Mar 28

“Itemized deductions” … All Good Things Must Come to an End

As the old adage goes all good things must come to an end. This is hard to visualize when it comes to anything that has to do with taxes, but this happens to be the case with itemized deductions. As part of the bipartisan agreements of the 2012 American Tax Relief Act the Pease Rule has been reinstated on itemized deductions and personal exemptions for the individuals the government has labeled as “high income” tax payers.

The rule is as follows, the unprotected itemized deductions are to be reduced by the lessor of the following two amounts:

  • 3% of the amounts by which AGI exceeds the threshold amounts listed above
  • Or 80% of unprotected itemized deductions.

So what does this mean to you???

Named after the congressman who originated the rule, it has been nonexistent the last 11 years thanks to the Bush era tax cuts, but has now reared its ugly head once again. The most basic explanation of the rule is that it limits the amount of itemized deductions for high income earners resulting in roughly a 1% overall increase to your tax rate. The adjusted gross income thresholds for when the phase outs begin are as follows:

  • Married Filing Joint: $300,000
  • Head of Household: $275,000
  • Single: $250,000
  • Married Filing Separately: $150,000

These are the base income levels for the 2013 tax year, but will be adjusted for inflation going forward. An important thing to remember is that these dollar amounts are adjusted gross income (AGI) amounts not taxable income amounts.

There are some itemized deductions protected from the rule and they include: Medical Expenses, which are already subject to 10% of a taxpayer’s adjusted gross income; investment interest expense, which is limited to investment income; and casualty or theft losses, which are also subject to 10% of a taxpayer’s adjusted gross income as well.

The unprotected itemized deductions subject to the rule are the three most common deductions: home mortgage interest, state and local taxes, and charitable deductions.

An example:

You are filing married filing jointly and your AGI is $500,000. Therefore, your AGI is $200,000 above the Pease threshold amounts and your unprotected itemized deductions add up to $50,000. The unprotected itemized deductions would be reduced by the lessor of the 3% rule, $6,000($200,000 x 3%) or the 80% rule, $40,000($50,000×80%), therefore your adjusted unprotected itemized deductions would be $44,000($50,000-$6,000).

The realistic effect of this limitation is that it will increase the rate of tax you pay on income above the thresholds previously state by roughly 1%. A simple way to estimate this additional tax would be that for every $100 dollars above your threshold for your filing situation you are being taxed on $103.

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Mar 25

Use care in classifying contractors vs. employees

*originally posted to RGJ.com

The growth of independent contractors in the workforce has prompted some to call the new, post-recessionary U.S. work world the “1099 Economy,” referring to the name of the tax form filed by independent contractors.

An estimated 10.3 million U.S. workers are independent contractors, according to 2010 U.S. Census Bureau data, and all indications are that number is rapidly growing.

But, the growth of independent contractors has led to growing scrutiny by the Internal Revenue Service, which is seeking out companies that are misclassifying employees as independent contractors to avoid paying taxes and employee benefits.

Here are two steps a company should take to avoid the penalties, back taxes and interest that can come from misclassifying a worker as an independent contractor.

Be careful to make the correct classification

Get the classification of workers right the first time and continually monitor independent contractors so you are aware if a contractor’s relationship with your company changes and necessitates a re-classification as an employee.

The Internal Revenue Service uses a 20-part “right-to-control” test to determine whether a worker is an independent contractor or an employee. The more control a company has over when, where and how work is performed, the more likely the worker is an employee and not an independent contractor. Refer to the IRS website to review a list of all 20 elements that the IRS uses to determine whether a worker is an independent contractor vs. an employee.

Don’t be afraid of reclassifying your workers

While the IRS is turning up the level of scrutiny on companies that misclassify their workers as independent contractors, they also are offering leniency for those that address the problem. The Voluntary Worker Classification Settlement Program recently was expanded by the IRS and offers companies a way to avoid stiff penalties.

“Employers accepted into the program will generally pay an amount effectively equaling just over 1 percent of the wages paid to the reclassified workers for the past year,” according to the IRS. The program eliminates interest and penalties, and assures that employers will not be audited on payroll taxes related to the reclassified workers’ prior work.

When executed correctly, the independent contractor relationship can have benefits for both workers and companies.

Independent contractors have greater flexibility in work schedule and location and are able to pursue multiple entrepreneurial opportunities. Companies gain an on-demand workforce that can scale with the ebb and flow of business without the long-term costs and commitments of hiring full-time employees.

John Solari is the managing partner of J.A. Solari & Partners. He has 25 years of accounting experience and also is a member of the American Institute of Certified Public Accountants and the Nevada Society of Certified Public Accountants.

Feb 22

3 considerations in determining how to raise capital

Companies poised for growth first face important decisions about financing. Growing a business comes at a price, and that price can be paid many ways — loans, stock offerings, equity arrangements, bond offerings and crowdfunding. Here are three things businesses should consider when evaluating how to raise capital:

Cost of financing
One of the fundamental financing questions a business must grapple with is: How much am I willing to give up?

Many people think of the cost of financing as a simple interest rate, but a variety of funding options are available to companies, depending on their size and funding needs. Early stage companies with few assets and minimal revenue often find that venture capital is their primary option. Venture capitalists will require an equity stake in exchange for financing, and it is important for early stage companies to evaluate the level of control and future profits they will give up in that exchange.

Other funding options for early stage companies include crowdfunding, a new model that harnesses online networks to aggregate funding from a large base of small investors.

Crowdfunding engages consumers and raises brand awareness, but achieving large investment sums is difficult, and the process can be labor intensive.

Established companies have a much larger range of funding options, and stock, bond, equity stakes and loans should be explored with an eye for the most affordable overall financing option that raises the desired amount of capital.

Investment return
The price that a company will pay for investment capital should be directly tied to the opportunities for growth in the marketplace. Buying an undervalued competitor at an affordable price or increasing market share are opportunities that must be balanced with the price of capital. Calculating this equation correctly is key to building a strong and profitable business. Focus on investments that have a long-term payoff — technology and equipment that translate into continued efficiencies, or research and development that keeps new products in the pipeline.

Analyzing risk
A rational and balanced attitude toward risk is fundamental to good investment decisions. A business that is too risk averse might miss prime opportunities to grow, while a cavalier attitude toward risk can be devastating.

A clear-eyed, objective analysis of risk should guide every investment strategy. Stick with the fundamentals of good decision-making when assessing risk — the cost of debt, the value of the investment and the profit potential. A financed investment in your company always holds some risk, but minimizing risk is key to successful investing.

John Solari is the managing partner of J.A. Solari & Partners. He has 25 years of accounting experience and also is a member of the American Institute of Certified Public Accountants and the Nevada Society of Certified Public Accountants.

Feb 19

Taxpayer Loses $22,517 Donation Deduction on a Technicality

You’ve already given your charitable gifts for the 2012 tax year, but if you itemize your deductions, there is still time to think about records you need to keep for those deductions in case you are selected for audit. In the case of Durden v. Commissioner, a couple thought they had followed the rules when they filed their 2007 return, claiming a deduction for donations to their church. However, in May 2012 the Tax Court denied their deduction entirely.

The technicality – The Durdens made $22,517 in donations to their church throughout 2007, and the church provided them with an acknowledgment letter showing the total amount donated. So what was missing? A statement that no goods or services were provided to the taxpayer in exchange for their donations. After the IRS denied the deduction in 2009, the couple obtained a second letter from their church including the proper wording. However, it was too late and the Tax Court denied the deduction because, to the letter of the law, they did not have the required proof of the donation.

The lesson? Check your acknowledgment letters as they come in. For cash donations of $250 or more, a letter should contain all of the following: a) the amount donated, b) whether you received any goods or services in exchange for the donation and if so, an estimated value, and c) a statement that the only benefit you received was an intangible religious benefit, if that was the case. This letter must be received before the due date of the tax return, or the date the return is filed, whichever is earlier.

If your letters do not have the magic wording, especially for substantial donations, contact the charity and ask for a new letter prior to the due date of your tax return. In light of this case, all organizations taking charitable donations who don’t already use this wording should be updating their thank-you letters.

For more information on charitable deductions, give our office a call.

-Diane Ravenscroft, CPA
J.A. Solari & Partners LLC
(775) 827-3550

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