up, federal government spending will be cut, and unemployment most surely will rise. The good news, however, is that the federal deficit will undoubtedly be somewhat reduced.

This fiscal cliff, as it’s called, refers to a frenzy of fiscal changes that, collectively, have a far-ranging impact on all taxpayers and the economy. These changes in law are a result of a dizzying variety of tax laws enacted, altered, modified, or extended during the past 10 to 12 years. Congress’s failure to agree on its own budget cuts last summer forced the automatic spending sequestration of approximately $1.2 trillion in non-discriminatory spending cuts, across all line items, to be made over the next decade.

The Congressional Budget Office (CBO), a non-partisan arm of the U.S. Congress, estimates that the federal government could collect more than $200 billion more in personal income taxes in 2013 as a result of the changes in the personal income-tax laws. In addition, the CBO estimates that the expiration of the currently popular payroll tax cut of 2% on Social Security taxes will generate another $90 billion in revenue.

Obviously these gains are desperately needed to help balance the books of the U.S. government. However, they, in conjunction with the automatic spending sequestration, which is estimated to save the government $109 billion in 2013, will still fall well short of balancing the budget.

Other fiscal changes include the return of the 55% estate-tax rate. This item is actually a popular topic of discussion among most legislators, and has better curb appeal in getting reversed. However, the discontinuance of federally extended unemployment benefits is a hot potato, and their expiration could have a more serious impact on the U.S. economy, which relies heavily on consumer spending.

Other than a possible recession, the biggest impact of the fiscal cliff would be felt by individual taxpayers as the infamous Bush tax cuts are all reverted back to levels not seen since 2000. Gone would be the 10% income-tax rate and the imposition of a maximum 39.6% personal income-tax bracket. Also set to expire is the maximum 15% tax rate on long-term capital gains and qualified dividends.

In 2013, long-term capital-gains tax could be as high as 20%, and qualified dividends would be taxed at an individual’s ordinary tax rate, which could be as high as 39.6%. Both of these items, otherwise known as unearned income, would also be subject to an additional 3.8% surtax for taxpayers with adjusted gross income over certain levels.

The alternative minimum tax (AMT) will come into play for another 30 million taxpayers. The AMT is an archaic part of the tax code, first enacted in 1969 to increase the effective tax paid by taxpayers who, for a variety of reasons, were not paying any personal income taxes. The AMT basically increases the effective tax you pay by disallowing certain deductions that are allowed under the regular tax code.

Ironically, ever since the Bush tax cuts, more people became subject to the AMT because the built-in minimum tax rates of 24-26% had essentially wiped out the 10% and 15% tax brackets for higher earners. The CBO estimates that, even with the increase in the regular tax rates, the reduction in AMT income thresholds will still increase overall personal tax revenues. Taxpayers who reside in states where they pay higher real-estate taxes and a state income tax tend to be the victims of the AMT.

For residents in Massachusetts or Connecticut, it is very probable that an average married couple whose combined income is more than $100,000 will have the AMT.

Another area of concern is on the new 3.8% Medicare tax surtax that will be payable on unearned income, mostly by taxpayers in higher tax brackets (for example: a married couple with combined income of more than $250,000). This new tax could cause many people to shift their taxable investments, which may have an impact on financial markets.

With the expiration of the 2% Social Security tax cut, which was first enacted in 2011 and extended into 2012, an employee or self-employed individual should expect to pay up to an additional $2,202 more in Social Security tax in 2013.

So what does all this really mean? The fiscal cliff is getting nearer as Dec. 31 approaches, and without congressional action, the economy could very well give back the gains it recently made after the last recession from December 2007 to June 2009. Many experts suggest that, even though the country is not in a recession, the Jan. 1 fiscal changes will have a negative effect on the economy.

Government spending cuts will increase unemployment, higher income taxes will decrease consumer spending, and small-business owners may cut or curtail hiring. Meanwhile, investors may start shifting their portfolios to avoid the higher taxes on unearned income like capital gains and dividends. Basic uncertainty over fiscal policy and taxation is enough to make citizens pause and maintain the status quo; that alone will stymie an already semi-stagnant economy.

As a professional tax practitioner, I have learned to plan based on the tax code currently in effect. That code is complex and ever-changing. Changes in tax rates are a large part of careful tax planning, so making rash decisions or no decisions at all could increase your total tax burden.

We last saw major tax law changes at the end of 2010, but 11th-hour politics prevailed, and some tax relief was had as we headed into 2011. All taxpayers should stay abreast of the tax law changes, now and in the future, through self-awareness and professional support. Cautious optimism is my rule of thumb; the tax code is always in flux, and only over the long haul will proper tax planning really be effective, cliff or no cliff.

Nicholas LaPier, CPA, is the principal at Nicholas LaPier CPA P.C. in West Springfield; (413) 732-0200; www.lapiercpa.com

Crunching the Numbers

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A chart of area accounting firms

All About the AMT

By BusinessWest Staff February 14, 2012

What Is the Alternative Minimum Tax, and Who Will Be Paying It?

Sean Wandrei

Created in 1969, the alternative minimum tax, or AMT, was the result of a public outcry to congress that the rich and wealthy were not paying their fair share of taxes. Based on testimony by the secretary of the Treasurer, 155 individuals with an adjusted gross income above $200,000 didn’t pay any tax on their 1967 income-tax returns.
Accordingly, the AMT was designed as a safeguard to keep those individuals from slipping through tax loopholes. The AMT is a tax system that is calculated in parallel with an individual or corporation’s ‘regular’ tax. The higher of the two tax calculations is the one that must be paid. We will focus on AMT as it applies to the individual.

How the AMT Is Calculated
To calculate the AMT, all ‘preference’ items are added back to regular taxable income to arrive at AMT income. Then an AMT exemption is deducted from the AMT income to determine the AMT taxable income.
Preference items include state and local income taxes, sales and property taxes, accelerated depreciation, deductible medical expenses, miscellaneous itemized deductions, certain tax-exempt income, certain credits, incentive stock options, personal exemptions, and the standard deduction. These preference add-backs are items that many families who own their homes in high-income-tax states use as deductions on their regular income-tax return.
Why You May Have to Pay It
Based on the above information, there are certain taxpayers who are more likely to pay the AMT.
Large families fall into the AMT because they must add back all of their exemptions for AMT purposes. A family with a filing status of married filing jointly with four children, for example, get six personal exemptions for regular tax purposes. These six exemptions must be added back to calculate the AMT.
State and local taxes paid are also taken into consideration when determining whether the taxpayer is subject to the AMT. State and local income taxes paid are a deduction for regular tax and must be added back to calculate the AMT. The add-back includes not only state income tax, but also property taxes and excise taxes paid. From 2004 through 2007, residents of California, Connecticut, the District of Columbia, Maryland, Massachusetts, New Jersey, and New York paid the most ATM. These are all high-income-tax states.

What Does This Mean to You?
As it stands now, the exemption for 2011, for a married couple, is $74,450 (other filing statuses have different exemption amounts). The exemption is scheduled to revert back to the 2000 exemption amount of $45,000 for a married couple in 2012. That is 40% less than what it was. If this happens, then the amount of income that can be shielded from the AMT will be less, and more people will be pulled into the AMT. That would amount to an estimated 25 million additional taxpayers paying AMT.
The good news (if there is such a thing with taxes) is that Congress usually extends the increased AMT exemption amount. Congress tends to postpone dealing with difficult issues until it has to. So we may not know until the end of 2012 if there is going to be a patch that spares the additional 25 million taxpayers from the AMT in 2012.

How Can You Avoid the AMT?
It is difficult to plan to avoid the AMT because the regular and AMT tax systems run parallel with each other, leaving you to pay the greater of the two. Sometimes reducing one tax could increase the other tax. The best advice would be to look at your overall tax picture and start from there. You will need to know what items could cause you to be caught in the AMT and the relationship between your regular tax and the AMT. From there, you can implement a strategy that is right for you. You should review your plan if anything changes in your life or with the tax law.
One item that a taxpayer can control based on timing is the payment of estimated state income-tax payments and real-estate taxes. Since taxes paid are preference items and are added back to calculate the AMT, it may not be best to prepay those taxes prior to the end of a particular year. If you are subject to the AMT in that year, you won’t receive a tax benefit from paying early (say, in December). However, if you wait until after year end, you may have the opportunity to deduct your tax payment in the following year.
On the opposite side, if in one year you have a significant item of income resulting in a large state tax amount due with your return the following April, you will likely be subject to AMT in the year of payment since the tax will be disproportionately large compared to your income. Therefore, prepaying may be advised. Again, planning and understanding your own situation are key to determining what the best course of action is.
As always, it is best to plan and then plan some more to help reduce your overall tax bill. Calling your tax professional is a good way to start, and avoid paying more taxes than you should.

Sean Wandrei is a tax manager with Meyers Brothers Kalicka, P.C. His technical concentrations are in multistate taxation as well as real-estate entities; (413) 536-8510.

Record Keepers

A chart of the region’s accounting firms

AccountingFirmsBW1111a

Preparing for a Financial Audit

Or, a Primer on How to Make Friends with Your Auditor

Donna Roundy, CPA

Summer has passed, and it’s time to focus on the balance of the year, which includes preparing your fiscal records for your accountant. Generally, the focus at year end is tax-motivated — keeping your money in your pocket rather than Uncle Sam’s. Another focus for many, however, is getting information together for their auditor.
While preparing for an audit can seem arduous, there are many benefits of having an audit. An auditor can help you analyze and better understand your company’s financials and show you where improvements within your company can be made. An audit assesses any risks to your company, as well as the efficiency and quality of your company’s processes. One of the most important benefits of an audit could be the realization of fraud and illegal activities taking place within your company.
Recognizing and optimizing the benefits of an audit can help your company become more efficient and more profitable. This article will describe the steps involved in preparing for an audit, and how to optimize the value of an audit for your company.
Many organizations must prepare for a year-end audit at the end of each fiscal year. Whether your business is public, private, or nonprofit, you may be required to have an audit performed on your company. This requirement can be government-required (such as for nonprofit organizations). It can also come from a variety of other groups, such as investors, financial institutions, or a board of directors.
‘Audit’ is not a word many business owners want to hear, but with preparation and focus, an audit can go smoothly and prove to be a valuable exercise.
The best time to start preparing for the audit is right after the auditors leave at the beginning of the year. A significant focus of an audit is on internal controls and the organization’s policies and procedures. Sometimes your auditor may, either verbally or in writing, make suggestions to better segregate duties or create a step of review. Discuss with your fiscal director how best to implement those suggestions.
Due to these changes and possibly due to changing staff levels, the flow of information in your company may change subtly in ways that will require your policies and procedures manual to be updated. Providing your auditor with updated procedures is important because he or she needs to assess risk and ascertain that things are actually happening as intended.
Soon after Jan. 1, begin to close your books for the current fiscal year. Transactions should be posted to the year in which it occurred, including receivables and sales, inventory purchases, cost of goods sold, and operating costs. You also must reconcile all sub-ledgers to make sure they are accurate with your trial balance. Performing reconciliations for all balance-sheet accounts to accurately prepared schedules and third-party statements (bank statements, loan and vendor statements) is a large part of preparing your books for year end.
If you are finding that significant adjustments are necessary at this time, look back to the monthly closing process and see where procedures need to change. A monthly close is a mini-year end, and reconciliations should be performed in a timely manner. If this isn’t happening, the reports being used are inaccurate, and decisions are being made based on wrong information.
Normally your auditors will provide you with a list of the items they need for the audit. Gathering together the entirety of this list and having it in one place for the auditors the first day they walk in has a few benefits. Saving your auditor time from having to ask for things they’ve already asked for makes him or her more efficient, which can mean a lower fee. The auditor will need your time and attention during the audit, so it’s less stressful for you if you don’t also have on your agenda to pull together items they need throughout the day. More preparation can make the audit process easier for you and your company.
Auditors will be looking for a variety of information before they begin the audit. This information will include company bylaws, corporate charters, state registrations, formal policies, a procedure manual, and loan and lease agreements. Annually you must provide to your auditors any new loan or lease agreements and minutes from shareholders or board of directors meetings through the date of your audit. Any information explaining events during the fiscal year that could potentially have an impact on the financial statements must also be provided to your auditor.
Inform your employees when the audit will begin and how long the audit will last. Indentify which employees will be working with the auditors side-by-side on a day-to-day basis. You must make sure that these employees have an open schedule during the audit period. There also must be a workspace prepared for the auditors based on their needs.
Your responsibilities during the audit process are just as important as the steps taken leading up to the audit. Be prepared to explain your procedures for any of the following processes: payroll, cash receipts, accounts receivables/sales, computer systems and software, and how you identify and implement controls to minimize fraud risks. Set aside time during the audit to ask questions of the auditor or to answer any questions the auditor may have.
An audit of cash can provide a business with validity and accuracy of the cash flow within the company, as well as provide a better understanding of where errors may occur and tests to make sure they are not occurring.
Accounts receivables is frequently the largest asset a company can have. An auditor looks at all levels of accounts receivable to help you better understand the risks that could occur and the red flags to look for to prevent these risks.
Inventory audits are designed to keep track of a company’s products and merchandise. This procedure often leads to the influencing of future policies and decision-making within companies.
For your income and expenses, the auditor will typically prepare an expectation of what your income and expense balances should be. This will be based on your organization and your discussions with the auditor. Be prepared to explain fluctuations for accounts that may fall outside of these expectations. Audits performed on income and expenses are some of the most necessary of all.
Income or revenue is required to be recorded for tax purposes. If not properly kept track of, your tax return could be misleading causing larger problems in the long run. An audit of expenses ensures that internal controls are being followed, the reasonableness of your expense costs, and timeliness of the invoice to ensure reliability of the expense. Expense audits also ensure that vendors are real businesses and exist, as well as the accuracy of all contracts, invoices, and signatures.
An audit should be a positive and productive experience. When your staff and the auditors work together, you will save money, the audit will be completed efficiently, and the transaction or requirement that created the need for the audit can be fulfilled. You and your staff will also be in a greater position to understand the financial, data-system, and workflow-process needs of your firm, which will enable you to better plan for future challenges and capitalize on future opportunities.

Donna Roundy is a senior audit manager with the Holyoke-based certified public accounting firm Meyers Brothers Kalicka, P.C.; (413) 536-8510.

The 2010 Health Care Mandate

Understand the Many Ways It Can Impact Your Bottom Line

Bruce Fogel

Everybody knows that the government is out of money and needs to raise cash. However, do you understand the financial impact that the 2010 health care legislation will have on your family?
This isn’t just about everybody being required to carry health insurance. It is much more. The government is using this legislation as a revenue builder, and you will be paying the bill. So what will your cost be?

Individual Mandate
The new federal law requires that non-exempt individuals must maintain qualifying health-insurance coverage for themselves and their dependents or face a tax penalty after 2013. Similar to Massachusetts law, those without qualifying health coverage will be required to pay a tax penalty. The federal penalty will be the greater of: (a) $695 per year, up to a maximum of three times that amount, or $2,085, per family, or (b) 2.5% of household income over the threshold amount of income required for income-tax-return filing.
The penalty will be phased in according to the following schedule: $95 in 2014, $325 in 2015, and $695 in 2016 for the flat fee; or 1.0% of taxable income in 2014, 2.0% of taxable income in 2015, and 2.5% of taxable income in 2016. Beginning after 2016, the penalty will be increased annually by a cost-of-living adjustment.
Exemptions will be available for a variety of reasons, including but not limited to, financial hardship, those without coverage for less than three months, illegal aliens, prisoners, those for whom the lowest cost plan option exceeds 8% of household income, and those with incomes below the tax-filing threshold (in 2011 the threshold for taxpayers under age 65 is $9,500 for singles and $19,000 for couples).

Premium Assistance Tax Credits for Purchasing Health Insurance
A refundable tax credit is available to certain individuals who are not eligible for Medicaid, employer-subsidized health insurance, or other acceptable health coverage, and who get health insurance by enrolling in a qualified health plan through a state-run insurance exchange for tax years after 2013. While the credit generally will be payable directly to the insurer, individuals can elect to purchase health insurance out of pocket and then claim the credit on their Form 1040.
Based on the information provided to the exchange, the individual receives a premium-assistance credit based on income, and IRS pays the premium-assistance credit amount directly to the insurance plan in which the individual is enrolled. The individual then pays to the plan in which he or she is enrolled the dollar difference between the premium-assistance credit amount and the total premium charged for the plan. For employed individuals who purchase health insurance through an exchange, the premium payments are made through payroll deductions.
The premium-assistance credit will be available for individuals and families with incomes up to 400% of the federal poverty level ($43,320 for an individual or $88,200 for a family of four, using 2009 poverty level figures) who are not eligible for Medicaid, employer-sponsored insurance, or other acceptable coverage.

Higher Medicare Taxes on
High-income Taxpayers
High-income taxpayers will be subject to a tax increase on wages and a new levy on investments as well.

Higher Medicare Payroll Tax on Wages
Under current law, wages are subject to a 2.9% Medicare payroll tax with employees and employers paying 1.45% each. Self-employed people pay both halves of the tax, but are allowed to deduct half of this amount for income-tax purposes. While the payroll tax for Social Security applies to earnings up to an annual ceiling ($106,800 for 2011 and increasing to $110,100 for 2012), the Medicare tax is levied on all earnings without limit.
Under the provisions of the new law, which goes into effect in 2013, most taxpayers will continue to pay the 1.45% Medicare hospital-insurance tax, but single people earning more than $200,000, and married couples earning more than $250,000, will be required to pay an additional 0.9% (2.35% in total) on the excess over those base amounts. Self-employed individuals will pay 3.8% on earnings over the threshold.

Medicare Payroll Tax Extended to Investments
As part of the revenue-generation aspect of the new laws, beginning in 2013, a Medicare tax will, for the first time, be applied to net investment income. A new 3.8% tax will be imposed on such income of single taxpayers with adjusted gross income above $200,000, and joint filers over $250,000. Net investment income includes interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and net gain from disposition of property (other than most property held in a trade or business) reduced by properly allocable deductions to such income.
The new tax is intended to apply only to income in excess of the $200,000/$250,000 thresholds. For example, if a couple earns $200,000 in wages and $100,000 in capital gains, $50,000 will be subject to the new tax ($300,000 minus $250,000).
Additionally, while not directly applicable to individuals, this new tax is also applicable to estates and trusts. In such situations, the tax is 3.8% of the lesser of (a) undistributed net investment income, or (b) the excess of AGI over the dollar amount at which the highest estate- and income-tax bracket begins.

Threshold for Medical-expenses Deduction Raised
Under current law, taxpayers can include in their itemized deductions unreimbursed medical expenses for regular income-tax purposes (not AMT) only to the extent that those expenses exceed 7.5% of the taxpayer’s AGI.
As noted, the new law raises the threshold for itemized medical expense deductions from 7.5% of AGI to 10%, effective for tax years beginning after Dec. 31, 2012. However, it should be noted that the threshold for individuals age 65 and older (and their spouses) will remain unchanged at 7.5% through 2016.

Reimbursement Limited for Some OTC Medications
Qualified medical expenses, which are expenses that can be reimbursed tax-free through a health reimbursement account (HRA), health flexible savings account (FSA), health savings account (HAS), or Archer Medical Savings Account (MSA), no longer include over-the-counter medicines (except for insulin, which continues to qualify), unless prescribed by a doctor, effective for tax years beginning after Dec. 31, 2010.

Increased Penalties on Non-qualified Distributions
from HSAs and Archer MSAs
The penalty tax on distributions from a health savings account or an Archer MSA that are not used for qualified medical expenses has been increased to 20% (from 10% for HSAs and from 15% for Archer MSAs) of the disbursed amount, effective for distributions made after Dec. 31, 2010.

FSAs Limited to $2,500
An FSA is one of a number of tax-advantaged financial accounts that can be set up through a cafeteria plan of an employer. It allows an employee to set aside a portion of his or her earnings to pay for qualified expenses as established in the cafeteria plan, most commonly for medical expenses, but often for dependent care or other expenses. Under current law, there is no limit on the amount of contributions to an FSA. Under the new law, however, allowable contributions to health FSAs will be capped at $2,500 per year, effective for tax years beginning after Dec. 31, 2012. The dollar amount will be indexed for inflation after 2013.

Dependent Coverage in Employer Health Plans
Effective as of March 30, 2010, the new law extended the general exclusion for reimbursements for medical-care expenses under an employer-provided accident or health plan to any child of an employee who has not attained age 27 (whether they qualify as a dependent or not) as of the end of the tax year.
This change is also intended to apply to the exclusion for employer-provided coverage under an accident or health plan for injuries or sickness for such a child. A parallel change is made for voluntary employee benefit associations (VEBAs) and 401(h) accounts. Also, self-employed individuals are permitted to take a deduction for the health insurance costs of any child of the taxpayer who has not attained age 27 as of the end of the tax year.

Excise Tax on Tanning Services
The new law imposes a 10% excise tax on indoor tanning services. The tax, which will be paid by the individual on whom the tanning services are performed, but collected and remitted by the person receiving payment for the tanning services, will take effect July 1, 2010.

Liberalized Adoption-credit and Adoption-assistance Rules
For tax years beginning after Dec. 31, 2009, the adoption tax credit is increased by $1,000, made refundable, and extended through 2011. The employer-provided adoption-assistance exclusion is also increased by $1,000.

Bottom Line
These are some of the highlights of the 55-page health care legislation that was signed into law by President Obama on March 30, 2010. It affects every American citizen to varying financial degrees and phases, in different aspects, at various timeframes. If you have questions about how it will affect your family, it would be wise to consult with your tax advisor.

Bruce M. Fogel, Esq. is a partner with Bacon Wilson, P.C. in Northampton. He is a member of the firm’s estate-planning, elder, real-estate, and business departments. He has extensive experience in matters relating to income, gift, and estate taxes, and he focuses on the tax implications of all legal transactions. He also co-hosts the “Taxes and Assets” radio show on WHMP-AM; (413) 584-1287;
[email protected]

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