IRS

Business owners: When it comes to IRS audits, be prepared

If you recently filed your 2016 income tax return (rather than filing for an extension) you may now be wondering whether it’s likely that your business could be audited by the IRS based on your filing. Here’s what every business owner should know about the process.

Catching the IRS’s eye

Many business audits occur randomly, but a variety of tax-return-related items are likely to raise red flags with the IRS and may lead to an audit. Here are a few examples:

  • Significant inconsistencies between previous years’ filings and your most current filing,
  • Gross profit margin or expenses markedly different from those of other businesses in your industry, and
  • Miscalculated or unusually high deductions.

An owner-employee salary that’s inordinately higher or lower than those in similar companies in his or her location can also catch the IRS’s eye, especially if the business is structured as a corporation.

Response measures

If you’re selected for an audit, you’ll be notified by letter. Generally, the IRS won’t make initial contact by phone. But if there’s no response to the letter, the agency may follow up with a call.

The good news is that many audits simply request that you mail in documentation to support certain deductions you’ve taken. Others may ask you to take receipts and other documents to a local IRS office. Only the most severe version, the field audit, requires meeting with one or more IRS auditors.

More good news: In no instance will the agency demand an immediate response. You’ll be informed of the discrepancies in question and given time to prepare. To do so, you’ll need to collect and organize all relevant income and expense records. If any records are missing, you’ll have to reconstruct the information as accurately as possible based on other documentation.

If the IRS selects you for an audit, our firm can help you:

  • Understand what the IRS is disputing (it’s not always crystal clear),
  • Gather the specific documents and information needed, and
  • Respond to the auditor’s inquiries in the most expedient and effective manner.

Don’t let an IRS audit ruin your year — be it this year, next year or whenever that letter shows up in the mail. By taking a meticulous, proactive approach to how you track, document and file your company’s tax-related information, you’ll make an audit much less painful and even decrease the chances that one happens in the first place.

© 2017

Choosing between a calendar tax year and a fiscal tax year

Many business owners use a calendar year as their company’s tax year. It’s intuitive and aligns with most owners’ personal returns, making it about as simple as anything involving taxes can be. But for some businesses, choosing a fiscal tax year can make more sense.

What’s a fiscal tax year?

A fiscal tax year consists of 12 consecutive months that don’t begin on January 1 or end on December 31 — for example, July 1 through June 30 of the following year. The year doesn’t necessarily need to end on the last day of a month. It might end on the same day each year, such as the last Friday in March.

Flow-through entities (partnerships, S corporations and, typically, limited liability companies) using a fiscal tax year must file their return by the 15th day of the third month following the close of their fiscal year. So, if their fiscal year ends on March 31, they would need to file their return by June 15. (Fiscal-year C corporations generally must file their return by the 15th day of the fourth month following the fiscal year close.)

When a fiscal year makes sense

A key factor to consider is that if you adopt a fiscal tax year you must use the same time period in maintaining your books and reporting income and expenses. For many seasonal businesses, a fiscal year can present a more accurate picture of the company’s performance.

For example, a snowplowing business might make the bulk of its revenue between November and March. Splitting the revenue between December and January to adhere to a calendar year end would make obtaining a solid picture of performance over a single season difficult.

In addition, if many businesses within your industry use a fiscal year end and you want to compare your performance to your peers, you’ll probably achieve a more accurate comparison if you’re using the same fiscal year.

Before deciding to change your fiscal year, be aware that the IRS requires businesses that don’t keep books and have no annual accounting period, as well as most sole proprietorships, to use a calendar year.

It can make a difference

If your company decides to change its tax year, you’ll need to obtain permission from the IRS. The change also will likely create a one-time “short tax year” — a tax year that’s less than 12 months. In this case, your income tax typically will be based on annualized income and expenses. But you might be able to use a relief procedure under Section 443(b)(2) of the Internal Revenue Code to reduce your tax bill.

Although choosing a tax year may seem like a minor administrative matter, it can have an impact on how and when a company pays taxes. We can help you determine whether a calendar or fiscal year makes more sense for your business.

© 2017

New HRA offers small employers an attractive, tax-advantaged health care option

In December, Congress passed the 21st Century Cures Act. The long and complex bill covers a broad range of health care topics, but of particular interest to some businesses should be the Health Reimbursement Arrangement (HRA) provision. Specifically, qualified small employers can now use HRAs to reimburse employees who purchase individual insurance coverage, rather than providing employees with costly group health plans.

The need for HRA relief

Employers can use HRAs to reimburse their workers’ medical expenses, including health insurance premiums, up to a certain amount each year. The reimbursements are excludable from employees’ taxable income, and untapped amounts can be rolled over to future years. HRAs generally have been considered to be group health plans for tax purposes.

But the Affordable Care Act (ACA) prohibits group health plans from imposing annual or lifetime benefits limits and requires such plans to provide certain preventive services without any cost-sharing by employees. And according to previous IRS guidance, “standalone HRAs” — those not tied to an existing group health plan — didn’t comply with these rules, even if the HRAs were used to purchase health insurance coverage that did comply. Businesses that provided the HRAs were subject to fines of $100 per day for each affected employee.

The IRS position was troublesome for smaller businesses that struggled to pay for traditional group health plans or to administer their own self-insurance plans. The changes in the Cures Act give these employers a third option for providing one of the benefits most valued by today’s employees.

The QSEHRA

Under the Cures Act, certain small employers can maintain general purpose, standalone HRAs that aren’t “group health plans” for most purposes under the Internal Revenue Code, Employee Retirement Income Security Act and Public Health Service Act.

More specifically, the legislation allows employers that aren’t “applicable large employers” under the ACA to provide a Qualified Small Employer HRA (QSEHRA) if they don’t offer a group health plan to any of their employees. Annual benefits under a QSEHRA:

  • Can’t exceed an indexed maximum of $4,950 per year ($10,000 if family members are covered),
  • Must be employer-funded (no salary reductions), and
  • Can be used for only IRC Section 213(d) medical care.

QSEHRA benefits must be offered on the same terms to all “eligible employees” (certain individuals can be disregarded) and may be excluded from income only if the recipient has minimum essential coverage. There is a notice requirement and employees’ permitted benefits must be reported on Form W-2.

If you’re interested in exploring the QSEHRA option for your business, contact us for further details.

© 2017

To deduct business losses, you may have to prove “material participation”

You can only deduct losses from an S corporation, partnership or LLC if you “materially participate” in the business. If you don’t, your losses are generally “passive” and can only be used to offset income from other passive activities. Any excess passive loss is suspended and must be carried forward to future years.

Material participation is determined based on the time you spend in a business activity. For most business owners, the issue rarely arises — you probably spend more than 40 hours working on your enterprise. However, there are situations when the IRS questions participation.

Several tests

To materially participate, you must spend time on an activity on a regular, continuous and substantial basis.

You must also generally meet one of the tests for material participation. For example, a taxpayer must:

  1. Work 500 hours or more during the year in the activity,
  2. Participate in the activity for more than 100 hours during the year, with no one else working more than the taxpayer, or
  3. Materially participate in the activity for any five taxable years during the 10 tax years immediately preceding the taxable year. This can apply to a business owner in the early years of retirement.

There are other situations in which you can qualify for material participation. For example, you can qualify if the business is a personal service activity (such as medicine or law). There are also situations, such as rental businesses, where it is more difficult to claim material participation. In those trades or businesses, you must work more hours and meet additional tests.

Proving your involvement

In some cases, a taxpayer does materially participate, but can’t prove it to the IRS. That’s where good recordkeeping comes in. A good, contemporaneous diary or log can forestall an IRS challenge. Log visits to customers or vendors and trips to sites and banks, as well as time spent doing Internet research. Indicate the time spent. If you’re audited, it will generally occur several years from now. Without good records, you’ll have trouble remembering everything you did.

Passive activity losses are a complicated area of the tax code. Consult with your tax adviser for more information on your situation.

© 2016

Can you claim a home office deduction for business use?

You might be able to claim a deduction for the business use of a home office. If you qualify, you can deduct a portion of expenses, including rent or mortgage interest, depreciation, utilities, insurance, and repairs. The exact amount that can be deducted depends on how much of your home is used for business.

Basic rules for claiming deductions

The part of your home claimed for business use must be used:

  • Exclusively and regularly as your principal place of business,
  • As a place where you meet or deal with patients, clients, or customers in the normal course of business,
  • In connection with your trade or business in the case of a separate structure that’s not attached to your home, and
  • On a regular basis for the storage of inventory or samples.

A strict interpretation

The words “exclusively” and “regularly” are strictly interpreted by the IRS. Regularly means on a consistent basis. You can’t qualify a room in your home as an office if you use it only a couple of times a year to meet with customers. Exclusively means the specific area is used solely for business. The area can be a room or other separately identifiable space. A room that’s used for both business and personal purposes doesn’t meet the test.

The exclusive use rule doesn’t apply to a daycare facility in your home.

What if you’re audited?

Home office deductions can be an audit target. If you’re audited by the IRS, it shouldn’t result in additional taxes if you follow the rules, keep records of expenses and file an accurate, complete tax return. If you do have a home office, take pictures of the setup in case you sell the house or discontinue the use of the office while the tax return is still open to audit.

There are more rules than can be covered here. Contact us about how your business use of a home affects your tax situation now and in the future. Also be aware that deductions for a home office may affect the tax results when you eventually sell your home.

© 2016

Tax-Related Identity Theft

Identity theft is a growing problem, and tax-related identity theft in particular continues to increase each year. In 2015, tax-related identity theft continued to hold a high spot on the IRS’s annual “Dirty Dozen” tax scams list.

Tax return identity theft occurs when the taxpayer’s personal information, such as name, Social Security number (SSN), employer identification number, or other identifying information, is used without the taxpayer’s authority to file a fraudulent tax return (usually to claim a fraudulent refund or to obtain tax benefits). This type of identity theft carries serious consequences. It can take victims months just to prove their identity to the IRS, which in turn delays the processing of legitimate refund claims. According to the IRS, individual victims of identity theft “may lose job opportunities, be refused loans, education, housing or transportation, and may even be arrested for crimes they didn’t commit” (IRS Publication 4535, Identity Theft Prevention and Victim Assistance). Businesses may incur significant damage to their reputations, in addition to financial losses and the costs incurred to resolve the issues with numerous agencies.

Scams – Unless you have been in communication with a specific IRS agent regarding a specific matter, the IRS will never contact you via phone or email. Scammers often use these mediums to get personal information or con taxpayers into paying fake taxes/penalties. If the IRS needs to reach a taxpayer they generally do it via U.S. mail. Be suspicious. If you receive a notice that seems suspicious, we recommend that you contact a CPA.

Need help communicating with the IRS because you have been a victim of tax-related identity theft or you have received a suspicious notice? Atchley & Associates LLP may be able to assist you.

See the full article issued by The Tax Adviser on this topic at : http://www.thetaxadviser.com/issues/2015/dec/assisting-clients-with-tax-related-identity-theft.html#sthash.09Lk7sql.dpuf

The IRS Raises Tangible Property Expensing Threshold to $2,500; Simplifies Filing and Recordkeeping for Small Businesses

The IRS has made some changes today and simplified requirements for small businesses regarding paperwork and recordkeeping. According to the Notice 2015-82, the safe harbor threshold for deducting certain capital items has been raised from $500 to $2,500.

Those businesses that do not maintain an audited financial statement will be affected by these changes. Change applies to amounts spent to acquire, produce or improve tangible property that would qualify as capital item. The change in threshold to $2500 applies to any of these that is substantiated by an invoice.

“This important step simplifies taxes for small businesses, easing the recordkeeping and paperwork burden on small business owners and their tax preparers.” said IRS Commissioner John Koskinen.

The new $2,500 threshold takes effect starting with tax year 2016. The IRS will also provide audit protection to eligible businesses by not challenging use of the new $2,500 threshold in tax years prior to 2016.

For further information about this change, check the latest information found in Notice 2015-82, or in the IRS website.

Take steps to avoid this tax “gotcha”

Last summer the Trade Preferences Extension Act (TPEA) was signed into law, giving the President fast-track trade authority. But like many complex pieces of federal legislation, some provisions buried deep in the law don’t get as much publicity as the headline provisions. However, they can have a big impact on business.

One of these is Section 806, which has nothing to do with trade or globalization but everything to do with raising revenue. Specifically, Sec. 806 increases by up to 150% the potential penalties that must be paid by businesses that fail to file correct information returns or that provide incorrect payee statements.

Specifically, failing to file Forms W-2 and 1099 will trigger the increased penalties. So will failing to file new information returns required by the Affordable Care Act (ACA) for the first time in 2016. They include Forms 1094-C and 1095-C for applicable large employers and forms 1094-B and 1095-B for small employers.

Effective dates are imminent

The new penalties are effective for statements and information returns filed after December 31, 2015. Short-term penalty relief is provided under IRC Sections 6721 and 6722 for companies that demonstrate a good-faith effort to comply with the new ACA information reporting requirements. But this relief applies only to reported information that’s incorrect or incomplete (such as Social Security numbers). Relief isn’t available for companies that fail to file or furnish statements in a timely manner.

The general penalty for failing to file a correct information return with the IRS or provide correct payee statements has increased from $100 to $250 per return or statement. Meanwhile, the maximum annual penalty a company may be subject to has doubled — from $1.5 million to $3 million for large businesses and from $500,000 to $1 million for small businesses (those with gross annual receipts under $5 million).

Companies that correct their filing failures or inaccuracies within 30 days can pay a lower penalty. However, this also has been increased — from $30 to $50 per return with a maximum annual penalty of $175,000 for small businesses (up from $75,000) and $500,000 for large businesses (up from $250,000).

Intentional disregard is costly

If a failure is due to what the IRS considers to be intentional disregard, the penalty rises from $250 to $500 per return or statement with no annual maximum. The penalty amounts are expected to be adjusted for inflation every five years.

Also, failing to file required information and to provide required payee statements could lead to penalties that are double the annual maximum. This is because each of these errors is treated as a separate infraction. So, a large business that doesn’t file W-2 forms with the IRS or provide W-2 forms to employees could face annual penalties of up to $3 million for each error, for a total of up to $6 million.

Systems and controls are recommended

One of the best ways to guard against making the kinds of errors that lead to these increased penalties is to implement appropriate systems and controls for information reporting.

For example, consider using the IRS’s Taxpayer Identification Number On-line Matching service, which enables you to compare the 1099 information you have to the IRS’s records before filing an electronic return. If the information doesn’t match, you can ask payees for verification — and that can help reduce mistakes and subsequent penalties.

Be prepared

Don’t let Section 806 sneak up on you. Take steps now to make sure you aren’t subject to these tougher penalties.

© 2015

Payroll Service Providers (PSP)

The Spring SSA/IRS Reporter includes a useful article offering tips for organizations that use payroll service providers. A payroll service provider (PSP) can be an excellent option for employers that are looking for assistance with payroll processing and payroll tax deposit requirements. However, it is important to remember that the responsibility for timely filing and payment still lies with the employer. The IRS can hold you and your business ultimately responsible for unpaid taxes, or unfiled or late files returns. The IRS offers a few tips if you use a payroll service:

  1. Check to see if your payroll service is listed on the IRS Payroll Service Providers page. The listed providers have passed IRS testing requirements [Click here to see the full list].
  2. Know your tax due dates. The IRS offers Tax Calendar options that can help [Tax Calendar].
  3. Review your payroll tax reports for accuracy before they are filed.
  4. Enroll in EFTPS. You will be able to login and see the tax payments made under your EIN, and make missed payments, if necessary.
  5. Keep your organization’s address as the address of record with the IRS. This way you are sure to see any correspondence from the IRS and make sure that a response is made quickly.
  6. If you suspect your PSP is not complying with regulations, file a complaint with the IRS using Form 14157.

As always, Atchley & Associates, LLP is happy to answer questions or assist you in any way we can.

Reference. Publication 1693 (Rev. 6-2015) Catalog Number 15060W Department of the Treasury Internal Revenue Service www.irs.gov